Intangibles can be like-kind property.

The IRS has ruled on several occasions in the past that exchanged intangibles such as trademarks, trade names, mastheads, and advertiser and subscriber accounts could never be eligible for deferral under Sec. 1031. However, earlier this year it reversed course. In Chief Counsel Advice (CCA) 200911006, the Service took the unusual step of explicitly rescinding its earlier conclusions. CCA 200911006 arguably brings this area of the law more into line with other court and IRS guidance on the applicability of Sec. 1031 to intangible assets and provides taxpayers with more opportunity (if not more clarity) for business and tax planning.

Sec. 1031

Sec. 1031 provides a means to defer gain or loss on the disposition of assets via the exchange of like-kind assets (Sec. 1031(a)). In general, Sec. 1031 provides that taxpayers do not recognize gain or loss on the exchange of property held for productive use in a trade or business (or for investment) if the property is exchanged for like-kind property that is also to be held for productive use in a trade or business (or for investment). In determining whether intangible personal property is of like kind, the Sec. 1031 regulations require taxpayers to evaluate two separate criteria:

* The nature and character of the intangible rights involved (e.g., a patent or a copyright); and

* The nature and character of the underlying property to which the intangible property relates (Regs. Sec. 1.1031(a)-2(c)(1)).

The exchanged assets must be of like kind under both prongs.

The regulations give only two examples illustrating the application of these rules. Example 1 provides that an exchange of the copyright on a novel for the copyright on another novel is a like-kind exchange (Regs. Sec. 1.1031(a)-2(c)(3), Example (1)). Example 2, as a contrary example, provides that an exchange of the copyright on a novel for the copyright on a song is not a like-kind exchange (Regs. Sec. 1.1031(a)-2(c)(3), Example (2)). The regulations explicitly preclude the application of the like-kind exchange rules to exchanges of goodwill (Regs. Sec. 1.1031(a)-2(c)(2)). The IRS believes that goodwill and going concern value are "so inherently unique and inseparable from the business" that they can never be of like kind with any other goodwill or going concern value (T.D. 8343). Therefore, taxpayers wishing to avail themselves of Sec. 1031 for the exchange of intangible assets must establish at the very least that the exchanged intangibles are not goodwill or going concern value.

TAM 200602034

In 2006, the IRS released Technical Advice Memorandum (TAM) 200602034, which overlaid on top of the two-step analysis above a restrictive rule relating to trademarks and trade names. In the TAM, the taxpayer exchanged, among other things, a group of trademarks and trade names for another group of trademarks and trade names. Applying the two-step analysis, the taxpayer argued that all the exchanged trademarks and trade names were of like kind because:

* The nature and character of the rights involved are the same (i.e., all the trademarks and trade names provide the same legal protections); and

* The nature and character of the underlying property is also the same (i.e., the protected properties are all words, names, symbols, devices, or any combination thereof).

The IRS ruled, however, that trademarks and trade names were, "we believe, a component of a larger asset, either of goodwill, or of going concern, or both." Because the trademarks or trade names are "so closely related to (if not a part of) the goodwill and going concern value of a business, it is our view that trademarks and trade names should not be considered of like-kind under [section] 1031."

Under this view, Sec. 1031 can never apply to trademarks or trade names, no matter the facts, because those assets are considered to be equivalent to goodwill, which cannot be the subject of a like-kind exchange.

This TAM addressed a taxpayer's fact-specific question and may not be cited as precedent under Sec. 6110(k)(3). The ruling, however, provides an interpretation that the Service followed in at least one subsequent ruling.

FAA 20074401F

The Industry Counsel for Media issued advice in late 2007 that applied the same reasoning as TAM 200602034 in analyzing the exchange of one newspaper's mastheads, advertiser accounts, and subscriber accounts for another newspaper's mastheads, advertiser accounts, and subscriber accounts. The guidance concluded that those intangible properties were closely related to, if not part of, the goodwill and going concern value of the newspapers. As such, they could not be like-kind assets. Field Attorney Advice (FAA) 20074401F ventured a step further in its analysis than did TAM 200602034. The 2007 ruling noted, in reaching its conclusion, that the Supreme Court's ruling in Newark Morning Ledger Co., 507 U.S. 546 (1993), is not relevant in determining whether the like-kind rules can apply to intangibles.

Newark Morning Ledger Co.: Separately Identifiable Asset

In Newark Morning Ledger, the Supreme Court addressed whether a taxpayer may depreciate under Sec. 167 an intangible asset that is proven to have an "ascertainable value and a limited useful life, the duration of which can be ascertained with reasonable accuracy" and is therefore an asset separate from goodwill. The Court phrased the question in this manner to conform to the guidance of Regs. Sec. 1.167(a)-3, which provides that taxpayers may depreciate an intangible asset if they can show that the asset has "a limited period, the length of which can be estimated with reasonable accuracy." Sec. 167 does not permit a deduction for the depreciation of goodwill (Regs. Sec. 167(a)-3).

The taxpayer was a newspaper publisher that began depreciating the basis it had allocated (under an allocation method similar to the residual method required by Secs. 1060 and 338) to a purchased "paid subscriber" intangible asset. The IRS disallowed the deduction on the ground that the "paid subscriber" intangible was "indistinguishable" from goodwill and therefore could not be depreciated under Sec. 167. The Court ruled for the taxpayer because the Court believed that, under the facts presented in the case, the "paid subscribers" asset had a limited useful life and an ascertainable value, both of which could be ascertained with reasonable accuracy. The Court's holding provides that taxpayers who can establish the useful life and value of an intangible may be able to depreciate that intangible asset. In other words, if the taxpayer has an intangible asset separate and apart from goodwill, the taxpayer may be able to depreciate the asset under Sec. 167.

For purposes of Sec. 1031 like-kind exchanges, taxpayers also must identify that they have an intangible asset that is not goodwill or going concern value. As such, it appears that, contrary to the statement in FAA 20074401F, Newark Morning Ledger is pertinent to analyzing whether the like-kind rules apply to intangibles, i.e., analyzing whether the taxpayer has an asset separate and distinct from goodwill that it can exchange.

CCA 200911006

In CCA 200911006, the Office of Chief Counsel revisited the common conclusions reached in TAM 200602034 and FAA 20074401E Upon reconsideration, the IRS now asserts that the basic premise of those rulings (i.e., that trademarks, trade names, newspaper mastheads, advertiser accounts, and subscriber accounts are essentially the same as goodwill) was incorrect.

The Office of Chief Counsel noted:

   Upon further consideration, the Office of
   Chief Counsel (Income Tax Accounting)
   has concluded that the analysis of Newark
   Morning Ledger Co. applies in determining
   whether intangibles constitute
   goodwill or going concern value within
   the meaning of [section] 1.1031(a)-2(c)(2).

      Accordingly, intangibles such as
   trademarks, trade names, mastheads,
   and customer-based intangibles that
   can be separately described and valued
   apart from goodwill qualify as like-kind
   property under [section] 1031. In our opinion,
   except in rare and unusual situations,
   intangibles such as trademarks, trade
   names, mastheads, and customer-based
   intangibles can be separately described
   and valued apart from goodwill. Of
   course, to qualify as like-kind property
   under [section] 1031, the property must satisfy
   all other requirements of [section] 1031
   including the nature and character rules
   of [Regs.] [section] 1.1031(a)-2(c)(1). Accordingly,
   the Service should not follow the
   position in TAM 200602034 and [FAA]
   20074401F on this issue.

The conclusion of the memorandum seems supportable as a matter of law, whereas the conclusions in TAM 200602034 and FAA 20074401F seem less so. Not only does Newark Morning Ledger Co. explicitly hold that taxpayers can carve out intangibles as separate from goodwill, but other common areas of tax law also lead to the same conclusion. For example, Sec. 197 identifies trademarks and trade names as assets separate and distinct from goodwill and going concern value. Sec. 197 permits, in general, the amortization of certain intangible assets, including trademarks and trade names, purchased as a part of a trade or business. In addition, trademarks and trade names are permitted a different treatment under Sec. 197 than are goodwill and going concern value: Sec. 197 may be applicable to self-created trademarks and trade names, whereas it cannot be applicable to self-created goodwill and/or going concern value (Sec. 197(c)(2)).

Further support for this conclusion can be found in the residual allocation methodology under Secs. 1060 and 338, which require the allocation of purchase price to intangible assets (such as trademarks and trade names) as assets separate from goodwill and going concern value (Secs. 1060 and 338(b)(5); Regs. Sec. 1.338-6(b) (2)). The residual method requires the allocation of purchase price in a cascading effect among preset categories of assets prior to the residual allocation of purchase price to goodwill and going concern. One of the pre-goodwill asset classes includes "all Section 197 intangibles, as defined in section 197, except for goodwill and going concern value" (Regs. Sec. 1.338-6(b)(2)(vi)).

Where Do We Go from Here?

The Office of Chief Counsel's memorandum has rescinded the blanket prohibition against applying Sec. 1031 to trademarks, trade names, newspaper mastheads, newspaper advertiser accounts, and newspaper subscriber accounts. Taxpayers are now able to apply the regulations' two-part analysis: (1) Are the nature and character of the rights involved of like kind; and (2) Are the nature and character of the underlying property to which the intangible personal property relates of like kind? The regulations do not, however, provide much additional guidance on applying the two-part analysis to intangible assets, presumably because of the myriad possible variations.

Based on Example 1 in the regulations, an exchange of a copyright on a novel for another copyright on a novel is a like-kind exchange (Regs. Sec. 1.1031(a)-2(c)(3), Example (1)). One can presume, therefore, that the exchange of a copyright on a mystery novel for the copyright on a romance novel is a like-kind exchange. What about the exchange of a copyright on a mystery novel for the copyright on a graphic novel? A graphic novel tells a story through words, just like a regular novel, but also with accompanying pictures. Is the graphic novel more like a mystery novel or more like the song in Example 2 (which is not considered like kind to the novel)? A song may also be a story or a narrative like a novel, but is set to music. Is that the telling difference? The regulations do not say.

Published guidance leads one to hope, however, that, provided with sufficient information from the taxpayer, the IRS may take a reasonable approach in this area. For example, the Service has ruled several times that a wide variety of electromagnetic spectra (e.g., radio waves and/or television waves) can be of like kind.

In Letter Ruling 200532008, the IRS ruled that the right to broadcast within a particular radio frequency is of like kind to the right to broadcast within a different radio frequency even though the exchanged rights are to different radio frequencies (i.e., different parts of the available electromagnetic spectrum), have different operating parameters (i.e., frequency, power, and antenna specifications), permit the transfer of different amounts of information, and are located in different geographic locations.

Similarly, the IRS ruled in TAM 200035005 that the exchange of a Federal Communications Commission (FCC) radio license for an FCC television license was a like-kind exchange. The Service held that the FCC licenses differed in grade or quality only, not in nature or character, even though one was for radio and one for television. In both cases, the IRS looked to the fact that the transferred spectrum rights and the received spectrum rights are all suitable for use by a taxpayer in its business of providing particular services. In addition, the IRS noted that any differences in spectrum rights are merely differences in grade or quality of such rights as opposed to differences in nature or character.

In the context of trademarks and trade names, taxpayers may be able to make a similar argument to establish that two trademarks are of like kind. First, taxpayers could establish that the nature and character of the trademark rights are similar because, for example, one trademark provides the same set of legal rights and protections as another. Second, taxpayers could establish that any differences in the underlying property are not differences in nature or character but merely in degree. For example, perhaps the taxpayer could establish that the exchanged trademarks protect property in the same business area (e.g., the name of a restaurant). While it is true that the businesses cannot be exactly the same, they do not appear to differ in degree any more than a radio frequency and a television frequency.

Conclusion

CCA 200911006 appears to remove a critical barrier that had arguable support to treat exchanges of trademarks, trade names, newspaper mastheads, newspaper advertiser accounts, and newspaper subscriber accounts as like-kind exchanges. The ruling frees taxpayers to evaluate the opportunities in this area. However, taxpayers must still apply the Regs. Sec. 1.1031(a)-2(c)(1) two-part analysis:

* Are the nature and character of the rights involved the same?

* Are the nature and character of the underlying property to which the intangible property relates the same?

Taxpayers should no longer have to fight the battle of whether intangible assets are separate and distinct from goodwill/going concern value (which cannot receive like-kind treatment) but will instead be able to prove, based on the facts involved, that an intangible asset qualifies for like-kind treatment, which will provide taxpayers with more options and opportunities to prove their case.

From Andrew Petti, J.D., LL.M., Louisville, KY