Publication 535 (2007), Business Expenses

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.

The various amortizable costs covered in this chapter are included in the list below. However, this chapter does not discuss amortization of bond premium. For information on that topic, see chapter 3 of Publication 550.

Deducting amortization
Amortizing costs of starting a business
Amortizing costs of getting a lease
Amortizing costs of section 197 intangibles
Amortizing reforestation costs
Amortizing costs of geological and geophysical costs
Amortizing costs of pollution control facilities
Amortizing costs of research and experimentation
Amortizing costs of certain tax preferences

Publication

544 Sales and Other Dispositions of Assets
550 Investment Income and Expenses
946 How To Depreciate Property

Form (and Instructions)

4562
Depreciation and Amortization
4626
Alternative Minimum Tax — Corporations
6251
Alternative Minimum Tax—Individuals

How To Deduct Amortization

To deduct amortization that begins during the current tax year, complete Part VI of Form 4562 and attach it to your income tax return.

To report amortization from previous years, in addition to amortization that begins in the current year, list on Form 4562 each item separately. For example, in 2006 you began to amortize a lease. In 2007, you began to amortize a second lease. Report amortization from the new lease on line 42 of your 2007 Form 4562. Report amortization from the 2006 lease on line 43 of your 2007 Form 4562.

If you do not have any new amortizable expenses for the current year, you are not required to complete Form 4562 (unless you are claiming depreciation). Report the current year's deduction for amortization that began in a prior year directly on the “Other deduction” or “Other expense line” of your return.

Starting a Business

When you start a business, treat all eligible costs you incur before you begin operating the business as capital expenditures which are part of your basis in the business. Generally, you recover costs for particular assets through depreciation deductions. Generally, you cannot recover other costs until you sell the business or otherwise go out of business. See Capital Expenses in chapter 1 for a discussion on how to treat these costs if you do not go into business.

However, you can elect to amortize certain costs for setting up and organizing your business. For costs paid or incurred before October 23, 2004, you can elect an amortization period of 60 months or more. For costs paid or incurred after October 22, 2004, you can elect to deduct a limited amount of start-up and organizational costs (see chapter 7). The costs that are not deducted currently can be amortized ratably over a 180-month period. The amortization period starts with the month you begin operating your active trade or business. See Code section 195(b) for limitations.

The cost must qualify as one of the following.

A business start-up cost.
An organizational cost for a corporation.
An organizational cost for a partnership.

Business Start-Up Costs

Start-up costs are amounts paid or incurred for: (a) creating an active trade or business; or (b) investigating the creation or acquisition of an active trade or business. Start-up costs include amounts paid or incurred in connection with an existing activity engaged in for profit; and for the production of income in anticipation of the activity becoming an active trade or business.

Qualifying costs. A start-up cost is amortizable if it meets both the following tests.

It is a cost you could deduct if you paid or incurred it to operate an existing active trade or business (in the same field as the one you entered into).
It is a cost you pay or incur before the day your active trade or business begins.

Start-up costs include amounts paid for the following:

An analysis or survey of potential markets, products, labor supply, transportation facilities, etc.
Advertisements for the opening of the business.
Salaries and wages for employees who are being trained and their instructors.
Travel and other necessary costs for securing prospective distributors, suppliers, or customers.
Salaries and fees for executives and consultants, or for similar professional services.

Nonqualifying costs. Start-up costs do not include deductible interest, taxes, or research and experimental costs. See Research and Experimental Costs, later.

Purchasing an active trade or business. Amortizable start-up costs for purchasing an active trade or business include only investigative costs incurred in the course of a general search for or preliminary investigation of the business. These are costs that help you decide whether to purchase a business. Costs you incur in an attempt to purchase a specific business are capital expenses that you cannot amortize.

Example.

On June 1st, you hired an accounting firm and a law firm to assist you in the potential purchase of XYZ, Inc. They researched XYZ's industry and analyzed the financial projections of XYZ, Inc. In September, the law firm prepared and submitted a letter of intent to XYZ, Inc. The letter stated that a binding commitment would result only after a purchase agreement was signed. The law firm and accounting firm continued to provide services including a review of XYZ's books and records and the preparation of a purchase agreement. On October 22nd, you signed a purchase agreement with XYZ, Inc.

All amounts paid or incurred to investigate the business before October 22nd are amortizable investigative costs. Amounts paid on or after that date relate to the attempt to purchase the business and therefore must be capitalized.

Disposition of business. If you completely dispose of your business before the end of the amortization period, you can deduct any remaining deferred start-up costs. However, you can deduct these deferred start-up costs only to the extent they qualify as a loss from a business.

Organizational Costs

Amounts paid to organize a corporation are the direct costs of creating the corporation.

Qualifying costs. To qualify as an organizational cost it must be:

For the creation of the corporation,
Chargeable to a capital account,
Amortized over the life of the corporation if the corporation had a fixed life, and.
Incurred before the end of the first tax year in which the corporation is in business.

A corporation using the cash method of accounting can amortize organizational costs incurred within the first tax year, even if it does not pay them in that year.

Examples of organizational costs include:

The cost of temporary directors.
The cost of organizational meetings.
State incorporation fees.
The cost of legal services.

Nonqualifying costs. The following items are capital expenses that cannot be amortized:

Costs for issuing and selling stock or securities, such as commissions, professional fees, and printing costs.
Costs associated with the transfer of assets to the corporation.

Costs of Organizing a Partnership

The costs to organize a partnership are the direct costs of creating the partnership.

Qualifying costs. You can amortize an organizational cost only if it meets all the following tests.

It is for the creation of the partnership and not for starting or operating the partnership trade or business.
It is chargeable to a capital account.
It could be amortized over the life of the partnership if the partnership had a fixed life.
It is incurred by the due date of the partnership return (excluding extensions) for the first tax year in which the partnership is in business. However, if the partnership uses the cash method of accounting and pays the cost after the end of its first tax year, see Cash method partnership under How To Amortize, later.
It is for a type of item normally expected to benefit the partnership throughout its entire life.

Organizational costs include the following fees.

Legal fees for services incident to the organization of the partnership, such as negotiation and preparation of the partnership agreement.
Accounting fees for services incident to the organization of the partnership.
Filing fees.

Nonqualifying costs. The following costs cannot be amortized.

The cost of acquiring assets for the partnership or transferring assets to the partnership.
The cost of admitting or removing partners, other than at the time the partnership is first organized.
The cost of making a contract concerning the operation of the partnership trade or business including a contract between a partner and the partnership.
The costs for issuing and marketing interests in the partnership such as brokerage, registration, and legal fees and printing costs. These “syndication fees” are capital expenses that cannot be depreciated or amortized.

Liquidation of partnership. If a partnership is liquidated before the end of the amortization period, the unamortized amount of qualifying organizational costs can be deducted in the partnership's final tax year. However, these costs can be deducted only to the extent they qualify as a loss from a business.

How To Amortize

Deduct start-up and organizational costs in equal amounts over the applicable amortization period (discussed earlier). You can choose an amortization period for start-up costs that is different from the period you choose for organizational costs, as long as both are not less than the applicable amortization period. Once you choose an amortization period, you cannot change it.

To figure your deduction, divide your total start-up or organizational costs by the months in the amortization period. The result is the amount you can deduct for each month.

Cash method partnership. A partnership using the cash method of accounting can deduct an organizational cost only if it has been paid by the end of the tax year. However, any cost the partnership could have deducted as an organizational cost in an earlier tax year (if it had been paid that year) can be deducted in the tax year of payment.

How To Make the Election

To elect to amortize start-up or organizational costs, you must complete and attach Form 4562 and an accompanying statement (explained later) to your return for the first tax year you are in business. If you have both start-up and organizational costs, attach a separate statement to your return for each type of cost.

Generally, you must file the return by the due date (including any extensions). However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). For more information, see the instructions for Part VI of Form 4562.

Once you make the election to amortize start-up or organizational costs, you cannot revoke it.

If your business is organized as a corporation or partnership, only the corporation or partnership can elect to amortize its start-up or organizational costs. A shareholder or partner cannot make this election. You, as a shareholder or partner, cannot amortize any costs you incur in setting up your corporation or partnership. Only the corporation or partnership can amortize these costs.

However, you, as an individual, can elect to amortize costs you incur to investigate an interest in an existing partnership. These costs qualify as business start-up costs if you acquire the partnership interest.

Start-up costs election statement. If you elect to amortize your start-up costs, attach a separate statement that contains the following information.

A description of the business to which the start-up costs relate.
A description of each start-up cost incurred.
The month your active business began (or was acquired).
The number of months in your amortization period (which is generally 180 months).

Filing the statement early. You can elect to amortize your start-up costs by filing the statement with a return for any tax year before the year your active business begins. If you file the statement early, the election becomes effective in the month of the tax year your active business begins.

Revised statement. You can file a revised statement to include any start-up costs not included in your original statement. However, you cannot include on the revised statement any cost you previously treated on your return as a cost other than a start-up cost. You can file the revised statement with a return filed after the return on which you elected to amortize your start-up costs.

Organizational costs election statement. If you elect to amortize your corporation's or partnership's organizational costs, attach a separate statement that contains the following information.

A description of each cost.
The amount of each cost.
The date each cost was incurred.
The month your corporation or partnership began active business (or acquired the business).
The number of months in your amortization period (which is generally 180 months).

Partnerships. The statement prepared for a cash basis partnership must also indicate the amount paid before the end of the year for each cost.

You do not need to separately list any partnership organizational cost that is less than $10. Instead, you can list the total amount of these costs with the dates the first and last costs were incurred.

After a partnership makes the election to amortize organizational costs, it can later file an amended return to include additional organizational costs not included in the partnership's original return and statement.

Getting a Lease

If you get a lease for business property, you recover the cost by amortizing it over the term of the lease. The term of the lease for amortization purposes generally includes all renewal options (and any other period for which you and the lessor reasonably expect the lease to be renewed). However, renewal periods are not included if 75% or more of the cost of acquiring the lease is for the term of the lease remaining on the acquisition date (not including any period for which you may choose to renew, extend, or continue the lease).

How to amortize. Enter your deduction in Part VI of Form 4562 if you are deducting amortization that begins during the current year, or on the appropriate line of your tax return if you are not otherwise required to file Form 4562.

For more information on the costs of getting a lease, see Cost of Getting a Lease in
chapter 3.

Section 197 Intangibles

Generally, you may amortize the capitalized costs of “section 197 intangibles”(defined later) ratably over a 15-year period. You must amortize these costs if you hold the section 197 intangibles in connection with your trade or business or in an activity engaged in for the production of income.

You may not be able to amortize section 197 intangibles acquired in a transaction that did not result in a significant change in ownership or use. See Anti-Churning Rules, later.

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 (180 months). 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 an amortizable 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.

Tax-exempt use property subject to a lease. The amortization period for any section 197 intangible leased under a lease agreement entered into after March 12, 2004, to a tax-exempt organization, governmental unit, or foreign person or entity (other than a partnership), shall not be less than 125 percent of the lease term.

Cost attributable to other property. The rules for section 197 intangibles do not apply to any amount that is 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 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 and must be amortized over 180 months:

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

You cannot amortize any of the intangibles listed in items (1) through (8) that you created rather than acquired unless you created them in acquiring assets that make up a trade or business or a substantial part of a trade or business.

Goodwill. This is the value of a trade or business based on expected continued customer patronage due to its name, reputation, or any other factor.

Going concern value. This is the additional value of a trade or business that attaches to property because the property is an integral part of an ongoing business activity. It includes value based on the ability of a business to continue to function and generate income even though there is a change in ownership (but does not include any other section 197 intangible). It also includes value based on the immediate use or availability of an acquired trade or business, such as the use of earnings during any period in which the business would not otherwise be available or operational.

Workforce in place, etc. This includes the composition of a workforce (for example, its experience, education, or training). It also includes the terms and conditions of employment, whether contractual or otherwise, and any other value placed on employees or any of their attributes.

For example, you must amortize the part of the purchase price of a business that is for the existence of a highly skilled workforce. Also, you must amortize the cost of acquiring an existing employment contract or relationship with employees or consultants.

Business books and records, etc. This includes the intangible value of technical manuals, training manuals or programs, data files, and accounting or inventory control systems. It also includes the cost of customer lists, subscription lists, insurance expirations, patient or client files, and lists of newspaper, magazine, radio, and television advertisers.

Patents, copyrights, etc. This includes package design, computer software, and any interest in a film, sound recording, videotape, book, or other similar property, except as discussed later under Assets That Are Not Section 197 Intangibles.

Customer-based intangible. This is the composition of market, market share, and any other value resulting from the future provision of goods or services because of relationships with customers in the ordinary course of business. For example, you must amortize the part of the purchase price of a business that is for the existence of the following intangibles.

A customer base.
A circulation base.
An undeveloped market or market growth.
Insurance in force.
A mortgage servicing contract.
An investment management contract.
Any other relationship with customers involving the future provision of goods or services.

Accounts receivable or other similar rights to income for goods or services provided to customers before the acquisition of a trade or business are not section 197 intangibles.

Supplier-based intangible. This is the value resulting from the future acquisition of goods or services used or sold by the business because of business relationships with suppliers.

For example, you must amortize the part of the purchase price of a business that is for the existence of the following intangibles.

A favorable relationship with distributors (such as favorable shelf or display space at a retail outlet).
A favorable credit rating.
A favorable supply contract.

Government-granted license, permit, etc. This is any right granted by a governmental unit or an agency or instrumentality of a governmental unit. For example, you must amortize the capitalized costs of acquiring (including issuing or renewing) a liquor license, a taxicab medallion or license, or a television or radio broadcasting license.

Covenant not to compete. Section 197 intangibles include a covenant not to compete (or similar arrangement) entered into in connection with the acquisition of an interest in a trade or business, or a substantial portion of a trade or business. An interest in a trade or business includes an interest in a partnership or a corporation engaged in a trade or business.

An arrangement that requires the former owner to perform services (or to provide property or the use of property) is not similar to a covenant not to compete to the extent the amount paid under the arrangement represents reasonable compensation for those services or for that property or its use.

Franchise, trademark, or trade name. A franchise, trademark, or trade name is a section 197 intangible. You must amortize its purchase or renewal costs, other than certain contingent payments that you can deduct currently. For information on currently deductible contingent payments, see chapter 11.

Professional sports franchise. A franchise engaged in professional sports and any intangible assets acquired in connection with acquiring the franchise (including player contracts) is a section 197 intangible amortizable over a 15-year period.

Contract for the use of, or a term interest in, a section 197 intangible. Section 197 intangibles include any right under a license, contract, or other arrangement providing for the use of any section 197 intangible. It also includes any term interest in any section 197 intangible, whether the interest is outright or in trust.

Assets That Are Not Section 197 Intangibles

The following assets are not section 197 intangibles.

Any interest in a corporation, partnership, trust, or estate.
Any interest under an existing futures contract, foreign currency contract, notional principal contract, interest rate swap, or similar financial contract.
Any interest in land.
Most computer software. (See Computer software, later.)
Any of the following assets not acquired in connection with the acquisition of a trade or business or a substantial part of a trade or business.
1. An interest in a film, sound recording, video tape, book, or similar property.
2. A right to receive tangible property or services under a contract or from a governmental agency.
3. An interest in a patent or copyright.
4. Certain rights that have a fixed duration or amount. (See Rights of fixed duration or amount, later.)
An interest under either of the following.
1. An existing lease or sublease of tangible property.
2. A debt that was in existence when the interest was acquired.
A right to service residential mortgages unless the right is acquired in connection with the acquisition of a trade or business or a substantial part of a trade or business.
Certain transaction costs incurred by parties to a corporate organization or reorganization in which any part of a gain or loss is not recognized.

Intangible property that is not amortizable under the rules for section 197 intangibles can be depreciated if it meets certain requirements. 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 generally 36 months.

For more information on depreciating intangible property, see Intangible Property under What Method Can You Use To Depreciate Your Property? in chapter 1 of Publication 946.

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

Software that meets all 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.
Software that is not acquired in connection with the acquisition of a trade or business or a substantial part of a trade or business.

Computer software defined. Computer software includes all programs designed to cause a computer to perform a desired function. It also includes any database or similar item that is in the public domain and is incidental to the operation of qualifying software.

Rights of fixed duration or amount. Section 197 intangibles do not include any right under a contract or from a governmental agency if the right is acquired in the ordinary course of a trade or business (or in an activity engaged in for the production of income) but not as part of a purchase of a trade or business and either:

Has a fixed life of less than 15 years, or
Is of a fixed amount that, except for the rules for section 197 intangibles, would be recovered under a method similar to the unit-of-production method of cost recovery.

However, this does not apply to the following intangibles.

Goodwill.
Going concern value.
A covenant not to compete.
A franchise, trademark, or trade name.
A customer-related information base, customer-based intangible, or similar item.

Safe Harbor for Creative Property Costs

If you are engaged in the trade or business of film production, you may be able to amortize the creative property costs for properties not set for production within 3 years of the first capitalized transaction. You may amortize these costs ratably over a 15-year period beginning on the first day of the second half of the tax year in which you properly write off the costs for financial accounting purposes. If, during the 15-year period, you dispose of the creative property rights, you must continue to amortize the costs over the remainder of the 15-year period.

Creative property costs include costs paid or incurred to acquire and develop screenplays, scripts, story outlines, motion picture production rights to books and plays, and other similar properties for purposes of potential future film development, production, and exploitation.

Amortize these costs using the rules of Revenue Procedure 2004-36. For more information, see Revenue Procedure 2004-36 in Internal Revenue Bulletin 2004-24, which is available at www.irs.gov/pub/irs-irbs/irb04-24.pdf.

A change in the treatment of creative property costs is a change in method of accounting.

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 that is not otherwise depreciable or amortizable.

Under the anti-churning rules, you cannot use 15-year amortization for the intangible if any of the following conditions apply.

You or a related person (defined later) held or used the intangible at any time from July 25, 1991, through August 10, 1993.
You acquired the intangible from a person who held it at any time during the period in (1) and, as part of the transaction, the user did not change.
You granted the right to use the intangible to a person (or a person related to that person) who held or used it at any time during the period in (1). This applies only if the transaction in which you granted the right and the transaction in which you acquired the intangible are part of a series of related transactions. See Related person, later, for more information.

Exceptions. The anti-churning rules do not apply in the following situations.

You acquired the intangible from a decedent and its basis was stepped up to its fair market value.
The intangible was amortizable as a section 197 intangible by the seller or transferor you acquired it from. This exception does not apply if the transaction in which you acquired the intangible and the transaction in which the seller or transferor acquired it are part of a series of related transactions.
The gain-recognition exception, discussed later, applies.

Related person. For purposes of the anti-churning rules, the following are related persons.

An individual and his or her brothers, sisters, half-brothers, half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.).
A corporation and an individual who owns, directly or indirectly, more than 20% of the value of the corporation's outstanding stock.
Two corporations that are members of the same controlled group as defined in section 1563(a) of the Internal Revenue Code, except that “more than 20%” is substituted for “at least 80%” in that definition and the determination is made without regard to subsections (a)(4) and (e)(3)(C) of section 1563. (For an exception, see section 1.197-2(h)(6)(iv) of the regulations.)
A trust fiduciary and a corporation if more than 20% of the value of the corporation's outstanding stock is owned, directly or indirectly, by or for the trust or grantor of the trust.
The grantor and fiduciary, and the fiduciary and beneficiary, of any trust.
The fiduciaries of two different trusts, and the fiduciaries and beneficiaries of two different trusts, if the same person is the grantor of both trusts.
The executor and beneficiary of an estate.
A tax-exempt educational or charitable organization and a person who directly or indirectly controls the organization (or whose family members control it).
A corporation and a partnership if the same persons own more than 20% of the value of the outstanding stock of the corporation and more than 20% of the capital or profits interest in the partnership.
Two S corporations, and an S corporation and a regular corporation, if the same persons own more than 20% of the value of the outstanding stock of each corporation.
Two partnerships if the same persons own, directly or indirectly, more than 20% of the capital or profits interests in both partnerships.
A partnership and a person who owns, directly or indirectly, more than 20% of the capital or profits interests in the partnership.
Two persons who are engaged in trades or businesses under common control (as described in section 41(f)(1) of the Internal Revenue Code).

When to determine relationship. Persons are treated as related if the relationship existed at the following time.

In the case of a single transaction, immediately before or immediately after the transaction in which the intangible was acquired.
In the case of a series of related transactions (or a series of transactions that comprise a qualified stock purchase under section 338(d)(3) of the Internal Revenue Code), immediately before the earliest transaction or immediately after the last transaction.

Ownership of stock. In determining whether an individual directly or indirectly owns any of the outstanding stock of a corporation, the following rules apply.

Rule 1. Stock directly or indirectly owned by or for a corporation, partnership, estate, or trust is considered owned proportionately by or for its shareholders, partners, or beneficiaries.

Rule 2. An individual is considered to own the stock directly or indirectly owned by or for his or her family. Family includes only brothers and sisters, half-brothers and half-sisters, spouse, ancestors, and lineal descendants.

Rule 3. An individual owning (other than by applying Rule 2) any stock in a corporation is considered to own the stock directly or indirectly owned by or for his or her partner.

Rule 4. For purposes of applying Rule 1, 2, or 3, treat stock constructively owned by a person under Rule 1 as actually owned by that person. Do not treat stock constructively owned by an individual under Rule 2 or 3 as owned by the individual for reapplying Rule 2 or 3 to make another person the constructive owner of the stock.

Gain-recognition exception. This exception to the anti-churning rules applies if the person you acquired the intangible from (the transferor) meets both of the following requirements.

That person would not be related to you (as described under Related person, earlier) if the 20% test for ownership of stock and partnership interests were replaced by a 50% test.
That person chose to recognize gain on the disposition of the intangible and pay income tax on the gain at the highest tax rate. See chapter 2 in Publication 544 for information on making this choice.

If this exception applies, the anti-churning rules apply only to the amount of your adjusted basis in the intangible that is more than the gain recognized by the transferor.

Notification. If the person you acquired the intangible from chooses to recognize gain under the rules for this exception, that person must notify you in writing by the due date of the return on which the choice is made.

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.

More information. For more information about the anti-churning rules, including additional rules for partnerships, see Regulations section 1.197-2(h).

Incorrect Amount of Amortization Deducted

If you later discover that you deducted an incorrect amount for amortization for a section 197 intangible in any year, you may be able to make a correction for that year by filing an amended return. See Amended Return, next. If you are not allowed to make the correction on an amended return, you can change your accounting method to claim the correct amortization. See Changing Your Accounting Method, later.

Amended Return

If you deducted an incorrect correct amount for amortization, you can file an amended return to correct the following.

A mathematical error made in any year.
A posting error made in any year.
An amortization deduction for a section 197 intangible for which you have not adopted a method of accounting.

When to file. If an amended return is allowed, you must file it by the later of the following dates.

3 years from the date you filed your original return for the year in which you did not deduct the correct amount. (A return filed early is considered filed on the due date.)
2 years from the time you paid your tax for that year.

Changing Your Accounting Method

Generally, you must get IRS approval to change your method of accounting. File Form 3115, Application for Change in Accounting Method, to request a change to a permissible method of accounting for amortization.

The following are examples of a change in method of accounting for amortization.

A change in the amortization method, period of recovery, or convention of an amortizable asset.
A change in the accounting for amortizable assets from a single asset account to a multiple asset account (pooling), or vice versa.
A change in the accounting for amortizable assets from one type of multiple asset account to a different type of multiple asset account.

Changes in amortization that are not a change in method of accounting include the following:

A change in computing amortization in the tax year in which your use of the asset changes.
An adjustment in the useful life of an amortizable asset.
Generally, the making of a late amortization election or the revocation of a timely valid amortization election.
Any change in the placed-in-service date of an amortizable asset.

See section 1.446-1(e)(2)(ii(a) of the Regulations for more information and examples.

Automatic approval. In some instances, you may be able to get automatic approval from the IRS to change your method of accounting for amortization. For a list of automatic accounting method changes, see the Instructions for Form 3115. Also see the Instructions for Form 3115 for more information on getting approval, automatic approval procedures, and a list of exceptions to the automatic approval process.

For additional guidance, see Revenue Procedure 2006-12 on page 310 of Internal Revenue Bulletin 2006-3, available at www.irs.gov/pub/irs-irbs/irb06-03.pdf.

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). If multiple section 197 intangibles are disposed of in a single transaction or a series of related transactions, treat all of the section 197 intangibles as if they were a single asset for purposes of determining the amount of gain that is ordinary income. 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 elect to deduct a limited amount of reforestation costs paid or incurred during the tax year. See Reforestation Costs in chapter 7. You can elect to amortize the qualifying costs that are not deducted currently over an 84-month period. There is no limit on the amount of your amortization deduction for reforestation costs paid or incurred during the tax year.

The election 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 election.

A partner's or shareholder's share of amortizable costs is figured under the general rules for allocating items of income, loss, deduction, etc., of a partnership or S corporation. The amortizable costs of an estate are divided between the estate and the income beneficiary based on the income of the estate allocable to each.

Qualifying costs. Reforestation costs are the direct costs of planting or seeding for forestation or reforestation. 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.

Qualifying costs do not include costs for which the government reimburses you under a cost-sharing program, unless 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 of 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.

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 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.

How to make the election. To elect to amortize qualifying reforestation costs, complete 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 election 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 election, you can still make the election 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.

Revoking the election. You must get IRS approval to revoke your election to amortize qualifying reforestation costs. Your application to revoke the election must include your name, address, the years for which your election 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 election is to end.

Send the application to:

Internal Revenue Service
Associate Chief Counsel
Passthroughs and Special Industries
CC:PSI
1111 Constitution Ave., N.W., IR-5300
Washington, DC 20224

Geological and Geophysical Costs

You can amortize the cost of geological and geophysical expenses paid or incurred in connection with oil and gas exploration or development within the U.S. These costs can be amortized ratably over a 24-month period beginning on the mid-point of the tax year in which the expenses were paid or incurred. For major integrated oil companies (as defined in section 167(h)(5)) these costs must be amortized ratably over a 5-year period for costs paid or incurred after May 12, 2006 (a 7-year period for costs paid or incurred after December 19, 2007).

If you retire or abandon the property during the amortization period, no amortization deduction is allowed in the year of retirement or abandonment.

Pollution Control Facilities

You can elect to amortize the cost of a certified pollution control facility over 60 months. However, see Atmospheric pollution control facilities for an exception. The cost of a pollution control facility that is not eligible for amortization can be depreciated under the regular rules for depreciation. Also, you can claim a special depreciation allowance on a certified pollution control facility that is qualified property even if you elect to amortize its cost. You must reduce its cost (amortizable basis) by the amount of any special allowance you claim. See chapter 3 of Publication 946.

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.

Atmospheric pollution control facilities. Certain atmospheric pollution control facilities can be amortized over 84 months. To qualify, the following must apply.

The facility must be acquired and placed in service after April 11, 2005. If acquired, the original use must begin with you after April 11, 2005.
The facility must be used in connection with an electric generation plant or other property placed in operation after December 31, 1975, that is primarily coal fired.
If you construct, reconstruct, or erect the facility, only the basis attributable to the construction, reconstruction, or erection completed after April 11, 2005, qualifies.

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 Code sections 169 and 291(c) and the related regulations.

Research and Experimental Costs

You can elect to amortize your research and experimental costs, deduct them as current business expenses, or write them off over a 10-year period. If you elect 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 costs. For a definition of “research and experimental costs” and information on deducting them as current business expenses, see chapter 7.

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.

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 election. To elect to amortize research and experimental costs, complete 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 election, you can still make the election 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 election is binding for the year it is made and for all later years unless you obtain approval from the IRS to change to a different method.

Optional Write-off of Certain Tax Preferences

You can elect to amortize certain tax preference items over an optional period beginning in the tax year in which you incurred the costs. If you make this election there is no AMT adjustment. The applicable costs and the optional recovery periods are as follows:

Circulation costs — 3 years,
Intangible drilling and development costs — 60 months,
Mining exploration and development costs — 10 years, and
Research and experimental costs — 10 years.

How to make the election. To elect to amortize qualifying costs over the optional recovery period, complete Part VI of Form 4562 and attach a statement containing the following information to your return for the tax year in which the election begins:

Your name, address, and taxpayer identification number; and
The type of cost and the specific amount of the cost for which you are making the election.

Generally, the election must be made 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 election, you can still make the election 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.

Revoking the election. You must obtain consent from the IRS to revoke your election. Your request to revoke the election must be submitted to the IRS in the form of a letter ruling before the end of the tax year in which the optional recovery period ends. The request must contain all of the information necessary to demonstrate the rare and unusual circumstances that would justify granting revocation. If the request for revocation is approved, any unamortized costs are deductible in the year the revocation is effective.

8. Amortization

Introduction

Topics - This chapter discusses:

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