The short answer
Dual-license cannabis operators should first assign every cost that clearly belongs to medical or adult-use directly to that side, then group the remaining shared costs into pools and allocate each pool with a reasonable driver such as square footage, sales mix, labor hours or canopy. The method should be reasonable, applied consistently and documented in writing. It matters because, since April 28, 2026, medical activity is Schedule III and generally outside 280E, while adult-use is still Schedule I and fully subject to it.
Why does the medical vs adult-use split matter now?
Since April 28, 2026, state-licensed medical cannabis has been Schedule III. Section 280E only reaches Schedule I and II, so it generally no longer applies to medical activity going forward. Adult-use cannabis is still Schedule I and still fully subject to 280E as of mid-October 2026.
If you run both from one building, one team or one set of books, every shared dollar now has a tax consequence that depends on which side it lands on. Costs allocated to medical can generally be deducted as ordinary business expenses. Costs allocated to adult-use are generally disallowed unless they belong in COGS.
That creates an obvious temptation, and the IRS knows it. The goal isn't to push as much as possible to medical. It's to land on a split you can defend with your own records. Our Schedule III and 280E guide covers the timeline and the common allocation keys; this post is the practical build.
How do you build a dual-license allocation, step by step?
- Define the activities.List each entity, location and license, and what happens there: medical retail, adult-use retail, cultivation, manufacturing. Note which product and which customers flow through each.
- Make revenue clean first.Your POS and seed-to-sale data should tag every sale as medical or adult-use. Allocations driven by sales mix are only as good as this tag. If it's unreliable, fix it before anything else.
- Direct-assign what you can.Medical-only staff, adult-use-only marketing, product bought for one channel, excise tax that applies to one side. Direct assignment beats any formula.
- Group what's left into cost pools.Typical pools: facility (rent, utilities, repairs, security), retail labor, shared management, technology, insurance and general admin. Keep each pool to costs that behave the same way.
- Choose one driver per pool.Pick the measure that best reflects what actually causes the cost. A table of common choices follows below.
- Calculate monthly, not annually.Sales mix shifts. A monthly calculation is more accurate and easier to defend than a single year-end percentage.
- Write the memo.One to three pages: the activities, the pools, the drivers, why each driver is reasonable and where the data comes from.
- Apply it the same way every period.Change methods only when facts change, and document why. Flip-flopping toward whichever answer is cheaper is the fastest way to lose credibility.
Which allocation driver fits which cost?
| Cost pool | Common driver | Watch out for |
|---|---|---|
| Retail rent, utilities, security | Square footage by use, or sales mix if the floor is fully shared | Square footage only works if space is actually dedicated |
| Budtenders and retail staff | Transaction count or sales mix | Medical consults can take longer per transaction |
| Cultivation labor and inputs | Canopy or plant counts by channel | Product that switches channel after harvest |
| Shared managers and support staff | Time records or labor hours | Estimates without timesheets are weak |
| POS, compliance software, insurance | Sales mix or transaction count | Per-license fees should be direct-assigned |
| General and administrative | Revenue mix, or a blend of the other drivers | Keep it simple and explainable |
There's rarely one correct driver. A reasonable one, consistently applied and well supported, is the standard to aim for. If two drivers are equally reasonable, pick the one your data supports best, not the one that produces the lowest tax.
What does a dual-license allocation look like in numbers?
An illustrative dispensary selling to both medical patients and adult-use customers from one storefront. Monthly figures. Sales mix is 30% medical, 70% adult-use. The store has a dedicated 400 sq ft medical consultation area in a 4,000 sq ft space; the rest of the sales floor is shared.
| Cost pool | Monthly cost | Driver | Medical | Adult-use |
|---|---|---|---|---|
| Medical patient coordinator | $5,000 | Direct | $5,000 | $0 |
| Adult-use marketing | $6,000 | Direct | $0 | $6,000 |
| Rent and utilities | $20,000 | Dedicated sq ft, then sales mix on shared space | $7,400 | $12,600 |
| Retail staff | $40,000 | Transaction count (25% medical) | $10,000 | $30,000 |
| Software and insurance | $4,000 | Sales mix | $1,200 | $2,800 |
| Admin overhead | $10,000 | Sales mix | $3,000 | $7,000 |
| Total | $85,000 | $26,600 | $58,400 |
The rent line works like this: the dedicated 400 sq ft is 10% of the space, so $2,000 goes straight to medical. The remaining $18,000 covers shared space and is split by sales mix: $5,400 medical, $12,600 adult-use. Medical total: $7,400.
Under these assumptions, about 31% of shared and direct operating costs land on the medical side, close to its sales share. That's a sign the method is behaving sensibly. If your allocation put 60% of costs on a side that produced 30% of sales, expect to explain why.
The adult-use $58,400 is still generally disallowed under 280E unless any of it properly belongs in inventory cost. For a dispensary buying finished product, very little of it qualifies.
How do inventory and COGS fit into the split?
Operating expenses get most of the attention, but inventory needs the same discipline. Two points matter most:
- COGS follows the sale. Product sold to a medical patient should carry its cost to the medical side, and product sold to an adult-use customer to the adult-use side. If your POS tags sales correctly and your inventory system costs each item, this mostly happens automatically.
- Production costs follow the product. For cultivators and manufacturers, production costs are capitalized into inventory first and only hit COGS when the product sells. If one harvest supplies both channels, the cost should travel with the units to whichever channel they're sold through, rather than being split by a separate formula.
The adult-use side still depends on COGS as its main lever under 280E, so getting production costs fully into inventory there matters as much as ever. A clean chart of accounts with classes by license makes all of this far easier to run monthly.
What should your allocation memo include?
A good memo is short and specific. It should let someone who has never seen your business understand and re-perform the calculation.
- Licenses, entities and locations covered, and the effective date (April 28, 2026 for most operators' first split period)
- How revenue is tagged as medical or adult-use, and the system of record
- Each cost pool, what's in it and what's excluded
- The driver for each pool and a sentence on why it's reasonable
- Where the driver data comes from: POS reports, floor plans, timesheets, canopy records
- How often the calculation is run and who reviews it
- What would trigger a change in method
Keep the monthly calculations and source reports with the memo. A memo without the backup is a story; the backup is what makes it evidence.
What are the most common dual-license allocation mistakes?
- Starting with allocation before revenue is clean. If medical and adult-use sales aren't reliably separated, every sales-mix driver is built on sand.
- One blended percentage for everything. It's simple, but it ignores direct costs and cost behavior, and it's hard to defend.
- Year-end reconstruction. Rebuilding a split in March for the prior year is far weaker than a monthly process. It's also more expensive.
- Ignoring the January 1 to April 27 period. For calendar-year taxpayers, 2026 activity before April 28 was still under the old rules for medical. Your books need a clean cutoff.
- Assuming prior years reopen. The IRS has signaled that rescheduling doesn't reopen closed prior-year positions.
- Forgetting the entity layer. If medical and adult-use sit in different entities, intercompany charges need their own support.
If you'd like a second set of eyes on your split, our free Schedule III Split Check reviews your licensing, revenue tagging and shared costs. Ongoing allocation work is part of our cost allocation service.
Frequently asked questions
Is there an IRS-required method for splitting medical and adult-use costs?
No single method has been prescribed as of mid-October 2026, and IRS 280E guidance is on the priority guidance plan. The standard to aim for is a reasonable, consistently applied and documented method based on how costs are actually incurred.
Can I just allocate shared costs by revenue?
Revenue mix is a common and simple driver, especially for general overhead. For larger pools like rent, labor or cultivation, a driver that reflects actual usage, such as square footage, labor hours or canopy, is usually more defensible.
Does the allocation apply to all of 2026?
No. Medical activity moved to Schedule III effective April 28, 2026. For calendar-year taxpayers, activity before that date was still under the prior rules, so your books need a clean cutoff.
Do I need separate entities for medical and adult-use?
Not necessarily. Separate entities can make the split clearer but add intercompany complexity. Either way, you need clean revenue tagging, direct assignment where possible and a documented allocation method.