Section 197 Intangibles You must amortize over 15 years the capitalized costs of "section197 intangibles" you acquired after August 10, 1993. Section 197intangibles are defined later. You must amortize these costs if youhold the section 197 intangibles in connection with your trade orbusiness or in an activity engaged in for the production of income.Your deduction each year is the part of the adjusted basis (forpurposes of determining gain) of the intangible amortized ratably overa 15-year period, beginning with the month acquired. You are notallowed any other depreciation or amortization deduction for a section197 intangible. Section 197Intangibles Defined The following assets are section 197 intangibles. Goodwill. Going concern value. Workforce in place, including its composition and the termsand conditions (contractual or otherwise) of its employment. Business books and records, operating systems, or any otherinformation base, including lists or other information concerningcurrent or prospective customers. A patent, copyright, formula, process, design, pattern,know-how, format, or similar item. A customer-based intangible. A supplier-based intangible. Any item similar to items (3) through (7). A license, permit, or other right granted by a governmentalunit or agency (including renewals). A covenant not to compete entered into in connection withthe acquisition of an interest in a trade or business. A franchise, trademark, or trade name (includingrenewals). Caution: You cannot amortize any of the intangibles listed in items (1)through (8) that you created unless you created them in connectionwith the acquisition of assets constituting a trade or business or asubstantial part of a trade or business. Goodwill.Goodwill is the value of a trade or business based on expectedcontinued customer patronage due to its name, reputation, or any otherfactor. Going concern value.Going concern value is the additional value of a trade or businessthat attaches to property because the property is an integral part ofa going concern. It includes value based on the ability of a businessto continue to function and generate income even though there is achange in ownership. Workforce in place, etc.This includes the composition of a workforce (for example, itsexperience, education, or training). It also includes the terms andconditions of employment, whether contractual or otherwise, and anyother value placed on employees or any of their attributes. For example, you must amortize the part of the purchase price of atrade or business that is for the existence of a highly skilledworkforce. Also, you must amortize the cost of acquiring an existingemployment contract or relationship with employees or consultants aspart of the acquisition of a trade or business. Business books and records, etc.This includes the cost of technical manuals, training manuals orprograms, data files, and accounting or inventory control systems. Italso includes the cost of customer lists, subscription lists,insurance expirations, patient or client files, and lists ofnewspaper, magazine, radio, or television advertisers. Patents, copyrights, etc.This category includes package designs, computer software, and anyinterest in a film, sound recording, videotape, book, or other similarproperty, except as discussed later under Assets That Are NotSection 197 Intangibles. Customer-based intangible.A customer-based intangible is the composition of market, marketshare, and any other value resulting from the future provision ofgoods or services because of relationships with customers in theordinary course of business. You must amortize the part (if any) ofthe purchase price of a trade or business that is for the followingintangibles. Customer base. Circulation base. Undeveloped market or market growth. Insurance in force. Mortgage servicing contracts. Investment management contracts. Any other relationship with customers that involves thefuture provision of goods or services. Accounts receivable or other similar rights to income for goods orservices provided to customers before the acquisition of that trade orbusiness are not section 197 intangibles. Supplier-based intangible.accommodation in TorquayA supplier-based intangible is the value resulting from the futureacquisition of goods or services because of business relationshipswith suppliers of goods or services that are used or sold by thebusiness. For example, you must amortize the part of the purchase price of atrade or business that is based on the existence of any of thefollowing. A favorable relationship with distributors (such asfavorable shelf or display space at a retail outlet). A favorable credit rating. A favorable supply contract. Government-granted license, permit, etc.Any license, permit, or other right granted by a governmental unitor an agency or instrumentality of a governmental unit is a section197 intangible. For example, you must amortize the capitalized costsof acquiring (including issuing or renewing) a liquor license, ataxicab medallion or license, or a television or radio broadcastinglicense. Covenant not to compete.A covenant not to compete (or similar arrangement) entered into inconnection with the acquisition of an interest in a trade or businessor substantial portion of a trade or business, is a section 197intangible. An interest in a trade or business includes an interest ina partnership or stock in a corporation engaged in a trade orbusiness. If you pay or incur an amount under a covenant not to compete (orsimilar arrangement) after the year in which you entered into thecovenant (or similar arrangement), you must amortize that amount overthe months remaining in the 15-year amortization period. You cannot amortize amounts paid under a covenant not to compete(or similar arrangement) that represent additional consideration forthe purchase of stock in a corporation. You must add the amounts tothe basis of the acquired stock. Franchise, trademark, or trade name.A franchise, trademark, or trade name is a section 197 intangible.You can deduct amounts paid or incurred on the transfer, sale, orother disposition of a franchise, trademark, or trade name if all ofthe following apply to the amounts. They are contingent on the productivity, use, or dispositionof the franchise, trademark, or trade name. They are part of a series of payments payable at leastannually throughout the term of the transfer agreement. They are part of a series of payments which aresubstantially equal in amount or payable under a fixed formula. You must amortize any other amount, whether fixed or contingentthat you paid or incurred because of the transfer of a franchise,trademark, or trade name. Assets That Are NotSection 197 Intangibles The following assets are not section 197 intangibles. Any interest in a corporation, partnership, trust orestate. Any interest under an existing futures contract, foreigncurrency contract, notional principal contract, or similar financialcontract. Any interest in land. Most computer software (see Computer software defined,later). Any of the following not acquired in connectionwith the acquisition of a trade or business or a substantial part of atrade or business. An interest in a film, sound recording, videotape, book, orsimilar property. A right to receive tangible property or services under acontract or granted by a governmental agency. An interest in a patent or copyright. A right under a contract (or a right granted by agovernmental agency) if the right: Has a fixed life of less than 15 years, or Is of a fixed amount that, except for the section 197intangible provisions, would be recoverable under a method similar tothe unit-of-production method of cost recovery. An interest under either of the following. An existing lease or sublease of tangible property,or A debt that was in existence when the interest wasacquired. A professional sports franchise and any item acquired inconnection with the franchise. A right to service residential mortgages unless the right isacquired in the acquisition of a trade or business or a substantialpart of a trade or business. Certain transaction costs under a corporate organization orreorganization in which any part of a gain or loss is notrecognized. Computer software.Section 197 intangibles do not include computer software that is: Readily available for purchase by the general public, Subject to a nonexclusive license, and Not substantially changed. Software that is not acquired in the acquisition of asubstantial part of a business is not a section 197 intangible. If you are allowed to depreciate any computer software that is nota section 197 intangible, use the straight line method with a usefullife of 36 months. For more information on depreciation of computersoftware, see Publication 946. Computer software defined.Computer software includes all programs designed to cause acomputer to perform a desired function. It also includes any databaseor similar item that is in the public domain and is incidental to theoperation of qualifying software. Costs associated with nonsection 197 intangibles.Amounts you take into account in determining the cost of nonsection197 property are not considered section 197 intangibles. These amountsare added to the basis of the property. For example, none of the costsof acquiring real property held for the production of rental incomeare considered goodwill, going concern value, or any other section 197intangible. Anti-Churning Rules Anti-churning rules prevent you from converting section 197intangibles that do not qualify for amortization into property thatwould qualify for amortization. You cannot use 15-year amortization for goodwill, going concernvalue, or any other intangible for which you cannot claim adepreciation deduction and for which an amortization deduction is onlyallowable under section 197 if: You acquired the goodwill, going concern value, or otherintangible after August 10, 1993, and Any of the following conditions apply: You or a related person (defined later) held or used theintangible at any time from July 25, 1991, through August 10,1993, You acquired the intangible from a person who held theintangible at any time from July 25, 1991, through August 10, 1993,and as part of the transaction, the user does not change, or You grant the right to use the intangible to a person (or aperson related to that person) who held or used the intangible at anytime from July 25, 1991, through August 10, 1993. Exception.The anti-churning rules do not apply to an intangible acquired froma decedent if the property's basis is stepped up to fair market value. Related person.For purposes of the anti-churning rules, the following are relatedpersons. Members of a family, including only brothers, sisters,half-brothers, half-sisters, spouse, ancestors (parents, grandparents,etc.), and lineal descendants (children, grandchildren, etc.). An individual and a corporation when the individual owns,directly or indirectly, more than 20% in value of the corporation'soutstanding stock. Two corporations that are members of the same controlledgroup as defined in section 1563(a) of the Internal Revenue Code,except that "more than 20%" is substituted for "at least 80%"in that definition and the determination is made without regard tosubsection (a)(4) and (e)(3)(C) of section 1563. A trust fiduciary and a corporation when the trust orgrantor of the trust owns, directly or indirectly, more than 20% invalue of the corporation's outstanding stock. A grantor and fiduciary, and the fiduciary and beneficiary,of any trust. Fiduciaries of two different trusts, and the fiduciary andbeneficiary of two different trusts, if the same person is the grantorof both trusts. A tax-exempt educational or charitable organization and aperson who, directly or indirectly, controls the organization, or amember of that person's family. A corporation and a partnership if the same persons own morethan 20% in value of the outstanding stock of the corporation and morethan 20% of the capital or profits interest in the partnership. Two S corporations if the same persons own more than 20% invalue of the outstanding stock of each corporation. Two corporations, one of which is an S corporation, if thesame persons own more than 20% in value of the outstanding stock ofeach corporation. Two partnerships if the same persons own, directly orindirectly, more than 20% of the capital or the profits interests inboth partnerships. A person and a partnership when the person owns, directly orindirectly, more than 20% of the capital or profits interests in thepartnership. Treat these persons as related to you if the relationship existsimmediately before or immediately after you acquire the intangible. Ownership of stock or partnership interest.In determining whether an individual owns, directly or indirectly,any of the outstanding stock of a corporation or an interest in apartnership, the following rules apply. Rule 1.Stock or a partnership interest owned, directly or indirectly, byor for a corporation, partnership, estate, or trust is consideredowned proportionately by or for its shareholders, partners, orbeneficiaries. (However, for a partnership interest owned by or for aC corporation, this applies only to shareholders who own, directly orindirectly, 5% or more in value of the stock of the corporation.) Rule 2.An individual is considered as owning the stock owned, directly orindirectly, by or for his or her family. Family includes only brothersand sisters, half-brothers and half-sisters, spouse, ancestors, andlineal descendants. Rule 3.An individual owning (other than by applying rule 2) any stock in acorporation is considered to own the stock owned, directly orindirectly, by or for his or her partner. Rule 4.For purposes of applying rule 1, 2, or 3, treat stock or apartnership interest constructively owned by a person under rule 1 asactually owned by that person. Do not treat stock or a partnershipinterest constructively owned by an individual under rule 2 or 3 asowned by the individual for reapplying rule 2 or 3 to make anotherperson the constructive owner of the stock or partnership interest. Exception.An exception to the anti-churning rules applies if you acquire anintangible from a person related to you by more than 20%, but not morethan 50%, under both of the following conditions. The seller recognizes gain on the disposition of theintangible. The seller pays income tax on the gain at the highest taxrate. If this exception applies, the anti-churning rules apply only tothe amount of your adjusted basis in the intangible that is more thanthe gain recognized by the seller. Note.If the income tax on the gain (figured without regard to this rule)is less than the tax on the gain at the highest rate, the sellerreports the difference as additional tax under this exception on Form1040, line 40 (or the appropriate line of other income tax returns).On the dotted line next to line 40, the seller should write "197." Anti-abuse rule.You cannot amortize any section 197 intangible acquired in atransaction in which either of the following was one of the principalpurposes. To avoid the requirement that the intangible be acquiredafter August 10, 1993. To avoid any of the anti-churning rules. Incorrect Amount ofAmortization Deducted If you did not deduct the correct amount of amortization for asection 197 intangible in any year, you may be able to make acorrection for that year by filing an amended return. See AmendedReturn, later. If you are not allowed to make the correction onan amended return, you can change your accounting method to claim thecorrect amount of amortization. See Changing Your AccountingMethod, later. Basis adjustment.If you could deduct amortization but you did not take thededuction, you must reduce the basis of the section 197 intangible bythe amount of amortization you were entitled to deduct. If you deductmore amortization than you should, you must decrease your basis by thecorrect amount of amortization plus any of the excess for which youreceived a tax benefit. Amended Return If you did not deduct the correct amount of amortization, you canfile an amended return to make any of the following corrections. To correct a mathematical error made in any year. To correct a posting error made in any year. To correct the amount of amortization for section 197intangibles for which you have not adopted a method of accounting. SeeChanging Your Accounting Method, later. If you did not deduct the correct amount of amortization forthe section 197 intangible on two or more consecutively filed taxreturns, you have adopted a method of accounting for that property. Ifyou have adopted a method of accounting, you cannot change the methodby filing amended returns. If an amended return is allowed, you must file it by the later ofthe following dates. 3 years from the date you filed your original return for theyear in which you did not deduct the correct amount. 2 years from the time you paid your tax for thatyear. A return filed early is considered filed on the due date. Changing YourAccounting Method If you did not deduct the correct amount of amortization for thesection 197 intangible on any two or more consecutively filed taxreturns, you have adopted a method of accounting for that property.You can claim the correct amount of amortization only by changing yourmethod of accounting for amortization. By changing your method ofaccounting, you will be able to take into account any unclaimed orexcess amortization from years before the year of change. Approval required.You must get IRS approval to change your method of accounting. FileForm 3115, Application for Change in Accounting Method, torequest a change to a permissible method of accounting foramortization. Revenue Procedure 97-27, which is in CumulativeBulletin 1997-1, gives general instructions for gettingapproval. Cumulative Bulletins are available at many libraries and IRSoffices. You do not need IRS approval to correct any mathematical orposting error. See Amended Return, earlier. Automatic approval.You may be able to obtain automatic approval from the IRS to changeyour method of accounting if you meet all the following conditions. The property is amortizable under section 197 of theInternal Revenue Code. It is property for which, under your present accountingmethod, you deducted less than or more than the amount of amortizationallowable in at least the two years immediately preceding the year ofchange. You owned the property at the beginning of the year ofchange. File Form 3115 to request a change to a permissible method ofaccounting for amortization. Revenue Procedure 98-60 and section2.01 of its Appendix, which is in Internal Revenue Bulletin No.1998-51, has instructions for getting automatic approval andlists exceptions to the automatic approval procedures. Exceptions.You generally cannot use the automatic approval procedure under anyof the following situations. You (your federal income tax return) are underexamination. You are before a federal court or an appeals office for anyincome tax issue and the method of accounting to be changed is anissue under consideration by the federal court or appealsoffice. You changed the same method of accounting (with or withoutobtaining IRS approval) during the last five years (including the yearof change). You filed a Form 3115 to change the same method ofaccounting during the last five years (including the year of change),but did not make the change because the Form 3115 was withdrawn, notperfected, denied, or not granted. Also, see the exceptions listed in section 2.01(2)(b) of theAppendix of Revenue Procedure 98-60. Disposition ofSection 197 Intangibles A section 197 intangible is treated as depreciable property used inyour trade or business. If you dispose of property held for more thanone year, any gain on the disposition, up to the amount of allowableamortization, is ordinary income (section 1245 gain). Any remaininggain, or loss, is a section 1231 gain or loss. If you held theproperty one year or less, any gain or loss on its disposition is anordinary gain or loss. For more information on ordinary or capitalgain or loss on business property, see chapter 3 in Publication 544. Nondeductible loss.If you acquire more than one section 197 intangible in atransaction (or series of related transactions) and later dispose ofone of them or if one of them becomes worthless, you cannot deduct anyloss on the intangible. Instead, increase the adjusted basis of eachremaining amortizable section 197 intangible by the part of thenondeductible loss. Figure the increase by multiplying thenondeductible loss on the disposition of the intangible by thefollowing fraction. The numerator is the adjusted basis of the remainingintangible on the date of the disposition. The denominator is the total adjusted basis of all remainingamortizable section 197 intangibles on the date of thedisposition. Covenant not to compete.A covenant not to compete, or similar arrangement, is notconsidered disposed of or worthless before you dispose of your entireinterest in the trade or business for which you entered into thecovenant. Nonrecognition transfers.If you dispose of one section 197 intangible and acquire another ina nonrecognition transfer, treat the part of the adjusted basis of theacquired intangible that is not more than the adjusted basis of thetransferred intangible as if it were the transferred section 197intangible. You continue to amortize this part of the adjusted basisover the remaining amortization period of the transferred section 197intangible. Nonrecognition transfers include transfers to acorporation, partnership contributions and distributions, like-kindexchanges, and involuntary conversions. Example.You own a section 197 intangible you have amortized for 4 fullyears. It has a remaining unamortized basis of $30,000. You exchangethe asset plus $10,000 for a like-kind section 197 intangible. Thenonrecognition provisions of like-kind exchanges apply. You amortize$30,000 of the basis of the acquired section 197 intangible over the11 years remaining in the original 15-year amortization period for thetransferred asset and the other $10,000 of adjusted basis over 15years.