Amortization

Amortization is a method of recovering (deducting) certain capital costs over a fixed period of time. It is similar to the straight line method of depreciation. See chapter 9 in Publication 535 for more information on the topics presented in this section.

Going Into Business

When you go into business, treat all costs you incur to get your business started as capital expenses. Capital expenses are a part of your basis in the business. Generally, you recover costs for particular assets through depreciation deductions. However, you generally cannot recover other costs until you sell the business or otherwise go out of business.

You can choose to amortize over a period of 60 months or more certain costs for setting up your business, such as business start-up costs.

Business start-up costs. Start-up costs are costs for creating an active trade or business or investigating the creation or acquisition of an active trade or business. Start-up costs include any amounts paid or incurred in connection with any activity engaged in for profit and for the production of income before the trade or business begins, in anticipation of the activity becoming an active trade or business.

For more information, see Going Into Business in chapter 9 of Publication 535.

Reforestation Costs

You can choose to amortize a limited amount of reforestation costs for qualified timber property over a period of 84 months.

A trust cannot choose to amortize reforestation costs and cannot deduct its share of any amortizable reforestation costs of a partnership, S corporation, or estate.

Qualifying costs. Qualifying costs include only those costs you must capitalize and include in the adjusted basis of the property. They include costs for the following items.

• Site preparation.
• Seeds or seedlings.
• Labor.
• Tools.
• Depreciation on equipment used in planting and seeding.

If the government reimburses you for reforestation costs under a cost-sharing program, you can amortize these costs only if you include the reimbursement in your income.

Qualified timber property. Qualified timber property is property that contains trees in significant commercial quantities. It can be a woodlot or other site that you own or lease. The property qualifies only if it meets all the following requirements.

1. It is located in the United States.
2. It is held for the growing and cutting of timber you will either use in, or sell for use in, the commercial production of timber products.
3. It consists of at least one acre planted with tree seedlings in the manner normally used in forestation or reforestation.

Qualified timber property does not include property on which you have planted shelter belts and ornamental trees, such as Christmas trees.

Amortization period. The 84-month amortization period starts on the first day of the first month of the second half of the tax year you incur the costs (July 1 for a calendar year taxpayer), regardless of the month you actually incur the costs. You can claim amortization deductions for no more than 6 months of the first and last (eighth) tax years of the period.

Annual limit. Each year you can choose to amortize up to $10,000 ($5,000 if you are married filing separately) of qualifying costs you pay or incur during the year. You cannot carry over or carry back qualifying costs over the annual limit. If your qualifying costs are more than $10,000 for more than one piece of timber property, you can divide the annual limit among the properties in any manner you wish.

Maximum annual amortization deduction. The maximum annual deduction for costs incurred in any year is $1,428.57 ($10,000 × 7) or $714.29 ($5,000 × 7) if married filing separately. The maximum deduction in the first and last year of the 84-month period is one half ( 1/2) of the maximum annual deduction or $714.29 ($357.15 if married filing separately).

Estates. Estates can choose to amortize up to $10,000 of qualifying reforestation costs each year. These amortizable costs are divided between the income beneficiary and the estate based on the income of the estate allocable to each. The amortizable cost allocated to the beneficiary is subject to the beneficiary's annual limit.

Recapture. If you dispose of qualified timber property within 10 years after the tax year you incur qualifying reforestation expenses, report any gain as ordinary income up to the amortization taken. For information on recapture, see Depreciation Recapture in chapter 11.

Investment credit. Amortizable reforestation costs qualify for the investment credit, whether or not they are amortized. See Investment Credit in chapter 9.

How to make the choice. To choose to amortize qualifying reforestation costs, enter your deduction in Part VI of Form 4562. Attach a statement containing the following information.

• A description of the costs and the dates you incurred them.
• A description of the type of timber being grown and the purpose for which it is grown.

Attach a separate statement for each property for which you amortize reforestation costs.

Generally, you must make the choice on a timely filed return (including extensions) for the year in which you incurred the costs. However, if you timely filed your return for the year without making the choice, you can still make the choice by filing an amended return within 6 months of the due date of your return (excluding extensions). Attach Form 4562 and the statement to the amended return and write "Filed pursuant to section 301.9100-2" on Form 4562. File the amended return at the same address you filed the original return.

Pollution Control Facilities

You can choose to amortize over 60 months the cost of a certified pollution control facility.

Certified pollution control facility. A certified pollution control facility is a new identifiable treatment facility used in connection with a plant or other property in operation before 1976 to reduce or control water or atmospheric pollution or contamination. The facility must do so by removing, changing, disposing, storing, or preventing the creation or emission of pollutants, contaminants, wastes, or heat. The facility must be certified by the state and federal certifying authorities. Examples of such a facility include septic tanks and manure control facilities.

The federal certifying authority will not certify your property to the extent it appears you will recover (over the property's useful life) all or part of its cost from the profit based on its operation (such as through sales of recovered wastes). The federal certifying authority will describe the nature of the potential cost recovery. You must then reduce the amortizable basis of the facility by this potential recovery.

Example. This year, you purchase a new $7,500 manure control facility for use on your dairy farm. The farm has been in operation since you bought it in 1976 and all of the dairy plant was in operation before that date. You have no intention of recovering the cost of the facility through sale of the waste and a federal certifying authority has so certified.

Your manure control facility qualifies for amortization. You can elect to amortize its cost over 60 months. Otherwise, you can capitalize the cost and depreciate the facility.

In addition, to amortize its cost over 60 months, the facility must not significantly increase the output or capacity, extend the useful life, or reduce the total operating costs of the plant or other property. Also, it must not significantly change the nature of the manufacturing or production process or facility.

Example. This year, you converted your 100-sow farrow-to-finish swine operation, which has existed on your farm since 1975, to a 5,000-head finishing swine operation. Even though you are in a similar business after the conversion, you cannot amortize the cost of a manure control facility used in connection with your swine operation because you have significantly increased its output or capacity.

More information. For more information on the amortization of pollution control facilities see section 169 of the Internal Revenue Code and the related regulations.

Section 197 Intangibles

You must generally amortize over 15 years the capitalized costs of "section 197 intangibles" you acquired after August 10, 1993. You must amortize these costs if you hold the section 197 intangible in connection with your farming business or in an activity engaged in for the production of income. Your amortization deduction each year is the applicable part of the intangible's adjusted basis (for purposes of determining gain), figured by amortizing it ratably over 15 years. The 15-year period begins with the later of:

• The month the intangible is acquired, or
• The month the trade or business or activity engaged in for the production of income begins.

You cannot deduct amortization for the month you dispose of the intangible.

If you pay or incur an amount that increases the basis of a section 197 intangible after the 15-year period begins, amortize it over the remainder of the 15-year period beginning with the month the basis increase occurs.

You are not allowed any other depreciation or amortization deduction for an amortizable section 197 intangible.

Cost attributable to other property. The rules for section 197 intangibles do not apply to any amount included in determining the cost of property that is not a section 197 intangible. For example, if the cost of computer software is not separately stated from the cost of the hardware or other tangible property and you consistently treat it as part of the cost of the hardware or other tangible property, these rules do not apply. Similarly, none of the cost of acquiring real property held for the production of rental income is considered the cost of goodwill, going concern value, or any other section 197 intangible.

Section 197 Intangibles Defined

The following assets are section 197 intangibles.

1. Goodwill.
2. Going concern value.
3. Workforce in place.
4. Business books and records, operating systems, or any other information base, including lists or other information concerning current or prospective customers.
5. A patent, copyright, formula, process, design, pattern, know-how, format, or similar item.
6. A customer-based intangible.
7. A supplier-based intangible.
8. Any item similar to items (3) through (7).
9. A license, permit, or other right granted by a governmental unit or agency (including issuances and renewals).
10. A covenant not to compete entered into in connection with the acquisition of an interest in a trade or business.
11. A franchise, trademark, or trade name (including renewals).
12. A contract for the use of, or a term interest in, any item in this list.

You cannot amortize any intangible listed in items (1) through (8) that you created (rather than acquired), unless you created it in connection with the acquisition of assets constituting a trade or business or a substantial part of a trade or business.

Assets that are not section 197 intangibles. The following assets are not section 197 intangibles.

1. Any interest in land.
2. Most computer software (see Computer software, later).
3. An interest under either of the following.
1. An existing lease or sublease of tangible property.
2. A debt in existence when the interest was acquired.

Intangible property not amortizable under the rules for section 197 intangibles can be depreciated if it has a determinable useful life. You generally must use the straight line method over its useful life. For certain intangibles, the depreciation period is specified in the law and regulations. For example, the depreciation period for computer software that is not a section 197 intangible is 36 months. For more information on depreciating computer software, see Computer software under Excepted Property, earlier.

Interest in land. Section 197 intangibles do not include any interest in land. 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.

Computer software. Section 197 intangibles do not include the following types of computer software.

1. Software that meets the following requirements.
1. It is (or has been) readily available for purchase by the general public.
2. It is subject to a nonexclusive license.
3. It has not been substantially modified. This requirement is considered met if the cost of all modifications is not more than the greater of 25% of the price of the publicly available unmodified software or $2,000.
2. Software not acquired in connection with the acquisition of a trade or business or a substantial part of a trade or business.

Anti-Churning Rules

Anti-churning rules prevent you from amortizing most section 197 intangibles if the transaction in which you acquired them did not result in a significant change in ownership or use. These rules apply to goodwill and going concern value, and to any other section 197 intangible not otherwise depreciable or amortizable. For more information on the anti-churning rules, see chapter 9 in Publication 535.

Anti-Abuse Rule

You cannot amortize any section 197 intangible acquired in a transaction for which the principal purpose was either of the following.

• To avoid the requirement that the intangible be acquired after August 10, 1993.
• To avoid any of the anti-churning rules.

Dispositions

A section 197 intangible is treated as depreciable property used in your trade or business. If you held the intangible for more than one year, any gain on its disposition, up to the allowable amortization, is ordinary income (section 1245 gain). Any remaining gain or loss is a section 1231 gain or loss. If you held the intangible one year or less, any gain or loss on its disposition is an ordinary gain or loss. For more information, see chapter 2 in Publication 544.

Nondeductible loss. You cannot deduct any loss on the disposition or worthlessness of a section 197 intangible you acquired in the same transaction (or series of related transactions) as other section 197 intangibles you still have. Instead, increase the adjusted basis of each remaining amortizable section 197 intangible by a proportionate part of the nondeductible loss.

Previous| First | Next

Publication Index | IRS-Forms Main | Home