Taxation of Intellectual Property Purchases

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Costs incurred by a taxpayer in acquring intellectual property may be tax deductible, depending on what type of intellectual property is invovled and how the intellectual property is acquired. This often involves Internal Revenue Code (“Code”) §§ 263(a), 197, and 167.

Code § 263(a)

Code § 263(a) specifies that expenses to acquire certain intangible assets in a sale or similar transaction are not immediately deductible. These assets are usually referred to as “capital” assets. There are a number of exceptions, but these capital asset acquisition expenses are generally added to the tax basis of the asset and the tax savings are recoverable bit-by-bit over time. Employee compensation and overhead costs related to the acquisition of intangible assets and transaction costs that do not exceed $5,000 are specifically excluded from the capitalization rules.

Code § 197

Code § 197 allows taxpayers to deduct expenses to acuire certain intangible assets. With some exceptions, these intangible assets include any patent; copyright; formula; process; design; pattern; know-how; format; package design; computer software; and interest in a film, sound recording, video tape, book or other similar property. It does not include separately acquired patents, copyrights, and computer software; redily available software; or bundled software. Moreover, Code § 197 only applies to intangible assets that are acquired after August 10, 1993 and that are held with in connection with the conduct of a trade or business or an actiity described in Code § 212. If Code § 197 applies, the taxpayer may deduct the capitalized costs ratably over a fifteen-year period. Code § 197 also prohibits the taxpayer from obtanining any other depreciation or amortization with respect to the acquired property.

Code § 167

Code § 167 allows taxpayers to deduct expenses in acquiring certain intellectual property. Code § 167 generally applies to capitalized costs associated with intellectual property if Code § 197 does not apply to the property. To be eligible for a depreciation deduction under this Code section, the property must have an ascertainable useful life and the taxpayer must be engaged in a trade or business or an activity for a profit.