New TAM highlights issues in like-kind exchanges involving intangibles.

• Author: Lipton, Richard M.
• Position: Technical advice memorandum

When corporations are considering the disposition of business assets, one of the issues that frequently arises is whether a like-kind exchange under section 1031 of the Internal Revenue Code might be available to defer gain recognition. Many businesses will have significant intangible assets, leading to an inquiry about how these intangible assets will be treated in a like-kind exchange.

In a recent technical advice memorandum (TAM 200602034), the Internal Revenue Service provided restrictive guidance on this topic. The IRS basically took the position that most intangibles do not qualify for like-kind exchange treatment. The IRS also looked at the section 1031 replacement property identification requirements in this TAM, and applied them rigorously to the taxpayer's disadvantage. At the bottom line, this TAM sends a clear message that the IRS will permit taxpayers to take advantage of tax deferral only if the requirements of section 1031 are specifically satisfied.

Facts

TAM 200602034 involved a parent corporation and several of its subsidiaries that apparently filed a consolidated return. The companies engaged in four transactions in one taxable year involving the transfer and acquisition of tangible and intangible business assets. The taxpayer claimed that all of gain on the sales and purchases were subject to deferral under section 1031.

In the first transaction, on Date 1 the taxpayer transferred the tangible and intangible assets pertaining to the business of Corporation 1 to Buyer 1. Corporation 1 was involved in the research, design, and manufacture of Product 1 in the United States and around the world, and Corporation 1 had facilities located in three states and one foreign country. The intangible assets transferred in this first transaction consisted of (1) patents, (2) trademarks (including design marks) and trade names, (3) designs and drawings, (4) software, and (5) trade secrets and know how.

In the second transaction, on Date 2 the taxpayer transferred substantially all of the assets of five subsidiaries (collectively, Corporations 2) to Buyer 2; Buyer 2 acquired certain other assets as well. Corporations 2, which were engaged in business in three states, designed, manufactured, marketed, and tested Product 2, which was used in certain types of industrial operations. The intangible assets transferred to Buyer 2 were divided into the same broad categories as related to the transfer to Buyer 1.

On the same date as the second transaction, the tax-payer acquired from Seller i the assets and business operations of Seller 1, a firm engaged in the research, design, manufacture, and marketing of Product X in the United States. Seller 1 had facilities in three states. The intangible assets acquired from Seller I were divided into four categories: (1) trademarks and trade names, (2) designs and drawings, (3) software and (4) trade secrets and know how.

On Date 3, the taxpayer acquired the assets of Seller 2. Seller 2's products and manufacturing operations were split into two divisions. One division was a leading producer of Product Xl, with manufacturing plants in foreign countries. The other division was a leading producer of Product X2, with facilities in the US and a foreign country. Seller 2 had a reputation for innovative engineering and manufacturing skills and was regarded as the industry's technological leader. The intangible assets acquired from Seller 2 included (1) patents, (2) designs and drawings, (3) software, and (4) trade secrets and know how.

The taxpayer claimed like-kind exchange treatment of the disposition of certain of the intangibles pertaining to Corporation 1 and Corporations 2 as well as the related acquisition of the intangible assets from Seller 1 and Seller 2. With respect to the assets sold by Corporation 1, the taxpayer claimed that the acquisition from Seller 1 of (1) trade makes and trade names and (2) trade secrets and know how qualified under section 1031. With respect to Corporations 2, the taxpayer claimed that the acquisition from Seller 1 of four types of intangible assets qualified under section 1031: (1) trademarks and trade names, (2) designs and drawings, (3) trade secrets and know how, and (4) software. The taxpayer also claimed that Corporations 2 were entitled to like-kind exchange treatment with respect to their acquisition from Seller 2 of (1) patents, (2) designs and drawings, (3) trade secrets and know how, and (4) software. The taxpayer did not claim like-kind exchange treatment with respect to any of the tangible assets involved in these transactions.

Richard M. Lipton is a partner in the Chicago office of Baker & McKenzie LLP. A graduate of Amherst College and the University of Chicago Law School, he is former chair of the American Bar Association's Section of Taxation and a fellow and officer of the American College of Tax Counsel. He is a frequent participant in educational programs sponsored by Tax Executives Institute and other organizations, and has published numerous articles in The Tax Executive and elsewhere.

Applicable Law

Section 1031(a)(1) generally provides that no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment. Under Treas. Reg. § 1.1031(a)-1(b), the words "like kind" refer to the nature and character of the property and not to its grade or quality and, further, that an exchange of one kind or class of property for a different kind or class is not a like-kind exchange.

Under Treas. Reg. § 1.1031(a)-2(a), personal properties of a like class are considered to be of "like kind" for purposes of section 1031. In determining whether exchange properties are of a like kind, no inference is to be drawn from the fact that the properties are not of a like class. Furthermore, Treas. Reg. § 1.1031(a)-2(b) provides that depreciable tangible personal properties are of a like class if they are either within the same General Asset Class (as defined in Treas. Reg. § 1.1031(a)-2(b)(2)) or within the same Product Class (as defined in Treas. Reg. § 1.1031(a)-2(b)(3)).

Under Treas. Reg. § 1.1031(a)-2(b)(1), a single property may not be classified within more than one General Asset Class or within more than one Product Class. Treas. Reg. § 1.1031(a)-2(b)(2) generally provides that property within a General Asset Class consists of depreciable...