In this video, we walk through 5 REG practice questions demonstrating how to calculate the basis of intangible assets, including start-up costs. These questions are from REG content area 3 on the AICPA CPA exam blueprints: Taxation of Property Transactions.
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
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How to Calculate the Basis of Intangible Assets, Including Start-up Costs
Calculating the tax basis of intangible assets involves determining the initial value of these assets for tax purposes. Intangible assets include non-physical assets such as patents, copyrights, trademarks, goodwill, and software. The tax basis impacts depreciation, amortization, and the calculation of gains or losses upon disposal. Here’s an overview of how to calculate the tax basis of intangible assets, including the treatment of organization costs, start-up costs, and loan costs.
1. Initial Basis of Intangible Assets
The initial basis of purchased intangible assets is usually their purchase price, including any related expenses necessary to acquire the asset and prepare it for its intended use. For intangible assets created internally, the basis may include costs directly related to the development of the asset, such as labor, materials, and a reasonable allocation of overhead.
2. Organization Costs
Organization costs are expenses related to the formation of a corporation or partnership. These can include legal fees, state incorporation fees, and costs of organizational meetings. For tax purposes, taxpayers can choose to deduct up to $5,000 of organizational costs in the year the business begins, with the remainder amortizable over a 180-month period. However, the $5,000 deduction is reduced by the amount by which the total organizational costs exceed $50,000, dollar for dollar.
3. Start-Up Costs
Start-up costs are expenses incurred before a business begins operating. They can include market research, travel related to opening the business, advertising for the opening of the business, employee training, and professional fees. Similar to organizational costs, taxpayers can elect to deduct up to $5,000 of start-up costs in the year the business begins, with the excess amounts being amortizable over 180 months. The $5,000 deduction is also reduced dollar-for-dollar by the amount by which the total start-up costs exceed $50,000.
4. Loan Costs
Loan costs, sometimes referred to as financing costs or loan origination fees, are expenses incurred to secure financing for the business. The treatment of these costs can vary. Generally, points or prepaid interest paid in connection with the acquisition of property or a business must be amortized over the life of the loan. Other loan-related expenses may be immediately deductible or capitalized and amortized, depending on their nature and the specific tax rules applicable.
Amortization of Intangible Assets
The basis of intangible assets is typically recovered over time through amortization for tax purposes. The IRS has specific rules for different types of intangible assets. For example, Section 197 intangibles (which include goodwill, going concern value, and workforce in place) are amortized on a straight-line basis over 15 years, regardless of their actual useful life.
Example:
Imagine you’ve started a new software company, Innovate Inc., and incurred the following costs:
- Purchase price of a patented technology: $100,000
- Legal fees for patent registration: $5,000
- Organization costs (legal fees for incorporation, state filing fees): $7,000
- Start-up costs (market analysis, advertising, initial employee training): $12,000
- Loan origination fees (for a $50,000 business loan over 5 years): $2,000
Calculations:
1. Initial Basis of the Patented Technology:
- Purchase price of patented technology: $100,000
- Legal fees for patent registration: $5,000
- Initial tax basis of the patented technology: $100,000 + $5,000 = $105,000
2. Organization Costs:
- Total organization costs: $7,000
- You can elect to deduct $5,000 in the first year and amortize the remaining $2,000 over 180 months ($7,000 – $5,000 = $2,000).
- Year 1 deduction: $5,000
- Remainder to be amortized over 180 months: $2,000
3. Start-Up Costs:
- Total start-up costs: $12,000
- You can elect to deduct $5,000 in the first year and amortize the remaining $7,000 over 180 months ($12,000 – $5,000 = $7,000).
- Year 1 deduction: $5,000
- Remainder to be amortized over 180 months: $7,000
4. Loan Costs:
- Total loan origination fees: $2,000
- These fees should be amortized over the life of the loan (5 years).
- To be amortized: $2,000
