IRS reverses field with ILM 200911006: trademarks, trade names and other customer-based intangibles are subject to 1031 exchange

In 2006 the IRS addressed the question of whether certain intangible assets were subject to Section 1031 treatment in TAM 200602034. In that case (Newark Morning Ledger Co. v. U.S., 507 U.S. 546 [1993]) the IRS adopted a very restrictive position.

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.

In March, however, the IRS issued a new Chief Counsel Advice legal memorandum (ILM 200911006) which significantly reverses the position set forth in TAM 200602034.

After giving further consideration to the issue, the IRS appears to have changed its position. Now, in line with Newark Morning Ledger Co. v. U.S., 507 U.S. 546 (1993), the IRS’s position is that “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 IRC section 1031.”

David Kostmayer of Dixon Hughes calls the ruling "a welcome reversal from the prior position taken by the Service regarding the ability to exchange certain intangible property under Section 1031." His advice:

Taxpayers engaging in the exchanging of intangibles, including business-for-business swaps, should consider the possibility of structuring the transaction as a tax-deferred exchange under Section 1031. However, any such transaction would need a valuation of the tangible property and intangibles being transferred because part of the property being transferred likely should be treated as goodwill or going concern value, which is not exchangeable under Section 1031.

If you believe your business could benefit from a 1031 exchange involving intangible assets, consult your tax advisor.

Following is the text of ILM 200911006:

Office of Chief Counsel
Internal Revenue Service

Number: 200911006
Release Date: 3/13/2009

UILC: 1031.02-00

date: February 12, 2009

to: Joyce L. Sugawara
Media and Entertainment Industry Counsel

from: Branch Chief, Branch 4, CC:ITA:4
(Income Tax & Accounting)

subject: Definition of Goodwill for purposes of § 1031 Exchanges

On January 13, 2006, the Office of Associate Chief Counsel (Income Tax & Accounting) issued technical advice (TAM 200602034) concluding that the registered trademarks and trade names of a business entity could not be of like kind to the trademarks and trade names of another business entity because they were “closely related to (if not a part of) the goodwill or going concern value of a business.” Under § 1.1031(a)-2(c)(2) of the Income Tax Regulations, the goodwill or going concern value of a business is not of like kind to the goodwill or going concern value of another business.

Using the rationale set forth in TAM 200602034, the Industry Counsel for Media (Large & Mid-Size Business) issued advice on November 2, 2007 (IRS NSAR 20074401F) concluding that (like the trademarks and trade names discussed in TAM 200602034) newspapers' mastheads, advertiser accounts and subscriber accounts were closely related to (if not a part of) the goodwill and going concern value of the newspapers. Consequently, the exchanged intangibles were not of like kind under § 1.1031(a)-2(c)(2) and the gain from the exchange was not eligible for deferral under § 1031 of the Internal Revenue Code. In reaching the conclusion, IRS NSAR 20074401F reasons that Newark Morning Ledger Co. v. U.S., 507 U.S. 546 (1993), which holds that an intangible asset is not goodwill for purposes of the depreciation rules if it can be separately described and valued apart from goodwill, is not relevant to the determination of whether intangibles are of like-kind under § 1031.