Disposition of Section 197 Intangibles

A section 197 intangible is treated as depreciable property used in your trade or business. If you held the intangible for more than 1 year, any gain on its disposition, up to the amount of allowable amortization, is ordinary income (section 1245 gain). Any remaining gain, or any loss, is a section 1231 gain or loss. If you held the intangible 1 year or less, any gain or loss on its disposition is an ordinary gain or loss. For more information on ordinary or capital gain or loss on business property, see chapter 3 in Publication 544.

Nondeductible loss.   You cannot deduct any loss on the disposition or worthlessness of a section 197 intangible that 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. Figure the increase by multiplying the nondeductible loss on the disposition of the intangible by the following fraction.

• The numerator is the adjusted basis of each remaining intangible on the date of the disposition.
• The denominator is the total adjusted bases of all remaining amortizable section 197 intangibles on the date of the disposition.

Covenant not to compete.   A covenant not to compete, or similar arrangement, is not considered disposed of or worthless before you dispose of your entire interest in the trade or business for which you entered into the covenant.

Nonrecognition transfers.   If you acquire a section 197 intangible in a nonrecognition transfer, you are treated as the transferor with respect to the part of your adjusted basis in the intangible that is not more than the transferor's adjusted basis. You amortize this part of the adjusted basis over the intangible's remaining amortization period in the hands of the transferor. Nonrecognition transfers include transfers to a corporation, partnership contributions and distributions, like-kind exchanges, and involuntary conversions.

In a like-kind exchange or involuntary conversion of a section 197 intangible, you must continue to amortize the part of your adjusted basis in the acquired intangible that is not more than your adjusted basis in the exchanged or converted intangible over the remaining amortization period of the exchanged or converted intangible. Amortize over a new 15-year period the part of your adjusted basis in the acquired intangible that is more than your adjusted basis in the exchanged or converted intangible.

Example.   You own a section 197 intangible you have amortized for 4 full years. It has a remaining unamortized basis of $30,000. You exchange the asset plus $10,000 for a like-kind section 197 intangible. The nonrecognition provisions of like-kind exchanges apply. You amortize $30,000 of the $40,000 adjusted basis of the acquired intangible over the 11 years remaining in the original 15-year amortization period for the transferred asset. You amortize the other $10,000 of adjusted basis over a new 15-year period.

Reforestation Costs

You can choose to amortize a limited amount of reforestation costs for qualified timber property over a period of 84 months. Reforestation costs are the direct costs of planting or seeding for forestation or reforestation.

The choice to amortize reforestation costs incurred by a partnership, S corporation, or estate must be made by the partnership, corporation, or estate. A partner, shareholder, or beneficiary cannot make that choice.

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.

Costs you can deduct currently are not qualifying costs.

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.

• It is located in the United States.
• 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.
• 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 or 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.

Example.   Last year (a full 12-month tax year), John Jones incurred qualifying reforestation costs of $8,400. His monthly amortization deduction ($100) is figured by dividing $8,400 by 84 months. Since it was the first year of the 84-month period, he can deduct only $600 ($100 × 6 months).

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 tax year. You cannot carry over or carry back qualifying costs over the annual limit. The annual limit applies to qualifying costs for all your qualified timber property.

If your qualifying costs are more than $10,000 for more than one piece of qualified timber property, you can divide the annual limit among any of the properties in any manner you wish.

Example.   You incurred $10,000 of qualifying costs on each of four qualified timber properties last year. You can allocate $2,500 to each property, $5,000 to two properties, or the entire $10,000 to any one property, or you can divide the $10,000 among some or all of the properties in any other manner.

Partnerships and S corporations.   A partnership or S corporation can choose to amortize up to $10,000 of qualifying reforestation costs each tax year. A partner's or shareholder's share of these amortizable costs is figured under the general rules for allocating items of income, loss, deductions, etc., of a partnership or S corporation.

The partner or shareholder is also subject to the annual limit of $10,000 ($5,000 if married filing separately) on qualifying costs. This limit applies to all the partner's or shareholder's qualifying costs, regardless of their source.

Example.   You are single and a partner in two partnerships, both of which incurred qualifying reforestation costs of more than $10,000 for the year. Each partnership chose to amortize these costs up to the $10,000 annual limit. Your share of that $10,000 is $6,000 for one partnership and $8,000 for the other. Although your qualifying costs total $14,000, the amount you can amortize is limited to $10,000.

Estates.   Estates can choose to amortize up to $10,000 of qualifying reforestation costs each tax year. These amortizable costs are divided between the estate and the income beneficiary 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.

Maximum annual amortization deduction.   The maximum annual amortization deduction for costs incurred in any tax 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 tax year of the 84-month amortization period is one half of the maximum annual deduction, or $714.29 ($357.15 if married filing separately).

Life tenant and remainderman.   If one person holds the property for life with the remainder going to another person, the life tenant is entitled to the full amortization (up to the annual limit) for qualifying reforestation costs incurred by the life tenant. Any remainder interest in the property is ignored for amortization purposes.

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 you took. See chapter 3 of Publication 544 for more information.

Investment credit.   Amortizable reforestation costs qualify for the investment credit, whether or not they are amortized. See the instructions for Form 3468 for information on the investment credit.

How to make the choice.   To choose to amortize qualifying reforestation costs, enter your deduction in Part VI of Form 4562 and attach a statement that contains 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 tax 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 the 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.

Where to report.   The following chart shows where to report your amortization deduction for qualifying reforestation costs after you enter it on Form 4562.

If you file . . .	The deduction goes on . . .
Schedule C (Form 1040)	Line 27
Schedule F (Form 1040)	Line 34
Form 1120	Line 26
Form 1120-A	Line 22
Form 1120S	Schedules K and K-1
Form 1065	Schedules K and K-1
None of the above	Line 34 of Form 1040 (identify as RFST)

Partner or shareholder.   If you are a partner in a partnership or a shareholder in an S corporation, see the instructions for Schedule K-1 (Form 1065 or Form 1120S) for information on where to report any allocated amortization for qualifying reforestation costs. However, if you have qualifying reforestation costs from other sources, your total deduction may be limited. See Annual limit, earlier.

Estate.   If the estate does not file Schedule C or F for the activity in which the qualifying reforestation costs were incurred, include the amortization deduction on line 15a of Form 1041.

Revoking the choice.   You must get IRS approval to revoke your choice to amortize qualifying reforestation costs. Your application to revoke the choice must include your name, address, the years for which your choice was in effect, and your reason for revoking it. You, or your duly authorized representative, must sign the application and file it at least 90 days before the due date (without extensions) for filing your income tax return for the first tax year for which your choice is to end.

Send the application to:

Commissioner of Internal Revenue
Washington, DC 20224

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 state and federal certifying authorities.

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.

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.

New identifiable treatment facility.   A new identifiable treatment facility is tangible depreciable property that is identifiable as a treatment facility. It does not include a building and its structural components unless the building is exclusively a treatment facility.

Basis reduction for corporations.   A corporation must reduce the amortizable basis of a pollution control facility by 20% before figuring the amortization deduction.

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

Research and Experimental Costs

You can amortize your research and experimental costs, deduct them as current business expenses, or write them off over a 10-year period. If you choose to amortize these costs, deduct them in equal amounts over 60 months or more. The amortization period begins the month you first receive an economic benefit from the expenditures. For a definition of research and experimental costs and information on deducting them as current business expenses, see chapter 8.

Optional write-off method.   Rather than amortize these costs or deduct them as a current expense, you have the option of deducting (writing off) research and experimental costs ratably over a 10-year period beginning with the tax year in which you incurred the costs.

For more information on the optional write-off method, see Internal Revenue Code section 59(e).

Costs you can amortize.   You can amortize costs chargeable to a capital account if you meet both the following requirements.

• You paid or incurred the costs in your trade or business.
• You are not deducting the costs currently.

How to make the choice.   To choose to amortize research and experimental costs, enter your deduction in Part VI of Form 4562 and attach it to your income tax return. Generally, you must file the return by the due date (including extensions). 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 the return (excluding extensions). Attach Form 4562 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.

Your choice is binding for the year it is made and for all later years unless you get IRS approval to change to a different method.

More information.   For more information on amortizing research and development costs, see section 174 of the Internal Revenue Code and the related regulations.

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