Amortizing Intangible Assets Under IRS Section 197
How the Cost of Business Assets is Spread Out Over Time
The cost of buying business assets is required to be spread out over the life of the asset. The IRS requires that tangible assets, like business equipment, machinery and vehicles, be depreciated. Intangible business assets, like intellectual property, customer base, and licenses, is amortized.
The processes of depreciating and amortizing are basically the same.
The value of the asset is determined, and the life of the asset is calculated by comparing it to other similar assets. One of several different methods is then used to spread out the cost, depending on the type of asset.
How Intangible Assets are Amortized
The IRS designates certain assets as intangible assets under Section 197 of the Internal Revenue Code. These intangible must usually be amortized (spread out) over 15 years. The classification of Section 197 intangibles is most often used in the valuation of a business for sale.
The IRS says,
You must generally amortize over 15 years the capitalized costs of “section 197 intangibles” you acquired after August 10, 1993. You must amortize these costs if you hold the section 197 intangibles in connection with your trade or business or in an activity engaged in for the production of income.
Section 197 amortization rules apply to some business assets, but not others, and Section 197 rules, as noted above, only apply to assets that are acquired, not created.
Section 197 Applies to These Intangible Assets
For purposes of Section 197, intangible assets include:
- Going concern value
- Workforce in place (that is, current employees, including their experience, education, and training)
- Business books and records, operating systems, or any other information base, including lists or other information concerning current or prospective customers
- A patent, copyright, formula, process, design, pattern, know-how, format, or similar item
- A customer-based intangible, including customer base and relationships with customers
- A supplier-based intangible (the value of future purchases due to relationships with vendors)
- Any item similar to items (3) through (7)
- A license, permit, or other right granted by a governmental unit or agency (including issuances and renewals)
- An agreement or covenant not to compete or non-compete agreement entered into in connection with the acquisition of an interest in a trade or business; and
- A franchise, trademark, or trade name
- A contract for the use of, or a term interest in, any item in this list
But the IRS says you cannot amortize assets in categories 1 through 8 if you created these assets, unless "you created them in acquiring assets that make up a trade or business or a substantial part of a trade or business."
Section 197 Does Not Apply to These Intangible Assets
Certain intangible assets are NOT considered to be Section 197 intangibles, and thus may not be amortized over 15 years:
- Copyrights and patents, interests in films, sound recordings, video tapes, books, or other similar property. Exception: If any of these intangibles are acquired as part of a business purchase, they may be considered Section 197 intangibles.
- Interests in a corporation, partnership, trust, or estate; in land, or in certain financial contracts
- Sports franchises
- Some computer software
- Some corporate transaction costs.
- Disclaimer: This article is provided for general information purposes only, and it is not intended to be tax or legal advice. Be sure to consult a tax professional before amortizing intangibles.
For More Information on Intangible Assets and Taxes
The IRS regulations on these intangible assets are complex. This is work for your CPA or business tax preparer. For more information, see this article from the IRS on Intangibles.