What Is the Recovery Period for Section 197 Intangibles?

Businesses acquire various assets to support operations and foster growth. These assets can be tangible, like machinery and buildings, or intangible, such as brand recognition and customer relationships. While tangible assets physically exist, intangible assets lack physical form yet hold significant value. For tax purposes, businesses can recover the cost of these assets over time through deductions. This process of cost recovery differs based on whether the asset is tangible or intangible.

Identifying Section 197 Intangibles

Section 197 of the Internal Revenue Code (IRC) addresses the tax treatment of intangible assets. These “Section 197 intangibles” are a category of non-physical assets acquired in connection with the purchase of a trade or business, or a substantial portion of one. The IRC provides uniform tax treatment for these assets.

Common examples of Section 197 intangibles include goodwill, which represents the value of a business beyond its identifiable assets, and going concern value, reflecting the added worth of an operational business. Other assets include customer lists, information bases, and workforce in place. Patents, copyrights, trademarks, trade names, and franchises are Section 197 intangibles if acquired as part of a business acquisition. Covenants not to compete, which are agreements preventing a seller from competing with the buyer, also fall under this classification when entered into with a business acquisition. Intangibles created by the business itself, rather than acquired, are not considered Section 197 intangibles.

The Amortization Recovery Period

The recovery period for Section 197 intangibles is set at 15 years. This statutory period applies uniformly to all assets classified under Section 197, regardless of their actual economic useful life. A recovery period is the fixed duration over which the cost of an asset can be deducted for tax purposes. This standardization was established to reduce disputes between taxpayers and the IRS regarding the useful life of intangible assets.

The 15-year amortization period distinguishes Section 197 intangibles from other intangible assets. Unlike some other intangible assets that may have varying amortization periods based on their determinable useful life, Section 197 assets follow this fixed schedule. The concept of amortization for intangibles is similar to depreciation for tangible assets, both allowing businesses to systematically deduct the cost of an asset over time. However, amortization specifically applies to non-physical assets, whereas depreciation applies to physical property.

Calculating Amortization

The annual amortization deduction for a Section 197 intangible is calculated by dividing the adjusted basis of the asset by 15 years. This results in an equal deduction amount each year, following a straight-line method. For instance, if a Section 197 intangible has an adjusted basis of $150,000, the annual amortization deduction would be $10,000 ($150,000 / 15 years).

The amortization period begins in the month the intangible asset is acquired and the active conduct of a trade or business commences. The “full month convention” applies, meaning that amortization is taken for the entire month of acquisition, regardless of the specific day the asset was obtained within that month. For example, an asset acquired on March 25th would still receive a full month’s amortization for March.

If an intangible asset is disposed of before the end of the 15-year period, the unrecovered basis cannot be immediately deducted as a loss. Instead, it is accounted for over the remaining portion of the original 15-year amortization period. Taxpayers report these deductions on Form 4562, “Depreciation and Amortization.”