A franchise, whether self‑created or acquired by purchase or other transfer, is
and therefore excluded from the denition of a “capital
asset” under I.R.C. §1221.
Because franchise rights are used in a trade or busi‑
ness, however, if these franchise rights are disposed of in a taxable disposition,
the gain or loss realized will be subject to the special rules of I.R.C. §1231, which
generally provides that gains are treated as long‑term capital gains and losses as
For a transferor other than a C corporation, favorable capital
gains rates would apply to net section 1231 gains (subject to the other special rules
for determining the amount of and tax on capital gains under I.R.C. subchapter P,
I.R.C. §§1201 et seq.), currently generally 15 percent.7 Under current law, corporate
net capital gain is generally taxed at the same rate as ordinary income.8 Moreover,
granted by a governmental unit or an agency or instrumentality thereof” is an “amortiz‑
able section 197 intangible”). Sports franchises and player contracts were excluded from
the denition of “amortizable section 197 intangible” for transfers prior to October 22,
2004. (Pub. L. 108‑357, Sec. 886(a)).
4. I.R.C. §197(d)(1)(F) (Lexis 2013) (a franchise is an “amortizable section 197 intan‑
gible”); id. §197(f)(7) (amortizable section 197 intangibles “shall be treated as property
which is of a character subject to the allowance for depreciation provided in section 167”).
5. Id. §1221(a)(2). Notice that a franchise, when transferred as part of a business,
will virtually never be a capital asset, even if self‑created, unlike nearly all other self‑cre‑
ated intangibles. Self‑created intangibles, with three exceptions, are excluded from the
denition of “amortizable section 197 intangibles.” Id. §197(c)(2). Franchises are one
of the exceptions. Id. §197(c)(2)(A). Accordingly, costs of developing a franchise must
be amortized over 15 years, even if they might otherwise be currently deductible. See
Treas. Reg. §1.197‑2(d)(2)(iii)(A) (as amended in 2013) (“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.”).
As explained in the text and the following note, gain on disposition of a franchise may
nevertheless be treated as capital gain in many circumstances. Franchises that escape
amortization by reason of being held for sale as inventory are ipso facto not capital assets
and therefore not eligible for capital gain treatment. Under current law, only a franchise
that is never amortized and is sold in isolation from any other assets is likely to have a
chance for classication as a capital asset.
6. The computation is somewhat more complex than this. If gains from section 1231
assets exceed losses from such assets, they are both treated as long‑term capital items
(netted, along with other capital gains and losses in accordance with the rules under
subchapter P of the I.R.C.) (I.R.C. §§1201 et seq., Lexis 2013). Otherwise, both gains and
losses are treated as items of ordinary income or loss. These computations are done before
taking into account carryover of losses, if any, from other years. Moreover, net section
1231 gains for a year will be treated as ordinary to the extent the taxpayer had net sec‑
tion 1231 losses in any of the ve years preceding the year of net section 1231 gains. An
amortizable section 197 intangible is also “section 1245 property,” and therefore subject
to the general rules applicable to recapture of depreciation as ordinary income in speci‑
ed circumstances. Finally, I.R.C. §1239 will apply to any gain recognized upon the sale or
exchange of a franchise to certain “related persons” (as dened in I.R.C. §1239(b) (Lexis
2013)), resulting in ordinary‑income treatment.
7. For noncorporate taxpayers in a bracket below 25 percent, the rate applicable
to net capital gain is ve percent (zero percent through 2012).
8. The same rate applies to S corporations with built‑in gains. See I.R.C. §1374 (Lexis
177Income Tax Considerations
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