Section 197 and Partnership Transactions

Originally published in June 2003

TABLE OF CONTENTS

PART ONE

1. INTRODUCTION

2. SECTION 197

   PART TWO

   I. Transfer of Interest in Assets Followed by Partnership Formation

2. Transfer of Partnership Interest: No Section 754 Election

3. Transfer of Partnership Interest: Section 754 Election Made

4. Partnership Termination

5. Transfers of Partnership Interests

6. The Section 197 Anti-Churning Rules

   PART ONE: INTRODUCTION

   I. INTRODUCTION

   1. Enacted as part of the Omnibus Budget Reconciliation Act of 1993, P.L. 103-66 Stat. 312, section 197 1 governs the tax treatment of acquired intangible assets.

   2. Section 197 comes into play whenever there is an allocation of consideration to an acquired amortizable section 197 intangible. In partnership transactions, the possibility of abuse arises upon the contribution of assets to a partnership, the transfer of an interest in a partnership, or the termination of a partnership.

   3. PART ONE of this Outline provides an introduction to section 197, as it relates to partnerships. PART TWO illustrates the application of section 197 in various partnership transactions.

2. SECTION 197

   1. Application of Section 197

      1. Section 197 and its 15-year amortization period apply to any "amortizable section 197 intangible."

      2. Section 197(c) defines the term "amortizable section 197 intangible" as a section 197 intangible that is

         a. acquired after the date of enactment of the statute (August 10, 1993), and

         b. held in connection with the conduct of a trade or business or an activity described in section 212. See Treas. Reg. § 1.197-2(d)(1).

      3. The term amortizable section 197 intangible does not include certain section 197 intangibles created by the taxpayer (self-created intangibles). See Section 197(c)(2); Treas. Reg. § 1.197-2(d)(2)(i).

         a. An intangible is self-created to the extent the taxpayer makes payments or otherwise incurs costs for its creation or improvement, whether the actual work is done by the taxpayer or by another person under a contract with the taxpayer. Treas. Reg. § 1.197- 2(d)(2)(ii).

         b. The following self-created intangibles are excluded from the definition of amortizable Section 197 intangibles:

         (i) goodwill;

         (ii) going concern value;

         (iii) workforce in place;

         (iv) information-based intangibles;

         (v) know-how intangibles;

         (vi) customer-based intangibles;

         (vii) supplier-based intangibles; and

         (viii) any similar items.

         Section 197(c)(2), (d)(1).

         c. The exception for self-created intangibles does not apply, however, if the intangible is created in connection with a transaction involving the acquisition of assets constituting a trade or business or a substantial portion thereof. Section 197(c)(2); see Treas. Reg. § 1.197-2(d)(2)(iii)(B). Thus, intangibles created in connection with such an acquisition will be treated as amortizable section 197 intangibles.

         (i) 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). Treas. Reg. § 1.197-2(e)(1).

         (ii) Whether acquired assets constitute a "substantial portion" of a trade or business is based on all the relevant facts and circumstances. Treas. Reg. § 1.197-2(e)(4).

         d. Pre-Section 197 law continues to control the tax treatment of assets excluded from section 197.

   2. Nonrecognition Transfers

      1. If a section 197 intangible is acquired in a nonrecognition transaction (e.g., section 721 or 731), the transferee generally stands in the shoes of the transferor to the extent of the transferor's basis for purposes of section 197.

      2. Section 197 would apply to the extent that there is a step-up in basis in connection with the nonrecognition transaction.

   3. Partnership Transactions

      1. A transaction in which a taxpayer acquires an interest in a partnership that owns an intangible will be treated as an acquisition of a section 197 intangible only to the extent that the taxpayer obtains a basis greater than the partnership's basis for the asset. See section 197(f)(9)(E).

      2. The acquiring partner will step into the shoes of the selling partner as to the remaining pre-existing basis in any such intangible owned by the partnership.

      3. If a section 197 intangible is transferred or deemed to be transferred due to a termination under section 708(b)(1), 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. Treas. Reg. § 1.197-2(g)(2)(iv).

      4. Newly finalized section 197 regulations provide rules for the application of sections 704(c), 732(d), 734(b), and 743(b) to section 197. Treas. Reg. § 1.197-2(g)(3) and (4). See Treas. Reg. § 1.197-2(k), Exs. 13-19.

   4. Anti-Churning Rules

      1. Extensive anti-churning rules are intended to prevent pre-existing non-amortizable intangibles from being converted into section 197 intangibles in transactions where the user does not change or where related parties are involved. Unlike the proposed regulations, the final regulations expressly state this purpose of the anti-churning rules and provide that the rules are to be applied in a manner that carries out their purpose. Treas. Reg. § 1.197-2(h)(1)(ii). A broad anti-abuse rule disqualifies any asset acquired in a transaction designed to avoid the effective date limitation discussed below.

      2. An amortization deduction under section 197 may not be taken for an asset that, but for section 197, would not be amortizable if (1) it was acquired after August 10, 1993, and (2) either (i) the taxpayer or a related person held or used the intangible at any time on or after July 25, 1991 and on or before August 10, 1993 (the "Interim Period"), (ii) the intangible was acquired from a person that held the intangible during the Interim Period and the user of the intangible does not change, or (iii) the taxpayer grants a former owner (who owned the intangible during the Interim Period) the...