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Amortize
Intangible Assets

Master the rules for systematically allocating the cost of intangible assets over their useful life: from patents and copyrights to goodwill.

CPA Regulation (REG)

What Are Intangible Assets?

Intangible assets are non-physical assets that provide economic benefit over time. Unlike buildings or equipment, you cannot touch them, but they hold real value on the balance sheet.

Patents
Exclusive rights to an invention, typically amortized over their legal or useful life.
Copyrights
Legal protection for original works, amortized over the shorter of legal or useful life.
Goodwill
Excess purchase price over fair value of net assets in a business combination.

Why Amortization Matters

Amortization is the process of systematically spreading the cost of an intangible asset over its useful life. It follows the matching principle: expense recognition should align with the periods that benefit from the asset.

Two Categories of Intangibles

Definite Life
Has a finite useful life: patents, copyrights, franchises with expiration dates. These are amortized over their useful life.
Indefinite Life
No foreseeable limit to benefit: goodwill, certain trademarks. These are not amortized but tested for impairment annually.

The Core Amortization Formula

Straight-Line Amortization
\(\text{Annual Expense} = \dfrac{\text{Cost}}{\text{Useful Life}}\)
(Residual value for intangibles is typically zero)

Amortization Over Time

$0 $30k $60k $90k $120k $150k 0 1 2 3 5 8 10 13 15 Years Book Value Book Value Annual Expense ($10k)

Section 197 Intangibles

IRC Section 197 applies to intangible assets acquired in connection with a business. These must be amortized over 15 years using the straight-line method, with no salvage value.

1
Goodwill and going-concern value
2
Workforce in place (assembled workforce)
3
Covenants not to compete (in connection with an acquisition)
4
Franchises, trademarks, and trade names
5
Customer-based intangibles (customer lists, relationships)
6
Patents, copyrights, formulas, and processes (if acquired)

GAAP vs. Tax Treatment

GAAP (ASC 350) Tax (IRC Sec 197)
Goodwill Not amortized: impairment test Amortized over 15 years
Patents Amortized over useful life Amortized over 15 years (if acquired)
Trademarks Indefinite life: impairment only Amortized over 15 years (if acquired)
Self-Created Capitalize or expense per ASC Generally not Sec 197: expense or capitalize
Method Straight-line (or pattern of benefit) Straight-line only

Non-Section 197 Exceptions

Not all intangibles fall under Section 197. These assets follow their own amortization or depreciation rules:

Computer Software
Off-the-shelf software: 36 months straight-line (or Sec 179 expensing).
Self-Created Intangibles
Generally expensed as incurred or capitalized under specific rules, not Sec 197.
Certain Rights
Mortgage servicing rights, film rights, and some financial instruments follow separate rules.

How to Apply the Rules

1
Identify the intangible. Determine what type of asset it is: patent, goodwill, trademark, covenant, etc.
2
Determine how it was obtained. Was it acquired in a business combination, or self-created?
3
Check Section 197 eligibility. Acquired intangibles in connection with a business purchase generally qualify.
4
Apply the amortization period. Section 197: 15 years. Non-197 patent: useful or legal life. Software: 36 months.
5
Calculate the annual deduction. Use \(\text{Cost} \div \text{Amortization Period}\). Prorate for partial years (monthly basis).

Example 1: Basic Section 197

A company acquires a business and allocates $300,000 of the purchase price to goodwill. The acquisition closes on July 1 of the tax year.

Example 2: Self-Created Patent

A company develops a patent internally. Legal fees and filing costs total $45,000. The patent has a remaining legal life of 18 years but an expected useful life of 9 years.

Example 3: Multiple Intangibles

A buyer acquires a business on January 1 and allocates the purchase price to several intangibles:

Asset Cost Period Annual Deduction
Goodwill $450,000 15 years $30,000
Covenant not to compete $75,000 15 years $5,000
Customer list $120,000 15 years $8,000
Off-the-shelf software $18,000 36 months $6,000

Anti-Churning Rules

Section 197 includes anti-churning provisions to prevent taxpayers from converting non-amortizable intangibles into amortizable ones through related-party transactions.

1
Applies to related-party acquisitions where the intangible was held before August 10, 1993 (the enactment date of Section 197).
2
Prevents amortization of goodwill and going-concern value acquired from related parties in certain transactions.
3
Related parties are defined broadly: >20% ownership, family members, and controlled entities under IRC Sections 267 and 707(b).

Common Mistakes

✕ Amortizing Goodwill Under GAAP
Under GAAP, goodwill is not amortized. It is only tested for impairment. This is different from tax treatment where it is amortized over 15 years.
✕ Using the Wrong Life
Section 197 intangibles always use 15 years, even if the actual useful life is shorter (e.g., a 3-year covenant not to compete).
✕ Including Self-Created Assets
Self-created intangibles (like internally developed goodwill or patents) are generally excluded from Section 197. They follow different rules.

Summary of Amortization Rules

Asset Type Sec 197? Amortization Period Method
Acquired Goodwill Yes 15 years Straight-line
Acquired Covenant Yes 15 years Straight-line
Acquired Customer List Yes 15 years Straight-line
Acquired Patent Yes 15 years Straight-line
Self-Created Patent No Shorter of legal/useful life Straight-line
Off-the-Shelf Software No 36 months Straight-line
Goodwill (GAAP) N/A Not amortized Impairment test

Question 1 of 5

A company acquires a business and allocates $225,000 to goodwill. Under IRC Section 197, what is the annual amortization deduction?

Question 2 of 5

Which of the following intangible assets is generally excluded from Section 197?

Question 3 of 5

A company acquires a covenant not to compete for $90,000 as part of a business purchase. The covenant has a contractual term of 3 years. How is it amortized for tax purposes?

Question 4 of 5

Under GAAP (ASC 350), how is acquired goodwill treated?

Question 5 of 5

A company acquires a franchise for $180,000 on April 1 as part of a business acquisition. What is the first-year Section 197 amortization deduction?