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Sunday, September 28, 2008


Under Code Section 1031, taxpayers can exchange property of like-kind without incurring current gain - that is, they can defer gain recognition by rolling over their tax basis into the replacement property. While most often applied to real property, such exchanges can include exchanges of trade or business property.

The goodwill or going concern value of a business is per se not property that can be like-kind and thus cannot qualify for Section 1031 nonrecognition. Therefore, in the exchange of a business property, the taxpayer needs to identify what portion of the business assets are in the nature of goodwill.

A recent article in the publication Business Entities discusses the IRS treatment of intangibles in Section 1031 exchanges. Determining which intangible assets are part of goodwill and which are not is a difficult task. The term “goodwill” has generally been defined as the expectancy of continued patronage. This expectancy may be due to the name or reputation of a trade or business or any other factor. The term “going concern value” has generally been described as the additional value that attaches to property because of its existence as an integral part of an ongoing business activity.

Prior to the enactment of Code Section 197 relating to the amortization of goodwill and other intangibles, there was frequent litigation about which intangible assets were part of goodwill. In Newark Morning Ledger, 507 US 546 , 123 L Ed 2d 288 (1993) the Supreme Court noted that the value of every intangible asset is related, to a greater or lesser degree, to the expectation that customers will continue their patronage (i.e., goodwill). Nevertheless, for purposes of amortization, the Supreme Court held that a taxpayer who is able to prove that a particular asset can be valued and has a limited useful life that can be ascertained with reasonable accuracy may still depreciate the asset's value over its useful life.

Code Section 197 ended the debate about which intangible assets were separate enough from goodwill to be amortizable. However, the issue of separateness remains for purposes of Section 1031, and the IRS continues to be expansive in categorizing intangible assets as part of related to goodwill, so as not to qualify for like-kind exchange treatment.

For example, in TAM 200602034, the IRS held that a taxpayer's trademarks and trade names were a component of goodwill or going concern value, and thus their exchange could not qualify for like-kind exchange treatment. In Memorandum 20074401F, the IRS determined that a taxpayer's advertiser accounts and subscriber accounts were closely related to goodwill and could not be distinguished from the taxpayer's trademarks and trade names, and thus were ineligible for like-kind exchange treatment.

Therefore, taxpayers engaged in Section 1031 exchanges with trade or business property can expect IRS resistance to like-kind treatment for many of the intangible assets of the business. Whether the IRS' broad sweep up of intangible assets into goodwill is legally appropriate remains to be seen.

Source: IRS Applies Expansive Definition of Goodwill for Section 1031 Purposes, Authored by Holly Belanger, Business Entities (WG&L)

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