The IRS recently reversed its long-standing position that intangibles such as trademarks, trade names, mastheads and customer-based intangibles could not qualify as like-kind property under section 1031 of the Internal Revenue Code (the "Code").
Prior to the release of Chief Counsel Advice ("CCA") 20091106 earlier this year (Feb. 12, 2009), the IRS had consistently stated that such intangibles could not qualify as like-kind property because they were too closely related to the goodwill or going concern value of a business. See TAM 200602034; IRS NSAR 20074401F. Because goodwill and going concern value are strictly excluded from qualifying as like-kind property under Treas. Reg. § 1.1031(a)-(2)(c)(2), so too were these intangibles.
In CCA 20091106, however, the IRS reversed its position and now states that intangibles such as trademarks, trade names, mastheads and customer-based intangibles may, in fact, qualify as like-kind property under section 1031 assuming they can be separately valued apart from a business's goodwill. The CCA goes on to state that except in rare or unusual circumstances, these types of intangibles should be able to be valued apart from goodwill creating a presumption in favor of like-kind property eligibility. (It is important to note, however, that this CCA does not hold that all trademarks, trade names and mastheads, for example, are automatically considered like-kind property to all other trademarks, trade names and mastheads. The nature and character requirements of Treas. Reg. § 1.1031(a)-(2)(c)(1) must still be met. However, this pronouncement is significant in reversing the IRS's prior stance that these types of intangibles essentially were per se not like-kind property to anything else because of their relation to goodwill and/or going concern value.)
In light of this new IRS pronouncement, both buyers and sellers of businesses may wish to consider whether an allocation of purchase price to intangible assets other than goodwill could create an opportunity for them to defer taxes in a like-kind exchange. Prior to the enactment of Code Section 197 in 1993, buyers often allocated purchase price to amortizable intangibles. Before Code Section 197, purchase price that was properly allocable to intangibles with ascertainable useful lives and capable of separate valuation could be amortized over those useful lives, while purchase price allocated to intangible assets like goodwill and going concern value were required to be permanently capitalized. As a result, buyers of businesses generally allocated as much of their purchase price as possible to separately identifiable intangible assets and away from goodwill and going concern value.
After the enactment of Code Section 197, however, this planning technique was largely mooted because Section 197 now provides a 15-year amortization for all purchased Section 197 intangibles used in a trade or business. Section 197 intangibles now include such items as patents, trademarks, covenants-not-to-compete, customer and subscription lists, goodwill, going concern value and other similar items. As a result, following the enactment of Code Section 197, regardless of how purchase price is allocated among intangibles, including goodwill, it generally is amortizable over 15 years for tax purposes.
Though the allocation of purchase price among intangibles may no longer be a significant issue for tax amortization purposes, it now may present an opportunity for tax savings in the like-kind exchange arena in light of the recent issuance of CCA 20091106. First, business owners looking to swap similar business lines now may potentially defer the gain associated with not only the "like-kind" or "like-class" tangible assets associated with their businesses, but also the "like-kind" non-goodwill intangibles that they dispose of in an "exchange."
Furthermore, due to the development of the rules for non-simultaneous, deferred exchanges and so-called reverse exchange "parking" transactions, business owners engaging in cash sales or purchases (rather than direct, simultaneous swaps) also may be able to defer otherwise taxable gain with respect to all of their assets, including non-goodwill intangibles, in a section 1031 exchange. While the rules for deferred exchanges involving all of the assets of a business can be fairly complicated, sellers now generally may enter into appropriate deferred exchange documents with a 1031 qualified intermediary ("QI"), close on a cash sale of a business with the net sales proceeds being transmitted directly to the QI, and potentially defer the otherwise taxable gain associated with those assets by reinvesting the proceeds and acquiring sufficient "like-kind" assets within 180 days of the original cash sale.
Similarly, buyers may "park" non-goodwill intangibles and other assets they purchase with an exchange accommodation titleholder ("EAT") in a so-called "reverse exchange" (while not losing control of the assets by entering into a simultaneous lease and/or other agreements with the EAT), and ultimately utilize the parked property as part of a 1031 exchange within 180 days. In light of the flexibility afforded under the deferred exchange and reverse exchange rules, the recent CCA could provide additional tax savings opportunities for both buyers and sellers of businesses that have intangible assets with built-in-gains.
In addition to the context of "business swaps," this new CCA also could provide an opportunity for taxpayers who are either buying or selling intellectual property ("IP") assets. These taxpayers now may be able to dispose of their IP assets more readily in a section 1031 exchange without triggering taxable gain. While Treas. Reg. § 1.1031(a)-(2)(c)(1) has always contemplated patents and copyrights being eligible for like-kind exchange treatment, this CCA specifically mentions trademarks and trade names as also being eligible. Furthermore, the CCA suggests that other types of intangibles that may be separately identified and valued apart from goodwill should be similarly eligible for section 1031 exchanges. As a result, taxpayers with IP assets should be aware of this seemingly expanded tax deferral opportunity.
With the development of the 1031 rules for deferred exchanges and the expansion of those rules to permit "reverse" exchanges as described above, taxpayers buying or selling IP assets now generally have up to 180 days to close on other "like-kind" property that they are "exchanging" into in order to be eligible for tax deferred exchange treatment. Although the 1031 rules are heavily form driven and require careful attention to documentation and details, they also generally are taxpayer-favorable and provide significant tax planning opportunities. These opportunities should be considered prior to the close of any purchase or sale that is intended to be part of a 1031 exchange in order to allow for appropriate transaction structuring.