Acquisitions Using Tax Partnerships - Maximizing the Rules for Amortizing Intangible Assets

Summary: A businesss goodwill and going concern value or other intangibles are often its most valuable assets. The interaction of the rules concerning acquisitions using tax partnerships and the Section 197 rules for transferred intangibles are addressed in such transactions. A partnership is generally allowed 15-year amortization for the cost basis in acquired intangibles from a sale or disguised sale, and stepped-up portion of basis in intangibles.

The Authors write: A taxpayer is permitted to amortize its tax basis in purchased intangibles ("amortizable Section 197 intangibles") on a straight-line basis over a 15-year period if the following conditions are satisfied: (1) the intangible was acquired after August 10, 1993 (or after July 25, 1991 in certain cases); (2) the intangible is used in connection with a trade or business or an activity engaged in for the production of income; (3) the intangible was not created by the taxpayer (subject to exceptions for certain types of intangibles); and (4) the intangible is not subject to IRC Section 197's anti-churning rules. Amortizable Section 197 intangibles include purchased goodwill and going concern value.

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For purposes of IRC Section 197's anti-churning rule, a person is related to a partnership if the person owns, directly or indirectly, more than 20% of the capital or profits interest in a partnership. In the case of a sale or disguised sale of an anti-churning intangible to an acquiring partnership, "relatedness" is tested between the seller and the partnership. Hence, where a partnership takes a cost basis in an anti-churning intangible as the result of a sale or disguised sale of the intangible to the partnership, the partnership may not amortize the intangible if the seller holds (directly as a partner or constructively through another person that is a partner) a greater-than-20% capital or profits interest in the partnership.

However, a special rule under IRC Section 197(f)(9)(E) provides that "with respect to any increase in the basis of partnership property under IRC Sections 732, 734, or 743, determinations . . . shall be made at the partner level and each partner shall be treated as having owned and used such partner's proportionate share of the partnership assets." Consequently, any step-up in the basis of an intangible under IRC Section 743(b) as the result of a sale or exchange of a partnership interest is generally not subject to the anti-churning limitation if the transferor and transferee are not related to each other under the IRC Section 197 anti-churning relatedness rules.

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To the extent a partnership takes a carryover basis in any "contributed intangible" (i.e., an intangible contributed to the partnership in a contribution to which IRC Section 721 applies), such carryover basis is amortizable only in the hands of the partnership if it was amortizable in the hands of the transferor (e.g., the contributing partner).

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The IRC Section 197 regulations [Treas. Reg. Section 1.197-2(h)(12)(vi)(B)] appear, fairly clearly, to not permit a partnership to make curative allocations of amortization deductions with respect to a contributed self-created intangible, since such an intangible would not have been "an amortizable Section 197 intangible in the hands of the contributing partner"(with certain exceptions...). However, the preamble to the final regulations suggests (but does not clearly state) that the rule is not so restrictive, and is instead intended only to preclude a partnership from using the curative method with respect to an anti-churning intangible.

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For more information, LEXIS.com subscribers can access LexisNexis Tax Advisor -- Federal Topical § 1E:8.04 and  1-7 Depreciation Handbook § 7.04 and 61-10 USC Law School Institutes On Major Tax Planning 10.syn.