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TAM addresses like-kind exchange of intangibles.

There is relatively little IRS guidance on exchanges of intangible property under Sec. 1031. In Technical Advice Memorandum (TAM) 200224004, the IRS held Federal Communications Commission (FCC) television licenses were like-kind to FCC radio licenses, by focusing on the underlying property's fundamental nature (i.e., a portion of the electromagnetic spectrum), rather than on asset use. However, recently issued TAM 200602034 suggests a substantially more restrictive IRS attitude.

TAM 200602034

The taxpayer was a multi-tiered corporation with several subsidiary corporations. Acting through its subsidiaries, it transferred and acquired various intellectual property (IP) that included patents, trademarks, copyrights and trade secrets, in transactions it intended to qualify as Sec. 1031 like-kind exchanges. One seller of the IP that the taxpayer acquired in an exchange had facilities in a foreign country.

The taxpayer claimed like-kind exchange treatment on the IP exchanges under Sec. 1031. The IRS disallowed most of them.

Like-Kind Requirement

For intangible property, relinquished property is like-kind to the replacement property only if the Regs. Sec. 1.1031 (a)-2(c) two-prong test is met, concerning the nature or character (1) of the rights involved and (2) of the underlying property to which the intangible personal property relates. Also, according to Regs. Sec. 1.1031(a)-2(c)(2), a business's goodwill and going-concern value are not like-kind to the goodwill and the going-concern value of another business.

In TAM 200602034, the IRS discussed three categories of IP: (1) patents, (2) trade names and trademarks and (3) unregistered IP (e.g., customer lists, knowhow and other trade secrets). As to patents, it held the first prong of the test was met if a patent was exchanged for another patent. However, in applying the second prong, it rejected the taxpayer's use of the patent law classification system in grouping the exchanged patents into one of four broad groups (machine, process, manufacture and composition of matter) and instead applied the six-digit North American Industry Classification System (NAICS) product codes (applicable in determining like-class for depreciable tangible personal property) in determining whether the underlying properties were like-kind.

The IRS also concluded no trade name or trademark could be like-kind to one another, as the IP's underlying assets consist of goodwill or going concern unique to each business (consistent with the statement in the regulations). For the unregistered IP, the IRS once again rejected the taxpayer's attempts to classify them through broad categories created by the Uniform Trade Secrets Act and instead applied the second prong of the test using six-digit NAICS codes.

Observation: Although Regs. Sec. 1.1031(a)-2(c) does not import the like-class standard used for depreciable tangible personal properties to intangibles, the IRS nonetheless used the NAICS codes for this purpose. Because the like-class system is a safe harbor, taxpayers arguably should still be permitted to demonstrate they can satisfy the underlying-property prong of the test by using a like-kind standard.

Foreign Property Exchange

In TAM 200602034, the IRS confirmed Sec. 1031 (h) (2) applies to both tangible and intangible personal property, and the situs of predominant use is where the IP is licensed to be enjoyed. Because the IRS reasoned the acquired intangibles were being used predominantly in the foreign country, it concluded the acquired foreign IP was not like-kind to the transferred domestic IP.

Observation: This approach may not be suitable in all circumstances. For example, because a website may be accessed from anywhere in the world, is the situs of the server, the users, the customers or the registration of the domain name the proper situs for determining predominant use?

Identification Requirement

Sec. 1031(a)(3) allows deferred exchanges of like-kind property, provided certain identification rules are met. Generally, a taxpayer must identify either three properties (regardless of fair market values (FMVs)), or any number of properties if the aggregate FMV at the end of the identification period does not exceed 200% of the aggregate FMV of all relinquished properties. If the taxpayer exceeds the limits imposed by these two rules, the replacement property may still be like-kind if the taxpayer acquires 95% of the identified replacement property or the replacement property is received within the 45-day identification period.

In TAM 200602034, the IRS concluded that the taxpayer had not met the identification requirements for some of the properties (except for IP acquired before the end of the 45-day identification period when no formal identification is required) because the FMV of the identified replacement properties exceeded 200% of the relinquished properties' FMV. It also found certain identifications were insufficiently detailed.

Common pitfall: For purposes of the 200% rule, the FMV of the designated replacement properties is determined at the end of the identification period. However, this rule can be violated inadvertently as a result of variations that occur subsequently--for example, an adjustment to the relinquished property's sale price as a result of a purchase price allocation agreement or a purchase price adjustment, or the replacement property's worth being substantially more than anticipated.

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Title Annotation:Technical Advice Memorandum
Author:Tran, Stephanie
Publication:The Tax Adviser
Date:Jul 1, 2006
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