Amortization is much like depreciation, in that some portion of the property value or expense is deducted over several tax years, but differs because it only applies to intangible property or expenses related to starting or organizing a business. The minimum amortization period is usually 180 months (15 years). There is no classification of class life based on the property as there is under the depreciation system, since intangible property does not decay like tangible property and there is usually no replacement for intangible property. Therefore, most property is amortized over a statutory 15 year (180 months) period. Unlike depreciation, amortization is always straight-line — there are no accelerated amortization methods. So if you buy a business in January, where $60,000 of the purchase price is attributable to goodwill, then an amortization deduction of $4000 (=$60,000 ÷15) can be deducted annually for the next 15 years.
When property is 1st amortized, it must be listed at the bottom of Form 4562, Depreciation and Amortization, along with a description of costs, the amount amortized, the date of acquisition of the property, and the amount claimed for the current year. The amount of the amortization of the new property is then added to the total of the amortized costs of property placed in service in previous years.
Other than intangible property, the most common costs that are amortized include starting and organizing a business, discussed in Business Startup and Organization Deductions, and getting a lease. Other, less common amortized costs include the costs of reforestation, pollution control facilities, geological and geophysical costs, research and experimentation, and certain tax preferences. There is an exception for buying rental property, in that the purchase is not considered to include goodwill, going concern value, or any other amortizable intangible property.
Section 197 Intangibles
A specific type of intangible property, referred to in the tax code as §197 intangible property, named for the section of the Internal Revenue Code that applies to such property, is amortized. Amortizable §197 intangible property consists of intangible property acquired for use in a trade or business or for the production of income. Intangibles, such as goodwill, copyrights, patents, and covenants not to compete, are also included, but only if they are acquired as part of the business. The buyer of a business has some leeway to either decrease or increase the amount of value attributed to §197 intangibles, depending on whether the buyer wants to shift part of the purchase price to assets with a faster recovery time or to assets with a longer recovery time, such as real estate.
Section 197 intangible property must generally be amortized over a 15-year period. The monthly deduction = the tax basis of the property divided by 180, the number of months in 15 years. If the tax basis of the property increases during the amortization period, then the amount of the increase must be amortized over the remaining period.
Amortization Deduction = Tax Basis of Property ÷ Number of Months in Amortization Period × Number of Months Property Was Held During the Tax Year
- Partial months count as full months.
Example: So if a copyright is purchased on May 19 for $5400 by a calendar-year taxpayer, then the amortization deduction will equal:
- Year 1: 8 × $5400/180 = 8 × $30 = $240
- 8 months are counted for the 1st year, because May is counted as a full month.
- Years 2 - 15: 12 × $30 = $360
- Year 16: 4 × $30 = $120
If the cost of a §197 intangible includes costs for tangible property or is considered part of tangible property, such as the software that is sold with a computer, then the intangible property is not amortized but deducted as depreciation on the tangible property.
The most common types of §197 intangibles include:
- business property:
- going concern value,
- business records,
- customer lists,
- covenants not to compete,
- intellectual property:
- trade names.
Note that a §197 intangible asset can only be acquired, it cannot be created. If the intangible asset, such as a patent or copyright, is created, then it was not purchased, and therefore, there is nothing to deduct. The expenses of creating the intangible asset are deducted as ordinary expenses — they are not amortized.
The disposition of a §197 intangible results in a gain or loss. If the asset has been held 1 year or less, then the gain or loss is ordinary. However, if it was held longer than 1 year, then the amount of the gain equal to the total deducted as amortization is treated as an ordinary gain (§1245 gain). The remaining gain is treated as a §1231 gain or loss, and whether that gain or loss is ordinary or capital is determined by §1231 rules.
A loss cannot be claimed on the disposition of a §197 intangible that was acquired in the same transaction or series of related transactions in which other §197 intangibles were acquired. Instead, the basis of the remaining intangibles must be increased by the amount of loss by the following formula:
|Increase in Basis |
of Each §197 Asset
|=||Nondeductible Loss||×||Original Basis of Each Asset |
Total Adjusted Basis of All §197 Intangibles
as of the Date of Disposition
If a transfer occurs that is not recognized for tax purposes, such as like-kind exchanges, involuntary conversions, and transfers to or from a business entity — then the amortization schedule for the original asset continues as if there were no exchange. If any consideration was given in addition to the exchanged asset, such as boot, then that excess amount must be amortized over a 15 year period, starting in the month of the exchange.
Example: How Boot Is Amortized
- You have intangible property, which you have amortized over the past 3 years with a remaining unamortized amount = $20,000.
- You exchange the asset for another intangible asset + $10,000 in boot.
- Therefore, $20,000 of the exchanged asset's tax basis would be amortized over the next 12 years, just as if you had kept the original asset, but the $10,000 of boot would be amortized over the next 15 years after the exchange.