Specific Asset And Allocation Of Commercial Loans

Taxpayer attempts to shift the allocation of commercial loan amortization schedule in favor of tangible personal property, i.e., machinery and equipment, over intangible property are constrained by the requirements that the allocations to specific assets reflect market value. On the other hand, the taxpayers will have an incentive to favor the allocation of the purchase price to intangibles rather than to real estate that is now depreciable over 39 years. Since the allocation is constrained by the requirement that the allocation reflect the market values of the assets, it is important that the taxpayer can defend their allocation of the purchase price of a business based on appraisals of the acquired assets.

Along the same line, it is important to value, thus assigning a basis to all assets acquired, even if they all are going to be amortized over 15 years. If the entire basis of acquired intangibles is assigned to a particular intangible such as a customer list, and a few years later another customer-based intangible acquired in the same transaction is sold, all of the proceeds would be taxable gain, since no basis was assigned to that asset.

While the new provision pertaining to customer-based intangibles is effective for all intangible assets acquired after Aug. 10, 2003, taxpayers can make one of two elections. First, taxpayers may apply the prior law to intangible assets acquired after Aug. 10, 2003, if such intangibles were acquired under a pre-existing binding written contract in effect on that date and at all times up to the acquisition.

The term "binding contract" is not defined, but the Service will probably use the same definition as in the investment transition rules of the Tax Reform Act of 1996. The second election permits taxpayers to apply the Section 197 provisions to intangible assets acquired after July 25, 2001, the date the original version of the law was introduced into Congress. If this election is made, it will apply to all intangible assets affected by Section 197 acquired by the taxpayer and all related parties under common control, as defined by Section 41. Computer software that is subject to a nonexclusive license and which has not been substantially modified is now amortizable over a 36-month period. Therefore, by making this election, all eligible software acquired after July 25, 2001, is amortized over 36 months. Even if the taxpayer has not made a business acquisition since July 25, 2001, it would be prudent to make this retroactive election in order to benefit from this reduced amortization period. Installment payments should be used for the purchase of Section 197 intangibles. Two benefits are possible if the purchase of intangibles is effected using an installment contract payable over a period of years. First, the seller may be able to use the installment method to defer the gain recognition. The purchaser will still be permitted to amortize the intangible over the 15-year period. Second, if no interest is specified in the sales contract (Section 483), interest on certain deferred payments and (Section 1272) inclusion in income of original issue discount will cause a portion of the future payments to be re-characterized as interest. Such income will be deductible over the period of the contract and not over the 15-year period, accelerating a portion of the deductions. This will benefit the buyer; however, the seller will recognize interest income over the same period.