Maximizing Sec. 197 amortization in partnership transactions.

• Author: Garre, Karen
• Position: IRC s. 197

Sec. 197 generally allows for amortization of purchased intangibles (including goodwill and going-concern value) acquired after its Aug. 10, 1993 effective date. Sec. 197 and January 1997 proposed regulations contain rules that prevent taxpayers from converting pre-1993 goodwill and going-concern value (pre-1993 intangible assets) and self-created intangible assets into amortizable Sec. 197 intangibles, through the use of certain partnership transactions. These rules can prevent a taxpayer that acquires an interest in a partnership that holds these types of intangibles (the buyer) from claiming amortization deductions for his share of the partnership's intangibles, even when the buyer is unrelated to the taxpayer disposing of a portion of the pre-1993 goodwill or going-concern value or self-created intangible (the seller).

Three rules under Sec. 197 affect partners' ability to amortize pre-1993 and self-created goodwill.

"Step-into-the-shoes" rule. According to Sec. 197(f)(2), if a Sec. 197 intangible is contributed to a partnership in a Sec. 721 transaction, the partnership is treated as the contributing partner with respect to as much of the intangible as does not exceed the contributing partner's tax basis in the intangible. Thus, if the intangible is not amortizable in the contributing partner's hands, it is generally not amortizable in the partnership's hands.

Anti-churning rules. The anti-churning rules prohibit taxpayers from claiming amortization from intangibles that were not amortizable before the enactment of Sec. 197 (e.g., goodwill and going-concern value). The anti-churning rules apply if a taxpayer acquires pre-1993 intangibles and the taxpayer or a related person holds or uses the intangibles before Sec. 197's effective date. A partnership is considered related to any partner that owns 20% or more of the interests in partnership capital or profits. Thus, if a seller retains a 20% or greater interest in the partnership, the anti-churning rules apply.

Practitioners have questioned whether it is appropriate to bifurcate pre- and post-1993 intangibles for purposes of applying the anti-churning rules. The common concern is that if a small amount of pre-1993 goodwill taints all of the partnership's or seller's goodwill, application of the anti-churning rule will exceed statutory intent as more time passes after Sec. 197's effective date. The Service has informally expressed concerns over the ability to administer a rule allowing a...