[Federal Register Volume 62, Number 11 (Thursday, January 16, 1997)]
[Proposed Rules]
[Pages 2336-2354]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-866]


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DEPARTMENT OF THE TREASURY
26 CFR Part 1

[REG-209709-94]
RIN 1545-AS77


Amortization of Intangible Property

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to the 
amortization of certain intangible property. The proposed regulations 
reflect changes to the law made by the Omnibus Budget Reconciliation 
Act of 1993 (OBRA '93), and affect taxpayers who acquired intangible 
property after August 10, 1993, or made a retroactive election to apply 
OBRA '93 to intangibles acquired after July 25, 1991. This document 
also provides notice of a public hearing on the proposed regulations.

DATES: Comments must be received by April 16, 1997. Requests to appear 
and outlines of oral comments to be presented at the public hearing 
scheduled for May 15, 1997, must be received by April 24, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-209709-94), room 
5228, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered between the 
hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-209709-94), Courier's 
Desk, Internal Revenue Service, 1111 Constitution Avenue NW., 
Washington, DC. Alternatively, taxpayers may submit comments 
electronically via the Internet by selecting the Tax Regs option of the 
IRS Home Page, or by submitting comments directly to the IRS Internet 
site at http:\\www.irs.ustreas.gov\prod\tax __regs\comments.html. The 
public hearing will be held in the Commissioner's Conference Room (Room 
3313), Internal Revenue Building, 1111 Constitution Avenue NW., 
Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, John 
Huffman at (202) 622-3110; concerning submissions and the hearing, 
Michael Slaughter at (202) 622-8452 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed regulations under sections 167(f) 
and 197. These provisions were added to the Internal Revenue Code of 
1986 (the Code) by section 13261 of OBRA '93, and apply to intangible 
property acquired after August 10, 1993 (or after July 25, 1991, if a 
valid retroactive election to apply OBRA '93 to intangibles has been 
made pursuant to Sec. 1.197-1T).
    The proposed regulations provide definitions and rules for 
amortization of intangible property subject to sections 197 and 167(f). 
On June 24, 1994, the IRS published Announcement 94-92 (1994-28 I.R.B. 
139) in the Federal Register (59 FR 32670) inviting comments under 
section 197 relating to the amortization of goodwill and certain other 
intangibles that should be addressed in proposed regulations. The IRS 
has reviewed these comments and has addressed certain issues raised in 
the comments in the proposed regulations. However, because these 
comments were received in anticipation of the issuance of these 
proposed regulations, and because these regulations are subject to 
further comment and a public hearing, no attempt has been made to 
describe all of the principal comments that are not reflected in these 
regulations or the reasons therefor.

Explanation of Provisions

1. General Overview

    Sections 167(f) and 197 provide comprehensive rules for the 
depreciation and amortization of many intangible assets. Intangible 
assets subject to section 197 are broadly defined to include most 
intangible assets acquired in connection with the acquisition of a 
trade or business and certain other separately acquired intangible 
assets. The adjusted basis of an amortizable section 197 intangible 
must be amortized over a 15-year period. Certain other intangible 
assets are excluded from section 197 for various reasons. In some 
cases, such as stock and partnership interests, the asset is property 
of a character that is not subject to an allowance for depreciation 
because it represents a permanent investment that can only be recovered 
through disposition of the asset (including worthlessness). In other 
cases, such as computer software,

[[Page 2337]]

purchased mortgage servicing rights, service and supply contracts, and 
certain other contracts or rights with a fixed duration, other cost 
recovery methods were prescribed by the OBRA '93 amendments. In still 
other cases, such as motion picture films, television series, books, 
and sound recordings, other cost recovery methods that were in effect 
prior to OBRA '93 are more appropriate under the circumstances. Section 
167(f) provides alternative methods of depreciation for certain of the 
intangibles excluded from the application of section 197.
    The proposed regulations provide guidance for certain intangible 
property subject to sections 167(f) and 197. The section 167(f) 
proposed regulations provide rules for intangible property subject to 
the allowance for depreciation under section 167 and specifically 
excluded from section 197. These intangible assets include certain 
computer software, rights to receive tangible property or services, 
rights of fixed duration, patents, copyrights, and mortgage servicing 
rights. These proposed regulations reserve guidance on the method of 
depreciating the cost of separately acquired rights to receive tangible 
property or services where the amount of the property or services to be 
received is not specified. The IRS invites comments on possible methods 
of depreciation in these cases.
    Because section 197 provides a method of amortization and, except 
in the case of certain covenants not to compete, governmental licenses, 
permits and other rights, and contracts for the use of section 197 
intangibles, does not alter the rules for determining the basis of an 
asset, section 197 generally does not apply to amounts that would 
otherwise be deductible. For example, section 197 does not generally 
apply to the costs of advertising because, in most cases, these costs 
are deductible under other provisions of the Code. See Rev. Rul. 92-80 
(1992-2 C.B. 57). In addition, section 197 does not apply to costs that 
would not, under general principles of Federal income tax law, be 
included in the basis of a section 197 intangible. For example, if a 
taxpayer borrows money to purchase the assets of a trade or business 
(including amortizable section 197 intangibles) and incurs fees in 
connection with the loan, these costs are generally amortized over the 
term of the loan rather than under the rules of sections 167(f) and 
197. As a further example, if the amortizable section 197 intangibles 
acquired in the transaction include a favorable supply contract, the 
amortizable basis in the contract does not include amounts required to 
be paid for goods to be received pursuant to the contract.
    In addition, section 197 does not apply to any amount for which a 
deduction would be disallowed under other provisions of the Code, such 
as section 162(k) (relating to amounts paid or incurred by a 
corporation in connection with the acquisition of its stock or the 
stock of a related person).
    No inference should be drawn from any provision in the proposed 
regulations concerning the classification of any section197 intangible 
as property, or whether any section 197 intangible is treated as 
tangible or intangible property, for other purposes of the Code. 
Furthermore, no inference should be drawn from any provision in the 
proposed regulations regarding (a) whether any section 197 intangible 
that is not an amortizable section 197 intangible may be amortized or 
depreciated under any provision of the Code other than section 197, or 
(b) the proper method for determining any allowance therefor. Finally, 
no inference should be drawn from any provision in the proposed 
regulations concerning whether any section 197 intangible (or any 
interest therein) has been purchased, leased, or licensed for Federal 
income tax purposes.
2. Section 197  Intangibles
    The proposed regulations define section 197 intangibles (subject to 
certain exceptions) as goodwill, going concern value, workforce in 
place, information base, know-how, customer-and supplier-based 
intangibles, governmental licenses and permits, covenants not to 
compete and other similar arrangements, franchises, trademarks, trade 
names, and contracts for the use of the foregoing assets.
A. Covenants Not to Compete
    Some commentators in response to Announcement 94-92 suggested that 
a covenant not to compete relating to the redemption of stock or a 
partnership interest from a departing stockholder or partner should be 
excluded from section 197 because this situation does not involve the 
acquisition of a trade or business. The legislative history provides, 
however, that section 197 applies to a covenant not to compete acquired 
with the assets of a trade or business, the stock in a corporation, or 
an interest in a partnership engaged in a trade or business. 
Consequently, the proposed regulations do not provide for this 
exception. In this regard, the proposed regulations provide that for 
purposes of section 197(f)(1)(B), the disposition or cancellation of 
redeemed stock of a corporation will not cause the covenant to be 
written off faster than over the 15-year amortization period provided 
for under section 197 (in the case of a covenant to which section 
162(k) does not apply).
B. Contracts for the Use of Section 197 Intangibles
    Some commentators also requested guidance on the extent to which 
contracts for the use of section 197 intangibles would be subject to 
section 197, in some cases suggesting that an intangible was not 
subject to section 197 unless the taxpayer obtained ownership of 
property for Federal income tax purposes. However, it is sometimes 
difficult to determine whether the terms of an agreement confer 
ownership, for Federal income tax purposes, of property, and the IRS 
and Treasury believe that the purposes of section 197 could be 
circumvented through the use of such agreements. Accordingly, the 
proposed regulations provide that contracts for the use of section 197 
intangibles will also be treated as section 197 intangibles. Contracts 
that are so treated may, however, be excluded under either section 
197(e)(4) (B) or (D) on the basis that they are contracts for the 
receipt of property or services, contracts having a fixed duration, or 
contracts having a fixed amount and recovered on a unit-of-production 
method or other similar method.

3. Intangibles Excluded From Section 197

A. Computer Software
    Section 197 intangibles do not include computer software that is 
readily available for purchase by the general public, is subject to a 
nonexclusive license, and has not been substantially modified. The 
proposed regulations provide a safe harbor for purposes of determining 
whether computer software has been substantially modified. Under the 
safe harbor, computer software has not been substantially modified if 
its capitalized cost does not exceed the greater of $2,000 or 125 
percent of the price at which the unmodified version of the software is 
readily available to the general public.
    The proposed regulations incorporate some of the provisions of 
Revenue Procedure 69-21 (1969-2 C.B. 303), involving the treatment of 
costs of computer software, and modify other provisions to the extent 
necessary to conform to the amortization rules provided under sections 
197 and 167(f). Consequently, if costs for developing computer software 
that the taxpayer has elected to treat as deferred expenses

[[Page 2338]]

under section 174(b) result in the development of a self-created 
intangible excluded under section 197(c)(2) and subject to the 
allowance for depreciation under section 167(a), deductions for the 
unrecovered expenditures are subject to section 167(f)(1). Computer 
software costs included, without being separately stated, in the cost 
of the computer hardware (bundled software) continue to be capitalized 
and depreciated as part of the computer hardware. The proposed 
regulations also continue to treat as currently deductible software 
costs properly and consistently treated as deductible (not capitalized) 
under Sec. 1.162-11.
B. Certain Separately Acquired Intangibles
    Certain intangibles are excepted from section 197 if they are not 
acquired as part of a purchase of a trade or business. The proposed 
regulations clarify that, for purposes of section 197, a group of 
assets constitutes a trade or business if their use would constitute a 
trade or business under section 1060; that is, if goodwill or going 
concern value could under any circumstances attach to the assets. 
Temporary and proposed regulations under section 1060, in turn, provide 
that a group of assets constitutes a trade or business for purposes of 
section 1060 if the use of such assets would constitute an active trade 
or business for purposes of section 355. However, in appropriate cases, 
even if the use of a group of assets would not constitute an active 
trade or business for purposes of section 355, such assets may 
nevertheless constitute a trade or business for purposes of section 
1060. See Sec. 1.1060-1T(b)(2).
    The IRS intends to provide additional guidance as to the 
circumstances under which the acquisition of a group of assets 
constitutes a trade or business for purposes of section 1060 in 
regulations under that section. Accordingly, the proposed regulations 
do not provide substantive guidance on this question, except to the 
extent that the considerations are unique to the application of section 
197. The IRS invites comments on the extent to which additional rules 
under section 197 may be necessary.
C. Certain Contracts and Governmental Rights
    While section 197 intangibles include licenses, permits, and other 
rights granted by a governmental unit or an agency or instrumentality 
thereof (section 197(d)(1)(D)), certain rights granted by these 
governmental entities are excluded from section 197 pursuant to section 
197(e)(4) (B) and (D), subject to the conditions and limitations 
therein. Because a particular right may be described in two or more of 
these provisions, the proposed regulations provide guidance regarding 
the potential conflict between, or overlap with, these provisions. 
Thus, a right that would be subject to section 197 pursuant to section 
197(d)(1)(D) may nevertheless be excluded if it is also described in 
section 197(e)(4) and meets all of the requirements for exclusion. 
Furthermore, a right that meets the requirements of either section 
197(e)(4)(B) or section 197(e)(4)(D) is excluded from section 197 even 
if it fails to meet one of the requirements for the other exclusion. In 
addition, any license, permit, or other right granted by a governmental 
unit that otherwise meets the definition of a franchise under section 
197(d)(1)(F), such as an FCC broadcast license or cable television 
franchise, is treated as a franchise under the regulations. 
Accordingly, these licenses do not qualify for any of the exceptions 
from section 197 provided under section 197(e)(4).

4. Special Rules of Application

A. Loss Disallowance Provisions
    The proposed regulations contain rules for the loss disallowance 
provisions set forth in section 197(f)(1). In particular, the proposed 
regulations provide that a taxpayer may not circumvent the loss 
disallowance rules, for example, by transferring some intangibles, 
whose adjusted basis is greater than their fair market value, to a 
corporation in exchange for stock in the corporation in a transaction 
described in section 351, while retaining other intangibles acquired in 
the same or related transaction, and then selling the stock. Special 
rules are also provided for the application of the loss disallowance 
provisions in cases where a taxpayer has disposed of all of the 
amortizable section 197 intangibles acquired in a single transaction 
but is treated as having retained other amortizable section 197 
intangibles solely by virtue of the retention of amortizable section 
197 intangibles by a related person.
B. Transactions Involving Partnerships
    The proposed regulations provide rules and examples relating to the 
treatment of section 197 intangibles acquired or transferred in certain 
partnership transactions, including terminations under section 
708(b)(1), and the application of section 197 to the special basis 
adjustments of partnership property for which a section 754 or section 
732(d) election is in effect. Guidance is also provided regarding the 
effect of curative and remedial allocations and the application of the 
anti-churning rules to certain partnership transactions.
    In the case of the termination of a partnership under section 
708(b)(1)(B) (relating to a sale or exchange of an interest), the rules 
contained in the proposed regulations are based on recently proposed 
regulations under that section, pursuant to which the new partnership 
is treated as having directly acquired the assets of the old 
partnership in exchange for the assumption of its liabilities and the 
issuance of interests in the new partnership. Accordingly, for purposes 
of section 197, the consequences of the termination of a partnership 
under section 708(b)(1)(B) may not be the same as the consequences of 
such a termination under the rules in effect at the time section 197 
was enacted.
C. Treatment of Contingent Payments
    The proposed regulations clarify that, except in the case of 
contingent payments, amounts paid for section 197 intangibles are 
treated as amounts chargeable to capital account, and the entire 
principal amount is amortized ratably over the 15-year amortization 
period beginning with the later of the month in which the intangible is 
acquired or the date on which the active conduct of a trade or business 
begins. Contingent payments for section 197 intangibles paid or 
incurred after the taxable year in which the intangible is acquired are 
added to basis at such time and generally amortized ratably over the 
remaining months in the 15-year period as of the beginning of the month 
the amount is paid or incurred. However, in order to reduce the 
administrative burden that may result from a requirement to maintain 
separate amortization schedules for each month during the 15-year 
period, taxpayers are permitted to use certain simplifying conventions. 
In addition, any amount that is not properly included in the basis of 
an amortizable section 197 intangible until after the expiration of the 
15-year period is amortized in full immediately upon the inclusion of 
the amount in the basis of the intangible. The proposed regulations 
refer to Sec. 1.461-1(a)(1) for rules governing the time at which an 
amount may be taken into account by a taxpayer using the cash receipts 
and disbursements method. They refer to Sec. 1.461-1(a)(2) for rules 
governing the time at which a liability is incurred and generally taken 
into account (for example, by treating the amount of the liability as a 
capital

[[Page 2339]]

expenditure) by an accrual basis taxpayer.

5. Anti-Churning Rules

    To be eligible for amortization, section 197 intangibles must 
qualify as amortizable section 197 intangibles. Generally, amortizable 
section 197 intangibles are section 197 intangibles that are acquired 
after August 10, 1993 (or acquired after July 25, 1991, and for which 
the taxpayer made a proper election under Sec. 1.197-1T) and held in 
connection with the conduct of a trade or business or an activity 
described in section 212.
    The proposed regulations provide anti-churning rules to prevent 
taxpayers from converting into amortizable section 197 intangibles 
existing goodwill, going concern value, and any other section 197 
intangible for which amortization would not have been allowable prior 
to OBRA '93 through the use of related persons and certain other 
transactions. The proposed regulations define the term related person 
for purposes of these rules.
    The proposed regulations also contain provisions for the exception 
to the anti-churning rules in situations where the seller elects to 
recognize gain and agrees to pay a specified amount of tax. The 
regulations reserve guidance on the manner of making this election. The 
IRS intends to issue a revenue procedure in order to provide interim 
guidance to taxpayers on the manner of making this election, and the 
final regulations will include the relevant provisions of this revenue 
procedure.
    The proposed regulations contain both an anti-churning anti-abuse 
rule and a general anti-abuse rule that provide that the Commissioner 
may recast any transaction if one of its principal purposes is to avoid 
the purposes of section 197.

6. Assumption Reinsurance Transactions

    Section 197(f)(5) provides special rules for section 197 
intangibles resulting from assumption reinsurance transactions. The 
proposed regulations reserve guidance on certain aspects of these 
transactions. The IRS invites comments on the extent to which 
additional guidance on the application of section 197 to these 
transactions may be necessary.

7. Proposed Effective Dates

    The regulations for sections 167(f) and 197 are proposed to be 
effective on the date on which the final regulations are published in 
the Federal Register. Regulations to implement section 197(e)(4)(D) 
(separately acquired contracts of fixed duration or amount) are 
proposed to be effective August 11, 1993, for property acquired after 
August 10, 1993 (or July 26, 1991, if a valid retroactive election has 
been made under Sec. 1.197-1T).

8. Accounting Method Changes

    A change in the method of depreciation or amortization of 
intangibles is a change in method of accounting that requires the 
consent of the Commissioner of Internal Revenue under section 446(e). 
To obtain this consent, a Form 3115, Application for Change in 
Accounting Method, generally must be filed within 180 days after the 
beginning of the taxable year in which the proposed change is to be 
made. Taxpayers that have adopted a method of accounting for certain 
intangibles may need to change their method of accounting to comply 
with the final regulations.

9. Basis Allocation Rules

    In separate notices the IRS and Treasury are issuing temporary and 
proposed amendments to the temporary regulations under sections 1060 
and 338(b). The existing temporary regulations establish a four-class 
system for allocating basis to individual assets in the case of a 
direct acquisition of assets constituting a trade or business or a 
deemed acquisition of assets as the result of an election under section 
338. Under this system, assets in the nature of goodwill and going 
concern value are included in Class IV, while other intangible assets, 
whether or not amortizable, are included in Class III. Each successive 
class is allocated basis under a residual method, subject to a fair 
market value limitation for all classes except Class IV. After basis 
has been allocated to each class in the aggregate, assets within each 
of the first three classes are allocated basis on a proportional 
method. This system is inconsistent with the policies of section 197, 
which prescribes uniform treatment for all amortizable section 197 
intangibles. Accordingly, appropriate modifications are being proposed.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It also has been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) does not apply to these regulations, and, because the 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this 
notice of proposed rulemaking will be submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted (in the 
manner described in ADDRESSES) timely to the IRS. All comments will be 
available for public inspection and copying.
    A public hearing has been scheduled for May 15, 1997, at 10 a.m. in 
the Commissioner s Conference Room (Room 3313), Internal Revenue 
Building, 1111 Constitution Avenue NW., Washington, DC 20224. Because 
of access restrictions, visitors will not be admitted beyond the 
Internal Revenue Building lobby more than 15 minutes before the hearing 
starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons that wish to present oral comments at the hearing must 
submit comments and an outline of the topics to be discussed and the 
time to be devoted to each topic (in the manner described in ADDRESSES) 
by April 16, 1997. A period of 10 minutes will be allotted to each 
person for making comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is John Huffman, Office 
of Assistant Chief Counsel (Passthroughs and Special Industries), IRS. 
However, other personnel from the IRS and Treasury Department 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.197-2 also issued under 26 U.S.C. 197(g). * * *


[[Page 2340]]


    Par. 2. Section 1.167(a)-3 is amended by adding a sentence at the 
end to read as follows:


Sec. 1.167(a)-3  Intangibles.

    * * * See Sec. 1.197-2 and Sec. 1.167(a)-14 for amortization of 
goodwill and certain other intangibles acquired after August 10, 1993, 
or after July 25, 1991, if a valid retroactive election under 
Sec. 1.197-1T has been made.
    Par. 3. Section 1.167(a)-6 is amended by adding two sentences at 
the end of paragraph (a) to read as follows:


Sec. 1.167(a)-6  Depreciation in special cases.

    (a) * * * See Sec. 1.167(a)-14(c)(4) for depreciation of a 
separately acquired interest in a patent or copyright described in 
section 167(f)(2) acquired after the date on which the final 
regulations are published in the Federal Register. See Sec. 1.197-2 for 
amortization of interests in patents and copyrights that constitute 
amortizable section 197 intangibles.
* * * * *
    Par. 4. Section 1.167(a)-14 is added to read as follows:


Sec. 1.167(a)-14  Treatment of certain intangible property excluded 
from section 197.

    (a) Overview. This section provides rules for the amortization of 
certain intangibles that are excluded from section 197 (relating to the 
amortization of goodwill and certain other intangibles). These excluded 
intangibles are specifically described in Sec. 1.197-2(c) (4), (6), 
(7), (11), and (13) and include certain computer software and certain 
other separately acquired rights, such as rights to receive tangible 
property or services, patents and copyrights, rights of fixed duration 
or amount, and certain mortgage servicing rights. Intangibles for which 
an amortization amount is determined under section 167(f) and 
intangibles otherwise excluded from section 197 (for example, self-
created intangibles described in Sec. 1.197-2(d)(2)) are amortizable 
only if they qualify as property subject to the allowance for 
depreciation under section 167(a).
    (b) Computer software--(1) In general. The amount of the deduction 
for computer software described in section 167(f)(1) and Sec. 1.197-
2(c)(4) is determined by amortizing the adjusted basis of the computer 
software using the straight line method described in Sec. 1.167(b)-1 
(except that its salvage value is treated as zero) and an amortization 
period of 36 months beginning with the month that the computer software 
is placed in service. If costs for developing computer software that 
the taxpayer properly elects to defer under section 174(b) result in 
the development of property subject to the allowance for depreciation 
under section 167, the rules of this paragraph (b) will apply to the 
unrecovered costs. In addition, this paragraph (b) applies to the cost 
of separately acquired computer software where these costs are 
separately stated and the costs are required to be capitalized under 
section 263(a).
    (2) Exceptions. Paragraph (b)(1) of this section does not apply to 
the cost of computer software properly and consistently treated as 
currently deductible (that is, not capitalized) under Sec. 1.162-11. 
The cost of acquiring an interest in computer software that is 
included, without being separately stated, in the cost of the hardware 
or other tangible property is treated as part of the cost of the 
hardware or other tangible property that is capitalized and depreciated 
under other applicable sections of the Internal Revenue Code.
    (c) Certain interests or rights acquired separately--(1) Certain 
rights to receive tangible property or services. The amount of the 
deduction for a separately acquired right to receive tangible property 
or services under a contract or from a governmental unit (specified in 
section 167(f)(2) and Sec. 1.197-2(c)(6)) is determined as follows:
    (i) Amortization of fixed amounts. The cost of acquiring a right to 
receive a fixed amount of tangible property or services is amortized 
for each taxable year by multiplying the basis (as determined under 
section 1011) of the right by a fraction, the numerator of which is the 
amount of tangible property or services received during the taxable 
year and the denominator of which is the total amount of tangible 
property or services received or to be received under the terms of the 
contract or governmental grant. For example, if a taxpayer acquires a 
favorable contract right to receive a fixed amount of raw materials 
during an unspecified period, the taxpayer must amortize the cost of 
acquiring the contract right by multiplying the total cost by a 
fraction, the numerator of which is the amount of raw materials 
received under the contract during the taxable year and the denominator 
of which is the total amount of raw materials received or to be 
received under the contract.
    (ii) Amortization of unspecified amount over fixed period. The cost 
of acquiring a right to receive an unspecified amount of tangible 
property or services over a fixed period is amortized ratably over the 
period of the right.
    (iii) Amortization in other cases. [Reserved]
    (2) Rights of fixed duration or amount. The amount of the deduction 
for a separately acquired right of fixed duration or amount received 
under a contract or granted by a governmental unit (specified in 
section 167(f)(2) and Sec. 1.197-2(c)(13)) and not covered by paragraph 
(c)(1) of this section is determined as follows:
    (i) Rights of a fixed amount. The cost of acquiring a right of a 
fixed amount is amortized for each taxable year by multiplying the cost 
of the right by a fraction, the numerator of which is the amount 
received or delivered during the taxable year and the denominator of 
which is the total amount to be received or delivered (including 
amounts received or delivered prior to the close of the taxable year) 
under the terms of the contract or governmental grant.
    (ii) Rights of unspecified amount and fixed duration of less than 
15 years. The cost of acquiring a right of an unspecified amount and a 
fixed duration of less than 15 years is amortized ratably over the 
period of the right.
    (3) Application of renewals. (i) For purposes of paragraphs (c) (1) 
and (2) of this section, the duration of a right under a contract (or 
granted by a governmental unit) includes any renewal period if, based 
on all of the facts and circumstances in existence at any time during 
the taxable year in which the right is acquired, the facts clearly 
indicate a reasonable expectancy of renewal.
    (ii) The mere fact that a taxpayer will have the opportunity to 
renew a contract right or other right on the same terms as are 
available to others, in a competitive auction or similar process that 
is designed to reflect fair market value and in which the taxpayer is 
not contractually advantaged, will generally not be taken into account 
in determining the duration of such right provided that the bidding 
produces a fair market value price comparable to the price that would 
be obtained if the rights were purchased immediately after renewal from 
a person (other than the person granting the renewal) in an arm's-
length transaction.
    (iii) The cost of a renewal not included in the terms of the 
contract or governmental grant is treated as the acquisition of a 
separate intangible asset.
    (4) Patents and copyrights. The amount of the deduction for a 
separately acquired interest in a patent or copyright described in 
section 167(f)(2) and Sec. 1.197-2(c)(7) is equal to the purchase price 
paid or incurred during the year if the purchase price is payable on at 
least an annual basis as either a

[[Page 2341]]

fixed amount per use or a fixed percentage of the revenue derived from 
the use of the patent or copyright. Otherwise, the cost or other basis 
of a separately acquired patent or copyright (or an interest therein) 
is depreciated ratably over its remaining useful life. If a patent or 
copyright becomes valueless in any year before its legal expiration, 
the adjusted basis may be deducted in that year.
    (5) Applicable rules and conventions. The period of amortization 
under paragraphs (c)(1) through (c)(4) of this section begins when the 
intangible is placed in service. For other applicable rules, see 
Sec. 1.197-2(f).
    (d) Mortgage servicing rights. The amount of the deduction for 
mortgage servicing rights described in section 167(f)(3) and 
Sec. 1.197-2(c)(11) is determined by using the straight line method 
described in Sec. 1.167(b)-1 (except that the salvage value is treated 
as zero) and an amortization period of 108 months. Mortgage servicing 
rights are not depreciable to the extent the rights are stripped 
coupons under section 1286. An event that renders mortgage servicing 
rights wholly worthless is considered a disposition of the rights. For 
purposes of determining the deduction for mortgage servicing rights and 
any loss from the sale, exchange, or other disposition of the rights, 
rights to service a pool of mortgages are treated as a single asset. 
Thus, if some (but not all) mortgages in a pool prepay and the taxpayer 
retains rights to service the remaining mortgages in the pool, no loss 
is recognized by reason of the prepayment. The adjusted basis of the 
mortgage servicing rights is not affected by the unrecognized loss.
    (e) Effective date. This section is applicable on the date final 
regulations are published in the Federal Register except that 
Sec. 1.167(a)-14(c)(2) (depreciation of the cost of certain separately 
acquired rights) and so much of Sec. 1.167(a)-14(c)(3) as relates to 
Sec. 1.167(a)-14(c)(2) are applicable August 11, 1993 (or July 26, 
1991, if a valid retroactive election has been made under Sec. 1.197-
1T).
    Par. 5. Section 1.197-0 is added to read as follows:


Sec. 1.197-0  Table of contents.

    This section lists the headings that appear in Sec. 1.197-2.
    Sec. 1.197-2  Amortization of goodwill and certain other 
intangibles.
    (a) Overview.
    (1) In general.
    (2) Section 167(f) property.
    (3) Amounts otherwise deductible.
    (4) Relationship to other Internal Revenue Code provisions.
    (b) Section 197 intangibles; in general.
    (1) Goodwill.
    (2) Going concern value.
    (3) Workforce in place.
    (4) Information base.
    (5) Know-how, etc.
    (6) Customer-based intangibles.
    (7) Supplier-based intangibles.
    (8) Licenses, permits, and other rights granted by governmental 
units.
    (9) Covenants not to compete and other similar arrangements.
    (10) Franchises, trademarks, and trade names.
    (11) Contracts for the use of, and term interests in, other 
section 197 intangibles.
    (12) Other similar items.
    (c) Section 197 intangibles; exceptions.
    (1) Interests in a corporation, partnership, trust, or estate.
    (2) Interests under certain financial contracts.
    (3) Interests in land.
    (4) Certain computer software.
    (i) In general.
    (ii) Separately acquired software.
    (iii) Other exceptions.
    (iv) Computer software defined.
    (v) Readily available to the general public.
    (5) Certain interests in films, sound recordings, video tapes, 
books, or other similar property.
    (6) Certain rights to receive tangible property or services.
    (7) Certain interests in patents or copyrights.
    (8) Interests under leases of tangible property.
    (i) Interest as a lessor.
    (ii) Interest as a lessee.
    (9) Interests under indebtedness.
    (i) In general.
    (ii) Exceptions.
    (10) Professional sports franchises.
    (11) Mortgage servicing rights.
    (12) Certain transaction costs.
    (13) Rights of fixed duration or amount.
    (d) Amortizable section 197 intangibles.
    (1) Definition.
    (2) Exception for self-created intangibles.
    (i) In general.
    (ii) Created by the taxpayer.
    (A) Defined.
    (B) Contracts for the use of intangibles.
    (C) Improvements and modifications.
    (iii) Exceptions.
    (3) Exception for property subject to anti-churning rules.
    (e) Purchase of a trade or business.
    (1) Goodwill or going concern value.
    (2) Customer-based intangibles.
    (3) Franchise, trademark, or trade name.
    (i) In general.
    (ii) Exceptions.
    (4) Acquisitions to be included.
    (5) Substantial portion.
    (6) Deemed asset purchases under section 338.
    (f) Computation of amortization deduction.
    (1) In general.
    (2) Treatment of contingent amounts.
    (i) Amounts added to basis during 15-year period.
    (ii) Amounts becoming fixed after expiration of 15-year period.
    (iii) Time for including amounts in basis.
    (3) Determination of amounts chargeable to capital account in 
certain cases.
    (i) Covenants not to compete, rights granted by governmental 
units, and contracts for the use of section 197 intangibles.
    (A) In general.
    (B) Time for taking amounts into account.
    (ii) Franchises, trademarks, or trade names and licenses, 
permits, and other rights granted by governmental units.
    (iii) Certain reinsurance transactions.
    (4) Transactions subject to section 338 or 1060.
    (g) Special rules.
    (1) Treatment of certain dispositions.
    (i) Loss disallowance rules.
    (A) In general.
    (B) Certain nonrecognition transfers.
    (ii) Separately acquired property.
    (iii) Disposition of a covenant not to compete.
    (iv) Taxpayers under common control.
    (A) In general.
    (B) Treatment of disallowed loss.
    (2) Treatment of certain nonrecognition and exchange 
transactions.
    (i) In general.
    (A) Transfer disregarded.
    (B) Application of general rule.
    (ii) Transactions covered.
    (iii) Certain exchanged-basis property.
    (iv) Transfers under section 708(b)(1).
    (A) In general.
    (B) Termination by sale or exchange of interest.
    (C) Other terminations.
    (D) Anti-churning rules.
    (v) Distributions to which section 732(d) applies.
    (vi) Curative and remedial allocations under section 704(c).
    (3) Application of section 754 to acquisitions of an interest in 
an intangible held through a partnership.
    (4) Treatment of certain reinsurance transactions.
    (i) In general.
    (ii) Determination of adjusted basis.
    (A) Acquisitions (other than under section 338) of specified 
insurance contracts.
    (B) Other acquisitions. [Reserved]
    (5) Amounts paid or incurred for a franchise, trademark, or 
trade name.
    (6) Amounts properly taken into account in determining the cost 
of property that is not a section 197 intangible.
    (7) Treatment of amortizable section 197 intangibles as 
depreciable property.
    (i) In general.
    (ii) Exceptions and limitations.
    (A) Unstated interest and original issue discount rules.
    (B) Treatment of other parties to transaction.
    (h) Anti-churning rules.
    (1) Conversions of existing goodwill, going concern value, and 
certain other section 197 intangibles.
    (2) Amounts deductible under section 1253(d).
    (3) Transition period.
    (4) Exceptions.
    (5) Special partnership provisions.
    (i) Basis increases.
    (ii) Curative and remedial allocations under section 704(c).

[[Page 2342]]

    (6) Related person.
    (i) In general.
    (ii) Time for testing relationships.
    (iii) De minimis rule.
    (A) In general.
    (B) Determination of beneficial ownership interest.
    (7) Special rules for entities that owned or used property at 
any time during the transition period and that are no longer in 
existence.
    (8) Special rules for section 338 deemed acquisitions.
    (9) Exception to anti-churning rules where gain is recognized.
    (i) In general.
    (ii) Manner of making election. [Reserved]
    (iii) Determination of highest marginal rate of tax.
    (A) Noncorporate taxpayers.
    (B) Corporations and tax-exempt entities.
    (iv) Special rule for pass-through entities.
    (v) Coordination with other provisions.
    (A) In general.
    (B) Section 1374.
    (C) Procedural and administrative provisions.
    (D) Installment method.
    (10) Transactions subject to both anti-churning and 
nonrecognition rules.
    (11) Anti-churning anti-abuse rule.
    (i) [Reserved].
    (j) General anti-abuse rule.
    (k) Examples.
    (l) Effective dates.

    Par. 6. Section 1.197-2 is added to read as follows:


Sec. 1.197-2  Amortization of goodwill and certain other intangibles.

    (a) Overview--(1) In general. Section 197 allows an amortization 
deduction for the capitalized costs of an amortizable section 197 
intangible and prohibits any other depreciation or amortization with 
respect to that property. Paragraphs (b), (c), and (e) of this section 
provide rules and definitions for determining whether property is a 
section 197 intangible, and paragraphs (d) and (e) of this section 
provide rules and definitions for determining whether a section 197 
intangible is an amortizable section 197 intangible. The amortization 
deduction under section 197 is determined by amortizing adjusted basis 
ratably over a 15-year period under the rules of paragraph (f) of this 
section. Section 197 also includes various special rules pertaining to 
the disposition of amortizable section 197 intangibles, nonrecognition 
transactions, anti-churning rules, and anti-abuse rules. Rules relating 
to these provisions are contained in paragraphs (g), (h), and (j) of 
this section. Examples demonstrating the application of these 
provisions are contained in paragraph (k) of this section. The 
effective date of the rules in this section is contained in paragraph 
(l) of this section.
    (2) Section 167(f) property. Section 167(f) prescribes rules for 
computing the depreciation deduction for certain property to which 
section 197 does not apply. See Sec. 1.167(a)-14 for rules under 
section 167(f) and paragraphs (c) (4), (6), (7), (11), and (13) of this 
section for a description of the property subject to section 167(f).
    (3) Amounts otherwise deductible. Except as otherwise provided in 
section 197(f)(3) and paragraphs (b)(11) and (f)(3) of this section, 
section 197 does not apply to amounts that would be currently 
deductible without regard to section 197.
    (4) Relationship to other Internal Revenue Code provisions. Section 
197 does not apply to any amount paid or incurred for a section 197 
intangible if a deduction for the amount would be disallowed under any 
provision of the Code other than section 263. (See, for example, 
section 162(k).)
    (b) Section 197 intangibles; in general. Except as otherwise 
provided in paragraph (c) of this section, the term section 197 
intangible means any property described in section 197(d)(1). The 
following rules and definitions provide guidance concerning property 
that is a section 197 intangible unless an exception applies:
    (1) Goodwill. Section 197 intangibles include goodwill. Goodwill is 
the value of a trade or business attributable to the expectancy of 
continued customer patronage. This expectancy may be due to the name or 
reputation of a trade or business or any other factor.
    (2) Going concern value. Section 197 intangibles include going 
concern value. Going concern value is the additional value that 
attaches to property by reason of its existence as an integral part of 
an ongoing business activity. Going concern value includes the value 
attributable to the ability of a trade or business (or a part of a 
trade or business) to continue functioning or generating income without 
interruption notwithstanding a change in ownership, but does not 
include any of the intangibles described in any other provision of this 
paragraph (b). It also includes the value that is attributable to the 
immediate use or availability of an acquired trade or business, such 
as, for example, the use of the revenues or net earnings that otherwise 
would not be received during any period if the acquired trade or 
business were not available or operational.
    (3) Workforce in place. Section 197 intangibles include workforce 
in place. Workforce in place (sometimes referred to as agency force or 
assembled workforce) includes the composition of a workforce (for 
example, the experience, education, or training of a workforce), the 
terms and conditions of employment whether contractual or otherwise, 
and any other value placed on employees or any of their attributes. 
Thus, the amount paid or incurred for workforce in place includes, for 
example, any portion of the purchase price of an acquired trade or 
business attributable to the existence of a highly-skilled workforce, 
an existing employment contract (or contracts), or a relationship with 
employees or consultants (including, but not limited to, any key 
employee contract or relationship). Workforce in place does not include 
any covenant not to compete or other similar arrangement described in 
paragraph (b)(9) of this section.
    (4) Information base. Section 197 intangibles include business 
books and records, operating systems, and any other information base, 
including lists or other information of current or prospective 
customers (regardless of the method of recording the information). 
Thus, the amount paid or incurred for these items includes, for 
example, any portion of the purchase price of an acquired trade or 
business attributable to the intangible value of technical manuals, 
training manuals or programs, data files, and accounting or inventory 
control systems. Other examples include the cost of acquiring customer 
lists, subscription lists, insurance expirations, patient or client 
files, or lists of newspaper, magazine, radio, or television 
advertisers.
    (5) Know-how, etc. Section 197 intangibles include any patent, 
copyright, formula, process, design, pattern, know-how, format, package 
design, computer software (as defined in paragraph (c)(4) of this 
section), or interest in a film, sound recording, video tape, book, or 
other similar property. (See, however, the exceptions in paragraph (c) 
of this section.)
    (6) Customer-based intangibles. Section 197 intangibles include any 
customer-based intangible. A customer-based intangible is any 
composition of market, market share, or other value resulting from the 
future provision of goods or services pursuant to contractual or other 
relationships in the ordinary course of business with customers. Thus, 
the amount paid or incurred for customer-based intangibles includes, 
for example, any portion of the purchase price of an acquired trade or 
business attributable to the existence of a customer base, a 
circulation base, an undeveloped market or market growth, insurance in 
force, the existence of a qualification to supply goods or services to 
a particular customer, a

[[Page 2343]]

mortgage servicing contract (as defined in paragraph (c)(11) of this 
section), an investment management contract, or other relationship with 
customers involving the future provision of goods or services. (See, 
however, the exceptions in paragraph (c) of this section.) In addition, 
customer-based intangibles include the deposit base and any similar 
asset of a financial institution. Thus, the amount paid or incurred for 
customer-based intangibles also includes any portion of the purchase 
price of an acquired financial institution attributable to the value 
represented by existing checking accounts, savings accounts, escrow 
accounts, and other similar items of the financial institution. 
However, any portion of the purchase price of an acquired trade or 
business attributable to accounts receivable or other similar rights to 
income for goods or services provided to customers prior to the 
acquisition of a trade or business is not an amount paid or incurred 
for a customer-based intangible.
    (7) Supplier-based intangibles. Section 197 intangibles include any 
supplier-based intangible. A supplier-based intangible is the value 
resulting from the future acquisition, pursuant to contractual or other 
relationships with suppliers in the ordinary course of business, of 
goods or services that will be sold or used by the taxpayer. Thus, the 
amount paid or incurred for supplier-based intangibles includes, for 
example, any portion of the purchase price of an acquired trade or 
business attributable to the existence of a favorable relationship with 
persons providing distribution services (such as favorable shelf or 
display space at a retail outlet), the existence of a favorable credit 
rating, or the existence of favorable supply contracts. The amount paid 
or incurred for supplier-based intangibles does not include any amount 
required to be paid for the goods or services themselves pursuant to 
the terms of the agreement or other relationship. In addition, see the 
exceptions in paragraph (c) of this section, including the exception in 
paragraph (c)(6) of this section for certain rights to receive tangible 
property or services from another person.
    (8) Licenses, permits, and other rights granted by governmental 
units. Section 197 intangibles include any license, permit, or other 
right granted by a governmental unit (including, for purposes of 
section 197, an agency or instrumentality thereof) even if the right is 
granted for an indefinite period or is reasonably expected to be 
renewed for an indefinite period. These rights include, for example, a 
liquor license, a taxi-cab medallion (or license), an airport landing 
or takeoff right (sometimes referred to as a slot), a regulated airline 
route, or a television or radio broadcasting license. The issuance or 
renewal of a license, permit, or other right granted by a governmental 
unit is considered an acquisition of the license, permit, or other 
right. (See, however, the exceptions in paragraph (c) of this section, 
including the exceptions in paragraph (c)(3) of this section for an 
interest in land, in paragraph (c)(8) of this section for an interest 
under a lease of tangible property, and in paragraphs (c) (6) and (13) 
of this section for certain rights granted by a governmental unit. See 
paragraph (b)(10) of this section for the treatment of franchises.)
    (9) Covenants not to compete and other similar arrangements. 
Section 197 intangibles include any covenant not to compete, or 
agreement having substantially the same effect, entered into in 
connection with the direct or indirect acquisition of an interest in a 
trade or business or a substantial portion thereof. For purposes of 
this paragraph (b)(9), an acquisition may be made in the form of an 
asset acquisition (including a qualified stock purchase that is treated 
as a purchase of assets under section 338), a stock acquisition or 
redemption, and the acquisition or redemption of a partnership 
interest. An agreement requiring the performance of services or the 
provision of property or the use of property (other than property of 
the acquired trade or business) does not have substantially the same 
effect as a covenant not to compete to the extent that the amount paid 
under the agreement represents reasonable compensation for the services 
actually rendered or for the property or use of the property actually 
provided.
    (10) Franchises, trademarks, and trade names. (i) Section 197 
intangibles include any franchise, trademark, or trade name. The term 
franchise includes any agreement that provides one of the parties to 
the agreement with the right to distribute, sell, or provide goods, 
services, or facilities, within a specified area. (See section 
1253(b)(1).) The term includes distributorships or other similar 
contractual arrangements pursuant to which the transferee is permitted 
or licensed to operate or conduct a trade or business within a specific 
area. The term trademark includes any word, name, symbol, or device, or 
any combination thereof, adopted and used by a manufacturer or merchant 
to identify goods or services and distinguish them from those 
manufactured or sold by others. The term trade name includes any name 
used by a manufacturer or merchant to identify or designate a 
particular trade or business or the name or title used by a person or 
organization engaged in a trade or business. A license, permit, or 
other right granted by a governmental unit is a franchise if it 
otherwise meets the definition of a franchise. A trademark or trade 
name includes any trademark or trade name arising under statute or 
applicable common law, and any similar right granted by contract. The 
renewal of a franchise, trademark, or trade name is treated as an 
acquisition of the franchise, trademark, or trade name.
    (ii) Notwithstanding the definitions provided in paragraph 
(b)(10)(i) of this section, any amount that is paid or incurred on 
account of a transfer, sale, or other disposition of a franchise, 
trademark, or trade name and that is subject to section 1253(d)(1) is 
not included in the basis of a section 197 intangible. (See paragraph 
(g)(5) of this section.)
    (11) Contracts for the use of, and term interests in, other section 
197 intangibles. Section 197 intangibles include any right under a 
license, contract, or other arrangement providing for the use of 
property that would be a section 197 intangible under any provision of 
this paragraph (b) (including this paragraph (b)(11)) after giving 
effect to all of the exceptions provided in paragraph (c) of this 
section. Section 197 intangibles also include any term interest 
(whether outright or in trust) in such property.
    (12) Other similar items. Section 197 intangibles include any other 
intangible property that is similar in all material respects to the 
property specifically described in section 197(d)(1)(C) and paragraphs 
(b)(3) through (b)(7) of this section. (See paragraph (g)(4) of this 
section for special rules regarding certain reinsurance transactions.)
    (c) Section 197 intangibles; exceptions. The term section 197 
intangible does not include property described in section 197(e). The 
following rules and definitions provide guidance concerning property to 
which the exceptions apply:
    (1) Interests in a corporation, partnership, trust, or estate. 
Section 197 intangibles do not include an interest in a corporation, 
partnership, trust, or estate. Thus, for example, amortization under 
section 197 is not available for the cost of acquiring stock, 
partnership interests, or interests in a trust or estate, whether or 
not the interests are regularly traded on an established market. (See 
paragraph (g)(3) of this section for special rules applicable to 
property of a partnership when a section

[[Page 2344]]

754 election is in effect for the partnership.)
    (2) Interests under certain financial contracts. Section 197 
intangibles do not include an interest under an existing futures 
contract, foreign currency contract, notional principal contract, 
interest rate swap, or other similar financial contract, whether or not 
the interest is regularly traded on an established market. However, 
this exception does not apply to an interest under a mortgage servicing 
contract, credit card servicing contract, or other contract to service 
another persons indebtedness, or an interest under an assumption 
reinsurance contract. (See paragraph (g)(4) of this section for the 
treatment of assumption reinsurance contracts. See paragraph (c)(11) of 
this section and Sec. 1.167(a)-14(d) for the treatment of mortgage 
servicing rights.)
    (3) Interests in land. Section 197 intangibles do not include any 
interest in land. For this purpose, 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. An interest in land does not include 
an airport landing or takeoff right, a regulated airline route, or a 
franchise to provide cable television service. The cost of acquiring a 
license, permit, or other land improvement right, such as a building 
construction or use permit, is taken into account in the same manner as 
the underlying improvement.
    (4) Certain computer software--(i) In general. Section 197 
intangibles do not include any interest in computer software that is 
(or has been) readily available to the general public on similar terms, 
is subject to a nonexclusive license, and has not been substantially 
modified for the user. Computer software will not be considered to have 
been substantially modified if its cost does not exceed the greater of 
125 percent of the price at which the unmodified version of the 
software is readily available to the general public or $2,000. For the 
purpose of determining whether computer software has been substantially 
modified--
    (A) Integrated programs acquired in a package from a single source 
are treated as a single computer program; and
    (B) Any cost incurred to install the computer software is not 
treated as a cost of the software.
    (ii) Separately acquired software. Section 197 intangibles do not 
include an interest in computer software that is not acquired as part 
of a purchase of a trade or business within the meaning of paragraph 
(e) of this section.
    (iii) Other exceptions. Neither section 197 nor section 167(f) 
apply in the following cases:
    (A) Any amount of the cost of an interest in computer software that 
is included, without being separately stated, in the cost of the 
hardware or other tangible property will be treated as part of the cost 
of the hardware or other tangible property.
    (B) Any amount of the cost of an interest in computer software that 
would be deductible under any provision other than section 167(f) or 
197 may be deducted and is not required to be capitalized.
    (iv) Computer software defined. For purposes of this section, 
computer software is any program or routine (that is, any sequence of 
machine-readable code) that is designed to cause a computer (as defined 
in section 168(i)(2)(B)(ii)) to perform a desired function or set of 
functions, and the documentation required to describe and maintain 
those programs. It includes all forms and media in which the software 
is contained, whether written, magnetic, or otherwise. Computer 
programs of all classes, for example, operating systems, executive 
systems, monitors, compilers and translators, assembly routines, and 
utility programs as well as application programs, are included. 
Computer software also includes any incidental and ancillary rights 
that are necessary to effect the acquisition of the title to, the 
ownership of, or the right to use the computer software, and that are 
used only in connection with that specific computer software. Such 
incidental and ancillary rights are not included in the definition of 
trademark or trade name under paragraph (b)(10)(i) of this section. For 
example, a trademark or trade name that is ancillary to the ownership 
or use of a specific computer software program in the taxpayer's trade 
or business and is not acquired for the purpose of marketing the 
computer software is included in the definition of computer software 
and is not included in the definition of trademark or trade name. 
Computer software does not include any data or information base 
described in paragraph (b)(4) of this section unless the data base or 
item is in the public domain and is incidental to a computer program. 
For this purpose, a copyrighted or proprietary data or information base 
is treated as in the public domain if its availability through the 
computer program does not contribute significantly to the cost of the 
program. For example, if a word-processing program includes a 
dictionary feature used to spell-check a document or any portion 
thereof, the entire program (including the dictionary feature) is 
computer software regardless of the form in which the feature is 
maintained or stored.
    (v) Readily available to the general public. Computer software will 
be treated as readily available to the general public if the software 
may be obtained on substantially the same terms by a significant number 
of persons that would reasonably be expected to use the software. The 
requirements of this paragraph (c)(4)(v) can be met even though the 
software is not available through a system of retail distribution.
    (5) Certain interests in films, sound recordings, video tapes, 
books, or other similar property. Section 197 intangibles do not 
include any interest (including an interest as a licensee) in a film, 
sound recording, video tape, book, or other similar property (such as 
the right to broadcast or transmit a live event) if the interest is not 
acquired as part of a purchase of a trade or business. A film, sound 
recording, video tape, book, or other similar property includes any 
incidental and ancillary rights (such as a trademark or trade name) 
that are necessary to effect the acquisition of title to, the ownership 
of, or the right to use the property and are used only in connection 
with that property. Such incidental and ancillary rights are not 
included in the definition of trademark or trade name under paragraph 
(b)(10)(i) of this section. For purposes of this paragraph (c)(5), 
computer software (as defined in paragraph (c)(4)(iv) of this section) 
is not treated as other property similar to a film, sound recording, 
video tape, or book. (See section 167 for amortization of excluded 
intangible property or interests.)
    (6) Certain rights to receive tangible property or services. 
Section 197 intangibles do not include any right to receive tangible 
property or services under a contract or from a governmental unit if 
the right is not acquired as part of a purchase of a trade or business. 
Any right that is described in the preceding sentence is not treated as 
a section 197 intangible even though the right is also described in 
section 197(d)(1)(D) and paragraph (b)(8) of this section (relating to 
certain governmental licenses, permits, and other rights) and even 
though the right fails to meet one or more of the requirements of 
paragraph (c)(13) of this section (relating to certain rights of fixed 
duration or amount). (See Sec. 1.167(a)-14(c) (1) and (3) for 
applicable rules.)
    (7) Certain interests in patents or copyrights. Section 197 
intangibles do not include any interest (including an interest as a 
licensee) in a patent, patent

[[Page 2345]]

application, or copyright that is not acquired as part of a purchase of 
a trade or business. (See Sec. 1.167(a)-14(c)(4) for applicable rules.)
    (8) Interests under leases of tangible property--(i) Interest as a 
lessor. Section 197 intangibles do not include any interest as a lessor 
under an existing lease or sublease of tangible real or personal 
property. In addition, the cost of acquiring an interest as a lessor in 
connection with the acquisition of tangible property is taken into 
account as part of the cost of the tangible property. For example, if a 
taxpayer acquires a shopping center that is leased to tenants operating 
retail stores, any portion of the purchase price attributable to 
favorable lease terms is taken into account as part of the basis of the 
shopping center and in determining the depreciation deduction allowed 
with respect to the shopping center. (See section 167(c)(2).)
    (ii) Interest as a lessee. Section 197 intangibles do not include 
any interest as a lessee under an existing lease of tangible real or 
personal property. For this purpose, an airline lease of an airport 
passenger or cargo gate is a lease of tangible property. The cost of 
acquiring such an interest is taken into account under section 178 and 
Sec. 1.162-11(a). If an interest as a lessee under a lease of tangible 
property is acquired in a transaction with any other intangible 
property, a portion of the total purchase price may be allocable to the 
interest as a lessee based on all of the relevant facts and 
circumstances.
    (9) Interests under indebtedness--(i) In general. Section 197 
intangibles do not include any interest (whether as a creditor or 
debtor) under an indebtedness in existence when the interest was 
acquired. Thus, for example, the value attributable to the assumption 
of an indebtedness with a below-market interest rate is not amortizable 
under section 197. In addition, the premium paid for acquiring a debt 
instrument with an above-market interest rate is not amortizable under 
section 197. See section 171 for rules concerning the treatment of 
amortizable bond premium.
    (ii) Exceptions. For purposes of this paragraph (c)(9), an interest 
under an existing indebtedness does not include the deposit base (and 
other similar items) of a financial institution. An interest under an 
existing indebtedness includes mortgage servicing rights, however, to 
the extent the rights are stripped coupons under section 1286.
    (10) Professional sports franchises. Section 197 intangibles do not 
include any franchise to engage in professional baseball, basketball, 
football, or any other professional sport, and any item (even though 
otherwise qualifying as a section 197 intangible) acquired in 
connection with such a franchise.
    (11) Mortgage servicing rights. Section 197 intangibles do not 
include any right described in section 197(e)(7) (concerning rights to 
service indebtedness secured by residential real property that are not 
acquired as part of a purchase of a trade or business). (See 
Sec. 1.167(a)-14(d) for applicable rules.)
    (12) Certain transaction costs. Section 197 intangibles do not 
include any fees for professional services and any transaction costs 
incurred by parties to a transaction in which all or any portion of the 
gain or loss is not recognized under part III of subchapter C of the 
Code.
    (13) Rights of fixed duration or amount. (i) Section 197 
intangibles do not include any right under a contract or any license, 
permit, or other right granted by a governmental unit if the right--
    (A) Is acquired in the ordinary course of business and not as part 
of a purchase of a trade or business;
    (B) Is not described in sections 197(d)(1) (A), (B), (C) (ii), 
(iv), or (vi), (E), or (F); and
    (C) Either--
    (1) Has a fixed duration of less than 15 years; or
    (2) Is fixed as to amount and the adjusted basis thereof is 
properly recoverable (without regard to this section) under a method 
similar to the unit-of-production method.
    (ii) See Sec. 1.167(a)-14(c) (2) and (3) for applicable rules.
    (d) Amortizable section 197 intangibles--(1) Definition. Except as 
otherwise provided in this paragraph (d), the term amortizable section 
197 intangible means any section 197 intangible acquired after August 
10, 1993 (or after July 25, 1991, if a valid retroactive election under 
Sec. 1.197-1T has been made), and held in connection with the conduct 
of a trade or business or an activity described in section 212.
    (2) Exception for self-created intangibles--(i) In general. Except 
as provided in paragraph (d)(2)(iii) of this section, amortizable 
section 197 intangibles do not include any section 197 intangible 
created by the taxpayer (a self-created intangible).
    (ii) Created by the taxpayer--(A) Defined. A section 197 intangible 
is created by the taxpayer to the extent the taxpayer makes payments or 
otherwise incurs costs for its creation, production, development, or 
improvement, whether the actual work is performed by the taxpayer or by 
another person under a contract with the taxpayer entered into before 
the creation, production, development, or improvement occurs. For 
example, a technological process developed specifically for a taxpayer 
under an arrangement with another person pursuant to which the taxpayer 
retains all rights to the process is created by the taxpayer.
    (B) Contracts for the use of intangibles. A section 197 intangible 
is not created by the taxpayer to the extent that it results from the 
entry into (or renewal of) a contract for the use of an existing 
section 197 intangible. Thus, for example, the exception for self-
created intangibles does not apply to legal and other professional fees 
incurred by a licensee in connection with the entry into (or renewal 
of) a contract for the use of know-how or similar property.
    (C) Improvements and modifications. If an existing section 197 
intangible is improved or otherwise modified by the taxpayer or by 
another person under a contract with the taxpayer, the existing 
intangible and the improvements or other modifications are treated as 
separate section 197 intangibles for purposes of this paragraph (d).
    (iii) Exceptions. (A) The exception for self-created intangibles 
does not apply to any section 197 intangible described in section 
197(d)(1)(D) (relating to licenses, permits or other rights granted by 
a governmental unit), 197(d)(1)(E) (relating to covenants not to 
compete), or 197(d)(1)(F) (relating to franchises, trademarks, and 
trade names). Thus, for example, capitalized costs incurred in the 
development, registration, or defense of a trademark or trade name do 
not qualify for the exception and are amortized over 15 years under 
section 197.
    (B) The exception for self-created intangibles does not apply to 
any section 197 intangible created in connection with the purchase of a 
trade or business (as defined in paragraph (e) of this section).
    (C) If a taxpayer disposes of a self-created intangible and 
subsequently reacquires the intangible in an acquisition described in 
paragraph (h)(4)(ii) of this section, the exception for self-created 
intangibles does not apply to the reacquired intangible.
    (3) Exception for property subject to anti-churning rules. 
Amortizable section 197 intangibles do not include any property to 
which the anti-churning rules of section 197(f)(9) and paragraph (h) of 
this section apply.
    (e) Purchase of a trade or business. Several of the exceptions in 
section 197 apply only to property that is not acquired in (or created 
in connection with) a transaction or series of related

[[Page 2346]]

transactions involving the acquisition of assets constituting a trade 
or business or a substantial portion thereof. Property acquired in (or 
created in connection with) such a transaction or series of related 
transactions is referred to in this section as property acquired as 
part of (or created in connection with) a purchase of a trade or 
business. For purposes of section 197 and this section, the 
applicability of the limitation is determined under the following 
rules:
    (1) Goodwill or going concern value. A group of assets constitutes 
a trade or business or a substantial portion thereof if their use would 
constitute a trade or business under section 1060 (that is, if goodwill 
or going concern value could under any circumstances attach to the 
assets). See Sec. 1.1060-1T(b)(2). For this purpose, all the facts and 
circumstances, including any employee relationships that continue (or 
covenants not to compete that are entered into) as part of the transfer 
of the assets, are taken into account in determining whether goodwill 
or going concern value could attach to the assets.
    (2) Customer-based intangibles. Whether or not a group of assets is 
otherwise described in paragraph (e)(1) of this section, a group of 
assets constitutes a trade or business or a substantial portion thereof 
if the assets include any customer-based intangibles (as defined in 
paragraph (b)(6) of this section) or are acquired in a transaction or 
series of related transactions that involve the creation of any 
customer-based intangibles.
    (3) Franchise, trademark, or trade name--(i) In general. The 
acquisition of a franchise, trademark, or trade name constitutes the 
acquisition of a trade or business or a substantial portion thereof.
    (ii) Exceptions. For purposes of this paragraph (e)(3)--
    (A) A trademark or trade name is disregarded if it is included in 
computer software under paragraph (c)(4) of this section or in an 
interest in a film, sound recording, video tape, book, or other similar 
property under paragraph (c)(5) of this section; and
    (B) A franchise, trademark, or trade name is disregarded if its 
value is nominal or the taxpayer irrevocably disposes of it immediately 
after its acquisition.
    (4) Acquisitions to be included. The assets acquired in a 
transaction (or series of related transactions) include only assets 
(including a beneficial or other indirect interest in assets where the 
interest is of a type described in paragraph (c)(1) of this section) 
acquired by the taxpayer and persons related to the taxpayer from 
another person and persons related to that other person. For purposes 
of this paragraph (e)(4), persons are related only if their 
relationship is described in section 267(b) or 707(b) or they are 
engaged in trades or businesses under common control within the meaning 
of section 41(f)(1).
    (5) Substantial portion. The determination of whether acquired 
assets constitute a substantial portion of a trade or business is to be 
based on all of the facts and circumstances, including the nature and 
the amount of the assets acquired as well as the nature and amount of 
the assets retained by the transferor. The value of the assets acquired 
relative to the value of the assets retained by the transferor is not 
determinative of whether the acquired assets constitute a substantial 
portion of a trade or business.
    (6) Deemed asset purchases under section 338. A qualified stock 
purchase that is treated as a purchase of assets under section 338 
shall be treated as a transaction involving the acquisition of assets 
constituting a trade or business only if the direct acquisition of the 
assets of the corporation would have been treated as the acquisition of 
assets constituting a trade or business.
    (f) Computation of amortization deduction--(1) In general. Except 
as provided in paragraph (f)(2) of this section, the amortization 
deduction allowable under section 197(a) is computed as follows:
    (i) The adjusted basis (for purposes of determining gain) of an 
amortizable section 197 intangible is amortized ratably over the 15-
year period beginning on the later of--
    (A) The first day of the month in which the property is acquired; 
or
    (B) In the case of property held in connection with the conduct of 
a trade or business, the first day of the month in which the active 
conduct of the trade or business begins.
    (ii) Except as otherwise provided in this section, adjusted basis 
is determined under section 1011 and salvage value is disregarded.
    (iii) Property is not eligible for amortization in the month of 
disposition.
    (iv) The amortization deduction for a short taxable year is based 
on the number of months in the short taxable year.
    (2) Treatment of contingent amounts--(i) Amounts added to basis 
during 15-year period. Any amount that is properly included in the 
basis of an amortizable section 197 intangible after the first month of 
the 15-year period described in paragraph (f)(1)(i) of this section and 
before the expiration of this period is amortized ratably over the 
remainder of the 15-year period. For this purpose, the remainder of the 
15-year period begins on the first day of the month in which the basis 
increase occurs. Any reasonable convention may be used to determine the 
month in which the basis increase incurs, provided that the method 
selected is used consistently for all amortizable section 197 
intangibles acquired in the same transaction (or series of related 
transactions) and that it does not result in any amount being added to 
basis earlier than the midpoint of the period (for example, annual, 
semi-annual, or quarterly) selected.
    (ii) Amounts becoming fixed after expiration of 15-year period. Any 
amount that is not properly included in the basis of an amortizable 
section 197 intangible until after the expiration of the 15-year period 
described in paragraph (f)(1)(i) of this section is amortized in full 
immediately upon the inclusion of the amount in the basis of the 
intangible.
    (iii) Time for including amounts in basis. See Sec. 1.461-1(a)(1) 
for rules governing the time at which an amount may be taken into 
account by a taxpayer using the cash receipts and disbursements method, 
and Sec. 1.461-1(a)(2) for rules governing the time at which a 
liability is incurred and generally taken into account (for example, by 
treating the amount of the liability as a capital expenditure) by an 
accrual basis taxpayer.
    (3) Determination of amounts chargeable to capital account in 
certain cases--(i) Covenants not to compete, rights granted by 
governmental units, and contracts for the use of section 197 
intangibles--(A) In general. In the case of a covenant not to compete 
or other similar arrangement described in paragraph (b)(9) of this 
section, any license, permit, or other right granted by a governmental 
unit or an agency or instrumentality thereof described in paragraph 
(b)(8) of this section, or a contract for the use of a section 197 
intangible described in paragraph (b)(11) of this section, the amount 
chargeable to capital account includes all amounts required to be paid 
pursuant to the agreement or right, whether or not any amount would be 
deductible under section 162 if the agreement or right were not a 
section 197 intangible.
    (B) Time for taking amounts into account. For purposes of this 
paragraph (f)(3), in applying the provisions of Secs. 1.461-1(a)(1) (in 
the case of a taxpayer using the cash receipts and disbursements method 
of accounting) and Sec. 1.461-1(a)(2) (in the case of a taxpayer using 
an accrual method of

[[Page 2347]]

accounting), all amounts required to be paid under an agreement 
described in paragraph (b) (9) or (11) of this section shall be treated 
as amounts payable under the terms of a debt instrument issued in 
exchange for property. Contingent payments made under an agreement 
described in paragraph (b) (9) or (11) of this section will be included 
in adjusted basis under the rules of paragraph (f)(2) of this section.
    (ii) Franchises, trademarks, or trade names and licenses, permits, 
and other rights granted by governmental units. The costs paid or 
incurred for the renewal of a franchise, trademark, or trade name or 
any license, permit, or other right granted by a governmental unit or 
an agency or instrumentality thereof are amortized over the 15-year 
period that begins with the month of renewal. Any costs paid or 
incurred for the issuance, or earlier renewal, continue to be taken 
into account over the remaining portion of the amortization period that 
began at the time of the issuance, or earlier renewal. Any amount paid 
or incurred for the protection, expansion, or defense of a trademark or 
trade name and chargeable to capital account is treated as an amount 
paid or incurred for a renewal.
    (iii) Certain reinsurance transactions. See paragraph (g)(4)(ii) of 
this section for special rules regarding the adjusted basis of an 
insurance contract acquired through an assumption reinsurance 
transaction.
    (4) Transactions subject to section 338 or 1060. In the case of a 
section 197 intangible deemed to have been acquired as the result of a 
qualified stock purchase within the meaning of section 338(d)(3), the 
basis shall be determined pursuant to section 338(b)(5) and the 
regulations thereunder. In the case of a section 197 intangible 
acquired in an applicable asset acquisition within the meaning of 
section 1060(c), the basis shall be determined pursuant to section 
1060(a) and the regulations thereunder.
    (g) Special rules--(1) Treatment of certain dispositions--(i) Loss 
disallowance rules--(A) In general. No loss is recognized on the 
disposition of an amortizable section 197 intangible acquired in a 
transaction or series of related transactions in which the taxpayer 
acquired other amortizable section 197 intangibles if, after the 
disposition, the taxpayer retains any of the other amortizable section 
197 intangibles, or the right to use, or an interest in, any of the 
other amortizable section 197 intangibles (the retained intangibles). 
Except as otherwise provided in paragraph (g)(1)(iv)(B) of this 
section, the adjusted basis of each of the retained intangibles is 
increased by the product of the loss that is not recognized solely by 
reason of this rule and a fraction, the numerator of which is the 
adjusted basis of the retained intangible on the date of the 
disposition and the denominator of which is the total adjusted bases of 
all the retained intangibles on that date. The abandonment of an 
amortizable section 197 intangible, or any other event rendering an 
amortizable section 197 intangible worthless, is treated as a 
disposition of the intangible for purposes of this paragraph (g)(1), 
and the abandoned or worthless intangible is disregarded (that is, it 
is not treated as a retained intangible) for purposes of applying this 
paragraph (g)(1) to the subsequent disposition of any other amortizable 
section 197 intangible.
    (B) Certain nonrecognition transfers. The loss disallowance rule in 
paragraph (g)(1)(i)(A) of this section also applies when a taxpayer 
transfers an amortizable section 197 intangible from an acquired trade 
or business in a transaction in which the intangible is transferred-
basis property and, after the transfer, retains other amortizable 
section 197 intangibles from the trade or business. Thus, for example, 
the transfer of an amortizable section 197 intangible to a corporation 
in exchange for stock in the corporation in a transaction described in 
section 351, or to a partnership in exchange for an interest in the 
partnership in a transaction described in section 721, when other 
amortizable section 197 intangibles acquired in the same transaction 
are retained, followed by a sale of the stock or partnership interest 
received, will not avoid the application of the loss disallowance 
provision to the extent the adjusted basis of the transferred 
intangible at the time of the sale exceeds its fair market value at 
that time.
    (ii) Separately acquired property. Paragraph (g)(1)(i) of this 
section does not apply to an amortizable section 197 intangible that is 
not acquired in a transaction or series of related transactions in 
which the taxpayer acquires other amortizable section 197 intangibles 
(a separately acquired intangible). Consequently, a loss may be 
recognized upon the disposition of a separately acquired section 197 
intangible. However, the termination or worthlessness of only a portion 
of an amortizable section 197 intangible is not the disposition of a 
separately acquired intangible. For example, neither the loss of 
several customers from an acquired customer list, the termination of 
several mortgages (not qualifying for the exception set forth in 
paragraph (c)(11) of this section) from an acquired mortgage pool, nor 
the worthlessness of only some information from an acquired data base 
constitutes the disposition of a separately acquired intangible.
    (iii) Disposition of a covenant not to compete. If a covenant not 
to compete or any other arrangement having substantially the same 
effect is entered into in connection with the direct or indirect 
acquisition of an interest in a trade or business, the disposition or 
worthlessness of the covenant or other arrangement will not be 
considered to occur until the disposition or worthlessness of all 
interests in that trade or business. For example, a covenant not to 
compete entered into in connection with the purchase of stock continues 
to be amortized on a 15-year straight-line basis (even after the 
covenant expires or becomes worthless) unless all the trades or 
businesses in which an interest was acquired through the stock purchase 
(or all the purchaser's interests in those trades or businesses) also 
are disposed of or become worthless.
    (iv) Taxpayers under common control--(A) In general. Except as 
provided in paragraph (g)(1)(iv)(B) of this section, all persons that 
would be treated as a single taxpayer under section 41(f)(1) are 
treated as a single taxpayer under this paragraph (g)(1). Thus, for 
example, a loss is not recognized on the disposition of an amortizable 
section 197 intangible by a member of a controlled group of 
corporations (as defined in section 41(f)(5)) if, after the 
disposition, another member retains other amortizable section 197 
intangibles acquired in the same transaction as the amortizable section 
197 intangible that has been disposed of.
    (B) Treatment of disallowed loss. If retained intangibles are held 
by a person other than the person incurring the disallowed loss, only 
the adjusted basis of intangibles retained by the person incurring the 
disallowed loss is increased, and only the adjusted basis of those 
intangibles is included in the denominator of the fraction described in 
paragraph (g)(1)(i)(A) of this section. If none of the retained 
intangibles are held by the person incurring the disallowed loss, the 
loss is allowed ratably, as a deduction under section 197, over the 
remainder of the period during which the intangible giving rise to the 
loss would have been amortizable, except that any remaining disallowed 
loss is allowed in full on the first date on which all other retained 
intangibles have been disposed of or become worthless.
    (2) Treatment of certain nonrecognition and exchange

[[Page 2348]]

transactions--(i) In general--(A) Transfer disregarded. Except as 
otherwise provided in paragraph (h) of this section, if a section 197 
intangible is transferred in a transaction described in paragraph 
(g)(2)(ii) of this section, the transfer is disregarded in 
determining--
    (1) Whether, with respect to so much of the intangible's basis in 
the hands of the transferee as does not exceed its basis in the hands 
of the transferor, the intangible is an amortizable section 197 
intangible; and
    (2) The amount of the deduction under section 197 with respect to 
such basis.
    (B) Application of general rule. If the intangible described in 
paragraph (g)(2)(i)(A) of this section was an amortizable section 197 
intangible in the hands of the transferor, the transferee will continue 
to amortize its adjusted basis, to the extent it does not exceed the 
transferor's adjusted basis, ratably over the remainder of the 
transferor's 15-year amortization period. If the intangible was not an 
amortizable section 197 intangible in the hands of the transferor, the 
transferee's adjusted basis, to the extent it does not exceed the 
transferor's adjusted basis, cannot be amortized under section 197. In 
either event, the intangible is treated, with respect to so much of its 
adjusted basis in the hands of the transferee as exceeds its adjusted 
basis in the hands of the transferor, in the same manner for purposes 
of section 197 as an intangible acquired from the transferor in a 
transaction that is not described in paragraph (g)(2)(ii) of this 
section. The rules of this paragraph (g)(2)(i) also apply to any 
subsequent transfers of the intangible in a transaction described in 
paragraph (g)(2)(ii) of this section.
    (ii) Transactions covered. The transactions described in this 
paragraph (g)(2)(ii) are--
    (A) Any transaction described in section 332, 351, 361, 721, or 
731; and
    (B) Any transaction between corporations that are members of the 
same consolidated group immediately after the transaction.
    (iii) Certain exchanged-basis property. This paragraph (g)(2)(iii) 
applies to property that is acquired in a transaction subject to 
section 1031 or 1033 and is permitted to be acquired without 
recognition of gain (replacement property). Except as otherwise 
provided in paragraph (h) of this section, replacement property is 
treated as if it were the property by reference to which its basis is 
determined (the predecessor property) in determining whether, with 
respect to so much of its basis as does not exceed the basis of the 
predecessor property, the replacement property is an amortizable 
section 197 intangible and the amortization period under section 197 
with respect to such basis. Thus, if the predecessor property was an 
amortizable section 197 intangible, the taxpayer will amortize the 
adjusted basis of the replacement property, to the extent it does not 
exceed the adjusted basis of the predecessor property, ratably over the 
remainder of the 15-year amortization period for the predecessor 
property. If the predecessor property was not an amortizable section 
197 intangible, the adjusted basis of the replacement property, to the 
extent it does not exceed the adjusted basis of the predecessor 
property, may not be amortized under section 197. In either event, the 
replacement property is treated, with respect to so much of its 
adjusted basis as exceeds the adjusted basis of the predecessor 
property, in the same manner for purposes of section 197 as property 
acquired from the transferee in a transaction that is not subject to 
section 1031 or 1033. (See paragraph (h) of this section for the 
application of the anti-churning rules.)
    (iv) Transfers under section 708(b)(1)--(A) In general. Paragraph 
(g)(2)(i) of this section applies to transfers of section 197 
intangibles that occur or are deemed to occur by reason of the 
termination of a partnership under section 708(b)(1).
    (B) Termination by sale or exchange of interest. In applying 
paragraph (g)(2)(i) of this section to a partnership that is terminated 
pursuant to section 708(b)(1)(B) (relating to a sale or exchange of an 
interest), the terminated partnership is treated as the transferor and 
the new partnership is treated as the transferee with respect to any 
section 197 intangible held by the terminated partnership immediately 
preceding the termination. (See paragraph (g)(3) of this section for 
the treatment of increases in the basis of property of the terminated 
partnership under section 743(b).)
    (C) Other terminations. In applying paragraph (g)(2)(i) of this 
section to a partnership that is terminated pursuant to section 
708(b)(1)(A) (relating to cessation of activities by a partnership), 
the terminated partnership is treated as the transferor and the 
distributee partner is treated as the transferee with respect to any 
section 197 intangible held by the terminated partnership immediately 
preceding the termination.
    (D) Anti-churning rules. See paragraph (h) of this section for the 
application of the anti-churning rules.
    (v) Distributions to which section 732(d) applies. Paragraph 
(g)(2)(i) of this section applies to a distribution of a section 197 
intangible to which section 732(d) (relating to special partnership 
basis to transferee) applies. For purposes of section 197, any increase 
in the basis of the distributed intangible under section 732(d) is 
taken into account by a partner as if the increased portion were 
attributable to the partner's acquisition of the underlying partnership 
property on the date of distribution from the transferor of the 
partnership interest or the deceased partner, as the case may be. For 
purposes of the effective date and anti-churning rules (paragraphs 
(d)(1) and (h) of this section), the intangible is treated as having 
been acquired by the transferee partner at the time of the transfer of 
the partnership interest described in section 732(d). For purposes of 
determining the amortization period under section 197 with respect to 
any increased basis, however, the intangible is treated as having been 
acquired by the transferee partner at the time of the distribution 
described in section 732(a). (See paragraph (h) of this section for the 
application of the anti-churning rules.)
    (vi) Curative and remedial allocations under section 704(c). For 
purposes of paragraph (g)(2)(i) of this section, if a section 197 
intangible is transferred to a partnership in a transaction described 
in section 721, the basis of the intangible in the hands of the 
transferor includes the amount of any curative or remedial allocations 
of amortization that are made to a noncontributing partner with respect 
to the contributed intangible under the curative or remedial methods 
for making allocations under section 704(c). Thus, for example, if a 
contributed intangible is not an amortizable section 197 intangible in 
the hands of the transferor, any remedial allocations of amortization 
made to a noncontributing partner with respect to the intangible are 
not amortizable under section 197. See Sec. 1.704-3(c) and (d) for a 
description of the curative and remedial methods.
    (3) Application of section 754 to acquisitions of an interest in an 
intangible held through a partnership. Any increase in the basis of 
partnership property under section 734(b) (relating to the optional 
adjustment to the basis of undistributed partnership property) or 
section 743(b) (relating to the optional adjustment to the basis of 
partnership property) is taken into account under section 197 by a 
partner as if the increased portion of the basis were attributable to 
the partner's acquisition of the underlying partnership property and as 
if the property were acquired from the distributee partner on the date 
of the

[[Page 2349]]

distribution (in the case of a basis increase under section 734(b)) or 
from the transferor of the partnership interest on the date of the 
transfer (in the case of a basis increase under section 743(b)). (See 
paragraph (h) of this section for the application of the anti-churning 
rules.)
    (4) Treatment of certain reinsurance transactions--(i) In general. 
Section 197 applies to any insurance contract acquired from another 
person through an assumption reinsurance transaction. For purposes of 
section 197, an assumption reinsurance transaction is--
    (A) Any arrangement in which one insurance company (the reinsurer) 
becomes solely liable to policyholders on contracts transferred by 
another insurance company (the ceding company); and
    (B) Any acquisition of an insurance contract that is treated as 
occurring by reason of an election under section 338.
    (ii) Determination of adjusted basis--(A) Acquisitions (other than 
under section 338) of specified insurance contracts. The amount taken 
into account for purposes of section 197 as the adjusted basis of 
specified insurance contracts (as defined in section 848(e)(1)) 
acquired in an assumption reinsurance transaction that is not described 
in paragraph (g)(4)(i)(B) of this section is equal to the excess of--
    (1) The amount paid or incurred (or treated as having been paid or 
incurred) by the reinsurer for the purchase of the contracts (as 
determined under Sec. 1.817-4(d)(2)), over
    (2) The amount of the specified policy acquisition expenses that 
are attributable to the reinsurer's net positive consideration for the 
reinsurance agreement (as determined under Sec. 1.848-2(f)(3)).
    (B) Other acquisitions. [Reserved]
    (5) Amounts paid or incurred for a franchise, trademark, or trade 
name. If an amount to which section 1253(d) (relating to the transfer, 
sale, or other disposition of a franchise, trademark, or trade name) 
applies is described in section 1253(d)(1)(B) (relating to contingent 
serial payments), the amount is deductible under section 1253(d)(1) and 
is not included in the adjusted basis of the intangible for purposes of 
section 197. Any other amount, whether fixed or contingent, to which 
section 1253(d) applies is chargeable to capital account under section 
1253(d)(2) and is amortizable only under section 197.
    (6) Amounts properly taken into account in determining the cost of 
property that is not a section 197 intangible. Section 197 does not 
apply to an amount that is properly taken into account in determining 
the cost of property that is not a section 197 intangible. The entire 
cost of acquiring the other property is included in its basis and 
recovered under other applicable Internal Revenue Code provisions.
    (7) Treatment of amortizable section 197 intangibles as depreciable 
property--(i) In general. An amortizable section 197 intangible is 
treated as property of a character subject to the allowance for 
depreciation under section 167. Thus, for example, an amortizable 
section 197 intangible is not a capital asset for purposes of section 
1221, but if held for more than one year, it generally qualifies under 
section 1231 as property used in a trade or business. Also, an 
amortizable section 197 intangible is section 1245 property and section 
1239 applies to any gain recognized upon its sale or exchange between 
related persons (as defined in section 1239(b)).
    (ii) Exceptions and limitations--(A) Unstated interest and original 
issue discount rules. In the case of the acquisition of any amortizable 
section 197 intangible in a transaction that would not be treated as 
the sale or exchange of property by the person from which the 
intangible was acquired, paragraph (g)(7)(i) of this section shall not 
apply (and the amortizable section 197 intangible shall not be treated 
as property) for purposes of--
    (1) Section 483(c) (relating to payments on account of the sale or 
exchange of property); and
    (2) Section 1274(c) (relating to debt instruments given in 
consideration for the sale or exchange of property).
    (B) Treatment of other parties to transaction. No person shall be 
treated as having sold, exchanged, or otherwise disposed of property in 
a transaction for purposes of any provision of the Internal Revenue 
Code solely by reason of the application of paragraph (g)(7)(i) of this 
section to any other party to the transaction.
    (h) Anti-churning rules--(1) Conversions of existing goodwill, 
going concern value, and certain other section 197 intangibles. Except 
as otherwise provided in this paragraph (h), goodwill, going concern 
value, or any other section 197 intangible for which a depreciation or 
amortization deduction would not have been allowable prior to the 
enactment of section 197 may not be amortized as an amortizable section 
197 intangible if the section 197 intangible is acquired by a taxpayer 
after August 10, 1993 (or after July 25, 1991, if a valid retroactive 
election pursuant to Sec. 1.197-1T has been made) and either--
    (i) The taxpayer or a related person held or used the intangible or 
an interest therein at any time during the transition period;
    (ii) The taxpayer acquired the intangible from a person that held 
the intangible at any time during the transition period and, as part of 
the transaction, the user of the intangible does not change; or
    (iii) The taxpayer grants the right to use the intangible to a 
person (or a person related to that person) that held or used the 
intangible at any time during the transition period.
    (2) Amounts deductible under section 1253(d). For purposes of 
paragraph (h)(1) of this section, deductions allowable under section 
1253(d)(2) or deductions allowable pursuant to an election under 
section 1253(d)(3) (in either case as in effect prior to the enactment 
of section 197) are treated as deductions allowable for amortization.
    (3) Transition period. For purposes of this paragraph (h), the 
transition period begins on July 25, 1991, and ends on August 10, 1993, 
except that for taxpayers that made a valid retroactive election 
pursuant to Sec. 1.197-1T, the transition period is July 25, 1991.
    (4) Exceptions. The anti-churning rules of this paragraph (h) do 
not apply to--
    (i) The acquisition of an intangible by a taxpayer if the basis of 
the intangible is determined under section 1014(a); or
    (ii) The acquisition of an intangible by a taxpayer that is an 
amortizable section 197 intangible in the hands of the seller (or 
transferor), but only if the acquisition by the taxpayer or sale by the 
seller (or transfer by the transferor) was not part of a transaction or 
a series of related transactions in which the seller (or transferor) 
previously acquired the intangible or interest therein.
    (5) Special partnership provisions--(i) Basis increases. In 
determining whether the anti-churning rules of this paragraph (h) apply 
to any increase in the basis of partnership property under section 732, 
734, or 743, the determinations are made at the partner level and each 
partner is treated as having owned and used the partner's proportionate 
share of the partnership property. Thus, for example, the anti-churning 
rules do not apply to an increase in the basis of partnership property 
under section 743(b) that occurs upon the acquisition of an interest in 
a partnership that has made a section 754 election if the person 
acquiring the partnership interest either is not related to the person 
transferring the partnership interest or acquired the interest upon the 
death of the former partner. Similarly, the anti-churning rules do not 
apply to a continuing partner's proportionate share of an increase in 
the

[[Page 2350]]

basis of partnership property under section 734(b) that occurs upon the 
distribution of property of a partnership that has made a section 754 
election if the continuing partner is not related to the distributee 
partner.
    (ii) Curative and remedial allocations under section 704(c). In 
determining whether the anti-churning rules of this paragraph (h) 
apply, any curative or remedial allocation of amortization made to a 
noncontributing partner under the curative or remedial methods for 
making allocations under section 704(c) is treated in the same manner 
as a noncurative or nonremedial allocation of amortization. Thus, for 
example, if the anti-churning rules would apply to a nonremedial 
allocation of amortization to a noncontributing partner, the anti-
churning rules apply to any remedial allocation of amortization. See 
Sec. 1.704-3 (c) and (d) for a description of the curative and remedial 
methods.
    (6) Related person--(i) In general. Except as otherwise provided in 
paragraph (h)(6)(iii) of this section, a person is related to another 
person for purposes of this paragraph (h) if--
    (A) The person bears a relationship to that person that would be 
specified in section 267(b) (determined without regard to section 
267(e)) and, by substitution, section 267(f)(1), if those sections were 
amended by substituting 20 percent for 50 percent; or
    (B) The person bears a relationship to that person that would be 
specified in section 707(b)(1) if that section was amended by 
substituting 20 percent for 50 percent; or
    (C) The persons are engaged in trades or businesses under common 
control (within the meaning of section 41(f)(1) (A) and (B)).
    (ii) Time for testing relationships. For purposes of this paragraph 
(h), a person is treated as related to another person if the 
relationship exists--
    (A) In the case of a single transaction, immediately before or 
immediately after the acquisition of the intangible involved; or
    (B) In the case of a series of related transactions, at any time 
during the period beginning immediately before the earliest acquisition 
and ending immediately after the last acquisition of any intangible 
acquired in the series of transactions.
    (iii) De minimis rule--(A) In general. Two corporations shall not 
be treated as related persons for purposes of this paragraph (h)(6) 
if--
    (1) The corporations would (but for the application of this 
paragraph (h)(6)(iii)) be treated as related persons solely by reason 
of substituting ``more than 20 percent'' for ``more than 50 percent'' 
in section 267(f)(1)(A); and
    (2) The beneficial ownership interest of one corporation in the 
stock of the other corporation represents less than 10 percent of the 
total combined voting power of all classes of stock entitled to vote 
and less than 10 percent of the total value of the shares of all 
classes of stock outstanding.
    (B) Determination of beneficial ownership interest. For purposes of 
this paragraph (h)(6)(iii), the beneficial ownership interest of one 
corporation in the stock of another corporation shall be determined 
under the principles of section 318(a), except that--
    (1) In applying section 318(a)(2)(C), the 50 percent limitation 
contained therein shall not be applied; and
    (2) Section 318(a)(3)(C) shall be applied by substituting ``20 
percent'' for ``50 percent''.
    (7) Special rules for entities that owned or used property at any 
time during the transition period and that are no longer in existence. 
A corporation, partnership, or trust that owned or used property at any 
time during the transition period and that is no longer in existence is 
deemed to be in existence for purposes of determining whether the 
taxpayer that acquired the property is related to the corporation, 
partnership, or trust.
    (8) Special rules for section 338 deemed acquisitions. In the case 
of a qualified stock purchase that is treated as a deemed sale and 
purchase of assets pursuant to section 338, the corporation that is 
treated as selling its assets as a result of an election thereunder 
(old target) is not considered related to the corporation that is 
treated as purchasing the assets (new target) if stock of old target 
meeting the requirements of section 1504(a)(2) is, or is deemed to have 
been, acquired by purchase after July 25, 1991. See Sec. 1.338-2(d). 
Thus, for example, if a corporation (the purchasing corporation) makes 
a qualified stock purchase of the stock of another corporation (target) 
from unrelated third parties in July 1997, and a section 338 election 
is made by the purchasing corporation, the deemed asset purchase shall 
not be considered as an acquisition between related persons solely by 
virtue of the fact that old target and new target are treated as the 
same corporation for certain other purposes of the Code or that old 
target and new target are the same corporation under the laws of the 
State or other jurisdiction of its organization. However, the anti-
churning rules of this paragraph (h) may nevertheless apply to a deemed 
asset purchase resulting from a section 338 election because old target 
and new target are otherwise treated as related parties within the 
meaning of paragraph (h)(6) of this section.
    (9) Exception to anti-churning rules where gain is recognized--(i) 
In general. If a taxpayer would not be subject to paragraph (h) but for 
the substitution of 20 percent for 50 percent under paragraph 
(h)(6)(i)(A) of this section and the person (whether or not subject to 
Federal income tax) from which the taxpayer acquires the intangible 
elects to recognize gain on the disposition of the intangible and, 
notwithstanding any other provision of the Internal Revenue Code, 
agrees to pay an amount that, when added to any other Federal income 
tax, equals the gain on the disposition multiplied by the highest 
marginal rate of tax imposed by section 1 (for individuals, estates, or 
trusts) or 11 (for corporations), whichever is applicable, for the 
taxable year in which the gain is realized by the person from which the 
taxpayer acquires the intangible, then the anti-churning rules 
described in this paragraph (h) only apply to the extent the taxpayer s 
adjusted basis in the intangible exceeds the gain recognized.
    (ii) Manner of making election. [Reserved]
    (iii) Determination of highest marginal rate of tax. For the 
purpose of determining the highest marginal rate of tax applicable to 
the person from which the taxpayer acquires the intangible, the 
following rules shall apply:
    (A) Noncorporate taxpayers. In the case of an individual, estate, 
or trust, the highest marginal rate of tax shall be the highest 
marginal rate of tax in effect under section 1, determined without 
regard to section 1(h).
    (B) Corporations and tax-exempt entities. In the case of a 
corporation or an entity that is exempt from tax under section 501(a), 
the highest marginal rate of tax shall be the highest marginal rate of 
tax in effect under section 11, determined without regard to any rate 
that is added to the otherwise applicable rate in order to offset the 
effect of the graduated rate schedule.
    (iv) Special rule for pass-through entities. In the case of a 
partnership or S corporation, the election under paragraph (h)(9)(i) of 
this section--
    (A) Shall be made by the entity rather than by its owners or 
members; and
    (B) Shall constitute an election by each of the owners or members 
of the entity (rather than the entity itself) to pay a tax, determined 
as provided in this paragraph (h)(9), on the portion of the gain 
properly allocable to each such owner or member.
    (v) Coordination with other provisions--(A) In general. For 
purposes

[[Page 2351]]

of applying any provision of chapter 1 or chapter 6 of the Code other 
than section 197(f)(9)(B), both the amount of gain subject to the tax 
determined under paragraph (h)(9)(i) of this section and the amount of 
the tax shall be disregarded. Thus, for example, the amount of the gain 
shall not be reduced by any net operating loss deduction under section 
172(a), any capital loss under section 1212, or any other similar loss 
or deduction. The amount of tax determined under paragraph (h)(9)(i) of 
this section shall not be reduced by any credit of the taxpayer. In 
computing the amount of any net operating loss, capital loss, or other 
similar loss or deduction, or any credit that may be carried to any 
taxable year, any gain recognized, and any tax paid, under paragraph 
(h)(9)(i) of this section shall not be taken into account.
    (B) Section 1374. No provision of paragraph (h)(9)(iv) of this 
section shall preclude the application of section 1374 (relating to a 
tax on certain built-in gains of S corporations) to any gain with 
respect to which the election described in paragraph (h)(9)(i) of this 
section is made. Neither paragraph (h)(9)(iv) nor paragraph 
(h)(9)(v)(A) of this section shall be treated as precluding a taxpayer 
from applying the provisions of section 1366(f)(2) (relating to 
treatment of the tax imposed by section 1374 as a loss sustained by the 
S corporation) in determining the amount of tax payable under paragraph 
(h)(9)(i) of this section.
    (C) Procedural and administrative provisions. For purposes of 
subtitle F, the amount determined under paragraph (h)(9)(i) of this 
section is treated as a tax imposed by section 1 or 11, as appropriate.
    (D) Installment method. The gain subject to the tax determined 
under paragraph (h)(9)(i) of this section may not be reported under the 
method described in section 453(a). Any such gain that would, but for 
the application of this paragraph (h)(9)(v)(D), be taken into account 
under section 453(a) shall be taken into account in the same manner as 
if an election under section 453(d) (relating to the election not to 
apply section 453(a)) had been made.
    (10) Transactions subject to both anti-churning and nonrecognition 
rules. If a person acquires a section 197 intangible in a transaction 
described in paragraph (g)(2) of this section from a person in whose 
hands the intangible was an amortizable section 197 intangible, and as 
a result of the transaction, the person is or becomes related to any 
person described in paragraph (h)(1) of this section, the intangible 
ceases to be an amortizable section 197 intangible in the hands of the 
transferee unless the exception provided in paragraph (h)(4)(ii) of 
this section applies. If a person acquires a section 197 intangible in 
anticipation of becoming related to any person described in paragraph 
(h)(1) of this section, the intangible is not an amortizable section 
197 intangible in the hands of the transferee.
    (11) Anti-churning anti-abuse rule. Section 197 does not apply to 
any intangible acquired by a taxpayer if the taxpayer acquires the 
intangible in a transaction one of the principal purposes of which is 
to avoid any of the anti-churning rules for intangibles described in 
paragraph (h)(1) of this section. Thus, for example, if section 197 
intangibles are acquired in a transaction (or series of related 
transactions) in which options to acquire stock are issued to a party 
to the transaction, but the option is not treated as having been 
exercised for purposes of paragraph (h)(6) of this section, this 
paragraph (h)(11) may apply to the transaction.
    (i) [Reserved].
    (j) General anti-abuse rule. The rules in this section shall be 
interpreted and applied as necessary and appropriate to prevent 
avoidance of the purposes of section 197. If one of the principal 
purposes of a transaction is to achieve a tax result that is 
inconsistent with the purposes of section 197, the Commissioner can 
recast the transaction for Federal tax purposes as appropriate to 
achieve tax results that are consistent with the purposes of section 
197, in light of the applicable statutory and regulatory provisions and 
the pertinent facts and circumstances.
    (k) Examples. The following examples illustrate the application of 
this section:

    Example 1. Computer software. (i) X purchases all of the assets 
of an existing trade or business from Y. One of the assets acquired 
is all of Y's rights in certain computer software previously used by 
Y under the terms of a nonexclusive license from the software 
developer. The software was developed for use by manufacturers to 
maintain a comprehensive accounting system, including general and 
subsidiary ledgers, payroll, accounts receivable and payable, cash 
receipts and disbursements, fixed asset accounting, and inventory 
cost accounting and controls. The software was not substantially 
modified for use by Y within the meaning of paragraph (c)(4)(i) of 
this section and was acquired directly by Y from the developer. The 
developer does not maintain wholesale or retail outlets but markets 
the software directly to ultimate users. Y's license of the software 
is limited to an entity that is actively engaged in business as a 
manufacturer.
    (ii) Notwithstanding these limitations, the software is 
considered to be readily available to the general public for 
purposes of paragraph (c)(4)(i) of this section. Accordingly, the 
software is not a section 197 intangible.
    Example 2. Governmental rights of fixed duration. (i) City M 
operates a municipal water system. In order to induce X to locate a 
new manufacturing business in the city, M grants X the right to 
purchase water for 16 years at a specified price. X incurs legal 
fees and other costs for professional services in the amount of $10x 
in connection with its efforts to obtain these rights.
    (ii) The rights granted by M are described in section 
197(e)(4)(B) and paragraph (c)(6) of this section and, thus, are not 
a section 197 intangible. This exclusion applies notwithstanding 
that the rights may not qualify for exclusion under section 
197(e)(4)(D) and paragraph (c)(13) of this section or that they also 
may be described in section 197(d)(1)(D) and paragraph (b)(8) of 
this section and, as such, may not be treated as self-created 
intangibles eligible for exclusion under section 197(c)(2).
    Example 3. Advertising costs. (i) Q manufactures and sells 
consumer products through a series of wholesalers and distributors. 
In order to increase sales of its product by encouraging consumer 
loyalty to its products and to enhance the value of the goodwill, 
trademarks, and trade names of the business, Q advertises its 
products to the consuming public. It regularly incurs costs to 
develop radio, television, and print advertisements. These costs 
generally consist of employee costs and amounts paid to independent 
advertising agencies. Q also incurs costs to run these 
advertisements in the various media for which they were developed. 
Except for the possible application of section 197, these costs 
would be ordinary and necessary expenses deductible under section 
162.
    (ii) The advertising costs are not subject to amortization under 
section 197 pursuant to paragraph (a)(3) of this section because 
they are otherwise deductible.
    Example 4. Covenant not to compete acquired in connection with 
stock redemption. (i) R, a corporation, redeems all of its stock 
owned by A, an individual. R and A have no business relationships 
with each other except for the corporate-shartholder relationship. 
In connection with the stock redemption, R and A enter into an 
agreement containing a covenant not to compete. Under this 
agreement, A agrees that A will not compete with the business of R 
within a prescribed geographical territory for a period of three 
years after the date on which the stock redemption is completed. In 
exchange for this agreement, R pays A consideration in addition to 
the amount paid for the stock redeemed by R.
    (ii) Because the agreement was entered into in connection with 
the reacquisition by R of its stock, section 162(k) provides that no 
deduction shall be allowed for any amount paid or incurred pursuant 
to the agreement. Accordingly, pursuant to paragraph (a)(4) of this 
section, section 197 does not apply to these amounts.
    Example 5. Substantial portion of trade or business. (i) S owns 
and operates 100 restaurants in various locations. Each of these 
restaurants is operated using a well-established trade name made 
available to S

[[Page 2352]]

under the terms of a franchise agreement with F. S determined to 
cease operating one of the franchised restaurants. Accordingly, S 
sold to B all of the assets that it had used exclusively in 
connection with the operation of its restaurant at that location. B 
agreed to extend an offer of employment to all of the employees at 
that location. B acquired no rights to the franchise or to any of 
the trademarks or trade names that had been used by S.
    (ii) The transaction between B and S is a transaction involving 
the acquisition of assets constituting a trade or business or a 
substantial portion thereof within the meaning of paragraph (e) of 
this section, notwithstanding that B did not acquire a franchise 
from S or that the assets did not represent a substantial portion of 
the assets used by S in that trade or business.
    Example 6. Separate acquisition of franchise. (i) S is a 
franchisor of retail outlets for specialty coffees. On July 1, 1997, 
G enters into an agreement with S pursuant to which G is permitted 
to acquire and operate a store using the S trademark and trade name 
at the location specified in the agreement. G agrees to pay S 
$100,000 upon execution of the agreement and also agrees to pay, on 
a monthly basis throughout the term of the franchise, a specified 
percentage of gross sales from the store. The agreement contains 
detailed specifications for the construction and operation of the 
business, but G is not required to purchase from S any of the 
materials necessary to construct the improvements at the location 
specified in the franchise agreement.
    (ii) The franchise is a section 197 intangible within the 
meaning of paragraph (b)(10) of this section. The franchise does not 
qualify for the exclusion relating to self-created intangibles 
described in section 197(c)(2) and paragraph (d)(2) of this section 
because the franchise is described in section 197(d)(1)(F). In 
addition, because the acquisition of the franchise constitutes the 
acquisition of an interest in a trade or business or a substantial 
portion thereof, the franchise may not be excluded under section 
197(e)(4). Thus, the franchise is an amortizable section 197 
intangible, the basis of which must be recovered over a 15-year 
period. However, the amounts to be paid by G computed as a 
percentage of gross sales are not subject to the provisions of 
section 197 by reason of section 197(f)(4)(C) and paragraph 
(b)(10)(ii) of this section.
    Example 7. Acquisition and amortization of covenant not to 
compete. (i) As part of the acquisition of a trade or business from 
C, B and C enter into an agreement containing a covenant not to 
compete. Under this agreement, C agrees that it will not compete 
with the business acquired by B within a prescribed geographical 
territory for a period of three years after the date on which the 
business is sold to B. In exchange for this agreement, B agrees to 
pay C $90,000 per year for each year in the term of the agreement. 
The agreement further provides that, in the event of a breach by C 
of his obligations under the agreement, B may terminate the 
agreement, cease making any of the payments due thereafter, and 
pursue any other legal or equitable remedies available under 
applicable law. Assume that the amounts payable to C under the 
agreement represent the value of C's obligations to B pursuant to 
the covenant and that the present fair market value of B's rights 
under the agreement is $225,000. The aggregate consideration paid 
for all assets acquired in the transaction other than the covenant 
exceeds the sum of the amount of Class I assets and the aggregate 
fair market value of all Class II and Class III assets and all Class 
IV assets other than the covenant.
    (ii) Because the covenant is acquired in an applicable asset 
acquisition (within the meaning of section 1060(c)), the basis of B 
in the covenant cannot exceed its fair market value. See 
Sec. 1.1060-1T(e)(1). Under section 197(f)(3) and paragraphs 
(f)(3)(i) and (f)(4) of this section, the adjusted basis of B in the 
agreement, determined as of the date on which the agreement is 
entered into, is $225,000. B's deduction for amortization with 
respect to the amounts to be paid under the agreement is $1,250 per 
month, or $15,000 per year, for each year in the 15-year period 
beginning on the date on which the agreement is entered into. The 
excess of the amounts payable pursuant to the agreement over the 
amount allocated to the covenant under Sec. 1.1060-1T(e)(1), or 
$45,000, is allocated to Class V assets.
    Example 8. Breach of covenant not to compete subsequent to 
acquisition. (i) The facts are the same as in Example 7, except that 
at the end of the second year of the agreement, C breaches the 
agreement by competing against B. B and C enter into a settlement of 
all claims arising under the agreement and the subsequent breach by 
C by agreeing that B is not obligated to pay C the final installment 
of $90,000.
    (ii) Under paragraph (g)(1)(iii) of this section, the covenant 
is not treated as having been disposed of (or becoming worthless) 
because C has not disposed of all interests in the trade or business 
acquired in the same transaction as the covenant. The covenant is 
not a contingent income asset within the meaning of Sec. 1.1060-
1T(f)(4)(i). Accordingly, B must decrease the adjusted basis of any 
asset acquired from C by $90,000 at the beginning of the third year 
of the agreement in the manner provided by Sec. 1.1060-1T(f)(3)(i). 
To the extent that any decrease is allocated to an amortizable 
section 197 intangible, B must reduce the amount of its deduction 
for amortization under section 197 accordingly.
    Example 9. Loss disallowance rules involving related persons. 
(i) Assume that X and Y are treated as a single taxpayer for 
purposes of paragraph (g)(1)(iv) of this section. In a single 
transaction, X and Y acquired from Z all of the assets used by Z in 
a trade or business. Z had operated this business at two locations, 
and X and Y each desired to acquire the assets used by Z at one of 
the locations. Three years after the acquisition, X sold all of the 
assets, including amortizable section 197 intangibles, to an 
unrelated purchaser at a loss of $120,000.
    (ii) Because X and Y are treated as a single taxpayer for 
purposes of the loss disallowance rules of section 197(f)(1) and 
paragraph (g)(1) of this section, X may not recognize its loss on 
the sale of the amortizable section 197 intangibles. Under paragraph 
(g)(1)(iv) of this section, X must amortize its disallowed loss 
under section 197, and Y may not increase its adjusted basis in its 
amortizable section 197 intangibles by the amount of the realized 
loss of X that is disallowed. X must amortize the disallowed loss 
over the remainder of the amortization period for the amortizable 
section 197 intangibles it sold. Accordingly, X must amortize the 
disallowed loss at the rate of $10,000 per year (or $833 per month) 
for each of the 12 years remaining in the 15-year period.
    Example 10. Disposition of retained intangibles by related 
person. (i) The facts are the same as in Example 9, except that 10 
years after the acquisition of the assets by X and Y and seven years 
after the sale of the assets by X, Y sells all of the assets 
acquired from Z, including amortizable section 197 intangibles, to 
an unrelated purchaser.
    (ii) Upon the sale of assets by Y, X may recognize a loss equal 
to the unamortized loss. Accordingly, pursuant to paragraph 
(g)(1)(iv) of this section, X may recognize a loss in the amount of 
$50,000, the amount obtained by reducing the loss on the sale of the 
assets at the end of the third year ($120,000) by the amount of 
amortization allowed for the fourth through the tenth years 
($70,000).
    Example 11. Acquisition of an interest in partnership with no 
section 754 election. (i) A, B, and C each contribute $1,500 for 
equal shares in general partnership P. On January 1, 1998, P 
acquires as its sole asset an amortizable section 197 intangible for 
$4,500. P still holds the intangible on January 1, 2003, at which 
time the intangible has an adjusted basis to P of $3,000, and A, B, 
and C each have an adjusted basis of $1,000 in their partnership 
interests. D (who is not related to A) acquires A's interest in P 
for $1,600. No section 754 election is in effect for 2003.
    (ii) Pursuant to paragraph (h)(5)(i) of this section, there is 
no change in the basis or amortization of the intangible and D 
merely steps into the shoes of A with respect to the intangible. D's 
proportionate share of P's adjusted basis in the intangible is 
$1,000, which continues to be amortized over the 10 years remaining 
in the original 15-year amortization period for the intangible.
    Example 12. Acquisition of an interest in partnership with a 
section 754 election. (i) The facts are the same as in Example 11, 
except that a section 754 election is in effect for 2003.
    (ii) Pursuant to section 197(f)(9)(E) and paragraph (h)(5)(i) of 
this section, for purposes of section 197, D is treated as if P owns 
two assets. D's proportionate share of P's adjusted basis in one 
asset is $1,000, which continues to be amortized over the 10 years 
remaining in the original 15-year amortization period. For the other 
asset, D's proportionate share of P's adjusted basis is $600 (the 
amount of the basis increase under section 743 as a result of the 
section 754 election), which is amortized over a new 15-year period 
beginning January 2003. With respect to B and C, P's remaining 
$2,000 adjusted basis in the intangible continues to be amortized 
over the 10 years remaining in the original 15-year amortization 
period.

[[Page 2353]]

    Example 13. Payment to a retiring partner by partnership with a 
section 754 election. (i) The facts are the same as in Example 11, 
except that a section 754 election is in effect for 2003 and, 
instead of D acquiring A's interest in P, A retires from P. A, B, 
and C are not related to each other within the meaning of paragraph 
(h)(6) of this section. A receives a payment under section 736 from 
P of $1,600, all of which is in exchange for A's interest in the 
intangible asset owned by P.
    (ii) Pursuant to paragraph (h)(5)(i) of this section, because of 
the section 734 adjustment, P is treated as having two amortizable 
section 197 intangibles, one with a basis of $3,000 and a remaining 
amortization period of 10 years and the other with a basis of $600 
and a new amortization period of 15 years.
    Example 14. Termination of partnership under section 
708(b)(1)(B). (i) A and B are partners with equal shares in the 
capital and profits of general partnership P. P's only asset is an 
amortizable section 197 intangible, which P had acquired on January 
1, 1994. On January 1, 1999, the asset had a fair market value of 
$100 and a basis to P of $50. On that date, A sells his entire 
partnership interest in P to C, who is unrelated to A, for $50. At 
the time of the sale, the basis of each of A and B in their 
respective partnership interests is $25.
    (ii) The sale causes a termination of P under section 
708(b)(1)(B). Under section 708, the transaction is treated as if P 
transfers its sole asset to a new partnership in exchange for the 
assumption of its liabilities and the receipt of all of the 
interests in the new partnership. Immediately thereafter, P is 
treated as if it is liquidated, with B and C each receiving their 
proportionate share of the interests in the new partnership. The 
contribution by P of its asset to the new partnership is governed by 
section 721, and the liquidating distributions by P of the interests 
in the new partnership are governed by section 731. However, C does 
not realize a special basis adjustment under section 743 with 
respect to the amortizable section 197 intangible unless P had a 
section 754 election in effect for its taxable year in which the 
deemed transfer of the asset to the new partnership occurred.
    (iii) Under section 197, if P had a section 754 election in 
effect for its taxable year in which the deemed transfer of the 
asset to the new partnership occurred, C is treated as if the new 
partnership had acquired two assets from P immediately preceding its 
termination. Even though the adjusted basis of the new partnership 
in the two assets is determined solely under section 723, because 
the transfer of assets is a transaction described in section 721, 
the application of sections 743(b) and 754 to P immediately before 
its termination causes P to be treated as if it held two assets, for 
purposes of section 197, at this time. B's and C's proportionate 
share of the new partnership's adjusted basis is $25 each in one 
asset, which continues to be amortized over the 10 years remaining 
in the original 15-year amortization period. For the other asset, 
C's proportionate share of the new partnership's adjusted basis is 
$25 (the amount of the basis increase resulting from the application 
of section 743 to the sale or exchange by A of the interest in P), 
which is amortized over a new 15-year period beginning in January 
1999.
    (iv) If P did not have a section 754 election in effect for its 
taxable year in which the sale of the partnership interest by A to C 
occurred, the adjusted basis of the new partnership in the 
amortizable section 197 intangible is determined solely under 
section 723, because the transfer is a transaction described in 
section 721, and P does not have a basis increase in its section 197 
intangible. Under section 197(f)(2) and paragraph (g)(2) of this 
section, the new partnership continues to amortize the amortizable 
section 197 intangible over the 10 years remaining in the original 
15-year amortization period. No additional amortization is allowable 
with respect to this asset under section 197.
    Example 15. Disguised sale to partnership. (i) Assume that E and 
F are individuals who are unrelated to each other within the meaning 
of paragraph (h)(6) of this section. E has been engaged in the 
active conduct of a trade or business as a sole proprietor since 
1990. E and F form EF Partnership. E transfers all of the assets of 
the business, having a fair market value of $100x, to EF, and F 
transfers $40x of cash to EF. E receives a 60 percent interest in EF 
and the $40x of cash contributed by F, and F receives a 40 percent 
interest in EF, under circumstances in which the transfer by E is 
treated as a sale of property to EF under Sec. 1.707-3(b).
    (ii) Under Sec. 1.707-3(a)(1), the transaction is treated as if 
E had sold to EF a 40 percent interest in each asset for $40x and 
contributed the remaining 60 percent interest in each asset to EF in 
exchange solely for an interest in EF. Because E and EF are related 
persons within the meaning of paragraph (h)(6) of this section, no 
portion of any transferred section 197 intangible that E held during 
the transition period (as defined in paragraph (h)(3) of this 
section) is an amortizable section 197 intangible pursuant to 
paragraph (h)(1) of this section. Section 197(f)(9)(E) and paragraph 
(h)(5) of this section do not apply to any portion of the section 
197 intangible in the hands of EF because the basis of EF in these 
assets was not increased under any of sections 732, 734, or 743.
    Example 16. Acquisition by related person in nonrecognition 
transaction. (i) A owns a nonamortizable intangible that A acquired 
in 1990. In 1997, A sells a one-half interest in the intangible to B 
for cash. Immediately after the sale, A and B, who are unrelated to 
each other, form partnership P as equal partners. A and B each 
contribute their one-half interest in the intangible to P.
    (ii) P has a transferred basis in the intangible from A and B 
under section 723. The nonrecognition transfer rule under paragraph 
(g)(2)(i) of this section applies to A s transfer of its one-half 
interest in the intangible to P, and consequently P steps into A's 
shoes with respect to A's nonamortizable transferred basis. The 
anti-churning rules of paragraph (h)(1)(i) of this section apply to 
B's transfer of its one-half interest in the intangible to P, 
because A, who is related to P under paragraph (h)(6) of this 
section, held B's one-half interest in the intangible during the 
transition period. Pursuant to paragraph (h)(10) of this section, 
these rules apply to B's transfer of its one-half interest to P even 
though the nonrecognition transfer rule under paragraph (g)(2)(i) of 
this section would have permitted P to step into B's shoes with 
respect to B's otherwise amortizable basis. Therefore, P's entire 
basis in the intangible is nonamortizable.
    Example 17. Acquisition of partnership interest following 
formation of partnership. (i) The facts are the same as in Example 
16 except that, in 1996, A formed P with an affiliate and 
contributed the intangible to the partnership and except that 
thereafter, in an unrelated transaction, B purchases a 50 percent 
interest in P. P has a section 754 election in effect.
    (ii) For the reasons set forth in Example 14(iii), B is treated 
as if P owns two assets. B's proportionate share of P's adjusted 
basis in one asset is the same as A's proportionate share of P's 
adjusted basis in that asset, which is not amortizable under section 
197. For the other asset, B's proportionate share of the remaining 
adjusted basis of P is amortized over a new 15-year period.
    Example 18. Acquisition by related corporation in nonrecognition 
transaction. (i) The facts are the same as Example 16, except that P 
is a corporation.
    (ii) P has a transferred basis in the intangible from A and B 
under section 362. Pursuant to paragraph (h)(10) of this section, 
the application of the nonrecognition transfer rule under paragraph 
(g)(2)(i) and the anti-churning rules of paragraph (h)(1)(i) of this 
section to the facts of this Example 18 is the same as in Example 
16. Thus, P's entire basis in the intangible is nonamortizable.
    Example 19. Acquisition from corporation related to purchaser 
through remote indirect interest. (i) X, Y, and Z are each 
corporations that have only one class of issued and outstanding 
stock. X owns 25 percent of the stock of Y and Y owns 25 percent of 
the outstanding stock of Z. No other shareholder of any of these 
corporations is related to any other shareholder or to any of the 
corporations. On June 30, 1997, X purchases from Z section 197 
intangibles that Z owned during the transition period (as defined in 
paragraph (h)(3) of this section).
    (ii) Pursuant to paragraph (h)(6)(iii)(B) of this section, the 
beneficial ownership interest of X in Z is 6.25 percent, determined 
by treating X as if it owned a proportionate (25 percent) interest 
in the stock of Z that is actually owned by Y. Thus, even though X 
is related to Y and Y is related to Z, X and Z are not considered to 
be related for purposes of the anti- churning rules of section 197.
    Example 20. Gain recognition election. (i) B owns 25 percent of 
the stock of S, a corporation that uses the calendar year as its 
taxable year. No other shareholder of B or S is related to each 
other. S is not a member of a controlled group of corporations 
within the meaning of section 1563(a). S has section 197 intangibles 
that it owned during the transition period and was not permitted to 
amortize or depreciate under any other provision of the Code. S had 
a basis of $25,000 in the intangibles. In 1997, S sells

[[Page 2354]]

these intangibles to B for $75,000. S recognizes a gain of $50,000 
on the sale and has no other items of income, deduction, gain, or 
loss for the year, except that S also has a net operating loss of 
$20,000 from prior years that it would otherwise be entitled to use 
in 1997 pursuant to section 172(b). As part of the transaction with 
B, S agrees to make the gain recognition election pursuant to 
section 197(f)(9)(B).
    (ii) If the gain recognition election had not been made, S would 
have taxable income of $30,000 for 1997 and a tax liability of 
$4,500. As the result of the election, S must pay a total tax 
liability for the year of $17,500 (35 percent of $50,000), 
consisting of the sum of its regular tax liability of $4,500 and the 
additional amount of $13,000 pursuant to section 197(f)(9)(B).
    (iii) Pursuant to paragraph (h)(9)(v)(A) of this section, S 
determines the amount of its net operating loss deduction in 
subsequent years without regard to the gain recognized on the sale 
of the section 197 intangible to B. Accordingly, the entire $20,000 
net operating loss deduction that would have been available in 1997 
but for the gain recognition election may be used in 1998, subject 
to the limitations of section 172.
    (iv) B has a basis of $75,000 in the section 197 intangibles 
acquired from S. As the result of the gain recognition election by 
S, B may amortize $50,000 of its basis under section 197. The 
remaining basis may not be amortized by B.
    Example 21. Section 338 election. (i) P corporation makes a 
qualified stock purchase of the stock of T corporation from two 
shareholders in July 1997, and a section 338 election is made by P. 
One of the selling shareholders is an individual who owns 25 percent 
of the total value of the stock of each of the T and P corporation. 
No other shareholder of either T or P owns stock in both of these 
corporations, and no other shareholder is related to any other 
shareholder of either corporation.
    (ii) Old target and new target (as these terms are defined in 
Sec. 1.338-1(c)(13)) are members of a controlled group of 
corporations under section 267(b)(3), as modified by section 
197(f)(9)(C)(i), and any section 197 intangible held by old target 
at any time during the transition period is not an amortizable 
section 197 intangible in the hands of new target. However, a gain 
recognition election under paragraph (h)(9)(i) of this section may 
be made with respect to this transaction.

    (l) Effective dates. This section is applicable on the date 
final regulations are published in the Federal Register, except that 
Sec. 1.197-2(c)(13) (exception from section 197 for separately 
acquired rights of fixed duration or amount) is applicable August 
11, 1993 (or July 26, 1991, if a valid retroactive election has been 
made under Sec. 1.197-1T).
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 97-866 Filed 1-9-97; 2:53 pm]
BILLING CODE 4830-01-U