Amortization of Intangible Property

DEPARTMENT OF THE TREASURY

26 CFR Part 1

[REG-209709-94]

RIN 1545-AS77

Amortization of Intangible Property

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to the

amortization of certain intangible property. The proposed regulations

reflect changes to the law made by the Omnibus Budget Reconciliation

Act of 1993 (OBRA '93), and affect taxpayers who acquired intangible

property after August 10, 1993, or made a retroactive election to apply

OBRA '93 to intangibles acquired after July 25, 1991. This document

also provides notice of a public hearing on the proposed regulations.

DATES: Comments must be received by April 16, 1997. Requests to appear

and outlines of oral comments to be presented at the public hearing

scheduled for May 15, 1997, must be received by April 24, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-209709-94), room

5228, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions may be hand delivered between the

hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-209709-94), Courier's

Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,

Washington, DC. Alternatively, taxpayers may submit comments

electronically via the Internet by selecting the Tax Regs option of the

IRS Home Page, or by submitting comments directly to the IRS Internet

site at http:\\www.irs.ustreas.gov\prod\tax __regs\comments.html. The

public hearing will be held in the Commissioner's Conference Room (Room

3313), Internal Revenue Building, 1111 Constitution Avenue NW.,

Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, John

Huffman at (202) 622-3110; concerning submissions and the hearing,

Michael Slaughter at (202) 622-8452 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed regulations under sections 167(f)

and 197. These provisions were added to the Internal Revenue Code of

1986 (the Code) by section 13261 of OBRA '93, and apply to intangible

property acquired after August 10, 1993 (or after July 25, 1991, if a

valid retroactive election to apply OBRA '93 to intangibles has been

made pursuant to Sec. 1.197-1T).

The proposed regulations provide definitions and rules for

amortization of intangible property subject to sections 197 and 167(f).

On June 24, 1994, the IRS published Announcement 94-92 (1994-28 I.R.B.

139) in the Federal Register (59 FR 32670) inviting comments under

section 197 relating to the amortization of goodwill and certain other

intangibles that should be addressed in proposed regulations. The IRS

has reviewed these comments and has addressed certain issues raised in

the comments in the proposed regulations. However, because these

comments were received in anticipation of the issuance of these

proposed regulations, and because these regulations are subject to

further comment and a public hearing, no attempt has been made to

describe all of the principal comments that are not reflected in these

regulations or the reasons therefor.

Explanation of Provisions

1. General Overview

Sections 167(f) and 197 provide comprehensive rules for the

depreciation and amortization of many intangible assets. Intangible

assets subject to section 197 are broadly defined to include most

intangible assets acquired in connection with the acquisition of a

trade or business and certain other separately acquired intangible

assets. The adjusted basis of an amortizable section 197 intangible

must be amortized over a 15-year period. Certain other intangible

assets are excluded from section 197 for various reasons. In some

cases, such as stock and partnership interests, the asset is property

of a character that is not subject to an allowance for depreciation

because it represents a permanent investment that can only be recovered

through disposition of the asset (including worthlessness). In other

cases, such as computer software,

[[Page 2337]]

purchased mortgage servicing rights, service and supply contracts, and

certain other contracts or rights with a fixed duration, other cost

recovery methods were prescribed by the OBRA '93 amendments. In still

other cases, such as motion picture films, television series, books,

and sound recordings, other cost recovery methods that were in effect

prior to OBRA '93 are more appropriate under the circumstances. Section

167(f) provides alternative methods of depreciation for certain of the

intangibles excluded from the application of section 197.

The proposed regulations provide guidance for certain intangible

property subject to sections 167(f) and 197. The section 167(f)

proposed regulations provide rules for intangible property subject to

the allowance for depreciation under section 167 and specifically

excluded from section 197. These intangible assets include certain

computer software, rights to receive tangible property or services,

rights of fixed duration, patents, copyrights, and mortgage servicing

rights. These proposed regulations reserve guidance on the method of

depreciating the cost of separately acquired rights to receive tangible

property or services where the amount of the property or services to be

received is not specified. The IRS invites comments on possible methods

of depreciation in these cases.

Because section 197 provides a method of amortization and, except

in the case of certain covenants not to compete, governmental licenses,

permits and other rights, and contracts for the use of section 197

intangibles, does not alter the rules for determining the basis of an

asset, section 197 generally does not apply to amounts that would

otherwise be deductible. For example, section 197 does not generally

apply to the costs of advertising because, in most cases, these costs

are deductible under other provisions of the Code. See Rev. Rul. 92-80

(1992-2 C.B. 57). In addition, section 197 does not apply to costs that

would not, under general principles of Federal income tax law, be

included in the basis of a section 197 intangible. For example, if a

taxpayer borrows money to purchase the assets of a trade or business

(including amortizable section 197 intangibles) and incurs fees in

connection with the loan, these costs are generally amortized over the

term of the loan rather than under the rules of sections 167(f) and

197. As a further example, if the amortizable section 197 intangibles

acquired in the transaction include a favorable supply contract, the

amortizable basis in the contract does not include amounts required to

be paid for goods to be received pursuant to the contract.

In addition, section 197 does not apply to any amount for which a

deduction would be disallowed under other provisions of the Code, such

as section 162(k) (relating to amounts paid or incurred by a

corporation in connection with the acquisition of its stock or the

stock of a related person).

No inference should be drawn from any provision in the proposed

regulations concerning the classification of any section197 intangible

as property, or whether any section 197 intangible is treated as

tangible or intangible property, for other purposes of the Code.

Furthermore, no inference should be drawn from any provision in the

proposed regulations regarding (a) whether any section 197 intangible

that is not an amortizable section 197 intangible may be amortized or

depreciated under any provision of the Code other than section 197, or

(b) the proper method for determining any allowance therefor. Finally,

no inference should be drawn from any provision in the proposed

regulations concerning whether any section 197 intangible (or any

interest therein) has been purchased, leased, or licensed for Federal

income tax purposes.

2. Section 197 Intangibles

The proposed regulations define section 197 intangibles (subject to

certain exceptions) as goodwill, going concern value, workforce in

place, information base, know-how, customer-and supplier-based

intangibles, governmental licenses and permits, covenants not to

compete and other similar arrangements, franchises, trademarks, trade

names, and contracts for the use of the foregoing assets.

A. Covenants Not to Compete

Some commentators in response to Announcement 94-92 suggested that

a covenant not to compete relating to the redemption of stock or a

partnership interest from a departing stockholder or partner should be

excluded from section 197 because this situation does not involve the

acquisition of a trade or business. The legislative history provides,

however, that section 197 applies to a covenant not to compete acquired

with the assets of a trade or business, the stock in a corporation, or

an interest in a partnership engaged in a trade or business.

Consequently, the proposed regulations do not provide for this

exception. In this regard, the proposed regulations provide that for

purposes of section 197(f)(1)(B), the disposition or cancellation of

redeemed stock of a corporation will not cause the covenant to be

written off faster than over the 15-year amortization period provided

for under section 197 (in the case of a covenant to which section

162(k) does not apply).

B. Contracts for the Use of Section 197 Intangibles

Some commentators also requested guidance on the extent to which

contracts for the use of section 197 intangibles would be subject to

section 197, in some cases suggesting that an intangible was not

subject to section 197 unless the taxpayer obtained ownership of

property for Federal income tax purposes. However, it is sometimes

difficult to determine whether the terms of an agreement confer

ownership, for Federal income tax purposes, of property, and the IRS

and Treasury believe that the purposes of section 197 could be

circumvented through the use of such agreements. Accordingly, the

proposed regulations provide that contracts for the use of section 197

intangibles will also be treated as section 197 intangibles. Contracts

that are so treated may, however, be excluded under either section

197(e)(4) (B) or (D) on the basis that they are contracts for the

receipt of property or services, contracts having a fixed duration, or

contracts having a fixed amount and recovered on a unit-of-production

method or other similar method.

3. Intangibles Excluded From Section 197

A. Computer Software

Section 197 intangibles do not include computer software that is

readily available for purchase by the general public, is subject to a

nonexclusive license, and has not been substantially modified. The

proposed regulations provide a safe harbor for purposes of determining

whether computer software has been substantially modified. Under the

safe harbor, computer software has not been substantially modified if

its capitalized cost does not exceed the greater of $2,000 or 125

percent of the price at which the unmodified version of the software is

readily available to the general public.

The proposed regulations incorporate some of the provisions of

Revenue Procedure 69-21 (1969-2 C.B. 303), involving the treatment of

costs of computer software, and modify other provisions to the extent

necessary to conform to the amortization rules provided under sections

197 and 167(f). Consequently, if costs for developing computer software

that the taxpayer has elected to treat as deferred expenses

[[Page 2338]]

under section 174(b) result in the development of a self-created

intangible excluded under section 197(c)(2) and subject to the

allowance for depreciation under section 167(a), deductions for the

unrecovered expenditures are subject to section 167(f)(1). Computer

software costs included, without being separately stated, in the cost

of the computer hardware (bundled software) continue to be capitalized

and depreciated as part of the computer hardware. The proposed

regulations also continue to treat as currently deductible software

costs properly and consistently treated as deductible (not capitalized)

under Sec. 1.162-11.

B. Certain Separately Acquired Intangibles

Certain intangibles are excepted from section 197 if they are not

acquired as part of a purchase of a trade or business. The proposed

regulations clarify that, for purposes of section 197, a group of

assets constitutes a trade or business if their use would constitute a

trade or business under section 1060; that is, if goodwill or going

concern value could under any circumstances attach to the assets.

Temporary and proposed regulations under section 1060, in turn, provide

that a group of assets constitutes a trade or business for purposes of

section 1060 if the use of such assets would constitute an active trade

or business for purposes of section 355. However, in appropriate cases,

even if the use of a group of assets would not constitute an active

trade or business for purposes of section 355, such assets may

nevertheless constitute a trade or business for purposes of section

1060. See Sec. 1.1060-1T(b)(2).

The IRS intends to provide additional guidance as to the

circumstances under which the acquisition of a group of assets

constitutes a trade or business for purposes of section 1060 in

regulations under that section. Accordingly, the proposed regulations

do not provide substantive guidance on this question, except to the

extent that the considerations are unique to the application of section

197. The IRS invites comments on the extent to which additional rules

under section 197 may be necessary.

C. Certain Contracts and Governmental Rights

While section 197 intangibles include licenses, permits, and other

rights granted by a governmental unit or an agency or instrumentality

thereof (section 197(d)(1)(D)), certain rights granted by these

governmental entities are excluded from section 197 pursuant to section

197(e)(4) (B) and (D), subject to the conditions and limitations

therein. Because a particular right may be described in two or more of

these provisions, the proposed regulations provide guidance regarding

the potential conflict between, or overlap with, these provisions.

Thus, a right that would be subject to section 197 pursuant to section

197(d)(1)(D) may nevertheless be excluded if it is also described in

section 197(e)(4) and meets all of the requirements for exclusion.

Furthermore, a right that meets the requirements of either section

197(e)(4)(B) or section 197(e)(4)(D) is excluded from section 197 even

if it fails to meet one of the requirements for the other exclusion. In

addition, any license, permit, or other right granted by a governmental

unit that otherwise meets the definition of a franchise under section

197(d)(1)(F), such as an FCC broadcast license or cable television

franchise, is treated as a franchise under the regulations.

Accordingly, these licenses do not qualify for any of the exceptions

from section 197 provided under section 197(e)(4).

4. Special Rules of Application

A. Loss Disallowance Provisions

The proposed regulations contain rules for the loss disallowance

provisions set forth in section 197(f)(1). In particular, the proposed

regulations provide that a taxpayer may not circumvent the loss

disallowance rules, for example, by transferring some intangibles,

whose adjusted basis is greater than their fair market value, to a

corporation in exchange for stock in the corporation in a transaction

described in section 351, while retaining other intangibles acquired in

the same or related transaction, and then selling the stock. Special

rules are also provided for the application of the loss disallowance

provisions in cases where a taxpayer has disposed of all of the

amortizable section 197 intangibles acquired in a single transaction

but is treated as having retained other amortizable section 197

intangibles solely by virtue of the retention of amortizable section

197 intangibles by a related person.

B. Transactions Involving Partnerships

The proposed regulations provide rules and examples relating to the

treatment of section 197 intangibles acquired or transferred in certain

partnership transactions, including terminations under section

708(b)(1), and the application of section 197 to the special basis

adjustments of partnership property for which a section 754 or section

732(d) election is in effect. Guidance is also provided regarding the

effect of curative and remedial allocations and the application of the

anti-churning rules to certain partnership transactions.

In the case of the termination of a partnership under section

708(b)(1)(B) (relating to a sale or exchange of an interest), the rules

contained in the proposed regulations are based on recently proposed

regulations under that section, pursuant to which the new partnership

is treated as having directly acquired the assets of the old

partnership in exchange for the assumption of its liabilities and the

issuance of interests in the new partnership. Accordingly, for purposes

of section 197, the consequences of the termination of a partnership

under section 708(b)(1)(B) may not be the same as the consequences of

such a termination under the rules in effect at the time section 197

was enacted.

C. Treatment of Contingent Payments

The proposed regulations clarify that, except in the case of

contingent payments, amounts paid for section 197 intangibles are

treated as amounts chargeable to capital account, and the entire

principal amount is amortized ratably over the 15-year amortization

period beginning with the later of the month in which the intangible is

acquired or the date on which the active conduct of a trade or business

begins. Contingent payments for section 197 intangibles paid or

incurred after the taxable year in which the intangible is acquired are

added to basis at such time and generally amortized ratably over the

remaining months in the 15-year period as of the beginning of the month

the amount is paid or incurred. However, in order to reduce the

administrative burden that may result from a requirement to maintain

separate amortization schedules for each month during the 15-year

period, taxpayers are permitted to use certain simplifying conventions.

In addition, any amount that is not properly included in the basis of

an amortizable section 197 intangible until after the expiration of the

15-year period is amortized in full immediately upon the inclusion of

the amount in the basis of the intangible. The proposed regulations

refer to Sec. 1.461-1(a)(1) for rules governing the time at which an

amount may be taken into account by a taxpayer using the cash receipts

and disbursements method. They refer to Sec. 1.461-1(a)(2) for rules

governing the time at which a liability is incurred and generally taken

into account (for example, by treating the amount of the liability as a

capital

[[Page 2339]]

expenditure) by an accrual basis taxpayer.

5. Anti-Churning Rules

To be eligible for amortization, section 197 intangibles must

qualify as amortizable section 197 intangibles. Generally, amortizable

section 197 intangibles are section 197 intangibles that are acquired

after August 10, 1993 (or acquired after July 25, 1991, and for which

the taxpayer made a proper election under Sec. 1.197-1T) and held in

connection with the conduct of a trade or business or an activity

described in section 212.

The proposed regulations provide anti-churning rules to prevent

taxpayers from converting into amortizable section 197 intangibles

existing goodwill, going concern value, and any other section 197

intangible for which amortization would not have been allowable prior

to OBRA '93 through the use of related persons and certain other

transactions. The proposed regulations define the term related person

for purposes of these rules.

The proposed regulations also contain provisions for the exception

to the anti-churning rules in situations where the seller elects to

recognize gain and agrees to pay a specified amount of tax. The

regulations reserve guidance on the manner of making this election. The

IRS intends to issue a revenue procedure in order to provide interim

guidance to taxpayers on the manner of making this election, and the

final regulations will include the relevant provisions of this revenue

procedure.

The proposed regulations contain both an anti-churning anti-abuse

rule and a general anti-abuse rule that provide that the Commissioner

may recast any transaction if one of its principal purposes is to avoid

the purposes of section 197.

6. Assumption Reinsurance Transactions

Section 197(f)(5) provides special rules for section 197

intangibles resulting from assumption reinsurance transactions. The

proposed regulations reserve guidance on certain aspects of these

transactions. The IRS invites comments on the extent to which

additional guidance on the application of section 197 to these

transactions may be necessary.

7. Proposed Effective Dates

The regulations for sections 167(f) and 197 are proposed to be

effective on the date on which the final regulations are published in

the Federal Register. Regulations to implement section 197(e)(4)(D)

(separately acquired contracts of fixed duration or amount) are

proposed to be effective August 11, 1993, for property acquired after

August 10, 1993 (or July 26, 1991, if a valid retroactive election has

been made under Sec. 1.197-1T).

8. Accounting Method Changes

A change in the method of depreciation or amortization of

intangibles is a change in method of accounting that requires the

consent of the Commissioner of Internal Revenue under section 446(e).

To obtain this consent, a Form 3115, Application for Change in

Accounting Method, generally must be filed within 180 days after the

beginning of the taxable year in which the proposed change is to be

made. Taxpayers that have adopted a method of accounting for certain

intangibles may need to change their method of accounting to comply

with the final regulations.

9. Basis Allocation Rules

In separate notices the IRS and Treasury are issuing temporary and

proposed amendments to the temporary regulations under sections 1060

and 338(b). The existing temporary regulations establish a four-class

system for allocating basis to individual assets in the case of a

direct acquisition of assets constituting a trade or business or a

deemed acquisition of assets as the result of an election under section

338. Under this system, assets in the nature of goodwill and going

concern value are included in Class IV, while other intangible assets,

whether or not amortizable, are included in Class III. Each successive

class is allocated basis under a residual method, subject to a fair

market value limitation for all classes except Class IV. After basis

has been allocated to each class in the aggregate, assets within each

of the first three classes are allocated basis on a proportional

method. This system is inconsistent with the policies of section 197,

which prescribes uniform treatment for all amortizable section 197

intangibles. Accordingly, appropriate modifications are being proposed.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required. It also has been determined

that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) does not apply to these regulations, and, because the

regulations do not impose a collection of information on small

entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not

apply. Pursuant to section 7805(f) of the Internal Revenue Code, this

notice of proposed rulemaking will be submitted to the Chief Counsel

for Advocacy of the Small Business Administration for comment on its

impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any comments that are submitted (in the

manner described in ADDRESSES) timely to the IRS. All comments will be

available for public inspection and copying.

A public hearing has been scheduled for May 15, 1997, at 10 a.m. in

the Commissioner s Conference Room (Room 3313), Internal Revenue

Building, 1111 Constitution Avenue NW., Washington, DC 20224. Because

of access restrictions, visitors will not be admitted beyond the

Internal Revenue Building lobby more than 15 minutes before the hearing

starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons that wish to present oral comments at the hearing must

submit comments and an outline of the topics to be discussed and the

time to be devoted to each topic (in the manner described in ADDRESSES)

by April 16, 1997. A period of 10 minutes will be allotted to each

person for making comments.

An agenda showing the scheduling of the speakers will be prepared

after the deadline for receiving outlines has passed. Copies of the

agenda will be available free of charge at the hearing.

Drafting Information

The principal author of these regulations is John Huffman, Office

of Assistant Chief Counsel (Passthroughs and Special Industries), IRS.

However, other personnel from the IRS and Treasury Department

participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding

an entry in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.197-2 also issued under 26 U.S.C. 197(g). * * *

[[Page 2340]]

Par. 2. Section 1.167(a)-3 is amended by adding a sentence at the

end to read as follows:

Sec. 1.167(a)-3 Intangibles.

* * * See Sec. 1.197-2 and Sec. 1.167(a)-14 for amortization of

goodwill and certain other intangibles acquired after August 10, 1993,

or after July 25, 1991, if a valid retroactive election under

Sec. 1.197-1T has been made.

Par. 3. Section 1.167(a)-6 is amended by adding two sentences at

the end of paragraph (a) to read as follows:

Sec. 1.167(a)-6 Depreciation in special cases.

(a) * * * See Sec. 1.167(a)-14(c)(4) for depreciation of a

separately acquired interest in a patent or copyright described in

section 167(f)(2) acquired after the date on which the final

regulations are published in the Federal Register. See Sec. 1.197-2 for

amortization of interests in patents and copyrights that constitute

amortizable section 197 intangibles.

* * * * *

Par. 4. Section 1.167(a)-14 is added to read as follows:

Sec. 1.167(a)-14 Treatment of certain intangible property excluded

from section 197.

(a) Overview. This section provides rules for the amortization of

certain intangibles that are excluded from section 197 (relating to the

amortization of goodwill and certain other intangibles). These excluded

intangibles are specifically described in Sec. 1.197-2(c) (4), (6),

(7), (11), and (13) and include certain computer software and certain

other separately acquired rights, such as rights to receive tangible

property or services, patents and copyrights, rights of fixed duration

or amount, and certain mortgage servicing rights. Intangibles for which

an amortization amount is determined under section 167(f) and

intangibles otherwise excluded from section 197 (for example, self-

created intangibles described in Sec. 1.197-2(d)(2)) are amortizable

only if they qualify as property subject to the allowance for

depreciation under section 167(a).

(b) Computer software--(1) In general. The amount of the deduction

for computer software described in section 167(f)(1) and Sec. 1.197-

2(c)(4) is determined by amortizing the adjusted basis of the computer

software using the straight line method described in Sec. 1.167(b)-1

(except that its salvage value is treated as zero) and an amortization

period of 36 months beginning with the month that the computer software

is placed in service. If costs for developing computer software that

the taxpayer properly elects to defer under section 174(b) result in

the development of property subject to the allowance for depreciation

under section 167, the rules of this paragraph (b) will apply to the

unrecovered costs. In addition, this paragraph (b) applies to the cost

of separately acquired computer software where these costs are

separately stated and the costs are required to be capitalized under

section 263(a).

(2) Exceptions. Paragraph (b)(1) of this section does not apply to

the cost of computer software properly and consistently treated as

currently deductible (that is, not capitalized) under Sec. 1.162-11.

The cost of acquiring an interest in computer software that is

included, without being separately stated, in the cost of the hardware

or other tangible property is treated as part of the cost of the

hardware or other tangible property that is capitalized and depreciated

under other applicable sections of the Internal Revenue Code.

(c) Certain interests or rights acquired separately--(1) Certain

rights to receive tangible property or services. The amount of the

deduction for a separately acquired right to receive tangible property

or services under a contract or from a governmental unit (specified in

section 167(f)(2) and Sec. 1.197-2(c)(6)) is determined as follows:

(i) Amortization of fixed amounts. The cost of acquiring a right to

receive a fixed amount of tangible property or services is amortized

for each taxable year by multiplying the basis (as determined under

section 1011) of the right by a fraction, the numerator of which is the

amount of tangible property or services received during the taxable

year and the denominator of which is the total amount of tangible

property or services received or to be received under the terms of the

contract or governmental grant. For example, if a taxpayer acquires a

favorable contract right to receive a fixed amount of raw materials

during an unspecified period, the taxpayer must amortize the cost of

acquiring the contract right by multiplying the total cost by a

fraction, the numerator of which is the amount of raw materials

received under the contract during the taxable year and the denominator

of which is the total amount of raw materials received or to be

received under the contract.

(ii) Amortization of unspecified amount over fixed period. The cost

of acquiring a right to receive an unspecified amount of tangible

property or services over a fixed period is amortized ratably over the

period of the right.

(iii) Amortization in other cases. [Reserved]

(2) Rights of fixed duration or amount. The amount of the deduction

for a separately acquired right of fixed duration or amount received

under a contract or granted by a governmental unit (specified in

section 167(f)(2) and Sec. 1.197-2(c)(13)) and not covered by paragraph

(c)(1) of this section is determined as follows:

(i) Rights of a fixed amount. The cost of acquiring a right of a

fixed amount is amortized for each taxable year by multiplying the cost

of the right by a fraction, the numerator of which is the amount

received or delivered during the taxable year and the denominator of

which is the total amount to be received or delivered (including

amounts received or delivered prior to the close of the taxable year)

under the terms of the contract or governmental grant.

(ii) Rights of unspecified amount and fixed duration of less than

15 years. The cost of acquiring a right of an unspecified amount and a

fixed duration of less than 15 years is amortized ratably over the

period of the right.

(3) Application of renewals. (i) For purposes of paragraphs (c) (1)

and (2) of this section, the duration of a right under a contract (or

granted by a governmental unit) includes any renewal period if, based

on all of the facts and circumstances in existence at any time during

the taxable year in which the right is acquired, the facts clearly

indicate a reasonable expectancy of renewal.

(ii) The mere fact that a taxpayer will have the opportunity to

renew a contract right or other right on the same terms as are

available to others, in a competitive auction or similar process that

is designed to reflect fair market value and in which the taxpayer is

not contractually advantaged, will generally not be taken into account

in determining the duration of such right provided that the bidding

produces a fair market value price comparable to the price that would

be obtained if the rights were purchased immediately after renewal from

a person (other than the person granting the renewal) in an arm's-

length transaction.

(iii) The cost of a renewal not included in the terms of the

contract or governmental grant is treated as the acquisition of a

separate intangible asset.

(4) Patents and copyrights. The amount of the deduction for a

separately acquired interest in a patent or copyright described in

section 167(f)(2) and Sec. 1.197-2(c)(7) is equal to the purchase price

paid or incurred during the year if the purchase price is payable on at

least an annual basis as either a

[[Page 2341]]

fixed amount per use or a fixed percentage of the revenue derived from

the use of the patent or copyright. Otherwise, the cost or other basis

of a separately acquired patent or copyright (or an interest therein)

is depreciated ratably over its remaining useful life. If a patent or

copyright becomes valueless in any year before its legal expiration,

the adjusted basis may be deducted in that year.

(5) Applicable rules and conventions. The period of amortization

under paragraphs (c)(1) through (c)(4) of this section begins when the

intangible is placed in service. For other applicable rules, see

Sec. 1.197-2(f).

(d) Mortgage servicing rights. The amount of the deduction for

mortgage servicing rights described in section 167(f)(3) and

Sec. 1.197-2(c)(11) is determined by using the straight line method

described in Sec. 1.167(b)-1 (except that the salvage value is treated

as zero) and an amortization period of 108 months. Mortgage servicing

rights are not depreciable to the extent the rights are stripped

coupons under section 1286. An event that renders mortgage servicing

rights wholly worthless is considered a disposition of the rights. For

purposes of determining the deduction for mortgage servicing rights and

any loss from the sale, exchange, or other disposition of the rights,

rights to service a pool of mortgages are treated as a single asset.

Thus, if some (but not all) mortgages in a pool prepay and the taxpayer

retains rights to service the remaining mortgages in the pool, no loss

is recognized by reason of the prepayment. The adjusted basis of the

mortgage servicing rights is not affected by the unrecognized loss.

(e) Effective date. This section is applicable on the date final

regulations are published in the Federal Register except that

Sec. 1.167(a)-14(c)(2) (depreciation of the cost of certain separately

acquired rights) and so much of Sec. 1.167(a)-14(c)(3) as relates to

Sec. 1.167(a)-14(c)(2) are applicable August 11, 1993 (or July 26,

1991, if a valid retroactive election has been made under Sec. 1.197-

1T).

Par. 5. Section 1.197-0 is added to read as follows:

Sec. 1.197-0 Table of contents.

This section lists the headings that appear in Sec. 1.197-2.

Sec. 1.197-2 Amortization of goodwill and certain other

intangibles.

(a) Overview.

(1) In general.

(2) Section 167(f) property.

(3) Amounts otherwise deductible.

(4) Relationship to other Internal Revenue Code provisions.

(b) Section 197 intangibles; in general.

(1) Goodwill.

(2) Going concern value.

(3) Workforce in place.

(4) Information base.

(5) Know-how, etc.

(6) Customer-based intangibles.

(7) Supplier-based intangibles.

(8) Licenses, permits, and other rights granted by governmental

units.

(9) Covenants not to compete and other similar arrangements.

(10) Franchises, trademarks, and trade names.

(11) Contracts for the use of, and term interests in, other

section 197 intangibles.

(12) Other similar items.

(c) Section 197 intangibles; exceptions.

(1) Interests in a corporation, partnership, trust, or estate.

(2) Interests under certain financial contracts.

(3) Interests in land.

(4) Certain computer software.

(i) In general.

(ii) Separately acquired software.

(iii) Other exceptions.

(iv) Computer software defined.

(v) Readily available to the general public.

(5) Certain interests in films, sound recordings, video tapes,

books, or other similar property.

(6) Certain rights to receive tangible property or services.

(7) Certain interests in patents or copyrights.

(8) Interests under leases of tangible property.

(i) Interest as a lessor.

(ii) Interest as a lessee.

(9) Interests under indebtedness.

(i) In general.

(ii) Exceptions.

(10) Professional sports franchises.

(11) Mortgage servicing rights.

(12) Certain transaction costs.

(13) Rights of fixed duration or amount.

(d) Amortizable section 197 intangibles.

(1) Definition.

(2) Exception for self-created intangibles.

(i) In general.

(ii) Created by the taxpayer.

(A) Defined.

(B) Contracts for the use of intangibles.

(C) Improvements and modifications.

(iii) Exceptions.

(3) Exception for property subject to anti-churning rules.

(e) Purchase of a trade or business.

(1) Goodwill or going concern value.

(2) Customer-based intangibles.

(3) Franchise, trademark, or trade name.

(i) In general.

(ii) Exceptions.

(4) Acquisitions to be included.

(5) Substantial portion.

(6) Deemed asset purchases under section 338.

(f) Computation of amortization deduction.

(1) In general.

(2) Treatment of contingent amounts.

(i) Amounts added to basis during 15-year period.

(ii) Amounts becoming fixed after expiration of 15-year period.

(iii) Time for including amounts in basis.

(3) Determination of amounts chargeable to capital account in

certain cases.

(i) Covenants not to compete, rights granted by governmental

units, and contracts for the use of section 197 intangibles.

(A) In general.

(B) Time for taking amounts into account.

(ii) Franchises, trademarks, or trade names and licenses,

permits, and other rights granted by governmental units.

(iii) Certain reinsurance transactions.

(4) Transactions subject to section 338 or 1060.

(g) Special rules.

(1) Treatment of certain dispositions.

(i) Loss disallowance rules.

(A) In general.

(B) Certain nonrecognition transfers.

(ii) Separately acquired property.

(iii) Disposition of a covenant not to compete.

(iv) Taxpayers under common control.

(A) In general.

(B) Treatment of disallowed loss.

(2) Treatment of certain nonrecognition and exchange

transactions.

(i) In general.

(A) Transfer disregarded.

(B) Application of general rule.

(ii) Transactions covered.

(iii) Certain exchanged-basis property.

(iv) Transfers under section 708(b)(1).

(A) In general.

(B) Termination by sale or exchange of interest.

(C) Other terminations.

(D) Anti-churning rules.

(v) Distributions to which section 732(d) applies.

(vi) Curative and remedial allocations under section 704(c).

(3) Application of section 754 to acquisitions of an interest in

an intangible held through a partnership.

(4) Treatment of certain reinsurance transactions.

(i) In general.

(ii) Determination of adjusted basis.

(A) Acquisitions (other than under section 338) of specified

insurance contracts.

(B) Other acquisitions. [Reserved]

(5) Amounts paid or incurred for a franchise, trademark, or

trade name.

(6) Amounts properly taken into account in determining the cost

of property that is not a section 197 intangible.

(7) Treatment of amortizable section 197 intangibles as

depreciable property.

(i) In general.

(ii) Exceptions and limitations.

(A) Unstated interest and original issue discount rules.

(B) Treatment of other parties to transaction.

(h) Anti-churning rules.

(1) Conversions of existing goodwill, going concern value, and

certain other section 197 intangibles.

(2) Amounts deductible under section 1253(d).

(3) Transition period.

(4) Exceptions.

(5) Special partnership provisions.

(i) Basis increases.

(ii) Curative and remedial allocations under section 704(c).

[[Page 2342]]

(6) Related person.

(i) In general.

(ii) Time for testing relationships.

(iii) De minimis rule.

(A) In general.

(B) Determination of beneficial ownership interest.

(7) Special rules for entities that owned or used property at

any time during the transition period and that are no longer in

existence.

(8) Special rules for section 338 deemed acquisitions.

(9) Exception to anti-churning rules where gain is recognized.

(i) In general.

(ii) Manner of making election. [Reserved]

(iii) Determination of highest marginal rate of tax.

(A) Noncorporate taxpayers.

(B) Corporations and tax-exempt entities.

(iv) Special rule for pass-through entities.

(v) Coordination with other provisions.

(A) In general.

(B) Section 1374.

(C) Procedural and administrative provisions.

(D) Installment method.

(10) Transactions subject to both anti-churning and

nonrecognition rules.

(11) Anti-churning anti-abuse rule.

(i) [Reserved].

(j) General anti-abuse rule.

(k) Examples.

(l) Effective dates.

Par. 6. Section 1.197-2 is added to read as follows:

Sec. 1.197-2 Amortization of goodwill and certain other intangibles.

(a) Overview--(1) In general. Section 197 allows an amortization

deduction for the capitalized costs of an amortizable section 197

intangible and prohibits any other depreciation or amortization with

respect to that property. Paragraphs (b), (c), and (e) of this section

provide rules and definitions for determining whether property is a

section 197 intangible, and paragraphs (d) and (e) of this section

provide rules and definitions for determining whether a section 197

intangible is an amortizable section 197 intangible. The amortization

deduction under section 197 is determined by amortizing adjusted basis

ratably over a 15-year period under the rules of paragraph (f) of this

section. Section 197 also includes various special rules pertaining to

the disposition of amortizable section 197 intangibles, nonrecognition

transactions, anti-churning rules, and anti-abuse rules. Rules relating

to these provisions are contained in paragraphs (g), (h), and (j) of

this section. Examples demonstrating the application of these

provisions are contained in paragraph (k) of this section. The

effective date of the rules in this section is contained in paragraph

(l) of this section.

(2) Section 167(f) property. Section 167(f) prescribes rules for

computing the depreciation deduction for certain property to which

section 197 does not apply. See Sec. 1.167(a)-14 for rules under

section 167(f) and paragraphs (c) (4), (6), (7), (11), and (13) of this

section for a description of the property subject to section 167(f).

(3) Amounts otherwise deductible. Except as otherwise provided in

section 197(f)(3) and paragraphs (b)(11) and (f)(3) of this section,

section 197 does not apply to amounts that would be currently

deductible without regard to section 197.

(4) Relationship to other Internal Revenue Code provisions. Section

197 does not apply to any amount paid or incurred for a section 197

intangible if a deduction for the amount would be disallowed under any

provision of the Code other than section 263. (See, for example,

section 162(k).)

(b) Section 197 intangibles; in general. Except as otherwise

provided in paragraph (c) of this section, the term section 197

intangible means any property described in section 197(d)(1). The

following rules and definitions provide guidance concerning property

that is a section 197 intangible unless an exception applies:

(1) Goodwill. Section 197 intangibles include goodwill. Goodwill is

the value of a trade or business attributable to the expectancy of

continued customer patronage. This expectancy may be due to the name or

reputation of a trade or business or any other factor.

(2) Going concern value. Section 197 intangibles include going

concern value. Going concern value is the additional value that

attaches to property by reason of its existence as an integral part of

an ongoing business activity. Going concern value includes the value

attributable to the ability of a trade or business (or a part of a

trade or business) to continue functioning or generating income without

interruption notwithstanding a change in ownership, but does not

include any of the intangibles described in any other provision of this

paragraph (b). It also includes the value that is attributable to the

immediate use or availability of an acquired trade or business, such

as, for example, the use of the revenues or net earnings that otherwise

would not be received during any period if the acquired trade or

business were not available or operational.

(3) Workforce in place. Section 197 intangibles include workforce

in place. Workforce in place (sometimes referred to as agency force or

assembled workforce) includes the composition of a workforce (for

example, the experience, education, or training of a workforce), the

terms and conditions of employment whether contractual or otherwise,

and any other value placed on employees or any of their attributes.

Thus, the amount paid or incurred for workforce in place includes, for

example, any portion of the purchase price of an acquired trade or

business attributable to the existence of a highly-skilled workforce,

an existing employment contract (or contracts), or a relationship with

employees or consultants (including, but not limited to, any key

employee contract or relationship). Workforce in place does not include

any covenant not to compete or other similar arrangement described in

paragraph (b)(9) of this section.

(4) Information base. Section 197 intangibles include business

books and records, operating systems, and any other information base,

including lists or other information of current or prospective

customers (regardless of the method of recording the information).

Thus, the amount paid or incurred for these items includes, for

example, any portion of the purchase price of an acquired trade or

business attributable to the intangible value of technical manuals,

training manuals or programs, data files, and accounting or inventory

control systems. Other examples include the cost of acquiring customer

lists, subscription lists, insurance expirations, patient or client

files, or lists of newspaper, magazine, radio, or television

advertisers.

(5) Know-how, etc. Section 197 intangibles include any patent,

copyright, formula, process, design, pattern, know-how, format, package

design, computer software (as defined in paragraph (c)(4) of this

section), or interest in a film, sound recording, video tape, book, or

other similar property. (See, however, the exceptions in paragraph (c)

of this section.)

(6) Customer-based intangibles. Section 197 intangibles include any

customer-based intangible. A customer-based intangible is any

composition of market, market share, or other value resulting from the

future provision of goods or services pursuant to contractual or other

relationships in the ordinary course of business with customers. Thus,

the amount paid or incurred for customer-based intangibles includes,

for example, any portion of the purchase price of an acquired trade or

business attributable to the existence of a customer base, a

circulation base, an undeveloped market or market growth, insurance in

force, the existence of a qualification to supply goods or services to

a particular customer, a

[[Page 2343]]

mortgage servicing contract (as defined in paragraph (c)(11) of this

section), an investment management contract, or other relationship with

customers involving the future provision of goods or services. (See,

however, the exceptions in paragraph (c) of this section.) In addition,

customer-based intangibles include the deposit base and any similar

asset of a financial institution. Thus, the amount paid or incurred for

customer-based intangibles also includes any portion of the purchase

price of an acquired financial institution attributable to the value

represented by existing checking accounts, savings accounts, escrow

accounts, and other similar items of the financial institution.

However, any portion of the purchase price of an acquired trade or

business attributable to accounts receivable or other similar rights to

income for goods or services provided to customers prior to the

acquisition of a trade or business is not an amount paid or incurred

for a customer-based intangible.

(7) Supplier-based intangibles. Section 197 intangibles include any

supplier-based intangible. A supplier-based intangible is the value

resulting from the future acquisition, pursuant to contractual or other

relationships with suppliers in the ordinary course of business, of

goods or services that will be sold or used by the taxpayer. Thus, the

amount paid or incurred for supplier-based intangibles includes, for

example, any portion of the purchase price of an acquired trade or

business attributable to the existence of a favorable relationship with

persons providing distribution services (such as favorable shelf or

display space at a retail outlet), the existence of a favorable credit

rating, or the existence of favorable supply contracts. The amount paid

or incurred for supplier-based intangibles does not include any amount

required to be paid for the goods or services themselves pursuant to

the terms of the agreement or other relationship. In addition, see the

exceptions in paragraph (c) of this section, including the exception in

paragraph (c)(6) of this section for certain rights to receive tangible

property or services from another person.

(8) Licenses, permits, and other rights granted by governmental

units. Section 197 intangibles include any license, permit, or other

right granted by a governmental unit (including, for purposes of

section 197, an agency or instrumentality thereof) even if the right is

granted for an indefinite period or is reasonably expected to be

renewed for an indefinite period. These rights include, for example, a

liquor license, a taxi-cab medallion (or license), an airport landing

or takeoff right (sometimes referred to as a slot), a regulated airline

route, or a television or radio broadcasting license. The issuance or

renewal of a license, permit, or other right granted by a governmental

unit is considered an acquisition of the license, permit, or other

right. (See, however, the exceptions in paragraph (c) of this section,

including the exceptions in paragraph (c)(3) of this section for an

interest in land, in paragraph (c)(8) of this section for an interest

under a lease of tangible property, and in paragraphs (c) (6) and (13)

of this section for certain rights granted by a governmental unit. See

paragraph (b)(10) of this section for the treatment of franchises.)

(9) Covenants not to compete and other similar arrangements.

Section 197 intangibles include any covenant not to compete, or

agreement having substantially the same effect, entered into in

connection with the direct or indirect acquisition of an interest in a

trade or business or a substantial portion thereof. For purposes of

this paragraph (b)(9), an acquisition may be made in the form of an

asset acquisition (including a qualified stock purchase that is treated

as a purchase of assets under section 338), a stock acquisition or

redemption, and the acquisition or redemption of a partnership

interest. An agreement requiring the performance of services or the

provision of property or the use of property (other than property of

the acquired trade or business) does not have substantially the same

effect as a covenant not to compete to the extent that the amount paid

under the agreement represents reasonable compensation for the services

actually rendered or for the property or use of the property actually

provided.

(10) Franchises, trademarks, and trade names. (i) Section 197

intangibles include any franchise, trademark, or trade name. The term

franchise includes any agreement that provides one of the parties to

the agreement with the right to distribute, sell, or provide goods,

services, or facilities, within a specified area. (See section

1253(b)(1).) The term includes distributorships or other similar

contractual arrangements pursuant to which the transferee is permitted

or licensed to operate or conduct a trade or business within a specific

area. The term trademark includes any word, name, symbol, or device, or

any combination thereof, adopted and used by a manufacturer or merchant

to identify goods or services and distinguish them from those

manufactured or sold by others. The term trade name includes any name

used by a manufacturer or merchant to identify or designate a

particular trade or business or the name or title used by a person or

organization engaged in a trade or business. A license, permit, or

other right granted by a governmental unit is a franchise if it

otherwise meets the definition of a franchise. A trademark or trade

name includes any trademark or trade name arising under statute or

applicable common law, and any similar right granted by contract. The

renewal of a franchise, trademark, or trade name is treated as an

acquisition of the franchise, trademark, or trade name.

(ii) Notwithstanding the definitions provided in paragraph

(b)(10)(i) of this section, any amount that is paid or incurred on

account of a transfer, sale, or other disposition of a franchise,

trademark, or trade name and that is subject to section 1253(d)(1) is

not included in the basis of a section 197 intangible. (See paragraph

(g)(5) of this section.)

(11) Contracts for the use of, and term interests in, other section

197 intangibles. Section 197 intangibles include any right under a

license, contract, or other arrangement providing for the use of

property that would be a section 197 intangible under any provision of

this paragraph (b) (including this paragraph (b)(11)) after giving

effect to all of the exceptions provided in paragraph (c) of this

section. Section 197 intangibles also include any term interest

(whether outright or in trust) in such property.

(12) Other similar items. Section 197 intangibles include any other

intangible property that is similar in all material respects to the

property specifically described in section 197(d)(1)(C) and paragraphs

(b)(3) through (b)(7) of this section. (See paragraph (g)(4) of this

section for special rules regarding certain reinsurance transactions.)

(c) Section 197 intangibles; exceptions. The term section 197

intangible does not include property described in section 197(e). The

following rules and definitions provide guidance concerning property to

which the exceptions apply:

(1) Interests in a corporation, partnership, trust, or estate.

Section 197 intangibles do not include an interest in a corporation,

partnership, trust, or estate. Thus, for example, amortization under

section 197 is not available for the cost of acquiring stock,

partnership interests, or interests in a trust or estate, whether or

not the interests are regularly traded on an established market. (See

paragraph (g)(3) of this section for special rules applicable to

property of a partnership when a section

[[Page 2344]]

754 election is in effect for the partnership.)

(2) Interests under certain financial contracts. Section 197

intangibles do not include an interest under an existing futures

contract, foreign currency contract, notional principal contract,

interest rate swap, or other similar financial contract, whether or not

the interest is regularly traded on an established market. However,

this exception does not apply to an interest under a mortgage servicing

contract, credit card servicing contract, or other contract to service

another persons indebtedness, or an interest under an assumption

reinsurance contract. (See paragraph (g)(4) of this section for the

treatment of assumption reinsurance contracts. See paragraph (c)(11) of

this section and Sec. 1.167(a)-14(d) for the treatment of mortgage

servicing rights.)

(3) Interests in land. Section 197 intangibles do not include any

interest in land. For this purpose, an interest in land includes a fee

interest, life estate, remainder, easement, mineral right, timber

right, grazing right, riparian right, air right, zoning variance, and

any other similar right, such as a farm allotment, quota for farm

commodities, or crop acreage base. An interest in land does not include

an airport landing or takeoff right, a regulated airline route, or a

franchise to provide cable television service. The cost of acquiring a

license, permit, or other land improvement right, such as a building

construction or use permit, is taken into account in the same manner as

the underlying improvement.

(4) Certain computer software--(i) In general. Section 197

intangibles do not include any interest in computer software that is

(or has been) readily available to the general public on similar terms,

is subject to a nonexclusive license, and has not been substantially

modified for the user. Computer software will not be considered to have

been substantially modified if its cost does not exceed the greater of

125 percent of the price at which the unmodified version of the

software is readily available to the general public or $2,000. For the

purpose of determining whether computer software has been substantially

modified--

(A) Integrated programs acquired in a package from a single source

are treated as a single computer program; and

(B) Any cost incurred to install the computer software is not

treated as a cost of the software.

(ii) Separately acquired software. Section 197 intangibles do not

include an interest in computer software that is not acquired as part

of a purchase of a trade or business within the meaning of paragraph

(e) of this section.

(iii) Other exceptions. Neither section 197 nor section 167(f)

apply in the following cases:

(A) Any amount of the cost of an interest in computer software that

is included, without being separately stated, in the cost of the

hardware or other tangible property will be treated as part of the cost

of the hardware or other tangible property.

(B) Any amount of the cost of an interest in computer software that

would be deductible under any provision other than section 167(f) or

197 may be deducted and is not required to be capitalized.

(iv) Computer software defined. For purposes of this section,

computer software is any program or routine (that is, any sequence of

machine-readable code) that is designed to cause a computer (as defined

in section 168(i)(2)(B)(ii)) to perform a desired function or set of

functions, and the documentation required to describe and maintain

those programs. It includes all forms and media in which the software

is contained, whether written, magnetic, or otherwise. Computer

programs of all classes, for example, operating systems, executive

systems, monitors, compilers and translators, assembly routines, and

utility programs as well as application programs, are included.

Computer software also includes any incidental and ancillary rights

that are necessary to effect the acquisition of the title to, the

ownership of, or the right to use the computer software, and that are

used only in connection with that specific computer software. Such

incidental and ancillary rights are not included in the definition of

trademark or trade name under paragraph (b)(10)(i) of this section. For

example, a trademark or trade name that is ancillary to the ownership

or use of a specific computer software program in the taxpayer's trade

or business and is not acquired for the purpose of marketing the

computer software is included in the definition of computer software

and is not included in the definition of trademark or trade name.

Computer software does not include any data or information base

described in paragraph (b)(4) of this section unless the data base or

item is in the public domain and is incidental to a computer program.

For this purpose, a copyrighted or proprietary data or information base

is treated as in the public domain if its availability through the

computer program does not contribute significantly to the cost of the

program. For example, if a word-processing program includes a

dictionary feature used to spell-check a document or any portion

thereof, the entire program (including the dictionary feature) is

computer software regardless of the form in which the feature is

maintained or stored.

(v) Readily available to the general public. Computer software will

be treated as readily available to the general public if the software

may be obtained on substantially the same terms by a significant number

of persons that would reasonably be expected to use the software. The

requirements of this paragraph (c)(4)(v) can be met even though the

software is not available through a system of retail distribution.

(5) Certain interests in films, sound recordings, video tapes,

books, or other similar property. Section 197 intangibles do not

include any interest (including an interest as a licensee) in a film,

sound recording, video tape, book, or other similar property (such as

the right to broadcast or transmit a live event) if the interest is not

acquired as part of a purchase of a trade or business. A film, sound

recording, video tape, book, or other similar property includes any

incidental and ancillary rights (such as a trademark or trade name)

that are necessary to effect the acquisition of title to, the ownership

of, or the right to use the property and are used only in connection

with that property. Such incidental and ancillary rights are not

included in the definition of trademark or trade name under paragraph

(b)(10)(i) of this section. For purposes of this paragraph (c)(5),

computer software (as defined in paragraph (c)(4)(iv) of this section)

is not treated as other property similar to a film, sound recording,

video tape, or book. (See section 167 for amortization of excluded

intangible property or interests.)

(6) Certain rights to receive tangible property or services.

Section 197 intangibles do not include any right to receive tangible

property or services under a contract or from a governmental unit if

the right is not acquired as part of a purchase of a trade or business.

Any right that is described in the preceding sentence is not treated as

a section 197 intangible even though the right is also described in

section 197(d)(1)(D) and paragraph (b)(8) of this section (relating to

certain governmental licenses, permits, and other rights) and even

though the right fails to meet one or more of the requirements of

paragraph (c)(13) of this section (relating to certain rights of fixed

duration or amount). (See Sec. 1.167(a)-14(c) (1) and (3) for

applicable rules.)

(7) Certain interests in patents or copyrights. Section 197

intangibles do not include any interest (including an interest as a

licensee) in a patent, patent

[[Page 2345]]

application, or copyright that is not acquired as part of a purchase of

a trade or business. (See Sec. 1.167(a)-14(c)(4) for applicable rules.)

(8) Interests under leases of tangible property--(i) Interest as a

lessor. Section 197 intangibles do not include any interest as a lessor

under an existing lease or sublease of tangible real or personal

property. In addition, the cost of acquiring an interest as a lessor in

connection with the acquisition of tangible property is taken into

account as part of the cost of the tangible property. For example, if a

taxpayer acquires a shopping center that is leased to tenants operating

retail stores, any portion of the purchase price attributable to

favorable lease terms is taken into account as part of the basis of the

shopping center and in determining the depreciation deduction allowed

with respect to the shopping center. (See section 167(c)(2).)

(ii) Interest as a lessee. Section 197 intangibles do not include

any interest as a lessee under an existing lease of tangible real or

personal property. For this purpose, an airline lease of an airport

passenger or cargo gate is a lease of tangible property. The cost of

acquiring such an interest is taken into account under section 178 and

Sec. 1.162-11(a). If an interest as a lessee under a lease of tangible

property is acquired in a transaction with any other intangible

property, a portion of the total purchase price may be allocable to the

interest as a lessee based on all of the relevant facts and

circumstances.

(9) Interests under indebtedness--(i) In general. Section 197

intangibles do not include any interest (whether as a creditor or

debtor) under an indebtedness in existence when the interest was

acquired. Thus, for example, the value attributable to the assumption

of an indebtedness with a below-market interest rate is not amortizable

under section 197. In addition, the premium paid for acquiring a debt

instrument with an above-market interest rate is not amortizable under

section 197. See section 171 for rules concerning the treatment of

amortizable bond premium.

(ii) Exceptions. For purposes of this paragraph (c)(9), an interest

under an existing indebtedness does not include the deposit base (and

other similar items) of a financial institution. An interest under an

existing indebtedness includes mortgage servicing rights, however, to

the extent the rights are stripped coupons under section 1286.

(10) Professional sports franchises. Section 197 intangibles do not

include any franchise to engage in professional baseball, basketball,

football, or any other professional sport, and any item (even though

otherwise qualifying as a section 197 intangible) acquired in

connection with such a franchise.

(11) Mortgage servicing rights. Section 197 intangibles do not

include any right described in section 197(e)(7) (concerning rights to

service indebtedness secured by residential real property that are not

acquired as part of a purchase of a trade or business). (See

Sec. 1.167(a)-14(d) for applicable rules.)

(12) Certain transaction costs. Section 197 intangibles do not

include any fees for professional services and any transaction costs

incurred by parties to a transaction in which all or any portion of the

gain or loss is not recognized under part III of subchapter C of the

Code.

(13) Rights of fixed duration or amount. (i) Section 197

intangibles do not include any right under a contract or any license,

permit, or other right granted by a governmental unit if the right--

(A) Is acquired in the ordinary course of business and not as part

of a purchase of a trade or business;

(B) Is not described in sections 197(d)(1) (A), (B), (C) (ii),

(iv), or (vi), (E), or (F); and

(C) Either--

(1) Has a fixed duration of less than 15 years; or

(2) Is fixed as to amount and the adjusted basis thereof is

properly recoverable (without regard to this section) under a method

similar to the unit-of-production method.

(ii) See Sec. 1.167(a)-14(c) (2) and (3) for applicable rules.

(d) Amortizable section 197 intangibles--(1) Definition. Except as

otherwise provided in this paragraph (d), the term amortizable section

197 intangible means any section 197 intangible acquired after August

10, 1993 (or after July 25, 1991, if a valid retroactive election under

Sec. 1.197-1T has been made), and held in connection with the conduct

of a trade or business or an activity described in section 212.

(2) Exception for self-created intangibles--(i) In general. Except

as provided in paragraph (d)(2)(iii) of this section, amortizable

section 197 intangibles do not include any section 197 intangible

created by the taxpayer (a self-created intangible).

(ii) Created by the taxpayer--(A) Defined. A section 197 intangible

is created by the taxpayer to the extent the taxpayer makes payments or

otherwise incurs costs for its creation, production, development, or

improvement, whether the actual work is performed by the taxpayer or by

another person under a contract with the taxpayer entered into before

the creation, production, development, or improvement occurs. For

example, a technological process developed specifically for a taxpayer

under an arrangement with another person pursuant to which the taxpayer

retains all rights to the process is created by the taxpayer.

(B) Contracts for the use of intangibles. A section 197 intangible

is not created by the taxpayer to the extent that it results from the

entry into (or renewal of) a contract for the use of an existing

section 197 intangible. Thus, for example, the exception for self-

created intangibles does not apply to legal and other professional fees

incurred by a licensee in connection with the entry into (or renewal

of) a contract for the use of know-how or similar property.

(C) Improvements and modifications. If an existing section 197

intangible is improved or otherwise modified by the taxpayer or by

another person under a contract with the taxpayer, the existing

intangible and the improvements or other modifications are treated as

separate section 197 intangibles for purposes of this paragraph (d).

(iii) Exceptions. (A) The exception for self-created intangibles

does not apply to any section 197 intangible described in section

197(d)(1)(D) (relating to licenses, permits or other rights granted by

a governmental unit), 197(d)(1)(E) (relating to covenants not to

compete), or 197(d)(1)(F) (relating to franchises, trademarks, and

trade names). Thus, for example, capitalized costs incurred in the

development, registration, or defense of a trademark or trade name do

not qualify for the exception and are amortized over 15 years under

section 197.

(B) The exception for self-created intangibles does not apply to

any section 197 intangible created in connection with the purchase of a

trade or business (as defined in paragraph (e) of this section).

(C) If a taxpayer disposes of a self-created intangible and

subsequently reacquires the intangible in an acquisition described in

paragraph (h)(4)(ii) of this section, the exception for self-created

intangibles does not apply to the reacquired intangible.

(3) Exception for property subject to anti-churning rules.

Amortizable section 197 intangibles do not include any property to

which the anti-churning rules of section 197(f)(9) and paragraph (h) of

this section apply.

(e) Purchase of a trade or business. Several of the exceptions in

section 197 apply only to property that is not acquired in (or created

in connection with) a transaction or series of related

[[Page 2346]]

transactions involving the acquisition of assets constituting a trade

or business or a substantial portion thereof. Property acquired in (or

created in connection with) such a transaction or series of related

transactions is referred to in this section as property acquired as

part of (or created in connection with) a purchase of a trade or

business. For purposes of section 197 and this section, the

applicability of the limitation is determined under the following

rules:

(1) Goodwill or going concern value. A group of assets constitutes

a trade or business or a substantial portion thereof if their use would

constitute a trade or business under section 1060 (that is, if goodwill

or going concern value could under any circumstances attach to the

assets). See Sec. 1.1060-1T(b)(2). For this purpose, all the facts and

circumstances, including any employee relationships that continue (or

covenants not to compete that are entered into) as part of the transfer

of the assets, are taken into account in determining whether goodwill

or going concern value could attach to the assets.

(2) Customer-based intangibles. Whether or not a group of assets is

otherwise described in paragraph (e)(1) of this section, a group of

assets constitutes a trade or business or a substantial portion thereof

if the assets include any customer-based intangibles (as defined in

paragraph (b)(6) of this section) or are acquired in a transaction or

series of related transactions that involve the creation of any

customer-based intangibles.

(3) Franchise, trademark, or trade name--(i) In general. The

acquisition of a franchise, trademark, or trade name constitutes the

acquisition of a trade or business or a substantial portion thereof.

(ii) Exceptions. For purposes of this paragraph (e)(3)--

(A) A trademark or trade name is disregarded if it is included in

computer software under paragraph (c)(4) of this section or in an

interest in a film, sound recording, video tape, book, or other similar

property under paragraph (c)(5) of this section; and

(B) A franchise, trademark, or trade name is disregarded if its

value is nominal or the taxpayer irrevocably disposes of it immediately

after its acquisition.

(4) Acquisitions to be included. The assets acquired in a

transaction (or series of related transactions) include only assets

(including a beneficial or other indirect interest in assets where the

interest is of a type described in paragraph (c)(1) of this section)

acquired by the taxpayer and persons related to the taxpayer from

another person and persons related to that other person. For purposes

of this paragraph (e)(4), persons are related only if their

relationship is described in section 267(b) or 707(b) or they are

engaged in trades or businesses under common control within the meaning

of section 41(f)(1).

(5) Substantial portion. The determination of whether acquired

assets constitute a substantial portion of a trade or business is to be

based on all of the facts and circumstances, including the nature and

the amount of the assets acquired as well as the nature and amount of

the assets retained by the transferor. The value of the assets acquired

relative to the value of the assets retained by the transferor is not

determinative of whether the acquired assets constitute a substantial

portion of a trade or business.

(6) Deemed asset purchases under section 338. A qualified stock

purchase that is treated as a purchase of assets under section 338

shall be treated as a transaction involving the acquisition of assets

constituting a trade or business only if the direct acquisition of the

assets of the corporation would have been treated as the acquisition of

assets constituting a trade or business.

(f) Computation of amortization deduction--(1) In general. Except

as provided in paragraph (f)(2) of this section, the amortization

deduction allowable under section 197(a) is computed as follows:

(i) The adjusted basis (for purposes of determining gain) of an

amortizable section 197 intangible is amortized ratably over the 15-

year period beginning on the later of--

(A) The first day of the month in which the property is acquired;

or

(B) In the case of property held in connection with the conduct of

a trade or business, the first day of the month in which the active

conduct of the trade or business begins.

(ii) Except as otherwise provided in this section, adjusted basis

is determined under section 1011 and salvage value is disregarded.

(iii) Property is not eligible for amortization in the month of

disposition.

(iv) The amortization deduction for a short taxable year is based

on the number of months in the short taxable year.

(2) Treatment of contingent amounts--(i) Amounts added to basis

during 15-year period. Any amount that is properly included in the

basis of an amortizable section 197 intangible after the first month of

the 15-year period described in paragraph (f)(1)(i) of this section and

before the expiration of this period is amortized ratably over the

remainder of the 15-year period. For this purpose, the remainder of the

15-year period begins on the first day of the month in which the basis

increase occurs. Any reasonable convention may be used to determine the

month in which the basis increase incurs, provided that the method

selected is used consistently for all amortizable section 197

intangibles acquired in the same transaction (or series of related

transactions) and that it does not result in any amount being added to

basis earlier than the midpoint of the period (for example, annual,

semi-annual, or quarterly) selected.

(ii) Amounts becoming fixed after expiration of 15-year period. Any

amount that is not properly included in the basis of an amortizable

section 197 intangible until after the expiration of the 15-year period

described in paragraph (f)(1)(i) of this section is amortized in full

immediately upon the inclusion of the amount in the basis of the

intangible.

(iii) Time for including amounts in basis. See Sec. 1.461-1(a)(1)

for rules governing the time at which an amount may be taken into

account by a taxpayer using the cash receipts and disbursements method,

and Sec. 1.461-1(a)(2) for rules governing the time at which a

liability is incurred and generally taken into account (for example, by

treating the amount of the liability as a capital expenditure) by an

accrual basis taxpayer.

(3) Determination of amounts chargeable to capital account in

certain cases--(i) Covenants not to compete, rights granted by

governmental units, and contracts for the use of section 197

intangibles--(A) In general. In the case of a covenant not to compete

or other similar arrangement described in paragraph (b)(9) of this

section, any license, permit, or other right granted by a governmental

unit or an agency or instrumentality thereof described in paragraph

(b)(8) of this section, or a contract for the use of a section 197

intangible described in paragraph (b)(11) of this section, the amount

chargeable to capital account includes all amounts required to be paid

pursuant to the agreement or right, whether or not any amount would be

deductible under section 162 if the agreement or right were not a

section 197 intangible.

(B) Time for taking amounts into account. For purposes of this

paragraph (f)(3), in applying the provisions of Secs. 1.461-1(a)(1) (in

the case of a taxpayer using the cash receipts and disbursements method

of accounting) and Sec. 1.461-1(a)(2) (in the case of a taxpayer using

an accrual method of

[[Page 2347]]

accounting), all amounts required to be paid under an agreement

described in paragraph (b) (9) or (11) of this section shall be treated

as amounts payable under the terms of a debt instrument issued in

exchange for property. Contingent payments made under an agreement

described in paragraph (b) (9) or (11) of this section will be included

in adjusted basis under the rules of paragraph (f)(2) of this section.

(ii) Franchises, trademarks, or trade names and licenses, permits,

and other rights granted by governmental units. The costs paid or

incurred for the renewal of a franchise, trademark, or trade name or

any license, permit, or other right granted by a governmental unit or

an agency or instrumentality thereof are amortized over the 15-year

period that begins with the month of renewal. Any costs paid or

incurred for the issuance, or earlier renewal, continue to be taken

into account over the remaining portion of the amortization period that

began at the time of the issuance, or earlier renewal. Any amount paid

or incurred for the protection, expansion, or defense of a trademark or

trade name and chargeable to capital account is treated as an amount

paid or incurred for a renewal.

(iii) Certain reinsurance transactions. See paragraph (g)(4)(ii) of

this section for special rules regarding the adjusted basis of an

insurance contract acquired through an assumption reinsurance

transaction.

(4) Transactions subject to section 338 or 1060. In the case of a

section 197 intangible deemed to have been acquired as the result of a

qualified stock purchase within the meaning of section 338(d)(3), the

basis shall be determined pursuant to section 338(b)(5) and the

regulations thereunder. In the case of a section 197 intangible

acquired in an applicable asset acquisition within the meaning of

section 1060(c), the basis shall be determined pursuant to section

1060(a) and the regulations thereunder.

(g) Special rules--(1) Treatment of certain dispositions--(i) Loss

disallowance rules--(A) In general. No loss is recognized on the

disposition of an amortizable section 197 intangible acquired in a

transaction or series of related transactions in which the taxpayer

acquired other amortizable section 197 intangibles if, after the

disposition, the taxpayer retains any of the other amortizable section

197 intangibles, or the right to use, or an interest in, any of the

other amortizable section 197 intangibles (the retained intangibles).

Except as otherwise provided in paragraph (g)(1)(iv)(B) of this

section, the adjusted basis of each of the retained intangibles is

increased by the product of the loss that is not recognized solely by

reason of this rule and a fraction, the numerator of which is the

adjusted basis of the retained intangible on the date of the

disposition and the denominator of which is the total adjusted bases of

all the retained intangibles on that date. The abandonment of an

amortizable section 197 intangible, or any other event rendering an

amortizable section 197 intangible worthless, is treated as a

disposition of the intangible for purposes of this paragraph (g)(1),

and the abandoned or worthless intangible is disregarded (that is, it

is not treated as a retained intangible) for purposes of applying this

paragraph (g)(1) to the subsequent disposition of any other amortizable

section 197 intangible.

(B) Certain nonrecognition transfers. The loss disallowance rule in

paragraph (g)(1)(i)(A) of this section also applies when a taxpayer

transfers an amortizable section 197 intangible from an acquired trade

or business in a transaction in which the intangible is transferred-

basis property and, after the transfer, retains other amortizable

section 197 intangibles from the trade or business. Thus, for example,

the transfer of an amortizable section 197 intangible to a corporation

in exchange for stock in the corporation in a transaction described in

section 351, or to a partnership in exchange for an interest in the

partnership in a transaction described in section 721, when other

amortizable section 197 intangibles acquired in the same transaction

are retained, followed by a sale of the stock or partnership interest

received, will not avoid the application of the loss disallowance

provision to the extent the adjusted basis of the transferred

intangible at the time of the sale exceeds its fair market value at

that time.

(ii) Separately acquired property. Paragraph (g)(1)(i) of this

section does not apply to an amortizable section 197 intangible that is

not acquired in a transaction or series of related transactions in

which the taxpayer acquires other amortizable section 197 intangibles

(a separately acquired intangible). Consequently, a loss may be

recognized upon the disposition of a separately acquired section 197

intangible. However, the termination or worthlessness of only a portion

of an amortizable section 197 intangible is not the disposition of a

separately acquired intangible. For example, neither the loss of

several customers from an acquired customer list, the termination of

several mortgages (not qualifying for the exception set forth in

paragraph (c)(11) of this section) from an acquired mortgage pool, nor

the worthlessness of only some information from an acquired data base

constitutes the disposition of a separately acquired intangible.

(iii) Disposition of a covenant not to compete. If a covenant not

to compete or any other arrangement having substantially the same

effect is entered into in connection with the direct or indirect

acquisition of an interest in a trade or business, the disposition or

worthlessness of the covenant or other arrangement will not be

considered to occur until the disposition or worthlessness of all

interests in that trade or business. For example, a covenant not to

compete entered into in connection with the purchase of stock continues

to be amortized on a 15-year straight-line basis (even after the

covenant expires or becomes worthless) unless all the trades or

businesses in which an interest was acquired through the stock purchase

(or all the purchaser's interests in those trades or businesses) also

are disposed of or become worthless.

(iv) Taxpayers under common control--(A) In general. Except as

provided in paragraph (g)(1)(iv)(B) of this section, all persons that

would be treated as a single taxpayer under section 41(f)(1) are

treated as a single taxpayer under this paragraph (g)(1). Thus, for

example, a loss is not recognized on the disposition of an amortizable

section 197 intangible by a member of a controlled group of

corporations (as defined in section 41(f)(5)) if, after the

disposition, another member retains other amortizable section 197

intangibles acquired in the same transaction as the amortizable section

197 intangible that has been disposed of.

(B) Treatment of disallowed loss. If retained intangibles are held

by a person other than the person incurring the disallowed loss, only

the adjusted basis of intangibles retained by the person incurring the

disallowed loss is increased, and only the adjusted basis of those

intangibles is included in the denominator of the fraction described in

paragraph (g)(1)(i)(A) of this section. If none of the retained

intangibles are held by the person incurring the disallowed loss, the

loss is allowed ratably, as a deduction under section 197, over the

remainder of the period during which the intangible giving rise to the

loss would have been amortizable, except that any remaining disallowed

loss is allowed in full on the first date on which all other retained

intangibles have been disposed of or become worthless.

(2) Treatment of certain nonrecognition and exchange

[[Page 2348]]

transactions--(i) In general--(A) Transfer disregarded. Except as

otherwise provided in paragraph (h) of this section, if a section 197

intangible is transferred in a transaction described in paragraph

(g)(2)(ii) of this section, the transfer is disregarded in

determining--

(1) Whether, with respect to so much of the intangible's basis in

the hands of the transferee as does not exceed its basis in the hands

of the transferor, the intangible is an amortizable section 197

intangible; and

(2) The amount of the deduction under section 197 with respect to

such basis.

(B) Application of general rule. If the intangible described in

paragraph (g)(2)(i)(A) of this section was an amortizable section 197

intangible in the hands of the transferor, the transferee will continue

to amortize its adjusted basis, to the extent it does not exceed the

transferor's adjusted basis, ratably over the remainder of the

transferor's 15-year amortization period. If the intangible was not an

amortizable section 197 intangible in the hands of the transferor, the

transferee's adjusted basis, to the extent it does not exceed the

transferor's adjusted basis, cannot be amortized under section 197. In

either event, the intangible is treated, with respect to so much of its

adjusted basis in the hands of the transferee as exceeds its adjusted

basis in the hands of the transferor, in the same manner for purposes

of section 197 as an intangible acquired from the transferor in a

transaction that is not described in paragraph (g)(2)(ii) of this

section. The rules of this paragraph (g)(2)(i) also apply to any

subsequent transfers of the intangible in a transaction described in

paragraph (g)(2)(ii) of this section.

(ii) Transactions covered. The transactions described in this

paragraph (g)(2)(ii) are--

(A) Any transaction described in section 332, 351, 361, 721, or

731; and

(B) Any transaction between corporations that are members of the

same consolidated group immediately after the transaction.

(iii) Certain exchanged-basis property. This paragraph (g)(2)(iii)

applies to property that is acquired in a transaction subject to

section 1031 or 1033 and is permitted to be acquired without

recognition of gain (replacement property). Except as otherwise

provided in paragraph (h) of this section, replacement property is

treated as if it were the property by reference to which its basis is

determined (the predecessor property) in determining whether, with

respect to so much of its basis as does not exceed the basis of the

predecessor property, the replacement property is an amortizable

section 197 intangible and the amortization period under section 197

with respect to such basis. Thus, if the predecessor property was an

amortizable section 197 intangible, the taxpayer will amortize the

adjusted basis of the replacement property, to the extent it does not

exceed the adjusted basis of the predecessor property, ratably over the

remainder of the 15-year amortization period for the predecessor

property. If the predecessor property was not an amortizable section

197 intangible, the adjusted basis of the replacement property, to the

extent it does not exceed the adjusted basis of the predecessor

property, may not be amortized under section 197. In either event, the

replacement property is treated, with respect to so much of its

adjusted basis as exceeds the adjusted basis of the predecessor

property, in the same manner for purposes of section 197 as property

acquired from the transferee in a transaction that is not subject to

section 1031 or 1033. (See paragraph (h) of this section for the

application of the anti-churning rules.)

(iv) Transfers under section 708(b)(1)--(A) In general. Paragraph

(g)(2)(i) of this section applies to transfers of section 197

intangibles that occur or are deemed to occur by reason of the

termination of a partnership under section 708(b)(1).

(B) Termination by sale or exchange of interest. In applying

paragraph (g)(2)(i) of this section to a partnership that is terminated

pursuant to section 708(b)(1)(B) (relating to a sale or exchange of an

interest), the terminated partnership is treated as the transferor and

the new partnership is treated as the transferee with respect to any

section 197 intangible held by the terminated partnership immediately

preceding the termination. (See paragraph (g)(3) of this section for

the treatment of increases in the basis of property of the terminated

partnership under section 743(b).)

(C) Other terminations. In applying paragraph (g)(2)(i) of this

section to a partnership that is terminated pursuant to section

708(b)(1)(A) (relating to cessation of activities by a partnership),

the terminated partnership is treated as the transferor and the

distributee partner is treated as the transferee with respect to any

section 197 intangible held by the terminated partnership immediately

preceding the termination.

(D) Anti-churning rules. See paragraph (h) of this section for the

application of the anti-churning rules.

(v) Distributions to which section 732(d) applies. Paragraph

(g)(2)(i) of this section applies to a distribution of a section 197

intangible to which section 732(d) (relating to special partnership

basis to transferee) applies. For purposes of section 197, any increase

in the basis of the distributed intangible under section 732(d) is

taken into account by a partner as if the increased portion were

attributable to the partner's acquisition of the underlying partnership

property on the date of distribution from the transferor of the

partnership interest or the deceased partner, as the case may be. For

purposes of the effective date and anti-churning rules (paragraphs

(d)(1) and (h) of this section), the intangible is treated as having

been acquired by the transferee partner at the time of the transfer of

the partnership interest described in section 732(d). For purposes of

determining the amortization period under section 197 with respect to

any increased basis, however, the intangible is treated as having been

acquired by the transferee partner at the time of the distribution

described in section 732(a). (See paragraph (h) of this section for the

application of the anti-churning rules.)

(vi) Curative and remedial allocations under section 704(c). For

purposes of paragraph (g)(2)(i) of this section, if a section 197

intangible is transferred to a partnership in a transaction described

in section 721, the basis of the intangible in the hands of the

transferor includes the amount of any curative or remedial allocations

of amortization that are made to a noncontributing partner with respect

to the contributed intangible under the curative or remedial methods

for making allocations under section 704(c). Thus, for example, if a

contributed intangible is not an amortizable section 197 intangible in

the hands of the transferor, any remedial allocations of amortization

made to a noncontributing partner with respect to the intangible are

not amortizable under section 197. See Sec. 1.704-3(c) and (d) for a

description of the curative and remedial methods.

(3) Application of section 754 to acquisitions of an interest in an

intangible held through a partnership. Any increase in the basis of

partnership property under section 734(b) (relating to the optional

adjustment to the basis of undistributed partnership property) or

section 743(b) (relating to the optional adjustment to the basis of

partnership property) is taken into account under section 197 by a

partner as if the increased portion of the basis were attributable to

the partner's acquisition of the underlying partnership property and as

if the property were acquired from the distributee partner on the date

of the

[[Page 2349]]

distribution (in the case of a basis increase under section 734(b)) or

from the transferor of the partnership interest on the date of the

transfer (in the case of a basis increase under section 743(b)). (See

paragraph (h) of this section for the application of the anti-churning

rules.)

(4) Treatment of certain reinsurance transactions--(i) In general.

Section 197 applies to any insurance contract acquired from another

person through an assumption reinsurance transaction. For purposes of

section 197, an assumption reinsurance transaction is--

(A) Any arrangement in which one insurance company (the reinsurer)

becomes solely liable to policyholders on contracts transferred by

another insurance company (the ceding company); and

(B) Any acquisition of an insurance contract that is treated as

occurring by reason of an election under section 338.

(ii) Determination of adjusted basis--(A) Acquisitions (other than

under section 338) of specified insurance contracts. The amount taken

into account for purposes of section 197 as the adjusted basis of

specified insurance contracts (as defined in section 848(e)(1))

acquired in an assumption reinsurance transaction that is not described

in paragraph (g)(4)(i)(B) of this section is equal to the excess of--

(1) The amount paid or incurred (or treated as having been paid or

incurred) by the reinsurer for the purchase of the contracts (as

determined under Sec. 1.817-4(d)(2)), over

(2) The amount of the specified policy acquisition expenses that

are attributable to the reinsurer's net positive consideration for the

reinsurance agreement (as determined under Sec. 1.848-2(f)(3)).

(B) Other acquisitions. [Reserved]

(5) Amounts paid or incurred for a franchise, trademark, or trade

name. If an amount to which section 1253(d) (relating to the transfer,

sale, or other disposition of a franchise, trademark, or trade name)

applies is described in section 1253(d)(1)(B) (relating to contingent

serial payments), the amount is deductible under section 1253(d)(1) and

is not included in the adjusted basis of the intangible for purposes of

section 197. Any other amount, whether fixed or contingent, to which

section 1253(d) applies is chargeable to capital account under section

1253(d)(2) and is amortizable only under section 197.

(6) Amounts properly taken into account in determining the cost of

property that is not a section 197 intangible. Section 197 does not

apply to an amount that is properly taken into account in determining

the cost of property that is not a section 197 intangible. The entire

cost of acquiring the other property is included in its basis and

recovered under other applicable Internal Revenue Code provisions.

(7) Treatment of amortizable section 197 intangibles as depreciable

property--(i) In general. An amortizable section 197 intangible is

treated as property of a character subject to the allowance for

depreciation under section 167. Thus, for example, an amortizable

section 197 intangible is not a capital asset for purposes of section

1221, but if held for more than one year, it generally qualifies under

section 1231 as property used in a trade or business. Also, an

amortizable section 197 intangible is section 1245 property and section

1239 applies to any gain recognized upon its sale or exchange between

related persons (as defined in section 1239(b)).

(ii) Exceptions and limitations--(A) Unstated interest and original

issue discount rules. In the case of the acquisition of any amortizable

section 197 intangible in a transaction that would not be treated as

the sale or exchange of property by the person from which the

intangible was acquired, paragraph (g)(7)(i) of this section shall not

apply (and the amortizable section 197 intangible shall not be treated

as property) for purposes of--

(1) Section 483(c) (relating to payments on account of the sale or

exchange of property); and

(2) Section 1274(c) (relating to debt instruments given in

consideration for the sale or exchange of property).

(B) Treatment of other parties to transaction. No person shall be

treated as having sold, exchanged, or otherwise disposed of property in

a transaction for purposes of any provision of the Internal Revenue

Code solely by reason of the application of paragraph (g)(7)(i) of this

section to any other party to the transaction.

(h) Anti-churning rules--(1) Conversions of existing goodwill,

going concern value, and certain other section 197 intangibles. Except

as otherwise provided in this paragraph (h), goodwill, going concern

value, or any other section 197 intangible for which a depreciation or

amortization deduction would not have been allowable prior to the

enactment of section 197 may not be amortized as an amortizable section

197 intangible if the section 197 intangible is acquired by a taxpayer

after August 10, 1993 (or after July 25, 1991, if a valid retroactive

election pursuant to Sec. 1.197-1T has been made) and either--

(i) The taxpayer or a related person held or used the intangible or

an interest therein at any time during the transition period;

(ii) The taxpayer acquired the intangible from a person that held

the intangible at any time during the transition period and, as part of

the transaction, the user of the intangible does not change; or

(iii) The taxpayer grants the right to use the intangible to a

person (or a person related to that person) that held or used the

intangible at any time during the transition period.

(2) Amounts deductible under section 1253(d). For purposes of

paragraph (h)(1) of this section, deductions allowable under section

1253(d)(2) or deductions allowable pursuant to an election under

section 1253(d)(3) (in either case as in effect prior to the enactment

of section 197) are treated as deductions allowable for amortization.

(3) Transition period. For purposes of this paragraph (h), the

transition period begins on July 25, 1991, and ends on August 10, 1993,

except that for taxpayers that made a valid retroactive election

pursuant to Sec. 1.197-1T, the transition period is July 25, 1991.

(4) Exceptions. The anti-churning rules of this paragraph (h) do

not apply to--

(i) The acquisition of an intangible by a taxpayer if the basis of

the intangible is determined under section 1014(a); or

(ii) The acquisition of an intangible by a taxpayer that is an

amortizable section 197 intangible in the hands of the seller (or

transferor), but only if the acquisition by the taxpayer or sale by the

seller (or transfer by the transferor) was not part of a transaction or

a series of related transactions in which the seller (or transferor)

previously acquired the intangible or interest therein.

(5) Special partnership provisions--(i) Basis increases. In

determining whether the anti-churning rules of this paragraph (h) apply

to any increase in the basis of partnership property under section 732,

734, or 743, the determinations are made at the partner level and each

partner is treated as having owned and used the partner's proportionate

share of the partnership property. Thus, for example, the anti-churning

rules do not apply to an increase in the basis of partnership property

under section 743(b) that occurs upon the acquisition of an interest in

a partnership that has made a section 754 election if the person

acquiring the partnership interest either is not related to the person

transferring the partnership interest or acquired the interest upon the

death of the former partner. Similarly, the anti-churning rules do not

apply to a continuing partner's proportionate share of an increase in

the

[[Page 2350]]

basis of partnership property under section 734(b) that occurs upon the

distribution of property of a partnership that has made a section 754

election if the continuing partner is not related to the distributee

partner.

(ii) Curative and remedial allocations under section 704(c). In

determining whether the anti-churning rules of this paragraph (h)

apply, any curative or remedial allocation of amortization made to a

noncontributing partner under the curative or remedial methods for

making allocations under section 704(c) is treated in the same manner

as a noncurative or nonremedial allocation of amortization. Thus, for

example, if the anti-churning rules would apply to a nonremedial

allocation of amortization to a noncontributing partner, the anti-

churning rules apply to any remedial allocation of amortization. See

Sec. 1.704-3 (c) and (d) for a description of the curative and remedial

methods.

(6) Related person--(i) In general. Except as otherwise provided in

paragraph (h)(6)(iii) of this section, a person is related to another

person for purposes of this paragraph (h) if--

(A) The person bears a relationship to that person that would be

specified in section 267(b) (determined without regard to section

267(e)) and, by substitution, section 267(f)(1), if those sections were

amended by substituting 20 percent for 50 percent; or

(B) The person bears a relationship to that person that would be

specified in section 707(b)(1) if that section was amended by

substituting 20 percent for 50 percent; or

(C) The persons are engaged in trades or businesses under common

control (within the meaning of section 41(f)(1) (A) and (B)).

(ii) Time for testing relationships. For purposes of this paragraph

(h), a person is treated as related to another person if the

relationship exists--

(A) In the case of a single transaction, immediately before or

immediately after the acquisition of the intangible involved; or

(B) In the case of a series of related transactions, at any time

during the period beginning immediately before the earliest acquisition

and ending immediately after the last acquisition of any intangible

acquired in the series of transactions.

(iii) De minimis rule--(A) In general. Two corporations shall not

be treated as related persons for purposes of this paragraph (h)(6)

if--

(1) The corporations would (but for the application of this

paragraph (h)(6)(iii)) be treated as related persons solely by reason

of substituting ``more than 20 percent'' for ``more than 50 percent''

in section 267(f)(1)(A); and

(2) The beneficial ownership interest of one corporation in the

stock of the other corporation represents less than 10 percent of the

total combined voting power of all classes of stock entitled to vote

and less than 10 percent of the total value of the shares of all

classes of stock outstanding.

(B) Determination of beneficial ownership interest. For purposes of

this paragraph (h)(6)(iii), the beneficial ownership interest of one

corporation in the stock of another corporation shall be determined

under the principles of section 318(a), except that--

(1) In applying section 318(a)(2)(C), the 50 percent limitation

contained therein shall not be applied; and

(2) Section 318(a)(3)(C) shall be applied by substituting ``20

percent'' for ``50 percent''.

(7) Special rules for entities that owned or used property at any

time during the transition period and that are no longer in existence.

A corporation, partnership, or trust that owned or used property at any

time during the transition period and that is no longer in existence is

deemed to be in existence for purposes of determining whether the

taxpayer that acquired the property is related to the corporation,

partnership, or trust.

(8) Special rules for section 338 deemed acquisitions. In the case

of a qualified stock purchase that is treated as a deemed sale and

purchase of assets pursuant to section 338, the corporation that is

treated as selling its assets as a result of an election thereunder

(old target) is not considered related to the corporation that is

treated as purchasing the assets (new target) if stock of old target

meeting the requirements of section 1504(a)(2) is, or is deemed to have

been, acquired by purchase after July 25, 1991. See Sec. 1.338-2(d).

Thus, for example, if a corporation (the purchasing corporation) makes

a qualified stock purchase of the stock of another corporation (target)

from unrelated third parties in July 1997, and a section 338 election

is made by the purchasing corporation, the deemed asset purchase shall

not be considered as an acquisition between related persons solely by

virtue of the fact that old target and new target are treated as the

same corporation for certain other purposes of the Code or that old

target and new target are the same corporation under the laws of the

State or other jurisdiction of its organization. However, the anti-

churning rules of this paragraph (h) may nevertheless apply to a deemed

asset purchase resulting from a section 338 election because old target

and new target are otherwise treated as related parties within the

meaning of paragraph (h)(6) of this section.

(9) Exception to anti-churning rules where gain is recognized--(i)

In general. If a taxpayer would not be subject to paragraph (h) but for

the substitution of 20 percent for 50 percent under paragraph

(h)(6)(i)(A) of this section and the person (whether or not subject to

Federal income tax) from which the taxpayer acquires the intangible

elects to recognize gain on the disposition of the intangible and,

notwithstanding any other provision of the Internal Revenue Code,

agrees to pay an amount that, when added to any other Federal income

tax, equals the gain on the disposition multiplied by the highest

marginal rate of tax imposed by section 1 (for individuals, estates, or

trusts) or 11 (for corporations), whichever is applicable, for the

taxable year in which the gain is realized by the person from which the

taxpayer acquires the intangible, then the anti-churning rules

described in this paragraph (h) only apply to the extent the taxpayer s

adjusted basis in the intangible exceeds the gain recognized.

(ii) Manner of making election. [Reserved]

(iii) Determination of highest marginal rate of tax. For the

purpose of determining the highest marginal rate of tax applicable to

the person from which the taxpayer acquires the intangible, the

following rules shall apply:

(A) Noncorporate taxpayers. In the case of an individual, estate,

or trust, the highest marginal rate of tax shall be the highest

marginal rate of tax in effect under section 1, determined without

regard to section 1(h).

(B) Corporations and tax-exempt entities. In the case of a

corporation or an entity that is exempt from tax under section 501(a),

the highest marginal rate of tax shall be the highest marginal rate of

tax in effect under section 11, determined without regard to any rate

that is added to the otherwise applicable rate in order to offset the

effect of the graduated rate schedule.

(iv) Special rule for pass-through entities. In the case of a

partnership or S corporation, the election under paragraph (h)(9)(i) of

this section--

(A) Shall be made by the entity rather than by its owners or

members; and

(B) Shall constitute an election by each of the owners or members

of the entity (rather than the entity itself) to pay a tax, determined

as provided in this paragraph (h)(9), on the portion of the gain

properly allocable to each such owner or member.

(v) Coordination with other provisions--(A) In general. For

purposes

[[Page 2351]]

of applying any provision of chapter 1 or chapter 6 of the Code other

than section 197(f)(9)(B), both the amount of gain subject to the tax

determined under paragraph (h)(9)(i) of this section and the amount of

the tax shall be disregarded. Thus, for example, the amount of the gain

shall not be reduced by any net operating loss deduction under section

172(a), any capital loss under section 1212, or any other similar loss

or deduction. The amount of tax determined under paragraph (h)(9)(i) of

this section shall not be reduced by any credit of the taxpayer. In

computing the amount of any net operating loss, capital loss, or other

similar loss or deduction, or any credit that may be carried to any

taxable year, any gain recognized, and any tax paid, under paragraph

(h)(9)(i) of this section shall not be taken into account.

(B) Section 1374. No provision of paragraph (h)(9)(iv) of this

section shall preclude the application of section 1374 (relating to a

tax on certain built-in gains of S corporations) to any gain with

respect to which the election described in paragraph (h)(9)(i) of this

section is made. Neither paragraph (h)(9)(iv) nor paragraph

(h)(9)(v)(A) of this section shall be treated as precluding a taxpayer

from applying the provisions of section 1366(f)(2) (relating to

treatment of the tax imposed by section 1374 as a loss sustained by the

S corporation) in determining the amount of tax payable under paragraph

(h)(9)(i) of this section.

(C) Procedural and administrative provisions. For purposes of

subtitle F, the amount determined under paragraph (h)(9)(i) of this

section is treated as a tax imposed by section 1 or 11, as appropriate.

(D) Installment method. The gain subject to the tax determined

under paragraph (h)(9)(i) of this section may not be reported under the

method described in section 453(a). Any such gain that would, but for

the application of this paragraph (h)(9)(v)(D), be taken into account

under section 453(a) shall be taken into account in the same manner as

if an election under section 453(d) (relating to the election not to

apply section 453(a)) had been made.

(10) Transactions subject to both anti-churning and nonrecognition

rules. If a person acquires a section 197 intangible in a transaction

described in paragraph (g)(2) of this section from a person in whose

hands the intangible was an amortizable section 197 intangible, and as

a result of the transaction, the person is or becomes related to any

person described in paragraph (h)(1) of this section, the intangible

ceases to be an amortizable section 197 intangible in the hands of the

transferee unless the exception provided in paragraph (h)(4)(ii) of

this section applies. If a person acquires a section 197 intangible in

anticipation of becoming related to any person described in paragraph

(h)(1) of this section, the intangible is not an amortizable section

197 intangible in the hands of the transferee.

(11) Anti-churning anti-abuse rule. Section 197 does not apply to

any intangible acquired by a taxpayer if the taxpayer acquires the

intangible in a transaction one of the principal purposes of which is

to avoid any of the anti-churning rules for intangibles described in

paragraph (h)(1) of this section. Thus, for example, if section 197

intangibles are acquired in a transaction (or series of related

transactions) in which options to acquire stock are issued to a party

to the transaction, but the option is not treated as having been

exercised for purposes of paragraph (h)(6) of this section, this

paragraph (h)(11) may apply to the transaction.

(i) [Reserved].

(j) General anti-abuse rule. The rules in this section shall be

interpreted and applied as necessary and appropriate to prevent

avoidance of the purposes of section 197. If one of the principal

purposes of a transaction is to achieve a tax result that is

inconsistent with the purposes of section 197, the Commissioner can

recast the transaction for Federal tax purposes as appropriate to

achieve tax results that are consistent with the purposes of section

197, in light of the applicable statutory and regulatory provisions and

the pertinent facts and circumstances.

(k) Examples. The following examples illustrate the application of

this section:

Example 1. Computer software. (i) X purchases all of the assets

of an existing trade or business from Y. One of the assets acquired

is all of Y's rights in certain computer software previously used by

Y under the terms of a nonexclusive license from the software

developer. The software was developed for use by manufacturers to

maintain a comprehensive accounting system, including general and

subsidiary ledgers, payroll, accounts receivable and payable, cash

receipts and disbursements, fixed asset accounting, and inventory

cost accounting and controls. The software was not substantially

modified for use by Y within the meaning of paragraph (c)(4)(i) of

this section and was acquired directly by Y from the developer. The

developer does not maintain wholesale or retail outlets but markets

the software directly to ultimate users. Y's license of the software

is limited to an entity that is actively engaged in business as a

manufacturer.

(ii) Notwithstanding these limitations, the software is

considered to be readily available to the general public for

purposes of paragraph (c)(4)(i) of this section. Accordingly, the

software is not a section 197 intangible.

Example 2. Governmental rights of fixed duration. (i) City M

operates a municipal water system. In order to induce X to locate a

new manufacturing business in the city, M grants X the right to

purchase water for 16 years at a specified price. X incurs legal

fees and other costs for professional services in the amount of $10x

in connection with its efforts to obtain these rights.

(ii) The rights granted by M are described in section

197(e)(4)(B) and paragraph (c)(6) of this section and, thus, are not

a section 197 intangible. This exclusion applies notwithstanding

that the rights may not qualify for exclusion under section

197(e)(4)(D) and paragraph (c)(13) of this section or that they also

may be described in section 197(d)(1)(D) and paragraph (b)(8) of

this section and, as such, may not be treated as self-created

intangibles eligible for exclusion under section 197(c)(2).

Example 3. Advertising costs. (i) Q manufactures and sells

consumer products through a series of wholesalers and distributors.

In order to increase sales of its product by encouraging consumer

loyalty to its products and to enhance the value of the goodwill,

trademarks, and trade names of the business, Q advertises its

products to the consuming public. It regularly incurs costs to

develop radio, television, and print advertisements. These costs

generally consist of employee costs and amounts paid to independent

advertising agencies. Q also incurs costs to run these

advertisements in the various media for which they were developed.

Except for the possible application of section 197, these costs

would be ordinary and necessary expenses deductible under section

162.

(ii) The advertising costs are not subject to amortization under

section 197 pursuant to paragraph (a)(3) of this section because

they are otherwise deductible.

Example 4. Covenant not to compete acquired in connection with

stock redemption. (i) R, a corporation, redeems all of its stock

owned by A, an individual. R and A have no business relationships

with each other except for the corporate-shartholder relationship.

In connection with the stock redemption, R and A enter into an

agreement containing a covenant not to compete. Under this

agreement, A agrees that A will not compete with the business of R

within a prescribed geographical territory for a period of three

years after the date on which the stock redemption is completed. In

exchange for this agreement, R pays A consideration in addition to

the amount paid for the stock redeemed by R.

(ii) Because the agreement was entered into in connection with

the reacquisition by R of its stock, section 162(k) provides that no

deduction shall be allowed for any amount paid or incurred pursuant

to the agreement. Accordingly, pursuant to paragraph (a)(4) of this

section, section 197 does not apply to these amounts.

Example 5. Substantial portion of trade or business. (i) S owns

and operates 100 restaurants in various locations. Each of these

restaurants is operated using a well-established trade name made

available to S

[[Page 2352]]

under the terms of a franchise agreement with F. S determined to

cease operating one of the franchised restaurants. Accordingly, S

sold to B all of the assets that it had used exclusively in

connection with the operation of its restaurant at that location. B

agreed to extend an offer of employment to all of the employees at

that location. B acquired no rights to the franchise or to any of

the trademarks or trade names that had been used by S.

(ii) The transaction between B and S is a transaction involving

the acquisition of assets constituting a trade or business or a

substantial portion thereof within the meaning of paragraph (e) of

this section, notwithstanding that B did not acquire a franchise

from S or that the assets did not represent a substantial portion of

the assets used by S in that trade or business.

Example 6. Separate acquisition of franchise. (i) S is a

franchisor of retail outlets for specialty coffees. On July 1, 1997,

G enters into an agreement with S pursuant to which G is permitted

to acquire and operate a store using the S trademark and trade name

at the location specified in the agreement. G agrees to pay S

$100,000 upon execution of the agreement and also agrees to pay, on

a monthly basis throughout the term of the franchise, a specified

percentage of gross sales from the store. The agreement contains

detailed specifications for the construction and operation of the

business, but G is not required to purchase from S any of the

materials necessary to construct the improvements at the location

specified in the franchise agreement.

(ii) The franchise is a section 197 intangible within the

meaning of paragraph (b)(10) of this section. The franchise does not

qualify for the exclusion relating to self-created intangibles

described in section 197(c)(2) and paragraph (d)(2) of this section

because the franchise is described in section 197(d)(1)(F). In

addition, because the acquisition of the franchise constitutes the

acquisition of an interest in a trade or business or a substantial

portion thereof, the franchise may not be excluded under section

197(e)(4). Thus, the franchise is an amortizable section 197

intangible, the basis of which must be recovered over a 15-year

period. However, the amounts to be paid by G computed as a

percentage of gross sales are not subject to the provisions of

section 197 by reason of section 197(f)(4)(C) and paragraph

(b)(10)(ii) of this section.

Example 7. Acquisition and amortization of covenant not to

compete. (i) As part of the acquisition of a trade or business from

C, B and C enter into an agreement containing a covenant not to

compete. Under this agreement, C agrees that it will not compete

with the business acquired by B within a prescribed geographical

territory for a period of three years after the date on which the

business is sold to B. In exchange for this agreement, B agrees to

pay C $90,000 per year for each year in the term of the agreement.

The agreement further provides that, in the event of a breach by C

of his obligations under the agreement, B may terminate the

agreement, cease making any of the payments due thereafter, and

pursue any other legal or equitable remedies available under

applicable law. Assume that the amounts payable to C under the

agreement represent the value of C's obligations to B pursuant to

the covenant and that the present fair market value of B's rights

under the agreement is $225,000. The aggregate consideration paid

for all assets acquired in the transaction other than the covenant

exceeds the sum of the amount of Class I assets and the aggregate

fair market value of all Class II and Class III assets and all Class

IV assets other than the covenant.

(ii) Because the covenant is acquired in an applicable asset

acquisition (within the meaning of section 1060(c)), the basis of B

in the covenant cannot exceed its fair market value. See

Sec. 1.1060-1T(e)(1). Under section 197(f)(3) and paragraphs

(f)(3)(i) and (f)(4) of this section, the adjusted basis of B in the

agreement, determined as of the date on which the agreement is

entered into, is $225,000. B's deduction for amortization with

respect to the amounts to be paid under the agreement is $1,250 per

month, or $15,000 per year, for each year in the 15-year period

beginning on the date on which the agreement is entered into. The

excess of the amounts payable pursuant to the agreement over the

amount allocated to the covenant under Sec. 1.1060-1T(e)(1), or

$45,000, is allocated to Class V assets.

Example 8. Breach of covenant not to compete subsequent to

acquisition. (i) The facts are the same as in Example 7, except that

at the end of the second year of the agreement, C breaches the

agreement by competing against B. B and C enter into a settlement of

all claims arising under the agreement and the subsequent breach by

C by agreeing that B is not obligated to pay C the final installment

of $90,000.

(ii) Under paragraph (g)(1)(iii) of this section, the covenant

is not treated as having been disposed of (or becoming worthless)

because C has not disposed of all interests in the trade or business

acquired in the same transaction as the covenant. The covenant is

not a contingent income asset within the meaning of Sec. 1.1060-

1T(f)(4)(i). Accordingly, B must decrease the adjusted basis of any

asset acquired from C by $90,000 at the beginning of the third year

of the agreement in the manner provided by Sec. 1.1060-1T(f)(3)(i).

To the extent that any decrease is allocated to an amortizable

section 197 intangible, B must reduce the amount of its deduction

for amortization under section 197 accordingly.

Example 9. Loss disallowance rules involving related persons.

(i) Assume that X and Y are treated as a single taxpayer for

purposes of paragraph (g)(1)(iv) of this section. In a single

transaction, X and Y acquired from Z all of the assets used by Z in

a trade or business. Z had operated this business at two locations,

and X and Y each desired to acquire the assets used by Z at one of

the locations. Three years after the acquisition, X sold all of the

assets, including amortizable section 197 intangibles, to an

unrelated purchaser at a loss of $120,000.

(ii) Because X and Y are treated as a single taxpayer for

purposes of the loss disallowance rules of section 197(f)(1) and

paragraph (g)(1) of this section, X may not recognize its loss on

the sale of the amortizable section 197 intangibles. Under paragraph

(g)(1)(iv) of this section, X must amortize its disallowed loss

under section 197, and Y may not increase its adjusted basis in its

amortizable section 197 intangibles by the amount of the realized

loss of X that is disallowed. X must amortize the disallowed loss

over the remainder of the amortization period for the amortizable

section 197 intangibles it sold. Accordingly, X must amortize the

disallowed loss at the rate of $10,000 per year (or $833 per month)

for each of the 12 years remaining in the 15-year period.

Example 10. Disposition of retained intangibles by related

person. (i) The facts are the same as in Example 9, except that 10

years after the acquisition of the assets by X and Y and seven years

after the sale of the assets by X, Y sells all of the assets

acquired from Z, including amortizable section 197 intangibles, to

an unrelated purchaser.

(ii) Upon the sale of assets by Y, X may recognize a loss equal

to the unamortized loss. Accordingly, pursuant to paragraph

(g)(1)(iv) of this section, X may recognize a loss in the amount of

$50,000, the amount obtained by reducing the loss on the sale of the

assets at the end of the third year ($120,000) by the amount of

amortization allowed for the fourth through the tenth years

($70,000).

Example 11. Acquisition of an interest in partnership with no

section 754 election. (i) A, B, and C each contribute $1,500 for

equal shares in general partnership P. On January 1, 1998, P

acquires as its sole asset an amortizable section 197 intangible for

$4,500. P still holds the intangible on January 1, 2003, at which

time the intangible has an adjusted basis to P of $3,000, and A, B,

and C each have an adjusted basis of $1,000 in their partnership

interests. D (who is not related to A) acquires A's interest in P

for $1,600. No section 754 election is in effect for 2003.

(ii) Pursuant to paragraph (h)(5)(i) of this section, there is

no change in the basis or amortization of the intangible and D

merely steps into the shoes of A with respect to the intangible. D's

proportionate share of P's adjusted basis in the intangible is

$1,000, which continues to be amortized over the 10 years remaining

in the original 15-year amortization period for the intangible.

Example 12. Acquisition of an interest in partnership with a

section 754 election. (i) The facts are the same as in Example 11,

except that a section 754 election is in effect for 2003.

(ii) Pursuant to section 197(f)(9)(E) and paragraph (h)(5)(i) of

this section, for purposes of section 197, D is treated as if P owns

two assets. D's proportionate share of P's adjusted basis in one

asset is $1,000, which continues to be amortized over the 10 years

remaining in the original 15-year amortization period. For the other

asset, D's proportionate share of P's adjusted basis is $600 (the

amount of the basis increase under section 743 as a result of the

section 754 election), which is amortized over a new 15-year period

beginning January 2003. With respect to B and C, P's remaining

$2,000 adjusted basis in the intangible continues to be amortized

over the 10 years remaining in the original 15-year amortization

period.

[[Page 2353]]

Example 13. Payment to a retiring partner by partnership with a

section 754 election. (i) The facts are the same as in Example 11,

except that a section 754 election is in effect for 2003 and,

instead of D acquiring A's interest in P, A retires from P. A, B,

and C are not related to each other within the meaning of paragraph

(h)(6) of this section. A receives a payment under section 736 from

P of $1,600, all of which is in exchange for A's interest in the

intangible asset owned by P.

(ii) Pursuant to paragraph (h)(5)(i) of this section, because of

the section 734 adjustment, P is treated as having two amortizable

section 197 intangibles, one with a basis of $3,000 and a remaining

amortization period of 10 years and the other with a basis of $600

and a new amortization period of 15 years.

Example 14. Termination of partnership under section

708(b)(1)(B). (i) A and B are partners with equal shares in the

capital and profits of general partnership P. P's only asset is an

amortizable section 197 intangible, which P had acquired on January

1, 1994. On January 1, 1999, the asset had a fair market value of

$100 and a basis to P of $50. On that date, A sells his entire

partnership interest in P to C, who is unrelated to A, for $50. At

the time of the sale, the basis of each of A and B in their

respective partnership interests is $25.

(ii) The sale causes a termination of P under section

708(b)(1)(B). Under section 708, the transaction is treated as if P

transfers its sole asset to a new partnership in exchange for the

assumption of its liabilities and the receipt of all of the

interests in the new partnership. Immediately thereafter, P is

treated as if it is liquidated, with B and C each receiving their

proportionate share of the interests in the new partnership. The

contribution by P of its asset to the new partnership is governed by

section 721, and the liquidating distributions by P of the interests

in the new partnership are governed by section 731. However, C does

not realize a special basis adjustment under section 743 with

respect to the amortizable section 197 intangible unless P had a

section 754 election in effect for its taxable year in which the

deemed transfer of the asset to the new partnership occurred.

(iii) Under section 197, if P had a section 754 election in

effect for its taxable year in which the deemed transfer of the

asset to the new partnership occurred, C is treated as if the new

partnership had acquired two assets from P immediately preceding its

termination. Even though the adjusted basis of the new partnership

in the two assets is determined solely under section 723, because

the transfer of assets is a transaction described in section 721,

the application of sections 743(b) and 754 to P immediately before

its termination causes P to be treated as if it held two assets, for

purposes of section 197, at this time. B's and C's proportionate

share of the new partnership's adjusted basis is $25 each in one

asset, which continues to be amortized over the 10 years remaining

in the original 15-year amortization period. For the other asset,

C's proportionate share of the new partnership's adjusted basis is

$25 (the amount of the basis increase resulting from the application

of section 743 to the sale or exchange by A of the interest in P),

which is amortized over a new 15-year period beginning in January

1999.

(iv) If P did not have a section 754 election in effect for its

taxable year in which the sale of the partnership interest by A to C

occurred, the adjusted basis of the new partnership in the

amortizable section 197 intangible is determined solely under

section 723, because the transfer is a transaction described in

section 721, and P does not have a basis increase in its section 197

intangible. Under section 197(f)(2) and paragraph (g)(2) of this

section, the new partnership continues to amortize the amortizable

section 197 intangible over the 10 years remaining in the original

15-year amortization period. No additional amortization is allowable

with respect to this asset under section 197.

Example 15. Disguised sale to partnership. (i) Assume that E and

F are individuals who are unrelated to each other within the meaning

of paragraph (h)(6) of this section. E has been engaged in the

active conduct of a trade or business as a sole proprietor since

1990. E and F form EF Partnership. E transfers all of the assets of

the business, having a fair market value of $100x, to EF, and F

transfers $40x of cash to EF. E receives a 60 percent interest in EF

and the $40x of cash contributed by F, and F receives a 40 percent

interest in EF, under circumstances in which the transfer by E is

treated as a sale of property to EF under Sec. 1.707-3(b).

(ii) Under Sec. 1.707-3(a)(1), the transaction is treated as if

E had sold to EF a 40 percent interest in each asset for $40x and

contributed the remaining 60 percent interest in each asset to EF in

exchange solely for an interest in EF. Because E and EF are related

persons within the meaning of paragraph (h)(6) of this section, no

portion of any transferred section 197 intangible that E held during

the transition period (as defined in paragraph (h)(3) of this

section) is an amortizable section 197 intangible pursuant to

paragraph (h)(1) of this section. Section 197(f)(9)(E) and paragraph

(h)(5) of this section do not apply to any portion of the section

197 intangible in the hands of EF because the basis of EF in these

assets was not increased under any of sections 732, 734, or 743.

Example 16. Acquisition by related person in nonrecognition

transaction. (i) A owns a nonamortizable intangible that A acquired

in 1990. In 1997, A sells a one-half interest in the intangible to B

for cash. Immediately after the sale, A and B, who are unrelated to

each other, form partnership P as equal partners. A and B each

contribute their one-half interest in the intangible to P.

(ii) P has a transferred basis in the intangible from A and B

under section 723. The nonrecognition transfer rule under paragraph

(g)(2)(i) of this section applies to A s transfer of its one-half

interest in the intangible to P, and consequently P steps into A's

shoes with respect to A's nonamortizable transferred basis. The

anti-churning rules of paragraph (h)(1)(i) of this section apply to

B's transfer of its one-half interest in the intangible to P,

because A, who is related to P under paragraph (h)(6) of this

section, held B's one-half interest in the intangible during the

transition period. Pursuant to paragraph (h)(10) of this section,

these rules apply to B's transfer of its one-half interest to P even

though the nonrecognition transfer rule under paragraph (g)(2)(i) of

this section would have permitted P to step into B's shoes with

respect to B's otherwise amortizable basis. Therefore, P's entire

basis in the intangible is nonamortizable.

Example 17. Acquisition of partnership interest following

formation of partnership. (i) The facts are the same as in Example

16 except that, in 1996, A formed P with an affiliate and

contributed the intangible to the partnership and except that

thereafter, in an unrelated transaction, B purchases a 50 percent

interest in P. P has a section 754 election in effect.

(ii) For the reasons set forth in Example 14(iii), B is treated

as if P owns two assets. B's proportionate share of P's adjusted

basis in one asset is the same as A's proportionate share of P's

adjusted basis in that asset, which is not amortizable under section

197. For the other asset, B's proportionate share of the remaining

adjusted basis of P is amortized over a new 15-year period.

Example 18. Acquisition by related corporation in nonrecognition

transaction. (i) The facts are the same as Example 16, except that P

is a corporation.

(ii) P has a transferred basis in the intangible from A and B

under section 362. Pursuant to paragraph (h)(10) of this section,

the application of the nonrecognition transfer rule under paragraph

(g)(2)(i) and the anti-churning rules of paragraph (h)(1)(i) of this

section to the facts of this Example 18 is the same as in Example

16. Thus, P's entire basis in the intangible is nonamortizable.

Example 19. Acquisition from corporation related to purchaser

through remote indirect interest. (i) X, Y, and Z are each

corporations that have only one class of issued and outstanding

stock. X owns 25 percent of the stock of Y and Y owns 25 percent of

the outstanding stock of Z. No other shareholder of any of these

corporations is related to any other shareholder or to any of the

corporations. On June 30, 1997, X purchases from Z section 197

intangibles that Z owned during the transition period (as defined in

paragraph (h)(3) of this section).

(ii) Pursuant to paragraph (h)(6)(iii)(B) of this section, the

beneficial ownership interest of X in Z is 6.25 percent, determined

by treating X as if it owned a proportionate (25 percent) interest

in the stock of Z that is actually owned by Y. Thus, even though X

is related to Y and Y is related to Z, X and Z are not considered to

be related for purposes of the anti- churning rules of section 197.

Example 20. Gain recognition election. (i) B owns 25 percent of

the stock of S, a corporation that uses the calendar year as its

taxable year. No other shareholder of B or S is related to each

other. S is not a member of a controlled group of corporations

within the meaning of section 1563(a). S has section 197 intangibles

that it owned during the transition period and was not permitted to

amortize or depreciate under any other provision of the Code. S had

a basis of $25,000 in the intangibles. In 1997, S sells

[[Page 2354]]

these intangibles to B for $75,000. S recognizes a gain of $50,000

on the sale and has no other items of income, deduction, gain, or

loss for the year, except that S also has a net operating loss of

$20,000 from prior years that it would otherwise be entitled to use

in 1997 pursuant to section 172(b). As part of the transaction with

B, S agrees to make the gain recognition election pursuant to

section 197(f)(9)(B).

(ii) If the gain recognition election had not been made, S would

have taxable income of $30,000 for 1997 and a tax liability of

$4,500. As the result of the election, S must pay a total tax

liability for the year of $17,500 (35 percent of $50,000),

consisting of the sum of its regular tax liability of $4,500 and the

additional amount of $13,000 pursuant to section 197(f)(9)(B).

(iii) Pursuant to paragraph (h)(9)(v)(A) of this section, S

determines the amount of its net operating loss deduction in

subsequent years without regard to the gain recognized on the sale

of the section 197 intangible to B. Accordingly, the entire $20,000

net operating loss deduction that would have been available in 1997

but for the gain recognition election may be used in 1998, subject

to the limitations of section 172.

(iv) B has a basis of $75,000 in the section 197 intangibles

acquired from S. As the result of the gain recognition election by

S, B may amortize $50,000 of its basis under section 197. The

remaining basis may not be amortized by B.

Example 21. Section 338 election. (i) P corporation makes a

qualified stock purchase of the stock of T corporation from two

shareholders in July 1997, and a section 338 election is made by P.

One of the selling shareholders is an individual who owns 25 percent

of the total value of the stock of each of the T and P corporation.

No other shareholder of either T or P owns stock in both of these

corporations, and no other shareholder is related to any other

shareholder of either corporation.

(ii) Old target and new target (as these terms are defined in

Sec. 1.338-1(c)(13)) are members of a controlled group of

corporations under section 267(b)(3), as modified by section

197(f)(9)(C)(i), and any section 197 intangible held by old target

at any time during the transition period is not an amortizable

section 197 intangible in the hands of new target. However, a gain

recognition election under paragraph (h)(9)(i) of this section may

be made with respect to this transaction.

(l) Effective dates. This section is applicable on the date

final regulations are published in the Federal Register, except that

Sec. 1.197-2(c)(13) (exception from section 197 for separately

acquired rights of fixed duration or amount) is applicable August

11, 1993 (or July 26, 1991, if a valid retroactive election has been

made under Sec. 1.197-1T).

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 97-866 Filed 1-9-97; 2:53 pm]

BILLING CODE 4830-01-U