Avoiding §1245 Recapture on Disposition of Previously Amortized §197 Assets
One obvious advantage of an asset purchase when acquiring a business, as opposed to the acquisition of stock, is the ability to amortize the portion of the purchase price allocated to intangible assets pursuant to §197. However, the advantage is somewhat ameliorated on a subsequent disposition of the purchased assets because such amortization is subject to §1245 ordinary income recapture. Given that §197 became effective for intangible asset acquisitions beginning on August 11, 1993, i.e., 32 years ago, there are many “second generation” dispositions of these intangible assets. However, is recapture of the full amount of amortization deductions always the case?
Sometimes forgotten are the concepts contained in PLR 201016053. In this PLR, the IRS privately ruled that two categories of customer relationships were severable from each other for purposes of gain and recapture computations, because the taxpayer was able to identify and value the two categories separately (referred to throughout the ruling as the “Acquired Customer Relationships” and the “Self-Created Customer Relationships,” respectively). For example, assume that a taxpayer acquired “customer relationships” for $1,000, which the taxpayer fully amortized. Upon a subsequent sale of the assets of the business, $5,000 of the purchase price is allocated to customer relationships. If the taxpayer is able to establish, for example, that the acquired customer relationships had a value of $400 and self-created customer relationships had a value of $4,600, only $400 of the sale proceeds would be subject to §1245 recapture. However, the clear implication of the PLR was that if the taxpayer had been unable to identify and value the two categories of customer relationships separately, they would have been treated as one mass asset, and any previously taken amortization deductions would have been subject to §1245 recapture. Needless to say, good recordkeeping is a key. Moreover, an appraisal of the acquired and self-created customer relationships is strongly recommended, as the purchaser generally would not care about what portion of the purchase price is allocated to any particular customer relationship.
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