Intangibles - amortization recapture and allocation of sales price.

• Author: Sites, David

Tax practitioners should exercise diligence when advising clients on dispositions of Sec. 197 intangibles. The rules regarding the character of income recognized on such dispositions require detailed analysis, especially in light of the Energy Tax Act of 2005 (ETA).

Amortizable Sec. 197 Intangibles

Sec. 197(a) entitles taxpayers to a deduction on amortizable Sec. 197 intangibles, determined by amortizing the intangible's adjusted basis over 15 years, beginning with the month it was acquired. Sec. 197(c) defines "amortizable Sec. 197 intangible" as any "Sec. 197 intangible" held in connection with the conduct of a trade or business or an activity described in Sec. 212. Sec. 197(d) and (e) define "197 intangible" and exceptions. The term "amortizable Sec. 197 intangible" does not include intangibles created by a taxpayer; see Sec. 197(c)(2)(B). Thus, for a taxpayer to be entitled to an amortization deduction on an amortizable Sec. 197 intangible, generally, it must have purchased the intangible. Further, amortization deductions are precluded under some circumstances by Sec. 197(f)(9)'s anti-churning rules.

Ordinary Income Recapture

When a taxpayer disposes of an amortizable Sec. 197 intangible, recapture rules may require treating any resulting gain as ordinary income. Sec. 1245(a)(1) provides that if Sec. 1245 property is disposed of at a gain, the transaction may result in ordinary income. Sec. 1245(a)(3) describes Sec. 1245 property, in part, as personal property, used in a trade or business, which is, or has been, subject to a depreciation allowance under Sec. 167. Under Sec. 197(f)(7), an amortizable Sec. 197 intangible is treated as property subject to the allowance for depreciation under Sec. 167. Regs. Sec. 1.197-2(g)(8) further clarifies that an amortizable Sec. 197 intangible is Sec. 1245 property.

In most transactions, the amount of ordinary income recognized under Sec. 1245 for an item of property equals the lesser of the gain on the particular item of Sec. 1245 property or the amount previously allowed (or allowable) as depreciation or amortization deductions on the property being disposed. Sec. 1245 applies to property disposed of at a gain, but not at a loss. According to Regs. Sec. 1.1245-1 (a), the "... amount of such gain shall be determined separately for each item of Sec. 1245 property." Thus, even if the sale of multiple items of Sec. 1245 property, as a whole, yields no gain (or even a loss), the operation of Sec. 1245...