[4830-01-u]
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-209709-94]
RIN 1545-AS77
Amortization of Intangible Property
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public
hearing.
SUMMARY: This document contains proposed regulations relating to
the amortization of certain intangible property. The proposed
regulations reflect changes to the law made by the Omnibus Budget
Reconciliation Act of 1993 (OBRA 93), and affect taxpayers who
acquired intangible property after August 10, 1993, or made a
retroactive election to apply OBRA 93 to intangibles acquired
after July 25, 1991. This document also provides notice of a
public hearing on the proposed regulations.
DATES: Comments must be received by April 16, 1997. Requests to
appear and outlines of oral comments to be presented at the
public hearing scheduled for May 15, 1997, must be received by
April 24, 1997.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-209709-94),
room 5228, Internal Revenue Service, POB 7604, Ben Franklin
Station, Washington, DC 20044. Submissions may be hand delivered
between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG- 209709-94), Courier s Desk, Internal Revenue Service, 1111
Constitution Avenue NW., Washington, DC. Alternatively,
taxpayers may submit comments electronically via the Internet by
selecting the Tax Regs option of the IRS Home Page, or by
submitting comments directly to the IRS Internet site at
http:\\www.irs.ustreas.gov\prod\tax_regs\comments.html. The
public hearing will be held in the Commissioner s Conference Room
(Room 3313), Internal Revenue Building, 1111 Constitution Avenue
NW., Washington, DC 20224.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations,
John Huffman at (202) 622-3110; concerning submissions and the
hearing, Michael Slaughter at (202) 622-8452 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed regulations under sections
167(f) and 197. These provisions were added to the Internal
Revenue Code of 1986 (the Code) by section 13261 of OBRA 93, and
apply to intangible property acquired after August 10, 1993 (or
after July 25, 1991, if a valid retroactive election to apply
OBRA 93 to intangibles has been made pursuant to 1.197-1T).
The proposed regulations provide definitions and rules for
amortization of intangible property subject to sections 197 and
167(f). On June 24, 1994, the IRS published Announcement 94-92
(1994-28 I.R.B. 139) in the Federal Register (59 FR 32670)
inviting comments under section 197 relating to the amortization
of goodwill and certain other intangibles that should be
addressed in proposed regulations. The IRS has reviewed these
comments and has addressed certain issues raised in the comments
in the proposed regulations. However, because these comments
were received in anticipation of the issuance of these proposed
regulations, and because these regulations are subject to further
comment and a public hearing, no attempt has been made to
describe all of the principal comments that are not reflected in
these regulations or the reasons therefor.
Explanation of Provisions
1. General overview
Sections 167(f) and 197 provide comprehensive rules for the
depreciation and amortization of many intangible assets.
Intangible assets subject to section 197 are broadly defined to
include most intangible assets acquired in connection with the
acquisition of a trade or business and certain other separately
acquired intangible assets. The adjusted basis of an amortizable
section 197 intangible must be amortized over a 15-year period.
Certain other intangible assets are excluded from section 197 for
various reasons. In some cases, such as stock and partnership
interests, the asset is property of a character that is not
subject to an allowance for depreciation because it represents a
permanent investment that can only be recovered through
disposition of the asset (including worthlessness). In other
cases, such as computer software, purchased mortgage servicing
rights, service and supply contracts, and certain other contracts
or rights with a fixed duration, other cost recovery methods were
prescribed by the OBRA 93 amendments. In still other cases,
such as motion picture films, television series, books, and sound
recordings, other cost recovery methods that were in effect prior
to OBRA 93 are more appropriate under the circumstances.
Section 167(f) provides alternative methods of depreciation for
certain of the intangibles excluded from the application of
section 197.
The proposed regulations provide guidance for certain
intangible property subject to sections 167(f) and 197. The
section 167(f) proposed regulations provide rules for intangible
property subject to the allowance for depreciation under section
167 and specifically excluded from section 197. These intangible
assets include certain computer software, rights to receive
tangible property or services, rights of fixed duration, patents,
copyrights, and mortgage servicing rights. These proposed
regulations reserve guidance on the method of depreciating the
cost of separately acquired rights to receive tangible property
or services where the amount of the property or services to be
received is not specified. The IRS invites comments on possible
methods of depreciation in these cases.
Because section 197 provides a method of amortization and,
except in the case of certain covenants not to compete,
governmental licenses, permits and other rights, and contracts
for the use of section 197 intangibles, does not alter the rules
for determining the basis of an asset, section 197 generally does
not apply to amounts that would otherwise be deductible. For
example, section 197 does not generally apply to the costs of
advertising because, in most cases, these costs are deductible
under other provisions of the Code. See Rev. Rul. 92-80 (1992-2
C.B. 57). In addition, section 197 does not apply to costs that
would not, under general principles of Federal income tax law, be
included in the basis of a section 197 intangible. For example,
if a taxpayer borrows money to purchase the assets of a trade or
business (including amortizable section 197 intangibles) and
incurs fees in connection with the loan, these costs are
generally amortized over the term of the loan rather than under
the rules of sections 167(f) and 197. As a further example, if
the amortizable section 197 intangibles acquired in the
transaction include a favorable supply contract, the amortizable
basis in the contract does not include amounts required to be
paid for goods to be received pursuant to the contract.
In addition, section 197 does not apply to any amount for
which a deduction would be disallowed under other provisions of
the Code, such as section 162(k) (relating to amounts paid or
incurred by a corporation in connection with the acquisition of
its stock or the stock of a related person).
No inference should be drawn from any provision in the
proposed regulations concerning the classification of any section
197 intangible as property, or whether any section 197 intangible
is treated as tangible or intangible property, for other purposes
of the Code. Furthermore, no inference should be drawn from any
provision in the proposed regulations regarding (a) whether any
section 197 intangible that is not an amortizable section 197
intangible may be amortized or depreciated under any provision of
the Code other than section 197, or (b) the proper method for
determining any allowance therefor. Finally, no inference should
be drawn from any provision in the proposed regulations
concerning whether any section 197 intangible (or any interest
therein) has been purchased, leased, or licensed for Federal
income tax purposes.
2. Section 197 intangibles
The proposed regulations define section 197 intangibles
(subject to certain exceptions) as goodwill, going concern value,
workforce in place, information base, know-how, customer- and
supplier-based intangibles, governmental licenses and permits,
covenants not to compete and other similar arrangements,
franchises, trademarks, trade names, and contracts for the use of
the foregoing assets.
A. Covenants not to Compete
Some commentators in response to Announcement 94-92
suggested that a covenant not to compete relating to the
redemption of stock or a partnership interest from a departing
stockholder or partner should be excluded from section 197
because this situation does not involve the acquisition of a
trade or business. The legislative history provides, however,
that section 197 applies to a covenant not to compete acquired
with the assets of a trade or business, the stock in a
corporation, or an interest in a partnership engaged in a trade
or business. Consequently, the proposed regulations do not
provide for this exception. In this regard, the proposed
regulations provide that for purposes of section 197(f)(1)(B),
the disposition or cancellation of redeemed stock of a
corporation will not cause the covenant to be written off faster
than over the 15-year amortization period provided for under
section 197 (in the case of a covenant to which section 162(k)
does not apply).
B. Contracts for the use of Section 197 Intangibles
Some commentators also requested guidance on the extent to
which contracts for the use of section 197 intangibles would be
subject to section 197, in some cases suggesting that an
intangible was not subject to section 197 unless the taxpayer
obtained ownership of property for Federal income tax purposes.
However, it is sometimes difficult to determine whether the terms
of an agreement confer ownership, for Federal income tax
purposes, of property, and the IRS and Treasury believe that the
purposes of section 197 could be circumvented through the use of
such agreements. Accordingly, the proposed regulations provide
that contracts for the use of section 197 intangibles will also
be treated as section 197 intangibles. Contracts that are so
treated may, however, be excluded under either section
197(e)(4)(B) or (D) on the basis that they are contracts for the
receipt of property or services, contracts having a fixed
duration, or contracts having a fixed amount and recovered on a
unit-of-production method or other similar method.
3. Intangibles excluded from section 197
A. Computer Software
Section 197 intangibles do not include computer software
that is readily available for purchase by the general public, is
subject to a nonexclusive license, and has not been substantially
modified. The proposed regulations provide a safe harbor for
purposes of determining whether computer software has been
substantially modified. Under the safe harbor, computer software
has not been substantially modified if its capitalized cost does
not exceed the greater of $2,000 or 125 percent of the price at
which the unmodified version of the software is readily available
to the general public.
The proposed regulations incorporate some of the provisions
of Revenue Procedure 69-21 (1969-2 C.B. 303), involving the
treatment of costs of computer software, and modify other
provisions to the extent necessary to conform to the amortization
rules provided under sections 197 and 167(f). Consequently, if
costs for developing computer software that the taxpayer has
elected to treat as deferred expenses under section 174(b) result
in the development of a self-created intangible excluded under
section 197(c)(2) and subject to the allowance for depreciation
under section 167(a), deductions for the unrecovered expenditures
are subject to section 167(f)(1). Computer software costs
included, without being separately stated, in the cost of the
computer hardware (bundled software) continue to be capitalized
and depreciated as part of the computer hardware. The proposed
regulations also continue to treat as currently deductible
software costs properly and consistently treated as deductible
(not capitalized) under 1.162-11.
B. Certain Separately Acquired Intangibles
Certain intangibles are excepted from section 197 if they
are not acquired as part of a purchase of a trade or business.
The proposed regulations clarify that, for purposes of section
197, a group of assets constitutes a trade or business if their
use would constitute a trade or business under section 1060; that
is, if goodwill or going concern value could under any
circumstances attach to the assets. Temporary and proposed
regulations under section 1060, in turn, provide that a group of
assets constitutes a trade or business for purposes of section
1060 if the use of such assets would constitute an active trade
or business for purposes of section 355. However, in appropriate
cases, even if the use of a group of assets would not constitute
an active trade or business for purposes of section 355, such
assets may nevertheless constitute a trade or business for
purposes of section 1060. See 1.1060-1T(b)(2).
The IRS intends to provide additional guidance as to the
circumstances under which the acquisition of a group of assets
constitutes a trade or business for purposes of section 1060 in
regulations under that section. Accordingly, the proposed
regulations do not provide substantive guidance on this question,
except to the extent that the considerations are unique to the
application of section 197. The IRS invites comments on the
extent to which additional rules under section 197 may be
necessary.
C. Certain Contracts and Governmental Rights
While section 197 intangibles include licenses, permits, and
other rights granted by a governmental unit or an agency or
instrumentality thereof (section 197(d)(1)(D)), certain rights
granted by these governmental entities are excluded from section
197 pursuant to section 197(e)(4)(B) and (D), subject to the
conditions and limitations therein. Because a particular right
may be described in two or more of these provisions, the proposed
regulations provide guidance regarding the potential conflict
between, or overlap with, these provisions. Thus, a right that
would be subject to section 197 pursuant to section 197(d)(1)(D)
may nevertheless be excluded if it is also described in section
197(e)(4) and meets all of the requirements for exclusion.
Furthermore, a right that meets the requirements of either
section 197(e)(4)(B) or section 197(e)(4)(D) is excluded from
section 197 even if it fails to meet one of the requirements for
the other exclusion. In addition, any license, permit, or other
right granted by a governmental unit that otherwise meets the
definition of a franchise under section 197(d)(1)(F), such as an
FCC broadcast license or cable television franchise, is treated
as a franchise under the regulations. Accordingly, these
licenses do not qualify for any of the exceptions from section
197 provided under section 197(e)(4).
4. Special rules of application
A. Loss Disallowance Provisions
The proposed regulations contain rules for the loss
disallowance provisions set forth in section 197(f)(1). In
particular, the proposed regulations provide that a taxpayer may
not circumvent the loss disallowance rules, for example, by
transferring some intangibles, whose adjusted basis is greater
than their fair market value, to a corporation in exchange for
stock in the corporation in a transaction described in section
351, while retaining other intangibles acquired in the same or
related transaction, and then selling the stock. Special rules
are also provided for the application of the loss disallowance
provisions in cases where a taxpayer has disposed of all of the
amortizable section 197 intangibles acquired in a single
transaction but is treated as having retained other amortizable
section 197 intangibles solely by virtue of the retention of
amortizable section 197 intangibles by a related person.
B. Transactions Involving Partnerships
The proposed regulations provide rules and examples relating
to the treatment of section 197 intangibles acquired or
transferred in certain partnership transactions, including
terminations under section 708(b)(1), and the application of
section 197 to the special basis adjustments of partnership
property for which a section 754 or section 732(d) election is in
effect. Guidance is also provided regarding the effect of
curative and remedial allocations and the application of the
anti-churning rules to certain partnership transactions.
In the case of the termination of a partnership under
section 708(b)(1)(B) (relating to a sale or exchange of an
interest), the rules contained in the proposed regulations are
based on recently proposed regulations under that section,
pursuant to which the new partnership is treated as having
directly acquired the assets of the old partnership in exchange
for the assumption of its liabilities and the issuance of
interests in the new partnership. Accordingly, for purposes of
section 197, the consequences of the termination of a partnership
under section 708(b)(1)(B) may not be the same as the
consequences of such a termination under the rules in effect at
the time section 197 was enacted.
C. Treatment of Contingent Payments
The proposed regulations clarify that, except in the case of
contingent payments, amounts paid for section 197 intangibles are
treated as amounts chargeable to capital account, and the entire
principal amount is amortized ratably over the 15-year
amortization period beginning with the later of the month in
which the intangible is acquired or the date on which the active
conduct of a trade or business begins. Contingent payments for
section 197 intangibles paid or incurred after the taxable year
in which the intangible is acquired are added to basis at such
time and generally amortized ratably over the remaining months in
the 15-year period as of the beginning of the month the amount is
paid or incurred. However, in order to reduce the administrative
burden that may result from a requirement to maintain separate
amortization schedules for each month during the 15-year period,
taxpayers are permitted to use certain simplifying conventions.
In addition, any amount that is not properly included in the
basis of an amortizable section 197 intangible until after the
expiration of the 15-year period is amortized in full immediately
upon the inclusion of the amount in the basis of the intangible.
The proposed regulations refer to 1.461-1(a)(1) for rules
governing the time at which an amount may be taken into account
by a taxpayer using the cash receipts and disbursements method.
They refer to 1.461-1(a)(2) for rules governing the time at
which a liability is incurred and generally taken into account
(for example, by treating the amount of the liability as a
capital expenditure) by an accrual basis taxpayer.
5. Anti-churning Rules
To be eligible for amortization, section 197 intangibles
must qualify as amortizable section 197 intangibles. Generally,
amortizable section 197 intangibles are section 197 intangibles
that are acquired after August 10, 1993 (or acquired after July
25, 1991, and for which the taxpayer made a proper election under
1.197-1T) and held in connection with the conduct of a trade or
business or an activity described in section 212.
The proposed regulations provide anti-churning rules to
prevent taxpayers from converting into amortizable section 197
intangibles existing goodwill, going concern value, and any other
section 197 intangible for which amortization would not have been
allowable prior to OBRA 93 through the use of related persons
and certain other transactions. The proposed regulations define
the term related person for purposes of these rules.
The proposed regulations also contain provisions for the
exception to the anti-churning rules in situations where the
seller elects to recognize gain and agrees to pay a specified
amount of tax. The regulations reserve guidance on the manner of
making this election. The IRS intends to issue a revenue
procedure in order to provide interim guidance to taxpayers on
the manner of making this election, and the final regulations
will include the relevant provisions of this revenue procedure.
The proposed regulations contain both an anti-churning
anti-abuse rule and a general anti-abuse rule that provide that
the Commissioner may recast any transaction if one of its
principal purposes is to avoid the purposes of section 197.
6. Assumption Reinsurance Transactions
Section 197(f)(5) provides special rules for section 197
intangibles resulting from assumption reinsurance transactions.
The proposed regulations reserve guidance on certain aspects of
these transactions. The IRS invites comments on the extent to
which additional guidance on the application of section 197 to
these transactions may be necessary.
7. Proposed Effective Dates
The regulations for sections 167(f) and 197 are proposed to
be effective on the date on which the final regulations are
published in the Federal Register. Regulations to implement
section 197(e)(4)(D) (separately acquired contracts of fixed
duration or amount) are proposed to be effective August 11, 1993,
for property acquired after August 10, 1993 (or July 26, 1991, if
a valid retroactive election has been made under 1.197-1T).
8. Accounting Method Changes
A change in the method of depreciation or amortization of
intangibles is a change in method of accounting that requires the
consent of the Commissioner of Internal Revenue under section
446(e). To obtain this consent, a Form 3115, Application for
Change in Accounting Method, generally must be filed within 180
days after the beginning of the taxable year in which the
proposed change is to be made. Taxpayers that have adopted a
method of accounting for certain intangibles may need to change
their method of accounting to comply with the final regulations.
9. Basis Allocation Rules
In separate notices the IRS and Treasury are issuing
temporary and proposed amendments to the temporary regulations
under sections 1060 and 338(b). The existing temporary
regulations establish a four-class system for allocating basis to
individual assets in the case of a direct acquisition of assets
constituting a trade or business or a deemed acquisition of
assets as the result of an election under section 338. Under
this system, assets in the nature of goodwill and going concern
value are included in Class IV, while other intangible assets,
whether or not amortizable, are included in Class III. Each
successive class is allocated basis under a residual method,
subject to a fair market value limitation for all classes except
Class IV. After basis has been allocated to each class in the
aggregate, assets within each of the first three classes are
allocated basis on a proportional method. This system is
inconsistent with the policies of section 197, which prescribes
uniform treatment for all amortizable section 197 intangibles.
Accordingly, appropriate modifications are being proposed.
Special Analyses
It has been determined that this notice of proposed
rulemaking is not a significant regulatory action as defined in
EO 12866. Therefore, a regulatory assessment is not required.
It also has been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply
to these regulations, and, because the regulations do not impose
a collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue Code, this notice of
proposed rulemaking will be submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on its
impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final
regulations, consideration will be given to any comments that are
submitted (in the manner described in ADDRESSES) timely to the
IRS. All comments will be available for public inspection and
copying.
A public hearing has been scheduled for May 15, 1997, at 10
a.m. in the Commissioner s Conference Room (Room 3313), Internal
Revenue Building, 1111 Constitution Avenue NW., Washington, DC
20224. Because of access restrictions, visitors will not be
admitted beyond the Internal Revenue Building lobby more than 15
minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons that wish to present oral comments at the hearing
must submit comments and an outline of the topics to be discussed
and the time to be devoted to each topic (in the manner described
in ADDRESSES) by April 16, 1997. A period of 10 minutes will be
allotted to each person for making comments.
An agenda showing the scheduling of the speakers will be
prepared after the deadline for receiving outlines has passed.
Copies of the agenda will be available free of charge at the
hearing.
Drafting Information
The principal author of these regulations is John Huffman,
Office of Assistant Chief Counsel (Passthroughs and Special Industries), IRS. However, other personnel from the IRS and
Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as
follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended
by adding an entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.197-2 also issued under 26 U.S.C. 197(g). * * *
Par. 2. Section 1.167(a)-3 is amended by adding a sentence
at the end to read as follows:
1.167(a)-3 Intangibles.
* * * See 1.197-2 and 1.167(a)-14 for amortization of goodwill
and certain other intangibles acquired after August 10, 1993, or
after July 25, 1991, if a valid retroactive election under
1.197-1T has been made.
Par. 3. Section 1.167(a)-6 is amended by adding two
sentences at the end of paragraph (a) to read as follows:
1.167(a)-6 Depreciation in special cases.
(a) * * * See 1.167(a)-14(c)(4) for depreciation of a
separately acquired interest in a patent or copyright described
in section 167(f)(2) acquired after the date on which the final
regulations are published in the Federal Register. See 1.197-2
for amortization of interests in patents and copyrights that
constitute amortizable section 197 intangibles.
* * * * *
Par. 4. Section 1.167(a)-14 is added to read as follows:
1.167(a)-14 Treatment of certain intangible property excluded
from section 197.
(a) Overview. This section provides rules for the
amortization of certain intangibles that are excluded from
section 197 (relating to the amortization of goodwill and certain
other intangibles). These excluded intangibles are specifically
described in 1.197-2(c)(4), (6), (7), (11), and (13) and include
certain computer software and certain other separately acquired
rights, such as rights to receive tangible property or services,
patents and copyrights, rights of fixed duration or amount, and
certain mortgage servicing rights. Intangibles for which an
amortization amount is determined under section 167(f) and
intangibles otherwise excluded from section 197 (for example,
self-created intangibles described in 1.197-2(d)(2)) are
amortizable only if they qualify as property subject to the
allowance for depreciation under section 167(a).
(b) Computer software--(1) In general. The amount of the
deduction for computer software described in section 167(f)(1)
and 1.197-2(c)(4) is determined by amortizing the adjusted basis
of the computer software using the straight line method described
in 1.167(b)-1 (except that its salvage value is treated as zero)
and an amortization period of 36 months beginning with the month
that the computer software is placed in service. If costs for
developing computer software that the taxpayer properly elects to
defer under section 174(b) result in the development of property
subject to the allowance for depreciation under section 167, the
rules of this paragraph (b) will apply to the unrecovered costs.
In addition, this paragraph (b) applies to the cost of separately
acquired computer software where these costs are separately
stated and the costs are required to be capitalized under section
263(a).
(2) Exceptions. Paragraph (b)(1) of this section does not
apply to the cost of computer software properly and consistently
treated as currently deductible (that is, not capitalized) under
1.162-11. The cost of acquiring an interest in computer
software that is included, without being separately stated, in
the cost of the hardware or other tangible property is treated as
part of the cost of the hardware or other tangible property that
is capitalized and depreciated under other applicable sections of
the Internal Revenue Code.
(c) Certain interests or rights acquired separately--(1)
Certain rights to receive tangible property or services. The
amount of the deduction for a separately acquired right to
receive tangible property or services under a contract or from a
governmental unit (specified in section 167(f)(2) and
1.197-2(c)(6)) is determined as follows:
(i) Amortization of fixed amounts. The cost of acquiring a
right to receive a fixed amount of tangible property or services
is amortized for each taxable year by multiplying the basis (as
determined under section 1011) of the right by a fraction, the
numerator of which is the amount of tangible property or services
received during the taxable year and the denominator of which is
the total amount of tangible property or services received or to
be received under the terms of the contract or governmental
grant. For example, if a taxpayer acquires a favorable contract
right to receive a fixed amount of raw materials during an
unspecified period, the taxpayer must amortize the cost of
acquiring the contract right by multiplying the total cost by a
fraction, the numerator of which is the amount of raw materials
received under the contract during the taxable year and the
denominator of which is the total amount of raw materials
received or to be received under the contract.
(ii) Amortization of unspecified amount over fixed period.
The cost of acquiring a right to receive an unspecified amount of
tangible property or services over a fixed period is amortized
ratably over the period of the right.
(iii) Amortization in other cases. [Reserved]
(2) Rights of fixed duration or amount. The amount of the
deduction for a separately acquired right of fixed duration or
amount received under a contract or granted by a governmental
unit (specified in section 167(f)(2) and 1.197-2(c)(13)) and not
covered by paragraph (c)(1) of this section is determined as
follows:
(i) Rights of a fixed amount. The cost of acquiring a right
of a fixed amount is amortized for each taxable year by
multiplying the cost of the right by a fraction, the numerator of
which is the amount received or delivered during the taxable year
and the denominator of which is the total amount to be received
or delivered (including amounts received or delivered prior to
the close of the taxable year) under the terms of the contract or
governmental grant.
(ii) Rights of unspecified amount and fixed duration of less
than 15 years. The cost of acquiring a right of an unspecified
amount and a fixed duration of less than 15 years is amortized
ratably over the period of the right.
(3) Application of renewals. (i) For purposes of paragraphs
(c)(1) and (2) of this section, the duration of a right under a
contract (or granted by a governmental unit) includes any renewal
period if, based on all of the facts and circumstances in
existence at any time during the taxable year in which the right
is acquired, the facts clearly indicate a reasonable expectancy
of renewal.
(ii) The mere fact that a taxpayer will have the opportunity
to renew a contract right or other right on the same terms as are
available to others, in a competitive auction or similar process
that is designed to reflect fair market value and in which the
taxpayer is not contractually advantaged, will generally not be
taken into account in determining the duration of such right
provided that the bidding produces a fair market value price
comparable to the price that would be obtained if the rights were
purchased immediately after renewal from a person (other than the
person granting the renewal) in an arm s-length transaction.
(iii) The cost of a renewal not included in the terms of the
contract or governmental grant is treated as the acquisition of a
separate intangible asset.
(4) Patents and copyrights. The amount of the deduction for
a separately acquired interest in a patent or copyright described
in section 167(f)(2) and 1.197-2(c)(7) is equal to the purchase
price paid or incurred during the year if the purchase price is
payable on at least an annual basis as either a fixed amount per
use or a fixed percentage of the revenue derived from the use of
the patent or copyright. Otherwise, the cost or other basis of a
separately acquired patent or copyright (or an interest therein)
is depreciated ratably over its remaining useful life. If a
patent or copyright becomes valueless in any year before its
legal expiration, the adjusted basis may be deducted in that
year.
(5) Applicable rules and conventions. The period of
amortization under paragraphs (c)(1) through (4) of this section
begins when the intangible is placed in service. For other
applicable rules, see 1.197-2(f).
(d) Mortgage servicing rights. The amount of the deduction
for mortgage servicing rights described in section 167(f)(3) and
1.197-2(c)(11) is determined by using the straight line method
described in 1.167(b)-1 (except that the salvage value is
treated as zero) and an amortization period of 108 months.
Mortgage servicing rights are not depreciable to the extent the
rights are stripped coupons under section 1286. An event that
renders mortgage servicing rights wholly worthless is considered
a disposition of the rights. For purposes of determining the
deduction for mortgage servicing rights and any loss from the
sale, exchange, or other disposition of the rights, rights to
service a pool of mortgages are treated as a single asset. Thus,
if some (but not all) mortgages in a pool prepay and the taxpayer
retains rights to service the remaining mortgages in the pool, no
loss is recognized by reason of the prepayment. The adjusted
basis of the mortgage servicing rights is not affected by the
unrecognized loss.
(e) Effective date. This section is applicable on the date
final regulations are published in the Federal Register except
that 1.167(a)-14(c)(2) (depreciation of the cost of certain
separately acquired rights) and so much of 1.167(a)-14(c)(3) as
relates to 1.167(a)-14(c)(2) are applicable August 11, 1993 (or
July 26, 1991, if a valid retroactive election has been made
under 1.197-1T).
Par. 5. Section 1.197-0 is added to read as follows:
1.197-0 Table of contents.
This section lists the headings that appear in 1.197-2.
1.197-2 Amortization of goodwill and certain other intangibles.
(a) Overview.
(1) In general.
(2) Section 167(f) property.
(3) Amounts otherwise deductible.
(4) Relationship to other Internal Revenue Code provisions.
(b) Section 197 intangibles; in general.
(1) Goodwill.
(2) Going concern value.
(3) Workforce in place.
(4) Information base.
(5) Know-how, etc.
(6) Customer-based intangibles.
(7) Supplier-based intangibles.
(8) Licenses, permits, and other rights granted by governmental
units.
(9) Covenants not to compete and other similar arrangements.
(10) Franchises, trademarks, and trade names.
(11) Contracts for the use of, and term interests in, other
section 197 intangibles.
(12) Other similar items.
(c) Section 197 intangibles; exceptions.
(1) Interests in a corporation, partnership, trust, or estate.
(2) Interests under certain financial contracts.
(3) Interests in land.
(4) Certain computer software.
(i) In general.
(ii) Separately acquired software.
(iii) Other exceptions.
(iv) Computer software defined.
(v) Readily available to the general public.
(5) Certain interests in films, sound recordings, video tapes,
books, or other similar property.
(6) Certain rights to receive tangible property or services.
(7) Certain interests in patents or copyrights.
(8) Interests under leases of tangible property.
(i) Interest as a lessor.
(ii) Interest as a lessee.
(9) Interests under indebtedness.
(i) In general.
(ii) Exceptions.
(10) Professional sports franchises.
(11) Mortgage servicing rights.
(12) Certain transaction costs.
(13) Rights of fixed duration or amount.
(d) Amortizable section 197 intangibles.
(1) Definition.
(2) Exception for self-created intangibles.
(i) In general.
(ii) Created by the taxpayer.
(A) Defined.
(B) Contracts for the use of intangibles.
(C) Improvements and modifications.
(iii) Exceptions.
(3) Exception for property subject to anti-churning rules.
(e) Purchase of a trade or business.
(1) Goodwill or going concern value.
(2) Customer-based intangibles.
(3) Franchise, trademark, or trade name.
(i) In general.
(ii) Exceptions.
(4) Acquisitions to be included.
(5) Substantial portion.
(6) Deemed asset purchases under section 338.
(f) Computation of amortization deduction.
(1) In general.
(2) Treatment of contingent amounts.
(i) Amounts added to basis during 15-year period.
(ii) Amounts becoming fixed after expiration of 15-year
period.
(iii) Time for including amounts in basis.
(3) Determination of amounts chargeable to capital account in
certain cases.
(i) Covenants not to compete, rights granted by governmental
units, and contracts for the use of section 197 intangibles.
(A) In general.
(B) Time for taking amounts into account.
(ii) Franchises, trademarks, or trade names and licenses,
permits, and other rights granted by governmental units.
(iii) Certain reinsurance transactions.
(4) Transactions subject to section 338 or 1060.
(g) Special rules.
(1) Treatment of certain dispositions.
(i) Loss disallowance rules.
(A) In general.
(B) Certain nonrecognition transfers.
(ii) Separately acquired property.
(iii) Disposition of a covenant not to compete.
(iv) Taxpayers under common control.
(A) In general.
(B) Treatment of disallowed loss.
(2) Treatment of certain nonrecognition and exchange
transactions.
(i) In general.
(A) Transfer disregarded.
(B) Application of general rule.
(ii) Transactions covered.
(iii) Certain exchanged-basis property.
(iv) Transfers under section 708(b)(1).
(A) In general.
(B) Termination by sale or exchange of interest.
(C) Other terminations.
(D) Anti-churning rules.
(v) Distributions to which section 732(d) applies.
(vi) Curative and remedial allocations under section 704(c).
(3) Application of section 754 to acquisitions of an interest
in an intangible held through a partnership.
(4) Treatment of certain reinsurance transactions.
(i) In general.
(ii) Determination of adjusted basis.
(A) Acquisitions (other than under section 338) of
specified insurance contracts.
(B) Other acquisitions. [Reserved]
(5) Amounts paid or incurred for a franchise, trademark, or
trade name.
(6) Amounts properly taken into account in determining the cost
of property that is not a section 197 intangible.
(7) Treatment of amortizable section 197 intangibles as
depreciable property.
(i) In general.
(ii) Exceptions and limitations.
(A) Unstated interest and original issue discount rules.
(B) Treatment of other parties to transaction.
(h) Anti-churning rules.
(1) Conversions of existing goodwill, going concern value, and
certain other section 197 intangibles.
(2) Amounts deductible under section 1253(d).
(3) Transition period.
(4) Exceptions.
(5) Special partnership provisions.
(i) Basis increases.
(ii) Curative and remedial allocations under section 704(c).
(6) Related person.
(i) In general.
(ii) Time for testing relationships.
(iii) De minimis rule.
(A) In general.
(B) Determination of beneficial ownership interest.
(7) Special rules for entities that owned or used property at
any time during the transition period and that are no longer in
existence.
(8) Special rules for section 338 deemed acquisitions.
(9) Exception to anti-churning rules where gain is recognized.
(i) In general.
(ii) Manner of making election. [Reserved]
(iii) Determination of highest marginal rate of tax.
(A) Noncorporate taxpayers.
(B) Corporations and tax-exempt entities.
(iv) Special rule for pass-through entities.
(v) Coordination with other provisions.
(A) In general.
(B) Section 1374.
(C) Procedural and administrative provisions.
(D) Installment method.
(10) Transactions subject to both anti-churning and
nonrecognition rules.
(11) Anti-churning anti-abuse rule.
(i) [Reserved].
(j) General anti-abuse rule.
(k) Examples.
(l) Effective dates.
Par. 6. Section 1.197-2 is added to read as follows:
1.197-2 Amortization of goodwill and certain other intangibles.
(a) Overview--(1) In general. Section 197 allows an
amortization deduction for the capitalized costs of an
amortizable section 197 intangible and prohibits any other
depreciation or amortization with respect to that property.
Paragraphs (b), (c), and (e) of this section provide rules and
definitions for determining whether property is a section 197
intangible, and paragraphs (d) and (e) of this section provide
rules and definitions for determining whether a section 197
intangible is an amortizable section 197 intangible. The
amortization deduction under section 197 is determined by
amortizing adjusted basis ratably over a 15-year period under the
rules of paragraph (f) of this section. Section 197 also
includes various special rules pertaining to the disposition of
amortizable section 197 intangibles, nonrecognition transactions,
anti-churning rules, and anti-abuse rules. Rules relating to
these provisions are contained in paragraphs (g), (h), and (j) of
this section. Examples demonstrating the application of these
provisions are contained in paragraph (k) of this section. The
effective date of the rules in this section is contained in
paragraph (l) of this section.
(2) Section 167(f) property. Section 167(f) prescribes
rules for computing the depreciation deduction for certain
property to which section 197 does not apply. See 1.167(a)-14
for rules under section 167(f) and paragraphs (c)(4), (6), (7),
(11), and (13) of this section for a description of the property
subject to section 167(f).
(3) Amounts otherwise deductible. Except as otherwise
provided in section 197(f)(3) and paragraphs (b)(11) and (f)(3)
of this section, section 197 does not apply to amounts that would
be currently deductible without regard to section 197.
(4) Relationship to other Internal Revenue Code provisions.
Section 197 does not apply to any amount paid or incurred for a
section 197 intangible if a deduction for the amount would be
disallowed under any provision of the Internal Revenue Code other
than section 263. (See, for example, section 162(k).)
(b) Section 197 intangibles; in general. Except as
otherwise provided in paragraph (c) of this section, the term
section 197 intangible means any property described in section
197(d)(1). The following rules and definitions provide guidance
concerning property that is a section 197 intangible unless an
exception applies:
(1) Goodwill. Section 197 intangibles include goodwill.
Goodwill is the value of a trade or business attributable to the
expectancy of continued customer patronage. This expectancy may
be due to the name or reputation of a trade or business or any
other factor.
(2) Going concern value. Section 197 intangibles include
going concern value. Going concern value is the additional value
that attaches to property by reason of its existence as an
integral part of an ongoing business activity. Going concern
value includes the value attributable to the ability of a trade
or business (or a part of a trade or business) to continue
functioning or generating income without interruption
notwithstanding a change in ownership, but does not include any
of the intangibles described in any other provision of this
paragraph (b). It also includes the value that is attributable
to the immediate use or availability of an acquired trade or
business, such as, for example, the use of the revenues or net
earnings that otherwise would not be received during any period
if the acquired trade or business were not available or
operational.
(3) Workforce in place. Section 197 intangibles include
workforce in place. Workforce in place (sometimes referred to as
agency force or assembled workforce) includes the composition of
a workforce (for example, the experience, education, or training
of a workforce), the terms and conditions of employment whether
contractual or otherwise, and any other value placed on employees
or any of their attributes. Thus, the amount paid or incurred
for workforce in place includes, for example, any portion of the
purchase price of an acquired trade or business attributable to
the existence of a highly-skilled workforce, an existing
employment contract (or contracts), or a relationship with
employees or consultants (including, but not limited to, any key
employee contract or relationship). Workforce in place does not
include any covenant not to compete or other similar arrangement
described in paragraph (b)(9) of this section.
(4) Information base. Section 197 intangibles include
business books and records, operating systems, and any other
information base, including lists or other information of current
or prospective customers (regardless of the method of recording
the information). Thus, the amount paid or incurred for these
items includes, for example, any portion of the purchase price of
an acquired trade or business attributable to the intangible
value of technical manuals, training manuals or programs, data
files, and accounting or inventory control systems. Other
examples include the cost of acquiring customer lists,
subscription lists, insurance expirations, patient or client
files, or lists of newspaper, magazine, radio, or television
advertisers.
(5) Know-how, etc. Section 197 intangibles include any
patent, copyright, formula, process, design, pattern, know-how,
format, package design, computer software (as defined in
paragraph (c)(4) of this section), or interest in a film, sound
recording, video tape, book, or other similar property. (See,
however, the exceptions in paragraph (c) of this section.)
(6) Customer-based intangibles. Section 197 intangibles
include any customer-based intangible. A customer-based
intangible is any composition of market, market share, or other
value resulting from the future provision of goods or services
pursuant to contractual or other relationships in the ordinary
course of business with customers. Thus, the amount paid or
incurred for customer-based intangibles includes, for example,
any portion of the purchase price of an acquired trade or
business attributable to the existence of a customer base, a
circulation base, an undeveloped market or market growth,
insurance in force, the existence of a qualification to supply
goods or services to a particular customer, a mortgage servicing
contract (as defined in paragraph (c)(11) of this section), an
investment management contract, or other relationship with
customers involving the future provision of goods or services.
(See, however, the exceptions in paragraph (c) of this section.)
In addition, customer-based intangibles include the deposit base
and any similar asset of a financial institution. Thus, the
amount paid or incurred for customer-based intangibles also
includes any portion of the purchase price of an acquired
financial institution attributable to the value represented by
existing checking accounts, savings accounts, escrow accounts,
and other similar items of the financial institution. However,
any portion of the purchase price of an acquired trade or
business attributable to accounts receivable or other similar
rights to income for goods or services provided to customers
prior to the acquisition of a trade or business is not an amount
paid or incurred for a customer-based intangible.
(7) Supplier-based intangibles. Section 197 intangibles
include any supplier-based intangible. A supplier-based
intangible is the value resulting from the future acquisition,
pursuant to contractual or other relationships with suppliers in
the ordinary course of business, of goods or services that will
be sold or used by the taxpayer. Thus, the amount paid or
incurred for supplier-based intangibles includes, for example,
any portion of the purchase price of an acquired trade or
business attributable to the existence of a favorable
relationship with persons providing distribution services (such
as favorable shelf or display space at a retail outlet), the
existence of a favorable credit rating, or the existence of
favorable supply contracts. The amount paid or incurred for
supplier-based intangibles does not include any amount required
to be paid for the goods or services themselves pursuant to the
terms of the agreement or other relationship. In addition, see
the exceptions in paragraph (c) of this section, including the
exception in paragraph (c)(6) of this section for certain rights
to receive tangible property or services from another person.
(8) Licenses, permits, and other rights granted by
governmental units. Section 197 intangibles include any license,
permit, or other right granted by a governmental unit (including,
for purposes of section 197, an agency or instrumentality
thereof) even if the right is granted for an indefinite period or
is reasonably expected to be renewed for an indefinite period.
These rights include, for example, a liquor license, a taxi-cab
medallion (or license), an airport landing or takeoff right
(sometimes referred to as a slot), a regulated airline route, or
a television or radio broadcasting license. The issuance or
renewal of a license, permit, or other right granted by a
governmental unit is considered an acquisition of the license,
permit, or other right. (See, however, the exceptions in
paragraph (c) of this section, including the exceptions in
paragraph (c)(3) of this section for an interest in land, in
paragraph (c)(8) of this section for an interest under a lease of
tangible property, and in paragraphs (c)(6) and (13) of this
section for certain rights granted by a governmental unit. See
paragraph (b)(10) of this section for the treatment of
franchises.)
(9) Covenants not to compete and other similar arrangements.
Section 197 intangibles include any covenant not to compete, or
agreement having substantially the same effect, entered into in
connection with the direct or indirect acquisition of an interest
in a trade or business or a substantial portion thereof. For
purposes of this paragraph (b)(9), an acquisition may be made in
the form of an asset acquisition (including a qualified stock
purchase that is treated as a purchase of assets under section
338), a stock acquisition or redemption, and the acquisition or
redemption of a partnership interest. An agreement requiring the
performance of services or the provision of property or the use
of property (other than property of the acquired trade or
business) does not have substantially the same effect as a
covenant not to compete to the extent that the amount paid under
the agreement represents reasonable compensation for the services
actually rendered or for the property or use of the property
actually provided.
(10) Franchises, trademarks, and trade names. (i) Section
197 intangibles include any franchise, trademark, or trade name.
The term franchise includes any agreement that provides one of
the parties to the agreement with the right to distribute, sell,
or provide goods, services, or facilities, within a specified
area. (See section 1253(b)(1).) The term includes
distributorships or other similar contractual arrangements
pursuant to which the transferee is permitted or licensed to
operate or conduct a trade or business within a specific area.
The term trademark includes any word, name, symbol, or device, or
any combination thereof, adopted and used by a manufacturer or
merchant to identify goods or services and distinguish them from
those manufactured or sold by others. The term trade name
includes any name used by a manufacturer or merchant to identify
or designate a particular trade or business or the name or title
used by a person or organization engaged in a trade or business.
A license, permit, or other right granted by a governmental unit
is a franchise if it otherwise meets the definition of a
franchise. A trademark or trade name includes any trademark or
trade name arising under statute or applicable common law, and
any similar right granted by contract. The renewal of a
franchise, trademark, or trade name is treated as an acquisition
of the franchise, trademark, or trade name.
(ii) Notwithstanding the definitions provided in paragraph
(b)(10)(i) of this section, any amount that is paid or incurred
on account of a transfer, sale, or other disposition of a
franchise, trademark, or trade name and that is subject to
section 1253(d)(1) is not included in the basis of a section 197
intangible. (See paragraph (g)(5) of this section.)
(11) Contracts for the use of, and term interests in, other
section 197 intangibles. Section 197 intangibles include any
right under a license, contract, or other arrangement providing
for the use of property that would be a section 197 intangible
under any provision of this paragraph (b) (including this
paragraph (b)(11)) after giving effect to all of the exceptions
provided in paragraph (c) of this section. Section 197
intangibles also include any term interest (whether outright or
in trust) in such property.
(12) Other similar items. Section 197 intangibles include
any other intangible property that is similar in all material
respects to the property specifically described in section
197(d)(1)(C) and paragraphs (b)(3) through (7) of this section.
(See paragraph (g)(4) of this section for special rules regarding
certain reinsurance transactions.)
(c) Section 197 intangibles; exceptions. The term section
197 intangible does not include property described in section
197(e). The following rules and definitions provide guidance
concerning property to which the exceptions apply:
(1) Interests in a corporation, partnership, trust, or
estate. Section 197 intangibles do not include an interest in a
corporation, partnership, trust, or estate. Thus, for example,
amortization under section 197 is not available for the cost of
acquiring stock, partnership interests, or interests in a trust
or estate, whether or not the interests are regularly traded on
an established market. (See paragraph (g)(3) of this section for
special rules applicable to property of a partnership when a
section 754 election is in effect for the partnership.)
(2) Interests under certain financial contracts. Section
197 intangibles do not include an interest under an existing
futures contract, foreign currency contract, notional principal
contract, interest rate swap, or other similar financial
contract, whether or not the interest is regularly traded on an
established market. However, this exception does not apply to an
interest under a mortgage servicing contract, credit card
servicing contract, or other contract to service another person s
indebtedness, or an interest under an assumption reinsurance
contract. (See paragraph (g)(4) of this section for the
treatment of assumption reinsurance contracts. See paragraph
(c)(11) of this section and 1.167(a)-14(d) for the treatment of
mortgage servicing rights.)
(3) Interests in land. Section 197 intangibles do not
include any interest in land. For this purpose, an interest in
land includes a fee interest, life estate, remainder, easement,
mineral right, timber right, grazing right, riparian right, air
right, zoning variance, and any other similar right, such as a
farm allotment, quota for farm commodities, or crop acreage base.
An interest in land does not include an airport landing or
takeoff right, a regulated airline route, or a franchise to
provide cable television service. The cost of acquiring a
license, permit, or other land improvement right, such as a
building construction or use permit, is taken into account in the
same manner as the underlying improvement.
(4) Certain computer software--(i) In general. Section 197
intangibles do not include any interest in computer software that
is (or has been) readily available to the general public on
similar terms, is subject to a nonexclusive license, and has not
been substantially modified for the user. Computer software will
not be considered to have been substantially modified if its cost
does not exceed the greater of 125 percent of the price at which
the unmodified version of the software is readily available to
the general public or $2,000. For the purpose of determining
whether computer software has been substantially modified--
(A) Integrated programs acquired in a package from a single
source are treated as a single computer program; and
(B) Any cost incurred to install the computer software is
not treated as a cost of the software.
(ii) Separately acquired software. Section 197 intangibles
do not include an interest in computer software that is not
acquired as part of a purchase of a trade or business within the
meaning of paragraph (e) of this section.
(iii) Other exceptions. Neither section 197 nor section
167(f) apply in the following cases:
(A) Any amount of the cost of an interest in computer
software that is included, without being separately stated, in
the cost of the hardware or other tangible property will be
treated as part of the cost of the hardware or other tangible
property.
(B) Any amount of the cost of an interest in computer
software that would be deductible under any provision other than
section 167(f) or 197 may be deducted and is not required to be
capitalized.
(iv) Computer software defined. For purposes of this
section, computer software is any program or routine (that is,
any sequence of machine-readable code) that is designed to cause
a computer (as defined in section 168(i)(2)(B)(ii)) to perform a
desired function or set of functions, and the documentation
required to describe and maintain those programs. It includes
all forms and media in which the software is contained, whether
written, magnetic, or otherwise. Computer programs of all
classes, for example, operating systems, executive systems,
monitors, compilers and translators, assembly routines, and
utility programs as well as application programs, are included.
Computer software also includes any incidental and ancillary
rights that are necessary to effect the acquisition of the title
to, the ownership of, or the right to use the computer software,
and that are used only in connection with that specific computer
software. Such incidental and ancillary rights are not included
in the definition of trademark or trade name under paragraph
(b)(10)(i) of this section. For example, a trademark or trade
name that is ancillary to the ownership or use of a specific
computer software program in the taxpayer s trade or business and
is not acquired for the purpose of marketing the computer
software is included in the definition of computer software and
is not included in the definition of trademark or trade name.
Computer software does not include any data or information base
described in paragraph (b)(4) of this section unless the data
base or item is in the public domain and is incidental to a
computer program. For this purpose, a copyrighted or proprietary
data or information base is treated as in the public domain if
its availability through the computer program does not contribute
significantly to the cost of the program. For example, if a
word-processing program includes a dictionary feature used to
spell-check a document or any portion thereof, the entire program
(including the dictionary feature) is computer software
regardless of the form in which the feature is maintained or
stored.
(v) Readily available to the general public. Computer
software will be treated as readily available to the general
public if the software may be obtained on substantially the same
terms by a significant number of persons that would reasonably be
expected to use the software. The requirements of this paragraph
(c)(4)(v) can be met even though the software is not available
through a system of retail distribution.
(5) Certain interests in films, sound recordings, video
tapes, books, or other similar property. Section 197 intangibles
do not include any interest (including an interest as a licensee)
in a film, sound recording, video tape, book, or other similar
property (such as the right to broadcast or transmit a live
event) if the interest is not acquired as part of a purchase of a
trade or business. A film, sound recording, video tape, book, or
other similar property includes any incidental and ancillary
rights (such as a trademark or trade name) that are necessary to
effect the acquisition of title to, the ownership of, or the
right to use the property and are used only in connection with
that property. Such incidental and ancillary rights are not
included in the definition of trademark or trade name under
paragraph (b)(10)(i) of this section. For purposes of this
paragraph (c)(5), computer software (as defined in paragraph
(c)(4)(iv) of this section) is not treated as other property
similar to a film, sound recording, video tape, or book. (See
section 167 for amortization of excluded intangible property or
interests.)
(6) Certain rights to receive tangible property or services.
Section 197 intangibles do not include any right to receive
tangible property or services under a contract or from a
governmental unit if the right is not acquired as part of a
purchase of a trade or business. Any right that is described in
the preceding sentence is not treated as a section 197 intangible
even though the right is also described in section 197(d)(1)(D)
and paragraph (b)(8) of this section (relating to certain
governmental licenses, permits, and other rights) and even though
the right fails to meet one or more of the requirements of
paragraph (c)(13) of this section (relating to certain rights of
fixed duration or amount). (See 1.167(a)-14(c)(1) and (3) for
applicable rules.)
(7) Certain interests in patents or copyrights. Section 197
intangibles do not include any interest (including an interest as
a licensee) in a patent, patent application, or copyright that is
not acquired as part of a purchase of a trade or business. (See
1.167(a)-14(c)(4) for applicable rules.)
(8) Interests under leases of tangible property--(i)
Interest as a lessor. Section 197 intangibles do not include any
interest as a lessor under an existing lease or sublease of
tangible real or personal property. In addition, the cost of
acquiring an interest as a lessor in connection with the
acquisition of tangible property is taken into account as part of
the cost of the tangible property. For example, if a taxpayer
acquires a shopping center that is leased to tenants operating
retail stores, any portion of the purchase price attributable to
favorable lease terms is taken into account as part of the basis
of the shopping center and in determining the depreciation
deduction allowed with respect to the shopping center. (See
section 167(c)(2).)
(ii) Interest as a lessee. Section 197 intangibles do not
include any interest as a lessee under an existing lease of
tangible real or personal property. For this purpose, an airline
lease of an airport passenger or cargo gate is a lease of
tangible property. The cost of acquiring such an interest is
taken into account under section 178 and 1.162-11(a). If an
interest as a lessee under a lease of tangible property is
acquired in a transaction with any other intangible property, a
portion of the total purchase price may be allocable to the
interest as a lessee based on all of the relevant facts and
circumstances.
(9) Interests under indebtedness--(i) In general. Section
197 intangibles do not include any interest (whether as a
creditor or debtor) under an indebtedness in existence when the
interest was acquired. Thus, for example, the value attributable
to the assumption of an indebtedness with a below-market interest
rate is not amortizable under section 197. In addition, the
premium paid for acquiring a debt instrument with an above-market
interest rate is not amortizable under section 197. See section
171 for rules concerning the treatment of amortizable bond
premium.
(ii) Exceptions. For purposes of this paragraph (c)(9), an
interest under an existing indebtedness does not include the
deposit base (and other similar items) of a financial
institution. An interest under an existing indebtedness includes
mortgage servicing rights, however, to the extent the rights are
stripped coupons under section 1286.
(10) Professional sports franchises. Section 197
intangibles do not include any franchise to engage in
professional baseball, basketball, football, or any other
professional sport, and any item (even though otherwise
qualifying as a section 197 intangible) acquired in connection
with such a franchise.
(11) Mortgage servicing rights. Section 197 intangibles do
not include any right described in section 197(e)(7) (concerning
rights to service indebtedness secured by residential real
property that are not acquired as part of a purchase of a trade
or business). (See 1.167(a)-14(d) for applicable rules.)
(12) Certain transaction costs. Section 197 intangibles do
not include any fees for professional services and any
transaction costs incurred by parties to a transaction in which
all or any portion of the gain or loss is not recognized under
part III of subchapter C of the Internal Revnue Code.
(13) Rights of fixed duration or amount. (i) Section 197
intangibles do not include any right under a contract or any
license, permit, or other right granted by a governmental unit if
the right--
(A) Is acquired in the ordinary course of business and not
as part of a purchase of a trade or business;
(B) Is not described in sections 197(d)(1)(A), (B), (C)(ii),
(iv), or (vi), (E), or (F); and
(C) Either--
(1) Has a fixed duration of less than 15 years; or
(2) Is fixed as to amount and the adjusted basis thereof is
properly recoverable (without regard to this section) under a
method similar to the unit-of-production method.
(ii) See 1.167(a)-14(c)(2) and (3) for applicable rules.
(d) Amortizable section 197 intangibles--(1) Definition.
Except as otherwise provided in this paragraph (d), the term
amortizable section 197 intangible means any section 197
intangible acquired after August 10, 1993 (or after July 25,
1991, if a valid retroactive election under 1.197-1T has been
made), and held in connection with the conduct of a trade or
business or an activity described in section 212.
(2) Exception for self-created intangibles--(i) In general.
Except as provided in paragraph (d)(2)(iii) of this section,
amortizable section 197 intangibles do not include any section
197 intangible created by the taxpayer (a self-created
intangible).
(ii) Created by the taxpayer--(A) Defined. A section 197
intangible is created by the taxpayer to the extent the taxpayer
makes payments or otherwise incurs costs for its creation,
production, development, or improvement, whether the actual work
is performed by the taxpayer or by another person under a
contract with the taxpayer entered into before the creation,
production, development, or improvement occurs. For example, a
technological process developed specifically for a taxpayer under
an arrangement with another person pursuant to which the taxpayer
retains all rights to the process is created by the taxpayer.
(B) Contracts for the use of intangibles. A section 197
intangible is not created by the taxpayer to the extent that it
results from the entry into (or renewal of) a contract for the
use of an existing section 197 intangible. Thus, for example,
the exception for self-created intangibles does not apply to
legal and other professional fees incurred by a licensee in
connection with the entry into (or renewal of) a contract for the
use of know-how or similar property.
(C) Improvements and modifications. If an existing section
197 intangible is improved or otherwise modified by the taxpayer
or by another person under a contract with the taxpayer, the
existing intangible and the improvements or other modifications
are treated as separate section 197 intangibles for purposes of
this paragraph (d).
(iii) Exceptions. (A) The exception for self-created
intangibles does not apply to any section 197 intangible
described in section 197(d)(1)(D) (relating to licenses, permits
or other rights granted by a governmental unit), 197(d)(1)(E)
(relating to covenants not to compete), or 197(d)(1)(F) (relating
to franchises, trademarks, and trade names). Thus, for example,
capitalized costs incurred in the development, registration, or
defense of a trademark or trade name do not qualify for the
exception and are amortized over 15 years under section 197.
(B) The exception for self-created intangibles does not
apply to any section 197 intangible created in connection with
the purchase of a trade or business (as defined in paragraph (e)
of this section).
(C) If a taxpayer disposes of a self-created intangible and
subsequently reacquires the intangible in an acquisition
described in paragraph (h)(4)(ii) of this section, the exception
for self-created intangibles does not apply to the reacquired
intangible.
(3) Exception for property subject to anti-churning rules.
Amortizable section 197 intangibles do not include any property
to which the anti-churning rules of section 197(f)(9) and
paragraph (h) of this section apply.
(e) Purchase of a trade or business. Several of the
exceptions in section 197 apply only to property that is not
acquired in (or created in connection with) a transaction or
series of related transactions involving the acquisition of
assets constituting a trade or business or a substantial portion
thereof. Property acquired in (or created in connection with)
such a transaction or series of related transactions is referred
to in this section as property acquired as part of (or created in
connection with) a purchase of a trade or business. For purposes
of section 197 and this section, the applicability of the
limitation is determined under the following rules:
(1) Goodwill or going concern value. A group of assets
constitutes a trade or business or a substantial portion thereof
if their use would constitute a trade or business under section
1060 (that is, if goodwill or going concern value could under any
circumstances attach to the assets). See 1.1060-1T(b)(2). For
this purpose, all the facts and circumstances, including any
employee relationships that continue (or covenants not to compete
that are entered into) as part of the transfer of the assets, are
taken into account in determining whether goodwill or going
concern value could attach to the assets.
(2) Customer-based intangibles. Whether or not a group of
assets is otherwise described in paragraph (e)(1) of this
section, a group of assets constitutes a trade or business or a
substantial portion thereof if the assets include any customer-
based intangibles (as defined in paragraph (b)(6) of this
section) or are acquired in a transaction or series of related
transactions that involve the creation of any customer-based
intangibles.
(3) Franchise, trademark, or trade name--(i) In general.
The acquisition of a franchise, trademark, or trade name
constitutes the acquisition of a trade or business or a
substantial portion thereof.
(ii) Exceptions. For purposes of this paragraph (e)(3)--
(A) A trademark or trade name is disregarded if it is
included in computer software under paragraph (c)(4) of this
section or in an interest in a film, sound recording, video tape,
book, or other similar property under paragraph (c)(5) of this
section; and
(B) A franchise, trademark, or trade name is disregarded if
its value is nominal or the taxpayer irrevocably disposes of it
immediately after its acquisition.
(4) Acquisitions to be included. The assets acquired in a
transaction (or series of related transactions) include only
assets (including a beneficial or other indirect interest in
assets where the interest is of a type described in paragraph
(c)(1) of this section) acquired by the taxpayer and persons
related to the taxpayer from another person and persons related
to that other person. For purposes of this paragraph (e)(4),
persons are related only if their relationship is described in
section 267(b) or 707(b) or they are engaged in trades or
businesses under common control within the meaning of section
41(f)(1).
(5) Substantial portion. The determination of whether
acquired assets constitute a substantial portion of a trade or
business is to be based on all of the facts and circumstances,
including the nature and the amount of the assets acquired as
well as the nature and amount of the assets retained by the
transferor. The value of the assets acquired relative to the
value of the assets retained by the transferor is not
determinative of whether the acquired assets constitute a
substantial portion of a trade or business.
(6) Deemed asset purchases under section 338. A qualified
stock purchase that is treated as a purchase of assets under
section 338 shall be treated as a transaction involving the
acquisition of assets constituting a trade or business only if
the direct acquisition of the assets of the corporation would
have been treated as the acquisition of assets constituting a
trade or business.
(f) Computation of amortization deduction--(1) In general.
Except as provided in paragraph (f)(2) of this section, the
amortization deduction allowable under section 197(a) is computed
as follows:
(i) The adjusted basis (for purposes of determining gain) of
an amortizable section 197 intangible is amortized ratably over
the 15-year period beginning on the later of--
(A) The first day of the month in which the property is
acquired; or
(B) In the case of property held in connection with the
conduct of a trade or business, the first day of the month in
which the active conduct of the trade or business begins.
(ii) Except as otherwise provided in this section, adjusted
basis is determined under section 1011 and salvage value is
disregarded.
(iii) Property is not eligible for amortization in the month
of disposition.
(iv) The amortization deduction for a short taxable year is
based on the number of months in the short taxable year.
(2) Treatment of contingent amounts--(i) Amounts added to
basis during 15-year period. Any amount that is properly
included in the basis of an amortizable section 197 intangible
after the first month of the 15-year period described in
paragraph (f)(1)(i) of this section and before the expiration of
this period is amortized ratably over the remainder of the 15-
year period. For this purpose, the remainder of the 15-year
period begins on the first day of the month in which the basis
increase occurs. Any reasonable convention may be used to
determine the month in which the basis increase incurs, provided
that the method selected is used consistently for all amortizable
section 197 intangibles acquired in the same transaction (or
series of related transactions) and that it does not result in
any amount being added to basis earlier than the midpoint of the
period (for example, annual, semi-annual, or quarterly) selected.
(ii) Amounts becoming fixed after expiration of 15-year
period. Any amount that is not properly included in the basis of
an amortizable section 197 intangible until after the expiration
of the 15-year period described in paragraph (f)(1)(i) of this
section is amortized in full immediately upon the inclusion of
the amount in the basis of the intangible.
(iii) Time for including amounts in basis. See 1.461-
1(a)(1) for rules governing the time at which an amount may be
taken into account by a taxpayer using the cash receipts and
disbursements method, and 1.461-1(a)(2) for rules governing the
time at which a liability is incurred and generally taken into
account (for example, by treating the amount of the liability as
a capital expenditure) by an accrual basis taxpayer.
(3) Determination of amounts chargeable to capital account
in certain cases--(i) Covenants not to compete, rights granted by
governmental units, and contracts for the use of section 197
intangibles--(A) In general. In the case of a covenant not to
compete or other similar arrangement described in paragraph
(b)(9) of this section, any license, permit, or other right
granted by a governmental unit or an agency or instrumentality
thereof described in paragraph (b)(8) of this section, or a
contract for the use of a section 197 intangible described in
paragraph (b)(11) of this section, the amount chargeable to
capital account includes all amounts required to be paid pursuant
to the agreement or right, whether or not any amount would be
deductible under section 162 if the agreement or right were not a
section 197 intangible.
(B) Time for taking amounts into account. For purposes of
this paragraph (f)(3), in applying the provisions of 1.461-
1(a)(1) (in the case of a taxpayer using the cash receipts and
disbursements method of accounting) and 1.461-1(a)(2) (in the
case of a taxpayer using an accrual method of accounting), all
amounts required to be paid under an agreement described in
paragraph (b)(9) or (11) of this section shall be treated as
amounts payable under the terms of a debt instrument issued in
exchange for property. Contingent payments made under an
agreement described in paragraph (b)(9) or (11) of this section
will be included in adjusted basis under the rules of paragraph
(f)(2) of this section.
(ii) Franchises, trademarks, or trade names and licenses,
permits, and other rights granted by governmental units. The
costs paid or incurred for the renewal of a franchise, trademark,
or trade name or any license, permit, or other right granted by a
governmental unit or an agency or instrumentality thereof are
amortized over the 15-year period that begins with the month of
renewal. Any costs paid or incurred for the issuance, or earlier
renewal, continue to be taken into account over the remaining
portion of the amortization period that began at the time of the
issuance, or earlier renewal. Any amount paid or incurred for
the protection, expansion, or defense of a trademark or trade
name and chargeable to capital account is treated as an amount
paid or incurred for a renewal.
(iii) Certain reinsurance transactions. See paragraph
(g)(4)(ii) of this section for special rules regarding the
adjusted basis of an insurance contract acquired through an
assumption reinsurance transaction.
(4) Transactions subject to section 338 or 1060. In the
case of a section 197 intangible deemed to have been acquired as
the result of a qualified stock purchase within the meaning of
section 338(d)(3), the basis shall be determined pursuant to
section 338(b)(5) and the regulations thereunder. In the case of
a section 197 intangible acquired in an applicable asset
acquisition within the meaning of section 1060(c), the basis
shall be determined pursuant to section 1060(a) and the
regulations thereunder.
(g) Special rules--(1) Treatment of certain
dispositions--(i) Loss disallowance rules--(A) In general. No
loss is recognized on the disposition of an amortizable section
197 intangible acquired in a transaction or series of related
transactions in which the taxpayer acquired other amortizable
section 197 intangibles if, after the disposition, the taxpayer
retains any of the other amortizable section 197 intangibles, or
the right to use, or an interest in, any of the other amortizable
section 197 intangibles (the retained intangibles). Except as
otherwise provided in paragraph (g)(1)(iv)(B) of this section,
the adjusted basis of each of the retained intangibles is
increased by the product of the loss that is not recognized
solely by reason of this rule and a fraction, the numerator of
which is the adjusted basis of the retained intangible on the
date of the disposition and the denominator of which is the total
adjusted bases of all the retained intangibles on that date. The
abandonment of an amortizable section 197 intangible, or any
other event rendering an amortizable section 197 intangible
worthless, is treated as a disposition of the intangible for
purposes of this paragraph (g)(1), and the abandoned or worthless
intangible is disregarded (that is, it is not treated as a
retained intangible) for purposes of applying this paragraph
(g)(1) to the subsequent disposition of any other amortizable
section 197 intangible.
(B) Certain nonrecognition transfers. The loss disallowance
rule in paragraph (g)(1)(i)(A) of this section also applies when
a taxpayer transfers an amortizable section 197 intangible from
an acquired trade or business in a transaction in which the
intangible is transferred-basis property and, after the transfer,
retains other amortizable section 197 intangibles from the trade
or business. Thus, for example, the transfer of an amortizable
section 197 intangible to a corporation in exchange for stock in
the corporation in a transaction described in section 351, or to
a partnership in exchange for an interest in the partnership in a
transaction described in section 721, when other amortizable
section 197 intangibles acquired in the same transaction are
retained, followed by a sale of the stock or partnership interest
received, will not avoid the application of the loss disallowance
provision to the extent the adjusted basis of the transferred
intangible at the time of the sale exceeds its fair market value
at that time.
(ii) Separately acquired property. Paragraph (g)(1)(i) of
this section does not apply to an amortizable section 197
intangible that is not acquired in a transaction or series of
related transactions in which the taxpayer acquires other
amortizable section 197 intangibles (a separately acquired
intangible). Consequently, a loss may be recognized upon the
disposition of a separately acquired section 197 intangible.
However, the termination or worthlessness of only a portion of an
amortizable section 197 intangible is not the disposition of a
separately acquired intangible. For example, neither the loss of
several customers from an acquired customer list, the termination
of several mortgages (not qualifying for the exception set forth
in paragraph (c)(11) of this section) from an acquired mortgage
pool, nor the worthlessness of only some information from an
acquired data base constitutes the disposition of a separately
acquired intangible.
(iii) Disposition of a covenant not to compete. If a
covenant not to compete or any other arrangement having
substantially the same effect is entered into in connection with
the direct or indirect acquisition of an interest in a trade or
business, the disposition or worthlessness of the covenant or
other arrangement will not be considered to occur until the
disposition or worthlessness of all interests in that trade or
business. For example, a covenant not to compete entered into in
connection with the purchase of stock continues to be amortized
on a 15-year straight-line basis (even after the covenant expires
or becomes worthless) unless all the trades or businesses in
which an interest was acquired through the stock purchase (or all
the purchaser s interests in those trades or businesses) also are
disposed of or become worthless.
(iv) Taxpayers under common control--(A) In general. Except
as provided in paragraph (g)(1)(iv)(B) of this section, all
persons that would be treated as a single taxpayer under section
41(f)(1) are treated as a single taxpayer under this paragraph
(g)(1). Thus, for example, a loss is not recognized on the
disposition of an amortizable section 197 intangible by a member
of a controlled group of corporations (as defined in section
41(f)(5)) if, after the disposition, another member retains other
amortizable section 197 intangibles acquired in the same
transaction as the amortizable section 197 intangible that has
been disposed of.
(B) Treatment of disallowed loss. If retained intangibles
are held by a person other than the person incurring the
disallowed loss, only the adjusted basis of intangibles retained
by the person incurring the disallowed loss is increased, and
only the adjusted basis of those intangibles is included in the
denominator of the fraction described in paragraph (g)(1)(i)(A)
of this section. If none of the retained intangibles are held by
the person incurring the disallowed loss, the loss is allowed
ratably, as a deduction under section 197, over the remainder of
the period during which the intangible giving rise to the loss
would have been amortizable, except that any remaining disallowed
loss is allowed in full on the first date on which all other
retained intangibles have been disposed of or become worthless.
(2) Treatment of certain nonrecognition and exchange
transactions--(i) In general--(A) Transfer disregarded. Except
as otherwise provided in paragraph (h) of this section, if a
section 197 intangible is transferred in a transaction described
in paragraph (g)(2)(ii) of this section, the transfer is
disregarded in determining--
(1) Whether, with respect to so much of the intangible s
basis in the hands of the transferee as does not exceed its basis
in the hands of the transferor, the intangible is an amortizable
section 197 intangible; and
(2) The amount of the deduction under section 197 with
respect to such basis.
(B) Application of general rule. If the intangible
described in paragraph (g)(2)(i)(A) of this section was an
amortizable section 197 intangible in the hands of the
transferor, the transferee will continue to amortize its adjusted
basis, to the extent it does not exceed the transferor s adjusted
basis, ratably over the remainder of the transferor s 15-year
amortization period. If the intangible was not an amortizable
section 197 intangible in the hands of the transferor, the
transferee s adjusted basis, to the extent it does not exceed the
transferor s adjusted basis, cannot be amortized under section
197. In either event, the intangible is treated, with respect to
so much of its adjusted basis in the hands of the transferee as
exceeds its adjusted basis in the hands of the transferor, in the
same manner for purposes of section 197 as an intangible acquired
from the transferor in a transaction that is not described in
paragraph (g)(2)(ii) of this section. The rules of this
paragraph (g)(2)(i) also apply to any subsequent transfers of the
intangible in a transaction described in paragraph (g)(2)(ii) of
this section.
(ii) Transactions covered. The transactions described in
this paragraph (g)(2)(ii) are--
(A) Any transaction described in section 332, 351, 361, 721,
or 731; and
(B) Any transaction between corporations that are members of
the same consolidated group immediately after the transaction.
(iii) Certain exchanged-basis property. This paragraph
(g)(2)(iii) applies to property that is acquired in a transaction
subject to section 1031 or 1033 and is permitted to be acquired
without recognition of gain (replacement property). Except as
otherwise provided in paragraph (h) of this section, replacement
property is treated as if it were the property by reference to
which its basis is determined (the predecessor property) in
determining whether, with respect to so much of its basis as does
not exceed the basis of the predecessor property, the replacement
property is an amortizable section 197 intangible and the
amortization period under section 197 with respect to such basis.
Thus, if the predecessor property was an amortizable section 197
intangible, the taxpayer will amortize the adjusted basis of the
replacement property, to the extent it does not exceed the
adjusted basis of the predecessor property, ratably over the
remainder of the 15-year amortization period for the predecessor
property. If the predecessor property was not an amortizable
section 197 intangible, the adjusted basis of the replacement
property, to the extent it does not exceed the adjusted basis of
the predecessor property, may not be amortized under section 197.
In either event, the replacement property is treated, with
respect to so much of its adjusted basis as exceeds the adjusted
basis of the predecessor property, in the same manner for
purposes of section 197 as property acquired from the transferee
in a transaction that is not subject to section 1031 or 1033.
(See paragraph (h) of this section for the application of the
anti-churning rules.)
(iv) Transfers under section 708(b)(1)--(A) In general.
Paragraph (g)(2)(i) of this section applies to transfers of
section 197 intangibles that occur or are deemed to occur by
reason of the termination of a partnership under section
708(b)(1).
(B) Termination by sale or exchange of interest. In
applying paragraph (g)(2)(i) of this section to a partnership
that is terminated pursuant to section 708(b)(1)(B) (relating to
a sale or exchange of an interest), the terminated partnership is
treated as the transferor and the new partnership is treated as
the transferee with respect to any section 197 intangible held by
the terminated partnership immediately preceding the termination.
(See paragraph (g)(3) of this section for the treatment of
increases in the basis of property of the terminated partnership
under section 743(b).)
(C) Other terminations. In applying paragraph (g)(2)(i) of
this section to a partnership that is terminated pursuant to
section 708(b)(1)(A) (relating to cessation of activities by a
partnership), the terminated partnership is treated as the
transferor and the distributee partner is treated as the
transferee with respect to any section 197 intangible held by the
terminated partnership immediately preceding the termination.
(D) Anti-churning rules. See paragraph (h) of this section
for the application of the anti-churning rules.
(v) Distributions to which section 732(d) applies.
Paragraph (g)(2)(i) of this section applies to a distribution of
a section 197 intangible to which section 732(d) (relating to
special partnership basis to transferee) applies. For purposes
of section 197, any increase in the basis of the distributed
intangible under section 732(d) is taken into account by a
partner as if the increased portion were attributable to the
partner s acquisition of the underlying partnership property on
the date of distribution from the transferor of the partnership
interest or the deceased partner, as the case may be. For
purposes of the effective date and anti-churning rules
(paragraphs (d)(1) and (h) of this section), the intangible is
treated as having been acquired by the transferee partner at the
time of the transfer of the partnership interest described in
section 732(d). For purposes of determining the amortization
period under section 197 with respect to any increased basis,
however, the intangible is treated as having been acquired by the
transferee partner at the time of the distribution described in
section 732(a). (See paragraph (h) of this section for the
application of the anti-churning rules.)
(vi) Curative and remedial allocations under section 704(c).
For purposes of paragraph (g)(2)(i) of this section, if a section
197 intangible is transferred to a partnership in a transaction
described in section 721, the basis of the intangible in the
hands of the transferor includes the amount of any curative or
remedial allocations of amortization that are made to a
noncontributing partner with respect to the contributed
intangible under the curative or remedial methods for making
allocations under section 704(c). Thus, for example, if a
contributed intangible is not an amortizable section 197
intangible in the hands of the transferor, any remedial
allocations of amortization made to a noncontributing partner
with respect to the intangible are not amortizable under section
197. See 1.704-3(c) and (d) for a description of the curative
and remedial methods.
(3) Application of section 754 to acquisitions of an
interest in an intangible held through a partnership. Any
increase in the basis of partnership property under section
734(b) (relating to the optional adjustment to the basis of
undistributed partnership property) or section 743(b) (relating
to the optional adjustment to the basis of partnership property)
is taken into account under section 197 by a partner as if the
increased portion of the basis were attributable to the partner s
acquisition of the underlying partnership property and as if the
property were acquired from the distributee partner on the date
of the distribution (in the case of a basis increase under
section 734(b)) or from the transferor of the partnership
interest on the date of the transfer (in the case of a basis
increase under section 743(b)). (See paragraph (h) of this
section for the application of the anti-churning rules.)
(4) Treatment of certain reinsurance transactions--(i) In
general. Section 197 applies to any insurance contract acquired
from another person through an assumption reinsurance
transaction. For purposes of section 197, an assumption
reinsurance transaction is--
(A) Any arrangement in which one insurance company (the
reinsurer) becomes solely liable to policyholders on contracts
transferred by another insurance company (the ceding company);
and
(B) Any acquisition of an insurance contract that is treated
as occurring by reason of an election under section 338.
(ii) Determination of adjusted basis--(A) Acquisitions
(other than under section 338) of specified insurance contracts.
The amount taken into account for purposes of section 197 as the
adjusted basis of specified insurance contracts (as defined in
section 848(e)(1)) acquired in an assumption reinsurance
transaction that is not described in paragraph (g)(4)(i)(B) of
this section is equal to the excess of--
(1) The amount paid or incurred (or treated as having been
paid or incurred) by the reinsurer for the purchase of the
contracts (as determined under 1.817-4(d)(2)); over
(2) The amount of the specified policy acquisition expenses
that are attributable to the reinsurer s net positive
consideration for the reinsurance agreement (as determined under
1.848-2(f)(3)).
(B) Other acquisitions. [Reserved]
(5) Amounts paid or incurred for a franchise, trademark, or
trade name. If an amount to which section 1253(d) (relating to
the transfer, sale, or other disposition of a franchise,
trademark, or trade name) applies is described in section
1253(d)(1)(B) (relating to contingent serial payments), the
amount is deductible under section 1253(d)(1) and is not included
in the adjusted basis of the intangible for purposes of section
197. Any other amount, whether fixed or contingent, to which
section 1253(d) applies is chargeable to capital account under
section 1253(d)(2) and is amortizable only under section 197.
(6) Amounts properly taken into account in determining the
cost of property that is not a section 197 intangible. Section
197 does not apply to an amount that is properly taken into
account in determining the cost of property that is not a section
197 intangible. The entire cost of acquiring the other property
is included in its basis and recovered under other applicable
Internal Revenue Code provisions.
(7) Treatment of amortizable section 197 intangibles as
depreciable property--(i) In general. An amortizable section 197
intangible is treated as property of a character subject to the
allowance for depreciation under section 167. Thus, for example,
an amortizable section 197 intangible is not a capital asset for
purposes of section 1221, but if held for more than one year, it
generally qualifies under section 1231 as property used in a
trade or business. Also, an amortizable section 197 intangible
is section 1245 property and section 1239 applies to any gain
recognized upon its sale or exchange between related persons (as
defined in section 1239(b)).
(ii) Exceptions and limitations--(A) Unstated interest and
original issue discount rules. In the case of the acquisition of
any amortizable section 197 intangible in a transaction that
would not be treated as the sale or exchange of property by the
person from which the intangible was acquired, paragraph
(g)(7)(i) of this section shall not apply (and the amortizable
section 197 intangible shall not be treated as property) for
purposes of--
(1) Section 483(c) (relating to payments on account of the
sale or exchange of property); and
(2) Section 1274(c) (relating to debt instruments given in
consideration for the sale or exchange of property).
(B) Treatment of other parties to transaction. No person
shall be treated as having sold, exchanged, or otherwise disposed
of property in a transaction for purposes of any provision of the
Internal Revenue Code solely by reason of the application of
paragraph (g)(7)(i) of this section to any other party to the
transaction.
(h) Anti-churning rules--(1) Conversions of existing
goodwill, going concern value, and certain other section 197
intangibles. Except as otherwise provided in this paragraph (h),
goodwill, going concern value, or any other section 197
intangible for which a depreciation or amortization deduction
would not have been allowable prior to the enactment of section
197 may not be amortized as an amortizable section 197 intangible
if the section 197 intangible is acquired by a taxpayer after
August 10, 1993 (or after July 25, 1991, if a valid retroactive
election pursuant to 1.197-1T has been made) and either--
(i) The taxpayer or a related person held or used the
intangible or an interest therein at any time during the
transition period;
(ii) The taxpayer acquired the intangible from a person that
held the intangible at any time during the transition period and,
as part of the transaction, the user of the intangible does not
change; or
(iii) The taxpayer grants the right to use the intangible to
a person (or a person related to that person) that held or used
the intangible at any time during the transition period.
(2) Amounts deductible under section 1253(d). For purposes
of paragraph (h)(1) of this section, deductions allowable under
section 1253(d)(2) or deductions allowable pursuant to an
election under section 1253(d)(3) (in either case as in effect
prior to the enactment of section 197) are treated as deductions
allowable for amortization.
(3) Transition period. For purposes of this paragraph (h),
the transition period begins on July 25, 1991, and ends on August
10, 1993, except that for taxpayers that made a valid retroactive
election pursuant to 1.197-1T, the transition period is July 25,
1991.
(4) Exceptions. The anti-churning rules of this paragraph
(h) do not apply to--
(i) The acquisition of an intangible by a taxpayer if the
basis of the intangible is determined under section 1014(a); or
(ii) The acquisition of an intangible by a taxpayer that is
an amortizable section 197 intangible in the hands of the seller
(or transferor), but only if the acquisition by the taxpayer or
sale by the seller (or transfer by the transferor) was not part
of a transaction or a series of related transactions in which the
seller (or transferor) previously acquired the intangible or
interest therein.
(5) Special partnership provisions--(i) Basis increases. In
determining whether the anti-churning rules of this paragraph (h)
apply to any increase in the basis of partnership property under
section 732, 734, or 743, the determinations are made at the
partner level and each partner is treated as having owned and
used the partner s proportionate share of the partnership
property. Thus, for example, the anti-churning rules do not
apply to an increase in the basis of partnership property under
section 743(b) that occurs upon the acquisition of an interest in
a partnership that has made a section 754 election if the person
acquiring the partnership interest either is not related to the
person transferring the partnership interest or acquired the
interest upon the death of the former partner. Similarly, the
anti-churning rules do not apply to a continuing partner s
proportionate share of an increase in the basis of partnership
property under section 734(b) that occurs upon the distribution
of property of a partnership that has made a section 754 election
if the continuing partner is not related to the distributee
partner.
(ii) Curative and remedial allocations under section 704(c).
In determining whether the anti-churning rules of this paragraph
(h) apply, any curative or remedial allocation of amortization
made to a noncontributing partner under the curative or remedial
methods for making allocations under section 704(c) is treated in
the same manner as a noncurative or nonremedial allocation of
amortization. Thus, for example, if the anti-churning rules
would apply to a nonremedial allocation of amortization to a
noncontributing partner, the anti-churning rules apply to any
remedial allocation of amortization. See 1.704-3(c) and (d) for
a description of the curative and remedial methods.
(6) Related person--(i) In general. Except as otherwise
provided in paragraph (h)(6)(iii) of this section, a person is
related to another person for purposes of this paragraph (h) if--
(A) The person bears a relationship to that person that
would be specified in section 267(b) (determined without regard
to section 267(e)) and, by substitution, section 267(f)(1), if
those sections were amended by substituting 20 percent for 50
percent; or
(B) The person bears a relationship to that person that
would be specified in section 707(b)(1) if that section was
amended by substituting 20 percent for 50 percent; or
(C) The persons are engaged in trades or businesses under
common control (within the meaning of section 41(f)(1)(A) and
(B)).
(ii) Time for testing relationships. For purposes of this
paragraph (h), a person is treated as related to another person
if the relationship exists--
(A) In the case of a single transaction, immediately before
or immediately after the acquisition of the intangible involved;
or
(B) In the case of a series of related transactions, at any
time during the period beginning immediately before the earliest
acquisition and ending immediately after the last acquisition of
any intangible acquired in the series of transactions.
(iii) De minimis rule--(A) In general. Two corporations
shall not be treated as related persons for purposes of this
paragraph (h)(6) if--
(1) The corporations would (but for the application of this
paragraph (h)(6)(iii)) be treated as related persons solely by
reason of substituting more than 20 percent for more than 50
percent in section 267(f)(1)(A); and
(2) The beneficial ownership interest of one corporation in
the stock of the other corporation represents less than 10
percent of the total combined voting power of all classes of
stock entitled to vote and less than 10 percent of the total
value of the shares of all classes of stock outstanding.
(B) Determination of beneficial ownership interest. For
purposes of this paragraph (h)(6)(iii), the beneficial ownership
interest of one corporation in the stock of another corporation
shall be determined under the principles of section 318(a),
except that--
(1) In applying section 318(a)(2)(C), the 50 percent
limitation contained therein shall not be applied; and
(2) Section 318(a)(3)(C) shall be applied by substituting
20 percent for 50 percent .
(7) Special rules for entities that owned or used property
at any time during the transition period and that are no longer
in existence. A corporation, partnership, or trust that owned or
used property at any time during the transition period and that
is no longer in existence is deemed to be in existence for
purposes of determining whether the taxpayer that acquired the
property is related to the corporation, partnership, or trust.
(8) Special rules for section 338 deemed acquisitions. In
the case of a qualified stock purchase that is treated as a
deemed sale and purchase of assets pursuant to section 338, the
corporation that is treated as selling its assets as a result of
an election thereunder (old target) is not considered related to
the corporation that is treated as purchasing the assets (new
target) if stock of old target meeting the requirements of
section 1504(a)(2) is, or is deemed to have been, acquired by
purchase after July 25, 1991. See 1.338-2(d). Thus, for
example, if a corporation (the purchasing corporation) makes a
qualified stock purchase of the stock of another corporation
(target) from unrelated third parties in July 1997, and a section
338 election is made by the purchasing corporation, the deemed
asset purchase shall not be considered as an acquisition between
related persons solely by virtue of the fact that old target and
new target are treated as the same corporation for certain other
purposes of the Code or that old target and new target are the
same corporation under the laws of the state or other
jurisdiction of its organization. However, the anti-churning
rules of this paragraph (h) may nevertheless apply to a deemed
asset purchase resulting from a section 338 election because old
target and new target are otherwise treated as related parties
within the meaning of paragraph (h)(6) of this section.
(9) Exception to anti-churning rules where gain is
recognized--(i) In general. If a taxpayer would not be subject
to paragraph (h) but for the substitution of 20 percent for 50
percent under paragraph (h)(6)(i)(A) of this section and the
person (whether or not subject to Federal income tax) from which
the taxpayer acquires the intangible elects to recognize gain on
the disposition of the intangible and, notwithstanding any other
provision of the Internal Revenue Code, agrees to pay an amount
that, when added to any other Federal income tax, equals the gain
on the disposition multiplied by the highest marginal rate of tax
imposed by section 1 (for individuals, estates, or trusts) or 11
(for corporations), whichever is applicable, for the taxable year
in which the gain is realized by the person from which the
taxpayer acquires the intangible, then the anti-churning rules
described in this paragraph (h) only apply to the extent the
taxpayer s adjusted basis in the intangible exceeds the gain
recognized.
(ii) Manner of making election. [Reserved]
(iii) Determination of highest marginal rate of tax. For
the purpose of determining the highest marginal rate of tax
applicable to the person from which the taxpayer acquires the
intangible, the following rules shall apply:
(A) Noncorporate taxpayers. In the case of an individual,
estate, or trust, the highest marginal rate of tax shall be the
highest marginal rate of tax in effect under section 1,
determined without regard to section 1(h).
(B) Corporations and tax-exempt entities. In the case of a
corporation or an entity that is exempt from tax under section
501(a), the highest marginal rate of tax shall be the highest
marginal rate of tax in effect under section 11, determined
without regard to any rate that is added to the otherwise
applicable rate in order to offset the effect of the graduated
rate schedule.
(iv) Special rule for pass-through entities. In the case of
a partnership or S corporation, the election under paragraph
(h)(9)(i) of this section--
(A) Shall be made by the entity rather than by its owners or
members; and
(B) Shall constitute an election by each of the owners or
members of the entity (rather than the entity itself) to pay a
tax, determined as provided in this paragraph (h)(9), on the
portion of the gain properly allocable to each such owner or
member.
(v) Coordination with other provisions--(A) In general. For
purposes of applying any provision of chapter 1 or chapter 6 of
the Code other than section 197(f)(9)(B), both the amount of gain
subject to the tax determined under paragraph (h)(9)(i) of this
section and the amount of the tax shall be disregarded. Thus,
for example, the amount of the gain shall not be reduced by any
net operating loss deduction under section 172(a), any capital
loss under section 1212, or any other similar loss or deduction.
The amount of tax determined under paragraph (h)(9)(i) of this
section shall not be reduced by any credit of the taxpayer. In
computing the amount of any net operating loss, capital loss, or
other similar loss or deduction, or any credit that may be
carried to any taxable year, any gain recognized, and any tax
paid, under paragraph (h)(9)(i) of this section shall not be
taken into account.
(B) Section 1374. No provision of paragraph (h)(9)(iv) of
this section shall preclude the application of section 1374
(relating to a tax on certain built-in gains of S corporations)
to any gain with respect to which the election described in
paragraph (h)(9)(i) of this section is made. Neither paragraph
(h)(9)(iv) nor paragraph (h)(9)(v)(A) of this section shall be
treated as precluding a taxpayer from applying the provisions of
section 1366(f)(2) (relating to treatment of the tax imposed by
section 1374 as a loss sustained by the S corporation) in
determining the amount of tax payable under paragraph (h)(9)(i)
of this section.
(C) Procedural and administrative provisions. For purposes
of subtitle F, the amount determined under paragraph (h)(9)(i) of
this section is treated as a tax imposed by section 1 or 11, as
appropriate.
(D) Installment method. The gain subject to the tax
determined under paragraph (h)(9)(i) of this section may not be
reported under the method described in section 453(a). Any such
gain that would, but for the application of this paragraph
(h)(9)(v)(D), be taken into account under section 453(a) shall be
taken into account in the same manner as if an election under
section 453(d) (relating to the election not to apply section
453(a)) had been made.
(10) Transactions subject to both anti-churning and
nonrecognition rules. If a person acquires a section 197
intangible in a transaction described in paragraph (g)(2) of this
section from a person in whose hands the intangible was an
amortizable section 197 intangible, and as a result of the
transaction, the person is or becomes related to any person
described in paragraph (h)(1) of this section, the intangible
ceases to be an amortizable section 197 intangible in the hands
of the transferee unless the exception provided in paragraph
(h)(4)(ii) of this section applies. If a person acquires a
section 197 intangible in anticipation of becoming related to any
person described in paragraph (h)(1) of this section, the
intangible is not an amortizable section 197 intangible in the
hands of the transferee.
(11) Anti-churning anti-abuse rule. Section 197 does not
apply to any intangible acquired by a taxpayer if the taxpayer
acquires the intangible in a transaction one of the principal
purposes of which is to avoid any of the anti-churning rules for
intangibles described in paragraph (h)(1) of this section. Thus,
for example, if section 197 intangibles are acquired in a
transaction (or series of related transactions) in which options
to acquire stock are issued to a party to the transaction, but
the option is not treated as having been exercised for purposes
of paragraph (h)(6) of this section, this paragraph (h)(11) may
apply to the transaction.
(i) [Reserved].
(j) General anti-abuse rule. The rules in this section
shall be interpreted and applied as necessary and appropriate to
prevent avoidance of the purposes of section 197. If one of the
principal purposes of a transaction is to achieve a tax result
that is inconsistent with the purposes of section 197, the
Commissioner can recast the transaction for Federal tax purposes
as appropriate to achieve tax results that are consistent with
the purposes of section 197, in light of the applicable statutory
and regulatory provisions and the pertinent facts and
circumstances.
(k) Examples. The following examples illustrate the
application of this section:
Example 1. Computer software. (i) X purchases all of the
assets of an existing trade or business from Y. One of the
assets acquired is all of Y s rights in certain computer software
previously used by Y under the terms of a nonexclusive license
from the software developer. The software was developed for use
by manufacturers to maintain a comprehensive accounting system,
including general and subsidiary ledgers, payroll, accounts
receivable and payable, cash receipts and disbursements, fixed
asset accounting, and inventory cost accounting and controls.
The software was not substantially modified for use by Y within
the meaning of paragraph (c)(4)(i) of this section and was
acquired directly by Y from the developer. The developer does
not maintain wholesale or retail outlets but markets the software
directly to ultimate users. Y's license of the software is
limited to an entity that is actively engaged in business as a
manufacturer.
(ii) Notwithstanding these limitations, the software is
considered to be readily available to the general public for
purposes of paragraph (c)(4)(i) of this section. Accordingly,
the software is not a section 197 intangible.
Example 2. Governmental rights of fixed duration. (i) City
M operates a municipal water system. In order to induce X to
locate a new manufacturing business in the city, M grants X the
right to purchase water for 16 years at a specified price. X
incurs legal fees and other costs for professional services in
the amount of $10x in connection with its efforts to obtain these
rights.
(ii) The rights granted by M are described in section
197(e)(4)(B) and paragraph (c)(6) of this section and, thus, are
not a section 197 intangible. This exclusion applies
notwithstanding that the rights may not qualify for exclusion
under section 197(e)(4)(D) and paragraph (c)(13) of this section
or that they also may be described in section 197(d)(1)(D) and
paragraph (b)(8) of this section and, as such, may not be treated
as self-created intangibles eligible for exclusion under section
197(c)(2).
Example 3. Advertising costs. (i) Q manufactures and sells
consumer products through a series of wholesalers and
distributors. In order to increase sales of its product by
encouraging consumer loyalty to its products and to enhance the
value of the goodwill, trademarks, and trade names of the
business, Q advertises its products to the consuming public. It
regularly incurs costs to develop radio, television, and print
advertisements. These costs generally consist of employee costs
and amounts paid to independent advertising agencies. Q also
incurs costs to run these advertisements in the various media for
which they were developed. Except for the possible application
of section 197, these costs would be ordinary and necessary
expenses deductible under section 162.
(ii) The advertising costs are not subject to amortization
under section 197 pursuant to paragraph (a)(3) of this section
because they are otherwise deductible.
Example 4. Covenant not to compete acquired in connection
with stock redemption. (i) R, a corporation, redeems all of its
stock owned by A, an individual. R and A have no business
relationships with each other except for the corporate-
shareholder relationship. In connection with the stock
redemption, R and A enter into an agreement containing a covenant
not to compete. Under this agreement, A agrees that A will not
compete with the business of R within a prescribed geographical
territory for a period of three years after the date on which the
stock redemption is completed. In exchange for this agreement, R
pays A consideration in addition to the amount paid for the stock
redeemed by R.
(ii) Because the agreement was entered into in connection
with the reacquisition by R of its stock, section 162(k) provides
that no deduction shall be allowed for any amount paid or
incurred pursuant to the agreement. Accordingly, pursuant to
paragraph (a)(4) of this section, section 197 does not apply to
these amounts.
Example 5. Substantial portion of trade or business. (i) S
owns and operates 100 restaurants in various locations. Each of
these restaurants is operated using a well-established trade name
made available to S under the terms of a franchise agreement with
F. S determined to cease operating one of the franchised
restaurants. Accordingly, S sold to B all of the assets that it
had used exclusively in connection with the operation of its
restaurant at that location. B agreed to extend an offer of
employment to all of the employees at that location. B acquired
no rights to the franchise or to any of the trademarks or trade
names that had been used by S.
(ii) The transaction between B and S is a transaction
involving the acquisition of assets constituting a trade or
business or a substantial portion thereof within the meaning of
paragraph (e) of this section, notwithstanding that B did not
acquire a franchise from S or that the assets did not represent a
substantial portion of the assets used by S in that trade or
business.
Example 6. Separate acquisition of franchise. (i) S is a
franchisor of retail outlets for specialty coffees. On July 1,
1997, G enters into an agreement with S pursuant to which G is
permitted to acquire and operate a store using the S trademark
and trade name at the location specified in the agreement. G
agrees to pay S $100,000 upon execution of the agreement and also
agrees to pay, on a monthly basis throughout the term of the
franchise, a specified percentage of gross sales from the store.
The agreement contains detailed specifications for the
construction and operation of the business, but G is not required
to purchase from S any of the materials necessary to construct
the improvements at the location specified in the franchise
agreement.
(ii) The franchise is a section 197 intangible within the
meaning of paragraph (b)(10) of this section. The franchise does
not qualify for the exclusion relating to self-created
intangibles described in section 197(c)(2) and paragraph (d)(2)
of this section because the franchise is described in section
197(d)(1)(F). In addition, because the acquisition of the
franchise constitutes the acquisition of an interest in a trade
or business or a substantial portion thereof, the franchise may
not be excluded under section 197(e)(4). Thus, the franchise is
an amortizable section 197 intangible, the basis of which must be
recovered over a 15-year period. However, the amounts to be paid
by G computed as a percentage of gross sales are not subject to
the provisions of section 197 by reason of section 197(f)(4)(C)
and paragraph (b)(10)(ii) of this section.
Example 7. Acquisition and amortization of covenant not to
compete. (i) As part of the acquisition of a trade or business
from C, B and C enter into an agreement containing a covenant not
to compete. Under this agreement, C agrees that it will not
compete with the business acquired by B within a prescribed
geographical territory for a period of three years after the date
on which the business is sold to B. In exchange for this
agreement, B agrees to pay C $90,000 per year for each year in
the term of the agreement. The agreement further provides that,
in the event of a breach by C of his obligations under the
agreement, B may terminate the agreement, cease making any of the
payments due thereafter, and pursue any other legal or equitable
remedies available under applicable law. Assume that the amounts
payable to C under the agreement represent the value of C s
obligations to B pursuant to the covenant and that the present
fair market value of B s rights under the agreement is $225,000.
The aggregate consideration paid for all assets acquired in the
transaction other than the covenant exceeds the sum of the amount
of Class I assets and the aggregate fair market value of all
Class II and Class III assets and all Class IV assets other than
the covenant.
(ii) Because the covenant is acquired in an applicable asset
acquisition (within the meaning of section 1060(c)), the basis of
B in the covenant cannot exceed its fair market value. See
1.1060-1T(e)(1). Under section 197(f)(3) and paragraphs
(f)(3)(i) and (4) of this section, the adjusted basis of B in the
agreement, determined as of the date on which the agreement is
entered into, is $225,000. B s deduction for amortization with
respect to the amounts to be paid under the agreement is $1,250
per month, or $15,000 per year, for each year in the 15-year
period beginning on the date on which the agreement is entered
into. The excess of the amounts payable pursuant to the
agreement over the amount allocated to the covenant under
1.1060-1T(e)(1), or $45,000, is allocated to Class V assets.
Example 8. Breach of covenant not to compete subsequent to
acquisition. (i) The facts are the same as in Example 7, except
that at the end of the second year of the agreement, C breaches
the agreement by competing against B. B and C enter into a
settlement of all claims arising under the agreement and the
subsequent breach by C by agreeing that B is not obligated to pay
C the final installment of $90,000.
(ii) Under paragraph (g)(1)(iii) of this section, the
covenant is not treated as having been disposed of (or becoming
worthless) because C has not disposed of all interests in the
trade or business acquired in the same transaction as the
covenant. The covenant is not a contingent income asset within
the meaning of 1.1060-1T(f)(4)(i). Accordingly, B must decrease
the adjusted basis of any asset acquired from C by $90,000 at the
beginning of the third year of the agreement in the manner
provided by 1.1060-1T(f)(3)(i). To the extent that any decrease
is allocated to an amortizable section 197 intangible, B must
reduce the amount of its deduction for amortization under section
197 accordingly.
Example 9. Loss disallowance rules involving related
persons. (i) Assume that X and Y are treated as a single
taxpayer for purposes of paragraph (g)(1)(iv) of this section.
In a single transaction, X and Y acquired from Z all of the
assets used by Z in a trade or business. Z had operated this
business at two locations, and X and Y each desired to acquire
the assets used by Z at one of the locations. Three years after
the acquisition, X sold all of the assets, including amortizable
section 197 intangibles, to an unrelated purchaser at a loss of
$120,000.
(ii) Because X and Y are treated as a single taxpayer for
purposes of the loss disallowance rules of section 197(f)(1) and
paragraph (g)(1) of this section, X may not recognize its loss on
the sale of the amortizable section 197 intangibles. Under
paragraph (g)(1)(iv) of this section, X must amortize its
disallowed loss under section 197, and Y may not increase its
adjusted basis in its amortizable section 197 intangibles by the
amount of the realized loss of X that is disallowed. X must
amortize the disallowed loss over the remainder of the
amortization period for the amortizable section 197 intangibles
it sold. Accordingly, X must amortize the disallowed loss at the
rate of $10,000 per year (or $833 per month) for each of the 12
years remaining in the 15-year period.
Example 10. Disposition of retained intangibles by related
person. (i) The facts are the same as in Example 9, except that
10 years after the acquisition of the assets by X and Y and seven
years after the sale of the assets by X, Y sells all of the
assets acquired from Z, including amortizable section 197
intangibles, to an unrelated purchaser.
(ii) Upon the sale of assets by Y, X may recognize a loss
equal to the unamortized loss. Accordingly, pursuant to
paragraph (g)(1)(iv) of this section, X may recognize a loss in
the amount of $50,000, the amount obtained by reducing the loss
on the sale of the assets at the end of the third year ($120,000)
by the amount of amortization allowed for the fourth through the
tenth years ($70,000).
Example 11. Acquisition of an interest in partnership with
no section 754 election. (i) A, B, and C each contribute $1,500
for equal shares in general partnership P. On January 1, 1998, P
acquires as its sole asset an amortizable section 197 intangible
for $4,500. P still holds the intangible on January 1, 2003, at
which time the intangible has an adjusted basis to P of $3,000,
and A, B, and C each have an adjusted basis of $1,000 in their
partnership interests. D (who is not related to A) acquires A s
interest in P for $1,600. No section 754 election is in effect
for 2003.
(ii) Pursuant to paragraph (h)(5)(i) of this section, there
is no change in the basis or amortization of the intangible and D
merely steps into the shoes of A with respect to the intangible.
D s proportionate share of P s adjusted basis in the intangible
is $1,000, which continues to be amortized over the 10 years
remaining in the original 15-year amortization period for the
intangible.
Example 12. Acquisition of an interest in partnership with
a section 754 election. (i) The facts are the same as in
Example 11, except that a section 754 election is in effect for
2003.
(ii) Pursuant to section 197(f)(9)(E) and paragraph
(h)(5)(i) of this section, for purposes of section 197, D is
treated as if P owns two assets. D s proportionate share of P s
adjusted basis in one asset is $1,000, which continues to be
amortized over the 10 years remaining in the original 15-year
amortization period. For the other asset, D s proportionate
share of P s adjusted basis is $600 (the amount of the basis
increase under section 743 as a result of the section 754
election), which is amortized over a new 15-year period beginning
January 2003. With respect to B and C, P s remaining $2,000
adjusted basis in the intangible continues to be amortized over
the 10 years remaining in the original 15-year amortization
period.
Example 13. Payment to a retiring partner by partnership
with a section 754 election. (i) The facts are the same as in
Example 11, except that a section 754 election is in effect for
2003 and, instead of D acquiring A s interest in P, A retires
from P. A, B, and C are not related to each other within the
meaning of paragraph (h)(6) of this section. A receives a
payment under section 736 from P of $1,600, all of which is in
exchange for A s interest in the intangible asset owned by P.
(ii) Pursuant to paragraph (h)(5)(i) of this section,
because of the section 734 adjustment, P is treated as having two
amortizable section 197 intangibles, one with a basis of $3,000
and a remaining amortization period of 10 years and the other
with a basis of $600 and a new amortization period of 15 years.
Example 14. Termination of partnership under section
708(b)(1)(B). (i) A and B are partners with equal shares in the
capital and profits of general partnership P. P s only asset is
an amortizable section 197 intangible, which P had acquired on
January 1, 1994. On January 1, 1999, the asset had a fair market
value of $100 and a basis to P of $50. On that date, A sells his
entire partnership interest in P to C, who is unrelated to A, for
$50. At the time of the sale, the basis of each of A and B in
their respective partnership interests is $25.
(ii) The sale causes a termination of P under section
708(b)(1)(B). Under section 708, the transaction is treated as
if P transfers its sole asset to a new partnership in exchange
for the assumption of its liabilities and the receipt of all of
the interests in the new partnership. Immediately thereafter, P
is treated as if it is liquidated, with B and C each receiving
their proportionate share of the interests in the new
partnership. The contribution by P of its asset to the new
partnership is governed by section 721, and the liquidating
distributions by P of the interests in the new partnership are
governed by section 731. However, C does not realize a special
basis adjustment under section 743 with respect to the
amortizable section 197 intangible unless P had a section 754
election in effect for its taxable year in which the deemed
transfer of the asset to the new partnership occurred.
(iii) Under section 197, if P had a section 754 election in
effect for its taxable year in which the deemed transfer of the
asset to the new partnership occurred, C is treated as if the new
partnership had acquired two assets from P immediately preceding
its termination. Even though the adjusted basis of the new
partnership in the two assets is determined solely under section
723, because the transfer of assets is a transaction described in
section 721, the application of sections 743(b) and 754 to P
immediately before its termination causes P to be treated as if
it held two assets, for purposes of section 197, at this time.
B s and C s proportionate share of the new partnership s adjusted
basis is $25 each in one asset, which continues to be amortized
over the 10 years remaining in the original 15-year amortization
period. For the other asset, C s proportionate share of the new
partnership s adjusted basis is $25 (the amount of the basis
increase resulting from the application of section 743 to the
sale or exchange by A of the interest in P), which is amortized
over a new 15-year period beginning in January 1999.
(iv) If P did not have a section 754 election in effect for
its taxable year in which the sale of the partnership interest by
A to C occurred, the adjusted basis of the new partnership in the
amortizable section 197 intangible is determined solely under
section 723, because the transfer is a transaction described in
section 721, and P does not have a basis increase in its section
197 intangible. Under section 197(f)(2) and paragraph (g)(2) of
this section, the new partnership continues to amortize the
amortizable section 197 intangible over the 10 years remaining in
the original 15-year amortization period. No additional
amortization is allowable with respect to this asset under
section 197.
Example 15. Disguised sale to partnership. (i) Assume that
E and F are individuals who are unrelated to each other within
the meaning of paragraph (h)(6) of this section. E has been
engaged in the active conduct of a trade or business as a sole
proprietor since 1990. E and F form EF Partnership. E transfers
all of the assets of the business, having a fair market value of
$100x, to EF, and F transfers $40x of cash to EF. E receives a
60 percent interest in EF and the $40x of cash contributed by F,
and F receives a 40 percent interest in EF, under circumstances
in which the transfer by E is treated as a sale of property to EF
under 1.707-3(b).
(ii) Under 1.707-3(a)(1), the transaction is treated as if
E had sold to EF a 40 percent interest in each asset for $40x and
contributed the remaining 60 percent interest in each asset to EF
in exchange solely for an interest in EF. Because E and EF are
related persons within the meaning of paragraph (h)(6) of this
section, no portion of any transferred section 197 intangible
that E held during the transition period (as defined in paragraph
(h)(3) of this section) is an amortizable section 197 intangible
pursuant to paragraph (h)(1) of this section. Section
197(f)(9)(E) and paragraph (h)(5) of this section do not apply to
any portion of the section 197 intangible in the hands of EF
because the basis of EF in these assets was not increased under
any of sections 732, 734, or 743.
Example 16. Acquisition by related person in nonrecognition
transaction. (i) A owns a nonamortizable intangible that A
acquired in 1990. In 1997, A sells a one-half interest in the
intangible to B for cash. Immediately after the sale, A and B,
who are unrelated to each other, form partnership P as equal
partners. A and B each contribute their one-half interest in the
intangible to P.
(ii) P has a transferred basis in the intangible from A and
B under section 723. The nonrecognition transfer rule under
paragraph (g)(2)(i) of this section applies to A s transfer of
its one-half interest in the intangible to P, and consequently P
steps into A s shoes with respect to A s nonamortizable
transferred basis. The anti-churning rules of paragraph
(h)(1)(i) of this section apply to B s transfer of its one-half
interest in the intangible to P, because A, who is related to P
under paragraph (h)(6) of this section, held B s one-half
interest in the intangible during the transition period.
Pursuant to paragraph (h)(10) of this section, these rules apply
to B s transfer of its one-half interest to P even though the
nonrecognition transfer rule under paragraph (g)(2)(i) of this
section would have permitted P to step into B s shoes with
respect to B s otherwise amortizable basis. Therefore, P s
entire basis in the intangible is nonamortizable.
Example 17. Acquisition of partnership interest following
formation of partnership. (i) The facts are the same as in
Example 16 except that, in 1996, A formed P with an affiliate and
contributed the intangible to the partnership and except that
thereafter, in an unrelated transaction, B purchases a 50 percent
interest in P. P has a section 754 election in effect.
(ii) For the reasons set forth in Example 14(iii), B is
treated as if P owns two assets. B s proportionate share of P s
adjusted basis in one asset is the same as A s proportionate
share of P s adjusted basis in that asset, which is not
amortizable under section 197. For the other asset, B s
proportionate share of the remaining adjusted basis of P is
amortized over a new 15-year period.
Example 18. Acquisition by related corporation in
nonrecognition transaction. (i) The facts are the same as
Example 16, except that P is a corporation.
(ii) P has a transferred basis in the intangible from A and
B under section 362. Pursuant to paragraph (h)(10) of this
section, the application of the nonrecognition transfer rule
under paragraph (g)(2)(i) and the anti-churning rules of
paragraph (h)(1)(i) of this section to the facts of this Example
18 is the same as in Example 16. Thus, P s entire basis in the
intangible is nonamortizable.
Example 19. Acquisition from corporation related to
purchaser through remote indirect interest. (i) X, Y, and Z are
each corporations that have only one class of issued and
outstanding stock. X owns 25 percent of the stock of Y and Y
owns 25 percent of the outstanding stock of Z. No other
shareholder of any of these corporations is related to any other
shareholder or to any of the corporations. On June 30, 1997, X
purchases from Z section 197 intangibles that Z owned during the
transition period (as defined in paragraph (h)(3) of this
section).
(ii) Pursuant to paragraph (h)(6)(iii)(B) of this section,
the beneficial ownership interest of X in Z is 6.25 percent,
determined by treating X as if it owned a proportionate (25
percent) interest in the stock of Z that is actually owned by Y.
Thus, even though X is related to Y and Y is related to Z, X and
Z are not considered to be related for purposes of the anti-
churning rules of section 197.
Example 20. Gain recognition election. (i) B owns 25
percent of the stock of S, a corporation that uses the calendar
year as its taxable year. No other shareholder of B or S is
related to each other. S is not a member of a controlled group
of corporations within the meaning of section 1563(a). S has
section 197 intangibles that it owned during the transition
period and was not permitted to amortize or depreciate under any
other provision of the Code. S had a basis of $25,000 in the
intangibles. In 1997, S sells these intangibles to B for
$75,000. S recognizes a gain of $50,000 on the sale and has no
other items of income, deduction, gain, or loss for the year,
except that S also has a net operating loss of $20,000 from prior
years that it would otherwise be entitled to use in 1997 pursuant
to section 172(b). As part of the transaction with B, S agrees
to make the gain recognition election pursuant to section
197(f)(9)(B).
(ii) If the gain recognition election had not been made, S
would have taxable income of $30,000 for 1997 and a tax liability
of $4,500. As the result of the election, S must pay a total tax
liability for the year of $17,500 (35 percent of $50,000),
consisting of the sum of its regular tax liability of $4,500 and
the additional amount of $13,000 pursuant to section
197(f)(9)(B).
(iii) Pursuant to paragraph (h)(9)(v)(A) of this section, S
determines the amount of its net operating loss deduction in
subsequent years without regard to the gain recognized on the
sale of the section 197 intangible to B. Accordingly, the entire
$20,000 net operating loss deduction that would have been
available in 1997 but for the gain recognition election may be
used in 1998, subject to the limitations of section 172.
(iv) B has a basis of $75,000 in the section 197 intangibles
acquired from S. As the result of the gain recognition election
by S, B may amortize $50,000 of its basis under section 197. The
remaining basis may not be amortized by B.
Example 21. Section 338 election. (i) P corporation makes
a qualified stock purchase of the stock of T corporation from two
shareholders in July 1997, and a section 338 election is made by
P. One of the selling shareholders is an individual who owns 25
percent of the total value of the stock of each of the T and P
corporation. No other shareholder of either T or P owns stock in
both of these corporations, and no other shareholder is related
to any other shareholder of either corporation.
(ii) Old target and new target (as these terms are defined
in 1.338-1(c)(13)) are members of a controlled group of
corporations under section 267(b)(3), as modified by section
197(f)(9)(C)(i), and any section 197 intangible held by old
target at any time during the transition period is not an
amortizable section 197 intangible in the hands of new target.
However, a gain recognition election under paragraph (h)(9)(i) of
this section may be made with respect to this transaction.
(l) Effective dates. This section is applicable on the date
final regulations are published in the Federal Register, except
that 1.197-2(c)(13) (exception from section 197 for separately
acquired rights of fixed duration or amount) is applicable August
11, 1993 (or July 26, 1991, if a valid retroactive election has
been made under 1.197-1T).
Margaret Milner Richardson
Commissioner of Internal Revenue