Internal Revenue Bulletin 1997-13 (PDF rendition): IRS Notices

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INCOME TAX
Rev. Rul. 97–16, page 4.
Low-income housing credit; satisfactory bond; ‘‘bond
factor’’ amounts for the period January through
March 1997.This ruling announces the monthly bond
factor amounts to be used by taxpayers who dispose of
qualified low-income buildings or interests therein during
the period January through March 1997.
T.D. 8710, page 4.
Final regulations relate to the consistency rules under
section 338 of the Code that apply to certain cases
involving controlled foreign corporations.
REG–209709–94, page 12.
Proposed regulations under sections 167 and 197 of
the Code relate to the amortization of certain intangible
property. A public hearing will be held on May 15, 1997.
EXEMPT ORGANIZATIONS
Announcement 97–27, page 30.
A list is given of organizations now classified as private
foundations.
EXCISE TAXES
Notice 97–22, page 9.
A determination has been made to add diglycidyl ether
of bisphenol-A to the list of taxable substances in
section 4672(a)(3) of the Code.
ADMINISTRATIVE
Rev. Proc. 97–22, page 9.
Books and records; electronic storage; imaging.Guid-
ance is provided for taxpayers that use an electronic
storage system (such as an imaging system) to maintain
books and records for purposes of section 6001 of the
Code.
Page 32.
Scenarios of disciplinary actions.The Office of Direc-
tor of Practice sets forth scenarios of disciplinary
actions involving individuals who represent taxpayers
before the Internal Revenue Service. The Service invites
comments.
Finding Lists begin on page 35.
Announcement of Disbarments and Suspensions begins on page 33.
Bulletin No. 1997–13
March 31, 1997
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be relied
upon as authoritative interpretations.

Mission of the Service
The purpose of the Internal Revenue Service is to
collect the proper amount of tax revenue at the least
cost; serve the public by continually improving the
quality of our products and services; and perform in a
manner warranting the highest degree of public
confidence in our integrity, efficiency and fairness.
Statement of Principles
of Internal Revenue
Tax Administration
The function of the Internal Revenue Service is to
administer the Internal Revenue Code. Tax policy
for raising revenue is determined by Congress.
With this in mind, it is the duty of the Service to
carry out that policy by correctly applying the laws
enacted by Congress; to determine the reasonable
meaning of various Code provisions in light of the
Congressional purpose in enacting them; and to
perform this work in a fair and impartial manner,
with neither a government nor a taxpayer point of view.
At the heart of administration is interpretation of the
Code. It is the responsibility of each person in the
Service, charged with the duty of interpreting the
law, to try to find the true meaning of the statutory
provision and not to adopt a strained construction in
the belief that he or she is ‘‘protecting the revenue.’’
The revenue is properly protected only when we as-
certain and apply the true meaning of the statute.
The Service also has the responsibility of applying
and administering the law in a reasonable,
practical manner. Issues should only be raised by
examining officers when they have merit, never
arbitrarily or for trading purposes. At the same
time, the examining officer should never hesitate
to raise a meritorious issue. It is also important
that care be exercised not to raise an issue or to
ask a court to adopt a position inconsistent with
an established Service position.
Administration should be both reasonable and
vigorous. It should be conducted with as little
delay as possible and with great courtesy and
considerateness. It should never try to overreach,
and should be reasonable within the bounds of law
and sound administration. It should, however, be
vigorous in requiring compliance with law and it
should be relentless in its attack on unreal tax
devices and fraud.
2

Introduction
The Internal Revenue Bulletin is the authoritative instru-
ment of the Commissioner of Internal Revenue for
announcing official rulings and procedures of the Inter-
nal Revenue Service and for publishing Treasury Deci-
sions, Executive Orders, Tax Conventions, legislation,
court decisions, and other items of general interest. It is
published weekly and may be obtained from the Superin-
tendent of Documents on a subscription basis. Bulletin
contents of a permanent nature are consolidated semi-
annually into Cumulative Bulletins, which are sold on a
single-copy basis.
It is the policy of the Service to publish in the Bulletin all
substantive rulings necessary to promote a uniform
application of the tax laws, including all rulings that
supersede, revoke, modify, or amend any of those
previously published in the Bulletin. All published rulings
apply retroactively unless otherwise indicated. Proce-
dures relating solely to matters of internal management
are not published; however, statements of internal
practices and procedures that affect the rights and
duties of taxpayers are published.
Revenue rulings represent the conclusions of the Ser-
vice on the application of the law to the pivotal facts
stated in the revenue ruling. In those based on positions
taken in rulings to taxpayers or technical advice to
Service field offices, identifying details and information
of a confidential nature are deleted to prevent unwar-
ranted invasions of privacy and to comply with statutory
requirements.
Rulings and procedures reported in the Bulletin do not
have the force and effect of Treasury Department
Regulations, but they may be used as precedents.
Unpublished rulings will not be relied on, used, or cited
as precedents by Service personnel in the disposition of
other cases. In applying published rulings and proce-
dures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be consid-
ered, and Service personnel and others concerned are
cautioned against reaching the same conclusions in
other cases unless the facts and circumstances are
substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on
provisions of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows:
Subpart A, Tax Conventions, and Subpart B, Legislation
and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and
Subparts. Also included in this part are Bank Secrecy
Act Administrative Rulings. Bank Secrecy Act Administra-
tive Rulings are issued by the Department of the
Treasury’s Office of the Assistant Secretary (Enforce-
ment).
Part IV.—Items of General Interest.
With the exception of the Notice of Proposed Rulemak-
ing and the disbarment and suspension list included in
this part, none of these announcements are consoli-
dated in the Cumulative Bulletins.
The first Bulletin for each month includes an index for
the matters published during the preceding month.
These monthly indexes are cumulated on a quarterly and
semiannual basis, and are published in the first Bulletin
of the succeeding quarterly and semi-annual period,
respectively.
The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents U.S. Government Printing Office, Washington, D.C. 20402.
3

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 42.—Low-Income Housing
Credit
Low-income housing credit; satis-
factory bond; ‘‘bond factor’’ amount
for the period January through
March 1997.This ruling announces the
monthly bond factor amounts to be used
by taxpayers who dispose of qualified
low-income buildings or interests therein
during the period January through
March 1997.
Rev. Rul. 97–16
In Rev. Rul. 90–60, 1990–2 C.B. 3,
the Internal Revenue Service provided
guidance to taxpayers concerning the
general methodology used by the Trea-
sury Department in computing the bond
factor amounts used in calculating the
amount of bond considered satisfactory
by the Secretary under § 42(j)(6) of the
Internal Revenue Code. It further an-
nounced that the Secretary would pub-
lish in the Internal Revenue Bulletin a
table of ‘‘bond factor’’ amounts for
dispositions occurring during each cal-
endar month.
This revenue ruling provides in Table
1 the bond factor amounts for calculat-
ing the amount of bond considered
satisfactory under § 42(j)(6) for disposi-
tions of qualified low-income buildings
or interests therein during the period
January through March 1997.
Table 1
Rev. Rul. 97–16
Monthly Bond Factor Amounts for Dispositions Expressed
As a Percentage of Total Credits
Calendar Year Building Placed in Service
or, if Section 42(f)(1) Election Was Made,
the Succeeding Calendar Year
Month of
Disposition
1987 1988 1989 1990 1991 1992 1993 1994 1995 19961997
Jan ’9779.70 82.08 84.67 87.70 91.25 95.32 99.53 103.58 107.56 111.85 112.52
Feb ’9779.46 81.83 84.41 87.43 90.96 95.00 99.17 103.18 107.11 111.28 112.52
Mar ’9779.23 81.59 84.15 87.16 90.67 94.69 98.83 102.81 106.69 110.79 112.52
For a list of bond factor amounts
applicable to dispositions occurring dur-
ing other calendar years, see the follow-
ing revenue rulings: Rev. Rul. 90–60,
1990–2 C.B. 3, for dispositions occur-
ring during calendar years 1987, 1988,
and 1989; Rev. Rul. 90–88, 1990–2 C.B.
7, for dispositions occurring during cal-
endar year 1990; Rev. Rul. 91–67,
1991–2 C.B. 13, for dispositions occur-
ring during calendar year 1991; Rev.
Rul. 92–101, 1992–2 C.B. 9, for dispo-
sitions occurring during calendar year
1992; Rev. Rul 93–83, 1993–2 C.B. 6,
for dispositions occurring during calen-
dar year 1993; Rev. Rul. 94–71, 1994–2
C.B. 4, for dispositions occurring during
calendar year 1994; Rev. Rul. 95–83,
1995–2 C.B. 8, for dispositions occur-
ring during calendar year 1995; Rev.
Rul. 96–16, 1996–1 C.B. 3, for disposi-
tions occurring during the period Janu-
ary through March 1996; Rev. Rul.
96–33, 1996–27 I.R.B. 4, for disposi-
tions occurring during the period April
through June 1996; Rev. Rul. 96–45,
1996–39 I.R.B. 5, for dispositions oc-
curring during the period July through
September 1996; and Rev. Rul. 96–59,
1996–50 I.R.B. 4, for dispositions oc-
curring during the period October
through December 1996.
DRAFTING INFORMATION
The principal author of this revenue
ruling is Jack Malgeri of the Office of
Assistant Chief Counsel (Passthroughs
and Special Industries). For further in-
formation regarding this revenue ruling,
contact Mr. Malgeri at (202) 622–3040
(not a toll-free call).
Section 338.—Certain Stock
Purchase Treated as Asset
Acquisitions
26 CFR 1.338–4: Asset and stock consistency.
T.D. 8710
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Revisions of the Section 338
Consistency Rules With Respect to
Target Affiliates That Are Controlled
Foreign Corporations
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations relating to the consis-
tency rules under section 338 of the
Internal Revenue Code of 1986 that are
applicable to certain cases involving
controlled foreign corporations. The fi-
nal regulations substantially revise and
simplify the stock and asset consistency
rules. The final regulations include the
provisions of the consistency rules ap-
plicable to controlled foreign corpora-
tions contained in recent proposed and
temporary regulations. The final regula-
tions would affect taxpayers that own
controlled foreign corporations.
EFFECTIVE DATE: These regulations
are effective January 20, 1997.
FOR FURTHER INFORMATION CON-
TACT: Kenneth D. Allison at (202)
622–3860 (not a toll-free number).
SUPPLEMENTARY
INFORMATION:
Background
This document contains final Income
Tax Regulations (26 CFR part 1) under
section 338 of the Internal Revenue
Code.
On January 20, 1994, temporary regu-
lations (T.D. 8516) were published in
theFederal Register(59 FR 2956)
under section 338 of the Internal Rev-
4

enue Code. See 1994–1 C.B. 119. A
notice of proposed rulemaking (INTL–
0177–90) cross-referencing the tempo-
rary regulations was published in the
Federal Registerfor the same day (59
FR 3045). See 1994–1 C.B. 818. The
temporary regulations provided rules to
replace the asset and stock consistency
rules of §§ 1.338–4T and 1.338–5T.
The temporary regulations included con-
sistency rules applicable to certain cases
involving controlled foreign corporations
(CFCs).
No written comments responding to
the notice were received. No public
hearing was requested or held. The
proposed regulations under section 338
are adopted as revised by this Treasury
decision, and the corresponding tempo-
rary regulations are removed.
Explanation of Provisions
The preamble to the temporary and
proposed regulations (1994–1 C.B. 119)
contains a discussion of the provisions.
Changes to the temporary and proposed
regulations are noted below.
Section 1.338–4T(h)(3) of the tempo-
rary regulations is clarified by stating
that the basis of the stock of a con-
trolled foreign corporate target affiliate
is not increased by section 1248 earn-
ings attributable to the disposition of an
asset in which a carryover basis is taken
under this section.
Section 1.338–4T(h)(4) of the tempo-
rary regulations addresses a situation in
which the income or gain from the
disposition of a controlled foreign cor-
poration target affiliate (CFC T affiliate)
asset is not subject to the consistency
rules of paragraph (h)(2). The regulation
states that if a CFC T affiliate pays a
dividend to a target (T) or a domestic T
affiliate wholly or partially out of the
earnings generated by the disposition of
that asset, and the dividend increases the
basis of the T stock under § 1.1502–32,
then the basis of the stock of the CFC T
affiliate is reduced by the amount of the
dividend that was paid from the earn-
ings and profits resulting from the asset
disposition. This rule applies to any
actual dividend, amount treated as a
dividend under section 1248 (or that
would have been so treated but for
section 1291) or amount included in
income under section 951(a)(1)(B).
The final regulations retain this rule.
The final regulations also add a special
ordering rule, in § 1.338–4(h)(4)(ii),
clarifying that any such dividend is first
considered attributable to earnings and
profits resulting from the disposition of
the asset.
Section 1.338–4(h)(4)(ii) is clarified
to state that the basis of the stock of a
controlled foreign corporation may not
be reduced below zero under the car-
ryover basis rules of § 1.338–4.
Section 1.338–4(h)(2)(iv)(A) and
§ 1.338–4(h)(4)(iii)(A) are added to al-
low the purchasing group in certain
instances to increase the basis of the
CFC T stock by the amount of either the
basis increase denied under § 1.338–
4(h)(2)(ii) or the basis reduction re-
quired under § 1.338–4(h)(4)(ii). The
rule applies when the purchasing group
disposes of an asset acquired from CFC
T that is subject to the consistency rules
to an unrelated party in a taxable trans-
action and includes in U.S. gross in-
come the greater of (i) the income or
gain equal to the basis amount denied to
the asset under either § 1.338–4(h)(2)(i)
or § 1.338–4(g) and § 1.338–4(h)(4)(i),
respectively, or (ii) the gain recognized
on the asset.
Similarly, § 1.338–4(h)(2)(iv)(B) and
§ 1.338–4(h)(4)(iii)(B) are added to al-
low the purchasing group to increase the
basis of an asset acquired from CFC T
that is subject to the consistency rules
by the basis amount denied to the asset
under either § 1.338–4(h)(2)(i) or
§ 1.338–4(g) and § 1.338–4(h)(4)(i).
The rule applies when the purchasing
group disposes of the stock of CFC T to
an unrelated party in a taxable transac-
tion and includes in U.S. gross income
the greater of (i) the gain equal to the
basis increase denied under § 1.338–
4(h)(2)(ii) or the basis reduction re-
quired under § 1.338–4(h)(4)(ii), respec-
tively, or (ii) the gain recognized in the
stock.
Special Analyses
It has been determined that this final
regulation is not a significant regulatory
action as defined in EO 12866. There-
fore, a regulatory assessment is not
required. It also has been determined
that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does
not apply to these regulations, and be-
cause the notice of proposed rulemaking
preceding the regulations was issued
prior to March 29, 1996 the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does
not apply. Therefore, a regulatory flex-
ibility analysis is not required. Pursuant
to section 7805(f) of the Internal Rev-
enue Code, the notice of proposed
rulemaking preceding these regulations
was submitted to the Small Business
Administration for comment on its im-
pact on small businesses.
Drafting Information
The principal author of these regula-
tions is Kenneth D. Allison of the Office
of Associate Chief Counsel (Interna-
tional), IRS. However, other personnel
from the IRS and Treasury Department
participated in their development.
*****
Adoption of Amendments to the Regula-
tions
Accordingly, 26 CFR part 1 is
amended as follows: PART 1—IN-
COME TAXES
Paragraph 1. The authority citation for
part 1 is amended by removing the entry
for Section 1.338–4T(h) to read as fol-
lows:
Authority: 26 U.S.C. 7805***
Par. 2. In § 1.338–0, the outline of
topics is amended by revising the entry
for § 1.338–4(h) and removing the entry
for § 1.338–4T to read as follows:
§ 1.338–0 Outline of topics.
*****
§ 1.338–4 Asset and stock consistency.
*****
(h) Consistency for target affiliates
that are controlled foreign corporations.
(1) In general.
(2) Income or gain resulting from
asset dispositions.
(i) General rule.
(ii) Basis of controlled foreign corpo-
ration stock.
(iii) Operating rule.
(iv) Increase in asset or stock basis.
(3) Stock issued by target affiliate
that is a controlled foreign corporation.
(4) Certain distributions.
(i) General rule.
(ii) Basis of controlled foreign corpo-
ration stock.
(iii) Increase in asset or stock basis.
(5) Examples.
*****
Par. 3. Section 1.338–4 is amended as
follows:
1. Paragraph (a)(5) is amended by
removing the language ‘‘Section 1.338–
4T(h)’’ and adding ‘‘Paragraph (h) of
this section’’ in its place.
2. Paragraph (c)(4) is amended by
removing the language ‘‘§ 1.338–
4T(h)(2)’’ and adding ‘‘paragraph (h)(2)
of this section’’ in its place.
5

3. Paragraph (d)(2)(iii) is amended by
removing the language ‘‘§ 1.338–
4T(h)(3)’’ and adding ‘‘paragraph (h)(3)
of this section’’ in its place.
4. Paragraph (g)(2) is amended by
removing the language ‘‘§ 1.338–
4T(h)(4)’’ and adding ‘‘paragraph (h)(4)
of this section’’ in its place.
5. Paragraph (h) is revised.
6. Paragraph (j)(3)9i)(A)(2) is
amended by removing the language
‘‘§ 1.338–4T(h)’’ and adding ‘‘para-
graph (h) of this section’’ in its place.
The revision reads as follows:
§ 1.338–4 Asset and stock consistency.
*****
(h)Consistency for target affiliates
that are controlled foreign corpora-
tions—(1)In general.This paragraph
(h) applies only if target is a domestic
corporation. For additional rules that
may apply with respect to controlled
foreign corporations, see paragraph (g)
of this section. The definitions and no-
menclature of § 1.338–1(b) and (c) and
paragraph (e) of this section apply for
purposes of this section.
(2)Income or gain resulting from
asset dispositions—(i)General rule.In-
come or gain of a target affiliate that is
a controlled foreign corporation from
the disposition of an asset is not re-
flected in the basis of target stock under
paragraph (c) of this section unless the
income or gain results in an inclusion
under section 951(a)(1)(A), 951(a)(1)-
(C), 1291 or 1293.
(ii)Basis of controlled foreign corpo-
ration stock.If, by reason of paragraph
(h)(2)(i) of this section, the carryover
basis rules of this section apply to an
asset, no increase in basis in the stock
of a controlled foreign corporation under
section 961(a) or 1293(d)(1), or under
regulations issued pursuant to section
1297(b)(5), is allowed to target or a
target affiliate to the extent the increase
is attributable to income or gain de-
scribed in paragraph (h)(2)(i) of this
section. A similar rule applies to the
basis of any property by reason of
which the stock of the controlled foreign
corporation is considered owned under
section 958(a)(2) or 1297(a).
(iii)Operating rule.For purposes of
this paragraph (h)(2)—
(A) If there is an income inclusion
under section 951 (a)(1)(A) or (C), the
shareholder’s income inclusion is first
attributed to the income or gain of the
controlled foreign corporation from the
disposition of the asset to the extent of
the shareholder’s pro rata share of such
income or gain; and
(B) Any income or gain under sec-
tion 1293 is first attributed to the in-
come or gain from the disposition of the
asset to the extent of the shareholder’s
pro rata share of the income or gain.
(iv)Increase in asset or stock basis—
(A) If the carryover basis rules under
paragraph (h)(2)(i) of this section apply
to an asset, and the purchasing corpora-
tion disposes of the asset to an unrelated
party in a taxable transaction and recog-
nizes and includes in its U.S. gross
income or the U.S. gross income of its
shareholders the greater of the income
or gain from the disposition of the asset
by the selling controlled foreign corpo-
ration that was reflected in the basis of
the target stock under paragraph (c) of
this section, or the gain recognized on
the asset by the purchasing corporation
on the disposition of the asset, then the
purchasing corporation or the target or a
target affiliate, as appropriate, shall in-
crease the basis of the selling controlled
foreign corporation stock subject to
paragraph (h)(2)(ii) of this section, as of
the date of the disposition of the asset
by the purchasing corporation, by the
amount of the basis increase that was
denied under paragraph (h)(2)(ii) of this
section. The preceding sentence shall
apply only to the extent that the con-
trolled foreign corporation stock is
owned (within the meaning of section
958(a)) by a member of the purchasing
corporation’s affiliated group.
(B) If the carryover basis rules under
paragraph (h)(2)(i) of this section apply
to an asset, and the purchasing corpora-
tion or the target or a target affiliate, as
appropriate, disposes of the stock of the
selling controlled foreign corporation to
an unrelated party in a taxable transac-
tion and recognizes and includes in its
U.S. gross income or the U.S. gross
income of its shareholders the greater of
the gain equal to the basis increase that
was denied under paragraph (h)(2)(ii) of
this section, or the gain recognized in
the stock by the purchasing corporation
or by the target or a target affiliate, as
appropriate, on the disposition of the
stock, then the purchasing corporation
shall increase the basis of the asset, as
of the date of the disposition of the
stock of the selling controlled foreign
corporation by the purchasing corpora-
tion or by the target or a target affiliate,
as appropriate, by the amount of the
basis increase that was denied pursuant
to paragraph (h)(2)(i) of this section.
The preceding sentence shall apply only
to the extent that the asset is owned
(within the meaning of section 958(a))
by a member of the purchasing corpora-
tion’s affiliated group.
(3)Stock issued by target affiliate
that is a controlled foreign corporation.
The exception to the carryover basis
rules of this section provided in para-
graph (d)(2)(iii) of this section does not
apply to stock issued by a target affiliate
that is a controlled foreign corporation.
After applying the carryover basis rules
of this section to the stock, the basis in
the stock is increased by the amount
treated as a dividend under section 1248
on the disposition of the stock (or that
would have been so treated but for
section 1291), except to the extent the
basis increase is attributable to the dis-
position of an asset in which a carryover
basis is taken under this section.
(4)Certain distributions—(i)General
rule.In the case of a target affiliate that
is a controlled foreign corporation, para-
graph (g) of this section applies with
respect to the target affiliate by treating
any reference to a dividend to which
section 243(a)(3) applies as a reference
to any amount taken into account under
§ 1.1502–32 in determining the basis of
target stock that is—
(A) A dividend;
(B) An amount treated as a dividend
under section 1248 (or that would have
been so treated but for section 1291); or
(C) An amount included in income
under section 951(a)(1)(B).
(ii)Basis of controlled foreign corpo-
ration stock.If the carryover basis rules
of this section apply to an asset, the
basis in the stock of the controlled
foreign corporation (or any property by
reason of which the stock is considered
owned under section 958(a)(2)) is re-
duced (but not below zero) by the sum
of any amounts that are treated, solely
by reason of the disposition of the asset,
as a dividend, amount treated as a
dividend under section 1248 (or that
would have been so treated but for
section 1291), or amount included in
income under section 951(a)(1)(B). For
this purpose, any dividend, amount
treated as a dividend under section 1248
(or that would have been so treated but
for section 1291), or amount included in
income under section 951(a)(1)(B) is
considered attributable first to earnings
and profits resulting from the disposition
of the asset.
(iii)Increase in asset or stock ba-
sis—(A) If the carryover basis rules
under paragraphs (g) and (h)(4)(i) of
6

this section apply to an asset, and the
purchasing corporation disposes of the
asset to an unrelated party in a taxable
transaction and recognizes and includes
in its U.S. gross income or the U.S.
gross income of its shareholders the
greater of the gain equal to the basis
increase denied in the asset pursuant to
paragraphs (g) and (h)(4)(i) of this sec-
tion, or the gain recognized on the asset
by the purchasing corporation on the
disposition of the asset, then the pur-
chasing corporation or the target or a
target affiliate, as appropriate, shall in-
crease the basis of the selling controlled
foreign corporation stock subject to
paragraph (h)(4)(ii) of this section, as of
the date of the disposition of the asset
by the purchasing corporation, by the
amount of the basis reduction under
paragraph (h)(4)(ii) of this section. The
preceding sentence shall apply only to
the extent that the controlled foreign
corporation stock is owned (within the
meaning of section 958(a)) by a member
of the purchasing corporation’s affiliated
group.
(B) If the carryover basis rules under
paragraphs (g) and (h)(4)(i) of this sec-
tion apply to an asset, and the purchas-
ing corporation or the target or a target
affiliate, as appropriate, disposes of the
stock of the selling controlled foreign
corporation to an unrelated party in a
taxable transaction and recognizes and
includes in its U.S. gross income or the
U.S. gross income of its shareholders
the greater of the amount of the basis
reduction under paragraph (h)(4)(ii) of
this section, or the gain recognized in
the stock by the purchasing corporation
or by the target or a target affiliate, as
appropriate, on the disposition of the
stock, then the purchasing corporation
shall increase the basis of the asset, as
of the date of the disposition of the
stock of the selling controlled foreign
corporation by the purchasing corpora-
tion or by the target or a target affiliate,
as appropriate, by the amount of the
basis increase that was denied pursuant
to paragraphs (g) and (h)(4)(i) of this
section. The preceding sentence shall
apply only to the extent that the asset is
owned (within the meaning of section
958(a)) by a member of the purchasing
corporation’s affiliated group.
(5)Examples.This paragraph (h) may
be illustrated by the following examples:
Example 1. Stock of target affiliate that is a
CFC.(a) The S group files a consolidated return;
however, T2 is a controlled foreign corporation.
On December 1 of Year 1, T1 sells the T2 stock to
P and recognizes gain. On January 2 of Year 2, P
makes a qualified stock purchase of T from S. No
section 338 election is made for T.
(b) Under paragraph (b)(1) of this section,
paragraph (d) of this section applies to the T2
stock. Under paragraph (h)(3) of this section,
paragraph (d)(2)(iii) of this section does not apply
to the T2 stock. Consequently, paragraph (d)(1) of
this section applies to the T2 stock. However, after
applying paragraph (d)(1) of this section, P’s basis
in the T2 stock is increased by the amount of T1’s
gain on the sale of the T2 stock that is treated as a
dividend under section 1248. Because P has a
carryover basis in the T2 stock, the T2 stock is not
considered purchased within the meaning of sec-
tion 338(h)(3) and no section 338 election may be
made for T2.
Example 2. Stock of target affiliate CFC; inclu-
sion under subpart F.(a) The S group files a
consolidated return; however, T2 is a controlled
foreign corporation. On December 1 of Year 1, T2
sells an asset to P and recognizes subpart F
income that results in an inclusion in T1’s gross
income under section 951(a)(1)(A). On January 2
of Year 2, P makes a qualified stock purchase of T
from S. No section 338 election is made for T.
(b) Because gain from the disposition of the
asset results in an inclusion under section
951(a)(1)(A), the gain is reflected in the basis of
the T stock as of T’s acquisition date. See
paragraph (h)(2)(i) of this section. Consequently,
under paragraph (b)(1) of this section, paragraph
(d)(1) of this section applies to the asset. In
addition, under paragraph (h)(2)(ii) of this section,
T1’s basis in the T2 stock is not increased under
section 961(a) by the amount of the inclusion that
is attributable to the sale of the asset.
(c) If, in addition to making a qualified stock
purchase of T, P acquires the T2 stock from T1 on
January 1 of Year 2, the results are the same for
the asset sold by T2. In addition, under paragraph
(h)(2)(ii) of this section, T1’s basis in the T2 stock
is not increased by the amount of the inclusion
that is attributable to the gain on the sale of the
asset. Further, under paragraph (h)(3) of this
section, paragraph (d)(1) of this section applies to
the T2 stock. However, after applying paragraph
(d)(1) of this section, P’s basis in the T2 stock is
increased by the amount of T1’s gain on the sale
of the T2 stock that is treated as a dividend under
section 1248. Finally, because P has a carryover
basis in the T2 stock, the T2 stock is not
considered purchased within the meaning of sec-
tion 338(h)(3) and no section 338 election may be
made for T2.
(d) If P makes a qualified stock purchase of T2
from T1, rather than of T from S, and T1’s gain
on the sale of T2 is treated as a dividend under
section 1248, under paragraph (h)(1) of this sec-
tion, paragraphs (h)(2) and (3) of this section do
not apply because there is no target that is a
domestic corporation. Consequently, the carryover
basis rules of paragraph do not apply to the asset
sold by T2 or the T2 stock.
Example 3. Gain reflected by reason of section
1248 dividend; gain from non-subpart F asset.(a)
The S group files a consolidated return; however,
T2 is a controlled foreign corporation. In Years 1
through 4, T2 does not pay any dividends to T1
and no amount is included in T1’s income under
section 951(a)(1)(B). On December 1 of Year 4,
T2 sells an asset with a basis of $400,000 to P for
$900,000. T2’s gain of $500,000 is not subpart F
income. On December 15 of Year 4, T1 sells T2,
in which it has a basis of $600,000, to P for
$1,600,000. Under section 1248, $800,000 of T1’s
gain of $1,000,000 is treated as a dividend.
However, in the absence of the sale of the asset by
T2 to P, only $300,000 would have been treated as
a dividend under section 1248. On December 30
of Year 4, P makes a qualified stock purchase of
T1 from T. No section 338 election is made for
T1. (b) Under paragraph (h)(4) of this section,
paragraph (g)(2) of this section applies by refer-
ence to the amount treated as a dividend under
section 1248 on the disposition of the T2 stock.
Because the amount treated as a dividend is taken
into account in determining T’s basis in the T1
stock under § 1.1502–32, the sale of the T2 stock
and the deemed dividend have the effect of a
transaction described in paragraph (g)(1) of this
section. Consequently, paragraph (d)(1) of this
section applies to the asset sold by T2 to P and P’s
basis in the asset is $400,000 as of December 1 of
Year 4.
(c) Under paragraph (h)(3) of this section, para-
graph (d)(1) of this section applies to the T2 stock
and P’s basis in the T2 stock is $600,000 as of
December 15 of Year 4. Under paragraphs (h)(3)
and (4)(ii) of this section, however, P’s basis in
the T2 stock is increased by $300,000 (the amount
of T1’s gain treated as a dividend under section
1248 ($800,000), other than the amount treated as
a dividend solely as a result of the sale of the
asset by T2 to P ($500,000)) to $900,000.
*****
§ 1.338–4T [Removed]
Par. 4. Section 1.338–4T is removed.
Par. 5. In § 1.338(i)–1, paragraphs (a)
and (b) are revised to read as follows:
§ 1.338(i)–1 Effective dates.
(a)In general.Sections 1.338–1
through 1.338–5 (except § 1.338–4(h)),
1.338(b)–1, and 1.338(h)(10)–1 gener-
ally are applicable for targets with ac-
quisition dates on or after January 20,
1994. Section 1.338–4(h) is applicable
for targets with acquisition dates on or
after January 20, 1997. Section 1.338–
4T(h) (as contained in 26 CFR part 1 as
revised April 1, 1996) is generally appli-
cable for targets with acquisition dates
on or after January 20, 1994, and before
January 20, 1997.
(b)Elective retroactive application.A
target with an acquisition date on or
after January 14, 1992 and before Janu-
ary 20, 1994 may apply §§ 1.338–1
through 1.338–5, 1.338–4T(h) (as con-
tained in 26 CFR part 1 as revised April
1, 1996), 1.338(b)–1, and 1.338(h)-
(10)–1 by including a statement with its
return (including a timely filed amended
return) for the period that includes the
acquisition date to the effect that it is
applying all of these sections pursuant
to this paragraph (b). A target with an
acquisition date on or after January 14,
1992, and before January 20, 1997, may
choose to apply § 1.338–4(h) for the
period that includes the acquisition date
pursuant to paragraph (b) of this section.
*****
7

Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved January 13, 1997.
Donald C. Lubick,
Assistant Secretary of the Treasury.
(Filed by the Office of the Federal Register on
January 22, 1997, 8:45 a.m., and published in the
issue of the Federal Register for January 23, 1997,
62 F.R. 3458)
8

Part III. Administrative, Procedural, and Miscellaneous
Tax on Certain Imported
Substances; Notice of
Determination
Notice 97–22
This notice announces a determina-
tion, under Notice 89–61, 1989–1 C.B.
717, that the list of taxable substances in
§ 4672(a)(3) will be modified to include
diglycidyl ether of bisphenol-A. This
modification is effective April 1, 1992.
Background
Under § 4672(a), an importer or ex-
porter of any substance may request that
the Secretary determine whether that
substance should be listed as a taxable
substance. The Secretary shall add the
substance to the list of taxable sub-
stances in § 4672(a)(3) if the Secretary
determines that taxable chemicals con-
stitute more than 50 percent of the
weight, or more than 50 percent of the
value, of the materials used to produce
the substance. This determination is to
be made on the basis of the predominant
method of production. Notice 89–61 sets
forth the rules relating to the determina-
tion process.
Determination
On February 24, 1997, the Secretary
determined that diglycidyl ether of
bisphenol-A should be added to the list
of taxable substances in § 4672(a)(3),
effective April 1, 1992.
The rate of tax prescribed for
diglycidyl ether of bisphenol-A, under
§ 4671(b)(3), is $7.08 per ton. This is
based upon a conversion factor for ben-
zene of 0.459, a conversion factor for
propylene of 0.494, a conversion factor
for chlorine of 0.833, and a conversion
factor for sodium hydroxide of 0.705.
The petitioner is Dow Chemical Com-
pany, a manufacturer and exporter of
this substance. No material comments
were received on this petition. The fol-
lowing information is the basis for the
determination.
HTS number: 3907.3
CAS number: 025085–99–8
Diglycidyl ether of bisphenol-A
(DGEBA) is derived from the taxable
chemicals benzene, propylene, chlorine,
and sodium hydroxide and produced
predominantly from epichlorohydrin and
bisphenol-A via a two-step reaction.
The stoichiometric material consump-
tion formula for this substance is:
2C
6
H
6
(benzene)+4C
3
H
6
(propylene)+4Cl
2
(chlorine) + 6 NaOH (sodium hydroxide)+2O
2
2
(oxygen) -----.(CH
3
)
2
C(C
6
H
4
OC
3
H
5
0)
2
(DGEBA) + CH
3
COCH
3
(acetone)+2HCl
(hydrogen chloride) + 6 NaCl (sodium chloride) +
5H
2
O (water)
Diglycidyl ether of bisphenol-A has
been determined to be a taxable sub-
stance because a review of its
stoichiometric material consumption for-
mula shows that, based on the predomi-
nant method of production, taxable
chemicals constitute 92.95 percent by
weight of the materials used in its
production.
The principal author of this notice is
Ruth Hoffman, Office of Assistant Chief
Counsel (Passthroughs and Special In-
dustries). For further information regard-
ing this notice contact Ruth Hoffman on
(202) 622–3130 (not a toll-free number).
26 CFR 601.105 Examination of returns and
claims for refund, credits or abatement; determi-
nation of correct tax liability.
(Also Part I, Section 6001; 1.6001–1.)
Rev. Proc. 97–22
SECTION 1. PURPOSE
This revenue procedure provides
guidance to taxpayers that maintain
books and records by using an elec-
tronic storage system that either images
their hardcopy (paper) books and
records, or transfers their computerized
books and records, to an electronic
storage media, such as an optical disk.
Records maintained in an electronic
storage system that complies with the
requirements of this revenue procedure
will constitute records within the mean-
ing of § 6001 of the Internal Revenue
Code.
SECTION 2. BACKGROUND
.01 Section 6001 provides that every
person liable for any tax imposed by the
Code, or for the collection thereof, must
keep such records, render such state-
ments, make such returns, and comply
with such rules and regulations as the
Secretary may from time to time pre-
scribe. Whenever necessary, the Secre-
tary may require any person, by notice
served upon that person or by regula-
tions, to make such returns, render such
statements, or keep such records, as the
Secretary deems sufficient to show
whether or not that person is liable for
tax.
.02 Section 1.6001–1(a) of the In-
come Tax Regulations provides that,
except for farmers and wage-earners,
any person subject to income tax, or any
person required to file a return of infor-
mation with respect to income, must
keep such books and records, including
inventories, as are sufficient to establish
the amount of gross income, deductions,
credits, or other matters required to be
shown by that person in any return of
such tax or information.
.03 Section 1.6001–1(e) provides that
the books or records required by § 6001
must be kept available at all times for
inspection by authorized internal rev-
enue officers or employees, and must be
retained so long as the contents thereof
may become material in the administra-
tion of any internal revenue law.
SECTION 3. SCOPE
.01 This revenue procedure applies to
taxpayers who maintain books and
records using an ‘‘electronic storage
system.’’ An electronic storage system is
a system to prepare, record, transfer,
index, store, preserve, retrieve, and re-
produce books and records by either:
(1) electronically imaging hardcopy
documents to an electronic storage me-
dia; or
(2) transferring computerized
books and records to an electronic stor-
age media using a technique such as
‘‘COLD’’ (computer output to laser
disk), which allows books and records
to be viewed or reproduced without the
use of the original program.
.02 The requirements of this revenue
procedure pertain to all matters under
the jurisdiction of the Commissioner of
Internal Revenue including, but not lim-
ited to, income, excise, employment,
and estate and gift taxes, as well as
employee plans and exempt organiza-
tions.
.03 A taxpayer’s use of a third party
(such as a service bureau or time-
sharing service) to provide the taxpayer
with an electronic storage system for its
books and records does not relieve the
taxpayer of the responsibilities described
in this revenue procedure.
.04 Except as otherwise provided in
this revenue procedure, all requirements
of § 6001 that apply to hardcopy books
and records apply as well to books and
records that are stored electronically
pursuant to this revenue procedure.
9

SECTION 4. ELECTRONIC
STORAGE SYSTEM
REQUIREMENTS
.01General Requirements.
(1) An electronic storage system
must ensure an accurate and complete
transfer of the hardcopy or computerized
books and records to an electronic stor-
age media. The electronic storage sys-
tem must also index, store, preserve,
retrieve, and reproduce the electronically
stored books and records.
(2) An electronic storage system
must include:
(a) reasonable controls to ensure
the integrity, accuracy, and reliability of
the electronic storage system;
(b) reasonable controls to pre-
vent and detect the unauthorized cre-
ation of, addition to, alteration of, dele-
tion of, or deterioration of electronically
stored books and records;
(c) an inspection and quality as-
surance program evidenced by regular
evaluations of the electronic storage sys-
tem including periodic checks of elec-
tronically stored books and records;
(d) a retrieval system that in-
cludes an indexing system (within the
meaning of section 4.02 of this revenue
procedure); and
(e) the ability to reproduce leg-
ible and readable hardcopies (within the
meaning of section 4.01(3) of this rev-
enue procedure) of electronically stored
books and records.
(3) All books and records repro-
duced by the electronic storage system
must exhibit a high degree of legibility
and readability when displayed on a
video display terminal and when repro-
duced in hardcopy. The term ‘‘legibil-
ity’’ means the observer must be able to
identify all letters and numerals posi-
tively and quickly to the exclusion of all
other letters or numerals. The term
‘‘readability’’ means that the observer
must be able to recognize a group of
letters or numerals as words or complete
numbers. The taxpayer must ensure that
the reproduction process maintains the
legibility and readability of the elec-
tronically stored document.
(4) The information maintained in
an electronic storage system must pro-
vide support for the taxpayer’s books
and records (including books and
records in an automated data processing
system). For example, the information
maintained in an electronic storage sys-
tem and the taxpayer’s books and
records must be cross-referenced in a
manner that provides an audit trail be-
tween the general ledger and the source
document(s).
(5) For each electronic storage sys-
tem used, the taxpayer must maintain,
and make available to the Service upon
request, complete descriptions of:
(a) the electronic storage system,
including all procedures relating to its
use; and
(b) the indexing system (see sec-
tion 4.02 of this revenue procedure).
(6) At the time of an examination,
or for the tests described in section 5 of
this revenue procedure, the taxpayer
must:
(a) retrieve and reproduce (in-
cluding hardcopies if requested) elec-
tronically stored books and records; and
(b) provide the Service with the
resources (e.g., appropriate hardware
and software, personnel, documentation,
etc.) necessary to locate, retrieve, read,
and reproduce (including hardcopies)
any electronically stored books and
records.
(7) An electronic storage system
must not be subject, in whole or in part,
to any agreement (such as a contract or
license) that would limit or restrict the
Service’s access to and use of the
electronic storage system on the taxpay-
er’s premises (or any other place where
the electronic storage system is main-
tained), including personnel, hardware,
software, files, indexes, and software
documentation.
(8) The taxpayer must retain elec-
tronically stored books and records so
long as their contents may become ma-
terial in the administration of the Inter-
nal Revenue laws under § 1.6001–1(e).
(9) The taxpayer may use more
than one electronic storage system. In
that event, each electronic storage sys-
tem must meet the requirements of this
revenue procedure. Electronically stored
books and records that are contained in
an electronic storage system with re-
spect to which the taxpayer ceases to
maintain the hardware and the software
necessary to satisfy the conditions of
this revenue procedure will be deemed
destroyed by the taxpayer, unless the
electronically stored books and records
remain available to the Service in con-
formity with this revenue procedure.
(10) Taxpayers may use reasonable
data compression or formatting tech-
nologies as part of their electronic stor-
age system so long as the requirements
of this revenue procedure are satisfied.
.02Requirements of an Indexing Sys-
tem.
(1) For purposes of this revenue
procedure, an ‘‘indexing system’’ is a
system that permits the identification
and retrieval for viewing or reproducing
of relevant books and records main-
tained in an electronic storage system.
For example, an indexing system might
consist of assigning each electronically
stored document a unique identification
number and maintaining a separate data-
base that contains descriptions of all
electronically stored books and records
along with their identification numbers.
In addition, any system used to main-
tain, organize, or coordinate multiple
electronic storage systems is treated as
an indexing system under this revenue
procedure. The requirement to maintain
an indexing system will be satisfied if
the indexing system is functionally com-
parable to a reasonable hardcopy filing
system. The requirement to maintain an
indexing system does not require that a
separate electronically stored books and
records description database be main-
tained if comparable results can be
achieved without a separate description
database.
(2) Reasonable controls must be
undertaken to protect the indexing sys-
tem against the unauthorized creation of,
addition to, alteration of, deletion of, or
deterioration of any entries.
.03Recommended Practices.The
implementation of records management
practices is a business decision that is
solely within the discretion of the tax-
payer. Records management practices
may include the labeling of electroni-
cally stored books and records, provid-
ing a secure storage environment, creat-
ing back-up copies, selecting an off-site
storage location, retaining hardcopies of
books or records that are illegible or
that cannot be accurately or completely
transferred to an electronic storage sys-
tem, and testing to confirm records
integrity.
SECTION 5. DISTRICT DIRECTOR
TESTING
.01 The District Director may peri-
odically initiate tests of a taxpayer’s
electronic storage system. These tests
may include an evaluation (by actual
use) of a taxpayer’s equipment and
software, as well as the procedures used
by a taxpayer to prepare, record, trans-
fer, index, store, preserve, retrieve, and
reproduce electronically stored docu-
ments. In some instances, the District
10

Director may choose to review the inter-
nal controls, security procedures, and
documentation associated with the tax-
payer’s electronic storage system.
.02 The tests described in section
5.01 of this revenue procedure are not
an ‘‘examination,’’ ‘‘investigation,’’ or
‘‘inspection’’ of the books and records
within the meaning of § 7605(b), or a
prior audit for purposes of § 530 of the
Revenue Act of 1978, 1978–3 (Vol.1)
C.B. 119, as amended by § 1122 of the
Small Business Job Protection Act of
1996, because these tests are not directly
related to the determination of the tax
liability of a taxpayer for a particular
taxable period.
.03 The District Director must inform
the taxpayer of the results of any tests
under this section.
SECTION 6. COMPLIANCE
.01 A taxpayer’s electronic storage
system that meets the requirements of
this revenue procedure will be treated as
being in compliance with the
recordkeeping requirements of § 6001
and the regulations thereunder.
.02 A taxpayer’s electronic storage
system that fails to meet the require-
ments of this revenue procedure may be
treated as not being in compliance with
the recordkeeping requirements of
§ 6001 and the regulations thereunder.
See section 9 of this revenue procedure
for applicable penalties. However, even
though a taxpayer’s electronic storage
system fails to meet the requirements of
this revenue procedure, the penalties
described in section 9 of this revenue
procedure may not apply if the taxpayer
maintains its original books and records,
or maintains its books and records in
micrographic form in conformity with
Rev. Proc. 81–46, 1981–2 C.B. 621.
SECTION 7. DESTRUCTION AND
DELETION OF ORIGINAL BOOKS
AND RECORDS
This revenue procedure permits the
destruction of the original hardcopy
books and records and the deletion of
the original computerized records (other
than ‘‘machine-sensible’’ records re-
quired to be retained by Rev. Proc.
91–59, 1991–2 C.B. 841), after the
taxpayer:
(1) has completed its own testing
of the electronic storage system that
establishes that hardcopy or computer-
ized books and records are being repro-
duced in compliance with all the provi-
sions of this revenue procedure; and
(2) has instituted procedures that
ensure its continued compliance with all
the provisions of this revenue procedure.
SECTION 8. IMPACT ON
MACHINE-SENSIBLE RECORDS
The provisions of this revenue proce-
dure regarding electronically stored
books and records do not relieve taxpay-
ers of the responsibility of retaining any
other books and records required to be
retained under § 6001. Such other
books and records may include
‘‘machine-sensible’’ records required to
be retained by Rev. Proc. 91–59 in
connection with the taxpayer’s use of an
automatic data processing (ADP) sys-
tem.
SECTION 9. PENALTIES
The District Director may issue a
Notice of Inadequate Records pursuant
to § 1.6001–1(d) if the taxpayer’s books
and records are available only as elec-
tronically stored books and records and
the taxpayer’s electronic storage system
fails to meet the requirements of this
revenue procedure. Taxpayers whose
electronic storage system fails to meet
the requirements of this revenue proce-
dure may also be subject to applicable
penalties under subtitle F of the Code,
including the § 6662(a) accuracy-related
civil penalty and the § 7203 willful
failure criminal penalty.
SECTION 10. INTERNAL REVENUE
SERVICE OFFICE CONTACT
.01 Questions regarding this revenue
procedure should be directed to the
Office of the Assistant Commissioner
(Examination). The telephone number
for this office is (202) 622–5480 (not a
toll-free number). Written questions
should be addressed to: Assistant Com-
missioner (Examination)
Attention: CP:EX
Internal Revenue Service
1111Constitution Ave., NW
Washington, DC 20224
.02 Questions regarding the applica-
tion of this revenue procedure to a
specific factual situation should be di-
rected to the appropriate District Direc-
tor.
SECTION 11. PAPERWORK
REDUCTION ACT
The collections of information con-
tained in this revenue procedure have
been reviewed and approved by the
Office of Management and Budget in
accordance with the Paperwork Reduc-
tion Act (44 U.S.C. 3507) under control
number 1545–1533.
An agency may not conduct or spon-
sor, and a person is not required to
respond to, a collection of information
unless the collection of information dis-
plays a valid control number.
The collections of information are in
sections 4 and 5 of this revenue proce-
dure. This information is required to
ensure that records maintained in an
electronic storage system will constitute
records within the meaning of § 6001.
The collections of information are man-
datory for a taxpayer who chooses to
electronically store its books and
records. The likely respondents are indi-
viduals, state or local governments,
farms, business or other for-profit insti-
tutions, federal agencies or employees,
nonprofit institutions, and small busi-
nesses or organizations.
The estimated total annual record-
keeping burden is 1,000,400 hours.
The estimated annual burden per
recordkeeper will vary from 20 hours to
22 hours, depending on individual cir-
cumstances, with an estimated average
of 20 hours. The estimated number of
recordkeepers is 50,000.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become ma-
terial in the administration of any inter-
nal revenue law. Generally tax returns
and tax return information are confiden-
tial, as required by 26 U.S.C. 6103.
11

Part IV. Items of General Interest
Notice of Proposed Rulemaking
and Notice of Public Hearing
Amortization of Intangible Property
REG–209709–94
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing and notice of public hearing.
SUMMARY: This document contains
proposed regulations relating to the am-
ortization of certain intangible property.
The proposed regulations reflect changes
to the law made by the Omnibus Budget
Reconciliation Act of 1993 (OBRA ’93),
and affect taxpayers who acquired intan-
gible property after August 10, 1993, or
made a retroactive election to apply
OBRA ’93 to intangibles acquired after
July 25, 1991. This document also pro-
vides notice of a public hearing on the
proposed regulations.
DATES: Comments must be received
by April 16, 1997. Requests to appear
and outlines of oral comments to be
presented at the public hearing sched-
uled for May 15, 1997, must be re-
ceived by April 24, 1997.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (REG–209709–94),
room 5228, Internal Revenue Service,
POB 7604, Ben Franklin Station, Wash-
ington, DC 20044. Submissions may be
hand delivered between the hours of 8
a.m. and 5 p.m. to: CC:DOM:CORP:R
(REG–209709–94), Courier’s Desk, In-
ternal Revenue Service,1111Constitu-
tion Avenue NW, Washington, DC. Al-
ternatively, taxpayers may submit
comments electronically via the Internet
by selecting the ‘‘Tax Regs’’ option of
the IRS Home Page, or by submitting
comments directly to the IRS Internet
site at http:\\www.irs.ustreas.gov\prod\
tax_regs\comments.html. The public
hearing will be held in the Commission-
er’s Conference Room (Room 3313),
Internal Revenue Building,1111Consti-
tution Avenue NW, Washington, DC
20224.
FOR FURTHER INFORMATION
CONTACT: Concerning the regulations,
John Huffman at (202) 622–3110; con-
cerning submissions and the hearing,
Michael Slaughter at (202) 622–8452
(not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed
regulations under sections 167(f) and
197. These provisions were added to the
Internal Revenue Code of 1986 (the
Code) by section 13261 of OBRA ’93,
and apply to intangible property ac-
quired after August 10, 1993 (or after
July 25, 1991, if a valid retroactive
election to apply OBRA ’93 to intan-
gibles has been made pursuant to
§ 1.197–1T).
The proposed regulations provide
definitions and rules for amortization of
intangible property subject to sections
197 and 167(f). On June 24, 1994, the
IRS published Announcement 94–92
(1994–28 I.R.B. 139) in theFederal
Register(59 FR 32670) inviting com-
ments under section 197 relating to the
amortization of goodwill and certain
other intangibles that should be ad-
dressed in proposed regulations. The
IRS has reviewed these comments and
has addressed certain issues raised in the
comments in the proposed regulations.
However, because these comments were
received in anticipation of the issuance
of these proposed regulations, and be-
cause these regulations are subject to
further comment and a public hearing,
no attempt has been made to describe
all of the principal comments that are
not reflected in these regulations or the
reasons therefor.
Explanation of Provisions
1.General overview
Sections 167(f) and 197 provide com-
prehensive rules for the depreciation and
amortization of many intangible assets.
Intangible assets subject to section 197
are broadly defined to include most
intangible assets acquired in connection
with the acquisition of a trade or busi-
ness and certain other separately ac-
quired intangible assets. The adjusted
basis of an amortizable section 197
intangible must be amortized over a
15-year period. Certain other intangible
assets are excluded from section 197 for
various reasons. In some cases, such as
stock and partnership interests, the asset
is property of a character that is not
subject to an allowance for depreciation
because it represents a permanent in-
vestment that can only be recovered
through disposition of the asset (includ-
ing worthlessness). In other cases, such
as computer software, purchased mort-
gage servicing rights, service and supply
contracts, and certain other contracts or
rights with a fixed duration, other cost
recovery methods were prescribed by
the OBRA ’93 amendments. In still
other cases, such as motion picture
films, television series, books, and
sound recordings, other cost recovery
methods that were in effect prior to
OBRA ’93 are more appropriate under
the circumstances. Section 167(f) pro-
vides alternative methods of deprecia-
tion for certain of the intangibles ex-
cluded from the application of section
197.
The proposed regulations provide
guidance for certain intangible property
subject to sections 167(f) and 197. The
section 167(f) proposed regulations pro-
vide rules for intangible property subject
to the allowance for depreciation under
section 167 and specifically excluded
from section 197. These intangible as-
sets include certain computer software,
rights to receive tangible property or
services, rights of fixed duration, pat-
ents, copyrights, and mortgage servicing
rights. These proposed regulations re-
serve guidance on the method of depre-
ciating the cost of separately acquired
rights to receive tangible property or
services where the amount of the prop-
erty or services to be received is not
specified. The IRS invites comments on
possible methods of depreciation in
these cases.
Because section 197 provides a
method of amortization and, except in
the case of certain covenants not to
compete, governmental licenses, permits
and other rights, and contracts for the
use of section 197 intangibles, does not
alter the rules for determining the basis
of an asset, section 197 generally does
not apply to amounts that would other-
wise be deductible. For example, section
197 does not generally apply to the
costs of advertising because, in most
cases, these costs are deductible under
other provisions of the Code. See Rev.
Rul. 92–80 (1992–2 C.B. 57). In addi-
tion, section 197 does not apply to costs
that would not, under general principles
of Federal income tax law, be included
in the basis of a section 197 intangible.
For example, if a taxpayer borrows
money to purchase the assets of a trade
or business (including amortizable sec-
tion 197 intangibles) and incurs fees in
connection with the loan, these costs are
12

generally amortized over the term of the
loan rather than under the rules of
sections 167(f) and 197. As a further
example, if the amortizable section 197
intangibles acquired in the transaction
include a favorable supply contract, the
amortizable basis in the contract does
not include amounts required to be paid
for goods to be received pursuant to the
contract.
In addition, section 197 does not
apply to any amount for which a deduc-
tion would be disallowed under other
provisions of the Code, such as section
162(k) (relating to amounts paid or
incurred by a corporation in connection
with the acquisition of its stock or the
stock of a related person).
No inference should be drawn from
any provision in the proposed regula-
tions concerning the classification of
any section 197 intangible as property,
or whether any section 197 intangible is
treated as tangible or intangible prop-
erty, for other purposes of the Code.
Furthermore, no inference should be
drawn from any provision in the pro-
posed regulations regarding (a) whether
any section 197 intangible that is not an
amortizable section 197 intangible may
be amortized or depreciated under any
provision of the Code other than section
197, or (b) the proper method for deter-
mining any allowance therefor. Finally,
no inference should be drawn from any
provision in the proposed regulations
concerning whether any section 197 in-
tangible (or any interest therein) has
been purchased, leased, or licensed for
Federal income tax purposes.
2.Section 197 intangibles
The proposed regulations define sec-
tion 197 intangibles (subject to certain
exceptions) as goodwill, going concern
value, workforce in place, information
base, know-how, customer- and supplier-
based intangibles, governmental licenses
and permits, covenants not to compete
and other similar arrangements, fran-
chises, trademarks, trade names, and
contracts for the use of the foregoing
assets.
A. Covenants not to Compete
Some commentators in response to
Announcement 94–92 suggested that a
covenant not to compete relating to the
redemption of stock or a partnership
interest from a departing stockholder or
partner should be excluded from section
197 because this situation does not
involve the acquisition of a trade or
business. The legislative history pro-
vides, however, that section 197 applies
to a covenant not to compete acquired
with the assets of a trade or business,
the stock in a corporation, or an interest
in a partnership engaged in a trade or
business. Consequently, the proposed
regulations do not provide for this ex-
ception. In this regard, the proposed
regulations provide that for purposes of
section 197(f)(1)(B), the disposition or
cancellation of redeemed stock of a
corporation will not cause the covenant
to be written off faster than over the
15-year amortization period provided for
under section 197 (in the case of a
covenant to which section 162(k) does
not apply).
B. Contracts for the Use of Section 197
Intangibles
Some commentators also requested
guidance on the extent to which con-
tracts for the use of section 197 intan-
gibles would be subject to section 197,
in some cases suggesting that an intan-
gible was not subject to section 197
unless the taxpayer obtained ownership
of property for Federal income tax pur-
poses. However, it is sometimes difficult
to determine whether the terms of an
agreement confer ownership, for Federal
income tax purposes, of property, and
the IRS and Treasury believe that the
purposes of section 197 could be cir-
cumvented through the use of such
agreements. Accordingly, the proposed
regulations provide that contracts for the
use of section 197 intangibles will also
be treated as section 197 intangibles.
Contracts that are so treated may, how-
ever, be excluded under either section
197(e)(4)(B) or (D) on the basis that
they are contracts for the receipt of
property or services, contracts having a
fixed duration, or contracts having a
fixed amount and recovered on a unit-
of-production method or other similar
method.
3.Intangibles excluded from section
197
A. Computer Software
Section 197 intangibles do not include
computer software that is readily avail-
able for purchase by the general public,
is subject to a nonexclusive license, and
has not been substantially modified. The
proposed regulations provide a safe har-
bor for purposes of determining whether
computer software has been substan-
tially modified. Under the safe harbor,
computer software has not been substan-
tially modified if its capitalized cost
does not exceed the greater of $2,000 or
125 percent of the price at which the
unmodified version of the software is
readily available to the general public.
The proposed regulations incorporate
some of the provisions of Revenue
Procedure 69–21 (1969–2 C.B. 303),
involving the treatment of costs of com-
puter software, and modify other provi-
sions to the extent necessary to conform
to the amortization rules provided under
sections 197 and 167(f). Consequently,
if costs for developing computer soft-
ware that the taxpayer has elected to
treat as deferred expenses under section
174(b) result in the development of a
self-created intangible excluded under
section 197(c)(2) and subject to the
allowance for depreciation under section
167(a), deductions for the unrecovered
expenditures are subject to section
167(f)(1). Computer software costs in-
cluded, without being separately stated,
in the cost of the computer hardware
(bundled software) continue to be capi-
talized and depreciated as part of the
computer hardware. The proposed regu-
lations also continue to treat as currently
deductible software costs properly and
consistently treated as deductible (not
capitalized) under § 1.162–11.
B. Certain Separately Acquired
Intangibles
Certain intangibles are excepted from
section 197 if they are not acquired as
part of a purchase of a trade or business.
The proposed regulations clarify that,
for purposes of section 197, a group of
assets constitutes a trade or business if
their use would constitute a trade or
business under section 1060; that is, if
goodwill or going concern value could
under any circumstances attach to the
assets. Temporary and proposed regula-
tions under section 1060, in turn, pro-
vide that a group of assets constitutes a
trade or business for purposes of section
1060 if the use of such assets would
constitute an active trade or business for
purposes of section 355. However, in
appropriate cases, even if the use of a
group of assets would not constitute an
active trade or business for purposes
of section 355, such assets may never-
theless constitute a trade or business
for purposes of section 1060. See
§ 1.1060–1T(b)(2).
The IRS intends to provide additional
guidance as to the circumstances under
which the acquisition of a group of
13

assets constitutes a trade or business for
purposes of section 1060 in regulations
under that section. Accordingly, the pro-
posed regulations do not provide sub-
stantive guidance on this question, ex-
cept to the extent that the considerations
are unique to the application of section
197. The IRS invites comments on the
extent to which additional rules under
section 197 may be necessary.
C. Certain Contracts and Governmental
Rights
While section 197 intangibles include
licenses, permits, and other rights
granted by a governmental unit or an
agency or instrumentality thereof (sec-
tion 197(d)(1)(D)), certain rights granted
by these governmental entities are ex-
cluded from section 197 pursuant to
section 197(e)(4)(B) and (D), subject to
the conditions and limitations therein.
Because a particular right may be de-
scribed in two or more of these provi-
sions, the proposed regulations provide
guidance regarding the potential conflict
between, or overlap with, these provi-
sions. Thus, a right that would be
subject to section 197 pursuant to sec-
tion 197(d)(1)(D) may nevertheless be
excluded if it is also described in sec-
tion 197(e)(4) and meets all of the
requirements for exclusion. Furthermore,
a right that meets the requirements of
either section 197(e)(4)(B) or section
197(e)(4)(D) is excluded from section
197 even if it fails to meet one of the
requirements for the other exclusion. In
addition, any license, permit, or other
right granted by a governmental unit
that otherwise meets the definition of a
franchise under section 197(d)(1)(F),
such as an FCC broadcast license or
cable television franchise, is treated as a
franchise under the regulations. Accord-
ingly, these licenses do not qualify for
any of the exceptions from section 197
provided under section 197(e)(4).
4.Special rules of application
A. Loss Disallowance Provisions
The proposed regulations contain
rules for the loss disallowance provi-
sions set forth in section 197(f)(1). In
particular, the proposed regulations pro-
vide that a taxpayer may not circumvent
the loss disallowance rules, for example,
by transferring some intangibles, whose
adjusted basis is greater than their fair
market value, to a corporation in ex-
change for stock in the corporation in a
transaction described in section 351,
while retaining other intangibles ac-
quired in the same or related transaction,
and then selling the stock. Special rules
are also provided for the application of
the loss disallowance provisions in cases
where a taxpayer has disposed of all of
the amortizable section 197 intangibles
acquired in a single transaction but is
treated as having retained other amortiz-
able section 197 intangibles solely by
virtue of the retention of amortizable
section 197 intangibles by a related
person.
B. Transactions Involving Partnerships
The proposed regulations provide
rules and examples relating to the treat-
ment of section 197 intangibles acquired
or transferred in certain partnership
transactions, including terminations un-
der section 708(b)(1), and the applica-
tion of section 197 to the special basis
adjustments of partnership property for
which a section 754 or section 732(d)
election is in effect. Guidance is also
provided regarding the effect of curative
and remedial allocations and the appli-
cation of the anti-churning rules to cer-
tain partnership transactions.
In the case of the termination of a
partnership under section 708(b)(1)(B)
(relating to a sale or exchange of an
interest), the rules contained in the pro-
posed regulations are based on recently
proposed regulations under that section,
pursuant to which the new partnership is
treated as having directly acquired the
assets of the old partnership in exchange
for the assumption of its liabilities and
the issuance of interests in the new
partnership. Accordingly, for purposes of
section 197, the consequences of the
termination of a partnership under sec-
tion 708(b)(1)(B) may not be the same
as the consequences of such a termina-
tion under the rules in effect at the time
section 197 was enacted.
C. Treatment of Contingent Payments
The proposed regulations clarify that,
except in the case of contingent pay-
ments, amounts paid for section 197
intangibles are treated as amounts
chargeable to capital account, and the
entire principal amount is amortized
ratably over the 15-year amortization
period beginning with the later of the
month in which the intangible is ac-
quired or the date on which the active
conduct of a trade or business begins.
Contingent payments for section 197
intangibles paid or incurred after the
taxable year in which the intangible is
acquired are added to basis at such time
and generally amortized ratably over the
remaining months in the 15-year period
as of the beginning of the month the
amount is paid or incurred. However, in
order to reduce the administrative bur-
den that may result from a requirement
to maintain separate amortization sched-
ules for each month during the 15-year
period, taxpayers are permitted to use
certain simplifying conventions. In addi-
tion, any amount that is not properly
included in the basis of an amortizable
section 197 intangible until after the
expiration of the 15-year period is amor-
tized in full immediately upon the inclu-
sion of the amount in the basis of the
intangible. The proposed regulations re-
fer to § 1.461–1(a)(1) for rules govern-
ing the time at which an amount may be
taken into account by a taxpayer using
the cash receipts and disbursements
method. They refer to § 1.461–1(a)(2)
for rules governing the time at which a
liability is incurred and generally taken
into account (for example, by treating
the amount of the liability as a capital
expenditure) by an accrual basis tax-
payer.
5.Anti-churning Rules
To be eligible for amortization, sec-
tion 197 intangibles must qualify as
amortizable section 197 intangibles.
Generally, amortizable section 197 in-
tangibles are section 197 intangibles that
are acquired after August 10, 1993 (or
acquired after July 25, 1991, and for
which the taxpayer made a proper elec-
tion under § 1.197–1T) and held in
connection with the conduct of a trade
or business or an activity described in
section 212.
The proposed regulations provide
anti-churning rules to prevent taxpayers
from converting into amortizable section
197 intangibles existing goodwill, going
concern value, and any other section
197 intangible for which amortization
would not have been allowable prior to
OBRA ’93 through the use of related
persons and certain other transactions.
The proposed regulations define the
term related person for purposes of
these rules.
The proposed regulations also contain
provisions for the exception to the anti-
churning rules in situations where the
seller elects to recognize gain and
agrees to pay a specified amount of tax.
The regulations reserve guidance on the
manner of making this election. The IRS
intends to issue a revenue procedure in
14

order to provide interim guidance to
taxpayers on the manner of making this
election, and the final regulations will
include the relevant provisions of this
revenue procedure.
The proposed regulations contain both
an anti-churning anti-abuse rule and a
general anti-abuse rule that provide that
the Commissioner may recast any trans-
action if one of its principal purposes is
to avoid the purposes of section 197.
6.Assumption Reinsurance Transactions
Section 197(f)(5) provides special
rules for section 197 intangibles result-
ing from assumption reinsurance trans-
actions. The proposed regulations re-
serve guidance on certain aspects of
these transactions. The IRS invites com-
ments on the extent to which additional
guidance on the application of section
197 to these transactions may be neces-
sary.
7.Proposed Effective Dates
The regulations for sections 167(f)
and 197 are proposed to be effective on
the date on which the final regulations
are published in theFederal Register.
Regulations to implement section
197(e)(4)(D) (separately acquired con-
tracts of fixed duration or amount) are
proposed to be effective August 11,
1993, for property acquired after August
10, 1993 (or July 26, 1991, if a valid
retroactive election has been made under
§ 1.197–1T).
8.Accounting Method Changes
A change in the method of deprecia-
tion or amortization of intangibles is a
change in method of accounting that
requires the consent of the Commis-
sioner of Internal Revenue under section
446(e). To obtain this consent, a Form
3115, Application for Change in Ac-
counting Method, generally must be
filed within 180 days after the beginning
of the taxable year in which the pro-
posed change is to be made. Taxpayers
that have adopted a method of account-
ing for certain intangibles may need to
change their method of accounting to
comply with the final regulations.
9.Basis Allocation Rules
In separate notices the IRS and Trea-
sury are issuing temporary and proposed
amendments to the temporary regula-
tions under sections 1060 and 338(b).
The existing temporary regulations es-
tablish a four-class system for allocating
basis to individual assets in the case of
a direct acquisition of assets constituting
a trade or business or a deemed acquisi-
tion of assets as the result of an election
under section 338. Under this system,
assets in the nature of goodwill and
going concern value are included in
Class IV, while other intangible assets,
whether or not amortizable, are included
in Class III. Each successive class is
allocated basis under a residual method,
subject to a fair market value limitation
for all classes except Class IV. After
basis has been allocated to each class in
the aggregate, assets within each of the
first three classes are allocated basis on
a proportional method. This system is
inconsistent with the policies of section
197, which prescribes uniform treatment
for all amortizable section 197 intan-
gibles. Accordingly, appropriate modifi-
cations are being proposed.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in EO
12866. Therefore, a regulatory assess-
ment is not required. It also has been
determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these
regulations, and, because the regulations
do not impose a collection of informa-
tion on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does
not apply. Pursuant to section 7805(f) of
the Internal Revenue Code, this notice
of proposed rulemaking will be submit-
ted to the Chief Counsel for Advocacy
of the Small Business Administration for
comment on its impact on small busi-
ness.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, consider-
ation will be given to any comments
that are submitted (in the manner de-
scribed in ADDRESSES) timely to the
IRS. All comments will be available for
public inspection and copying.
A public hearing has been scheduled
for May 15, 1997, at 10 a.m. in the
Commissioner’s Conference Room
(Room 3313), Internal Revenue Build-
ing,1111Constitution Avenue NW,
Washington, DC 20224. Because of ac-
cess restrictions, visitors will not be
admitted beyond the Internal Revenue
Building lobby more than 15 minutes
before the hearing starts.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing.
Persons that wish to present oral
comments at the hearing must submit
comments and an outline of the topics
to be discussed and the time to be
devoted to each topic (in the manner
described in ADDRESSES) by April 16,
1997. A period of 10 minutes will be
allotted to each person for making com-
ments.
An agenda showing the scheduling of
the speakers will be prepared after the
deadline for receiving outlines has
passed. Copies of the agenda will be
available free of charge at the hearing.
Drafting Information
The principal author of these regula-
tions is John Huffman, Office of Assis-
tant Chief Counsel (Passthroughs and
Special Industries), IRS. However, other
personnel from the IRS and Treasury
Department participated in their devel-
opment.
*****
Proposed Amendments to the Regula-
tions
Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by adding an
entry in numerical order to read as
follows:
Authority: 26 U.S.C. 7805***
Section 1.197–2 also issued under 26
U.S.C. 197(g).***
Par. 2. Section 1.167(a)–3 is amended
by adding a sentence at the end to read
as follows:
§ 1.167(a)–3 Intangibles.
* * * See §§ 1.197–2 and 1.167(a)–14
for amortization of goodwill and certain
other intangibles acquired after August
10, 1993, or after July 25, 1991, if a
valid retroactive election under § 1.197–
1T has been made.
Par. 3. Section 1.167(a)–6 is amended
by adding two sentences at the end of
paragraph (a) to read as follows:
§ 1.167(a)–6 Depreciation in special
cases.
(a)***See§1.167(a)–14(c)(4) for
depreciation of a separately acquired
interest in a patent or copyright de-
scribed in section 167(f)(2) acquired
after the date on which the final regula-
15

tions are published in the Federal Regis-
ter. See § 1.197–2 for amortization of
interests in patents and copyrights that
constitute amortizable section 197 intan-
gibles.
*****
Par. 4. Section 1.167(a)–14 is added
to read as follows:
§ 1.167(a)–14 Treatment of certain in-
tangible property excluded from section
197.
(a)Overview. This section provides
rules for the amortization of certain
intangibles that are excluded from sec-
tion 197 (relating to the amortization of
goodwill and certain other intangibles).
These excluded intangibles are specifi-
cally described in § 1.197–2(c)(4), (6),
(7), (11), and (13) and include certain
computer software and certain other
separately acquired rights, such as rights
to receive tangible property or services,
patents and copyrights, rights of fixed
duration or amount, and certain mort-
gage servicing rights. Intangibles for
which an amortization amount is deter-
mined under section 167(f) and intan-
gibles otherwise excluded from section
197 (for example, self-created intan-
gibles described in § 1.197–2(d)(2)) are
amortizable only if they qualify as prop-
erty subject to the allowance for depre-
ciation under section 167(a).
(b)Computer software—(1)In gen-
eral. The amount of the deduction for
computer software described in section
167(f)(1) and § 1.197–2(c)(4) is deter-
mined by amortizing the adjusted basis
of the computer software using the
straight line method described in
§ 1.167(b)–1 (except that its salvage
value is treated as zero) and an amorti-
zation period of 36 months beginning
with the month that the computer soft-
ware is placed in service. If costs for
developing computer software that the
taxpayer properly elects to defer under
section 174(b) result in the development
of property subject to the allowance for
depreciation under section 167, the rules
of this paragraph (b) will apply to the
unrecovered costs. In addition, this para-
graph (b) applies to the cost of sepa-
rately acquired computer software where
these costs are separately stated and the
costs are required to be capitalized un-
der section 263(a).
(2)Exceptions. Paragraph (b)(1) of
this section does not apply to the cost of
computer software properly and consis-
tently treated as currently deductible
(that is, not capitalized) under § 1.162–
11. The cost of acquiring an interest in
computer software that is included,
without being separately stated, in the
cost of the hardware or other tangible
property is treated as part of the cost of
the hardware or other tangible property
that is capitalized and depreciated under
other applicable sections of the Internal
Revenue Code.
(c)Certain interests or rights ac-
quired separately—(1)Certain rights to
receive tangible property or services.
The amount of the deduction for a
separately acquired right to receive tan-
gible property or services under a con-
tract or from a governmental unit (speci-
fied in section 167(f)(2) and § 1.197–
2(c)(6)) is determined as follows:
(i)Amortization of fixed amounts.
The cost of acquiring a right to receive
a fixed amount of tangible property or
services is amortized for each taxable
year by multiplying the basis (as deter-
mined under section 1011) of the right
by a fraction, the numerator of which is
the amount of tangible property or ser-
vices received during the taxable year
and the denominator of which is the
total amount of tangible property or
services received or to be received un-
der the terms of the contract or govern-
mental grant. For example, if a taxpayer
acquires a favorable contract right to
receive a fixed amount of raw materials
during an unspecified period, the tax-
payer must amortize the cost of acquir-
ing the contract right by multiplying the
total cost by a fraction, the numerator of
which is the amount of raw materials
received under the contract during the
taxable year and the denominator of
which is the total amount of raw materi-
als received or to be received under the
contract.
(ii)Amortization of unspecified
amount over fixed period. The cost of
acquiring a right to receive an unspeci-
fied amount of tangible property or
services over a fixed period is amortized
ratably over the period of the right.
(iii)Amortization in other cases. [Re-
served]
(2)Rights of fixed duration or
amount. The amount of the deduction
for a separately acquired right of fixed
duration or amount received under a
contract or granted by a governmental
unit (specified in section 167(f)(2) and
§ 1.197–2(c)(13)) and not covered by
paragraph (c)(1) of this section is deter-
mined as follows:
(i)Rights of a fixed amount. The cost
of acquiring a right of a fixed amount is
amortized for each taxable year by mul-
tiplying the cost of the right by a
fraction, the numerator of which is the
amount received or delivered during the
taxable year and the denominator of
which is the total amount to be received
or delivered (including amounts received
or delivered prior to the close of the
taxable year) under the terms of the
contract or governmental grant.
(ii)Rights of unspecified amount and
fixed duration of less than 15 years. The
cost of acquiring a right of an unspeci-
fied amount and a fixed duration of less
than 15 years is amortized ratably over
the period of the right.
(3)Application of renewals. (i) For
purposes of paragraphs (c)(1) and (2) of
this section, the duration of a right
under a contract (or granted by a gov-
ernmental unit) includes any renewal
period if, based on all of the facts and
circumstances in existence at any time
during the taxable year in which the
right is acquired, the facts clearly indi-
cate a reasonable expectancy of renewal.
(ii) The mere fact that a taxpayer will
have the opportunity to renew a contract
right or other right on the same terms as
are available to others, in a competitive
auction or similar process that is de-
signed to reflect fair market value and
in which the taxpayer is not contractu-
ally advantaged, will generally not be
taken into account in determining the
duration of such right provided that the
bidding produces a fair market value
price comparable to the price that would
be obtained if the rights were purchased
immediately after renewal from a person
(other than the person granting the re-
newal) in an arm’s-length transaction.
(iii) The cost of a renewal not in-
cluded in the terms of the contract or
governmental grant is treated as the
acquisition of a separate intangible asset.
(4)Patents and copyrights. The
amount of the deduction for a separately
acquired interest in a patent or copyright
described in section 167(f)(2) and
§ 1.197–2(c)(7) is equal to the purchase
price paid or incurred during the year if
the purchase price is payable on at least
an annual basis as either a fixed amount
per use or a fixed percentage of the
revenue derived from the use of the
patent or copyright. Otherwise, the cost
or other basis of a separately acquired
patent or copyright (or an interest
therein) is depreciated ratably over its
remaining useful life. If a patent or
copyright becomes valueless in any year
before its legal expiration, the adjusted
basis may be deducted in that year.
16

(5)Applicable rules and conventions.
The period of amortization under para-
graphs (c)(1) through (4) of this section
begins when the intangible is placed in
service. For other applicable rules, see
§ 1.197–2(f).
(d)Mortgage servicing rights. The
amount of the deduction for mortgage
servicing rights described in section
167(f)(3) and § 1.197–2(c)(11) is deter-
mined by using the straight line method
described in § 1.167(b)–1 (except that
the salvage value is treated as zero) and
an amortization period of 108 months.
Mortgage servicing rights are not depre-
ciable to the extent the rights are
stripped coupons under section 1286. An
event that renders mortgage servicing
rights wholly worthless is considered a
disposition of the rights. For purposes of
determining the deduction for mortgage
servicing rights and any loss from the
sale, exchange, or other disposition of
the rights, rights to service a pool of
mortgages are treated as a single asset.
Thus, if some (but not all) mortgages in
a pool prepay and the taxpayer retains
rights to service the remaining mort-
gages in the pool, no loss is recognized
by reason of the prepayment. The ad-
justed basis of the mortgage servicing
rights is not affected by the unrecog-
nized loss.
(e)Effective date. This section is ap-
plicable on the date final regulations are
published in theFederal Register
except that § 1.167(a)–14(c)(2) (depre-
ciation of the cost of certain separate-
ly acquired rights) and so much
of § 1.167(a)–14(c)(3) as relates to
§ 1.167(a)–14(c)(2) are applicable Au-
gust 11, 1993 (or July 26, 1991, if a
valid retroactive election has been made
under § 1.197–1T).
Par. 5. Section 1.197–0 is added to
read as follows:
§ 1.197–0 Table of contents.
This section lists the headings that
appear in § 1.197–2.
§ 1.197–2 Amortization of goodwill and
certain other intangibles.
(a) Overview.
(1) In general.
(2) Section 167(f) property.
(3) Amounts otherwise deductible.
(4) Relationship to other Internal
Revenue Code provisions.
(b) Section 197 intangibles; in gen-
eral.
(1) Goodwill.
(2) Going concern value.
(3) Workforce in place.
(4) Information base.
(5) Know-how, etc.
(6) Customer-based intangibles.
(7) Supplier-based intangibles.
(8) Licenses, permits, and other
rights granted by governmental units.
(9) Covenants not to compete and
other similar arrangements.
(10) Franchises, trademarks, and
trade names.
(11) Contracts for the use of, and
term interests in, other section 197 in-
tangibles.
(12) Other similar items.
(c) Section 197 intangibles; excep-
tions.
(1) Interests in a corporation, part-
nership, trust, or estate.
(2) Interests under certain financial
contracts.
(3) Interests in land.
(4) Certain computer software.
(i) In general.
(ii) Separately acquired software.
(iii) Other exceptions.
(iv) Computer software defined.
(v) Readily available to the gen-
eral public.
(5) Certain interests in films, sound
recordings, video tapes, books, or other
similar property.
(6) Certain rights to receive tan-
gible property or services.
(7) Certain interests in patents or
copyrights.
(8) Interests under leases of tan-
gible property.
(i) Interest as a lessor.
(ii) Interest as a lessee.
(9) Interests under indebtedness.
(i) In general.
(ii) Exceptions.
(10) Professional sports franchises.
(11) Mortgage servicing rights.
(12) Certain transaction costs.
(13) Rights of fixed duration or
amount.
(d) Amortizable section 197 intan-
gibles.
(1) Definition.
(2) Exception for self-created in-
tangibles.
(i) In general.
(ii) Created by the taxpayer.
(A) Defined.
(B) Contracts for the use of
intangibles.
(C) Improvements and modifi-
cations.
(iii) Exceptions.
(3) Exception for property subject
to anti-churning rules.
(e) Purchase of a trade or business.
(1) Goodwill or going concern
value.
(2) Customer-based intangibles.
(3) Franchise, trademark, or trade
name.
(i) In general.
(ii) Exceptions.
(4) Acquisitions to be included.
(5) Substantial portion.
(6) Deemed asset purchases under
section 338.
(f) Computation of amortization de-
duction.
(1) In general.
(2) Treatment of contingent
amounts.
(i) Amounts added to basis dur-
ing 15-year period.
(ii) Amounts becoming fixed af-
ter expiration of 15-year period.
(iii) Time for including amounts
in basis.
(3) Determination of amounts
chargeable to capital account in certain
cases.
(i) Covenants not to compete,
rights granted by governmental units,
and contracts for the use of section 197
intangibles.
(A) In general.
(B) Time for taking amounts
into account.
(ii) Franchises, trademarks, or
trade names and licenses, permits, and
other rights granted by governmental
units.
(iii) Certain reinsurance transac-
tions.
(4) Transactions subject to section
338 or 1060.
(g) Special rules.
(1) Treatment of certain disposi-
tions.
(i) Loss disallowance rules.
(A) In general.
(B) Certain nonrecognition
transfers.
(ii) Separately acquired property.
(iii) Disposition of a covenant
not to compete.
(iv) Taxpayers under common
control.
(A) In general.
(B) Treatment of disallowed
loss.
(2) Treatment of certain nonrecog-
nition and exchange transactions.
(i) In general.
(A) Transfer disregarded.
(B) Application of general
rule.
(ii) Transactions covered.
(iii) Certain exchanged-basis
property.
17

(iv) Transfers under section
708(b)(1).
(A) In general.
(B) Termination by sale or ex-
change of interest.
(C) Other terminations.
(D) Anti-churning rules.
(v) Distributions to which sec-
tion 732(d) applies.
(vi) Curative and remedial allo-
cations under section 704(c).
(3) Application of section 754 to
acquisitions of an interest in an intan-
gible held through a partnership.
(4) Treatment of certain reinsur-
ance transactions.
(i) In general.
(ii) Determination of adjusted
basis.
(A) Acquisitions (other than
under section 338) of specified insur-
ance contracts.
(B) Other acquisitions. [Re-
served]
(5) Amounts paid or incurred for a
franchise, trademark, or trade name.
(6) Amounts properly taken into
account in determining the cost of prop-
erty that is not a section 197 intangible.
(7) Treatment of amortizable sec-
tion 197 intangibles as depreciable prop-
erty.
(i) In general.
(ii) Exceptions and limitations.
(A) Unstated interest and
original issue discount rules.
(B) Treatment of other parties
to transaction.
(h) Anti-churning rules.
(1) Conversions of existing good-
will, going concern value, and certain
other section 197 intangibles.
(2) Amounts deductible under sec-
tion 1253(d).
(3) Transition period.
(4) Exceptions.
(5) Special partnership provisions.
(i) Basis increases.
(ii) Curative and remedial allo-
cations under section 704(c).
(6) Related person.
(i) In general.
(ii) Time for testing relation-
ships.
(iii) De minimis rule.
(A) In general.
(B) Determination of benefi-
cial ownership interest.
(7) Special rules for entities that
owned or used property at any time
during the transition period and that are
no longer in existence.
(8) Special rules for section 338
deemed acquisitions.
(9) Exception to anti-churning
rules where gain is recognized.
(i) In general.
(ii) Manner of making election.
[Reserved]
(iii) Determination of highest
marginal rate of tax.
(A) Noncorporate taxpayers.
(B) Corporations and tax-
exempt entities.
(iv) Special rule for pass-through
entities.
(v) Coordination with other pro-
visions.
(A) In general.
(B) Section 1374.
(C) Procedural and adminis-
trative provisions.
(D) Installment method.
(10) Transactions subject to both
anti-churning and nonrecognition rules.
(11) Anti-churning anti-abuse rule.
(i) [Reserved].
(j) General anti-abuse rule.
(k) Examples.
(l) Effective dates.
Par. 6. Section 1.197–2 is added to
read as follows:
§ 1.197–2 Amortization of goodwill and
certain other intangibles.
(a)Overview—(1)In general. Section
197 allows an amortization deduction
for the capitalized costs of anamortiz-
able section 197 intangibleand prohibits
any other depreciation or amortization
with respect to that property. Paragraphs
(b), (c), and (e) of this section provide
rules and definitions for determining
whether property is a section 197 intan-
gible, and paragraphs (d) and (e) of this
section provide rules and definitions for
determining whether asection 197 in-
tangibleis an amortizable section 197
intangible. The amortization deduction
under section 197 is determined by
amortizing adjusted basis ratably over a
15-year period under the rules of para-
graph (f) of this section. Section 197
also includes various special rules per-
taining to the disposition of amortizable
section 197 intangibles, nonrecognition
transactions, anti-churning rules, and
anti-abuse rules. Rules relating to these
provisions are contained in paragraphs
(g), (h), and (j) of this section. Ex-
amples demonstrating the application of
these provisions are contained in para-
graph (k) of this section. The effective
date of the rules in this section is
contained in paragraph (l) of this sec-
tion.
(2)Section 167(f) property. Section
167(f) prescribes rules for computing
the depreciation deduction for certain
property to which section 197 does not
apply. See § 1.167(a)–14 for rules under
section 167(f) and paragraphs (c)(4), (6),
(7), (11), and (13) of this section for a
description of the property subject to
section 167(f).
(3)Amounts otherwise deductible.
Except as otherwise provided in section
197(f)(3) and paragraphs (b)(11) and
(f)(3) of this section, section 197 does
not apply to amounts that would be
currently deductible without regard to
section 197.
(4)Relationship to other Internal
Revenue Code provisions. Section 197
does not apply to any amount paid or
incurred for a section 197 intangible if a
deduction for the amount would be
disallowed under any provision of the
Internal Revenue Code other than sec-
tion 263. (See, for example, section
162(k).)
(b)Section 197 intangibles; in gen-
eral. Except as otherwise provided in
paragraph (c) of this section, the term
section 197 intangiblemeans any prop-
erty described in section 197(d)(1). The
following rules and definitions provide
guidance concerning property that is a
section 197 intangible unless an excep-
tion applies:
(1)Goodwill. Section 197 intangibles
include goodwill. Goodwill is the value
of a trade or business attributable to the
expectancy of continued customer pa-
tronage. This expectancy may be due to
the name or reputation of a trade or
business or any other factor.
(2)Going concern value. Section 197
intangibles include going concern value.
Going concern value is the additional
value that attaches to property by reason
of its existence as an integral part of an
ongoing business activity. Going con-
cern value includes the value attribut-
able to the ability of a trade or business
(or a part of a trade or business) to
continue functioning or generating in-
come without interruption notwithstand-
ing a change in ownership, but does not
include any of the intangibles described
in any other provision of this paragraph
(b). It also includes the value that is
attributable to the immediate use or
availability of an acquired trade or busi-
ness, such as, for example, the use of
the revenues or net earnings that other-
wise would not be received during any
period if the acquired trade or business
were not available or operational.
18

(3)Workforce in place. Section 197
intangibles include workforce in place.
Workforce in place (sometimes referred
to as agency force or assembled
workforce) includes the composition of
a workforce (for example, the experi-
ence, education, or training of a
workforce), the terms and conditions of
employment whether contractual or oth-
erwise, and any other value placed on
employees or any of their attributes.
Thus, the amount paid or incurred for
workforce in place includes, for ex-
ample, any portion of the purchase price
of an acquired trade or business attribut-
able to the existence of a highly-skilled
workforce, an existing employment con-
tract (or contracts), or a relationship
with employees or consultants (includ-
ing, but not limited to, any key em-
ployee contract or relationship).
Workforce in place does not include any
covenant not to compete or other similar
arrangement described in paragraph
(b)(9) of this section.
(4)Information base. Section 197 in-
tangibles include business books and
records, operating systems, and any
other information base, including lists or
other information of current or prospec-
tive customers (regardless of the method
of recording the information). Thus, the
amount paid or incurred for these items
includes, for example, any portion of the
purchase price of an acquired trade or
business attributable to the intangible
value of technical manuals, training
manuals or programs, data files, and
accounting or inventory control systems.
Other examples include the cost of
acquiring customer lists, subscription
lists, insurance expirations, patient or
client files, or lists of newspaper, maga-
zine, radio, or television advertisers.
(5) Know-how, etc. Section 197 intan-
gibles include any patent, copyright,
formula, process, design, pattern, know-
how, format, package design, computer
software (as defined in paragraph (c)(4)
of this section), or interest in a film,
sound recording, video tape, book, or
other similar property. (See, however,
the exceptions in paragraph (c) of this
section.)
(6)Customer-based intangibles. Sec-
tion 197 intangibles include any
customer-based intangible. A customer-
based intangible is any composition of
market, market share, or other value
resulting from the future provision of
goods or services pursuant to contractual
or other relationships in the ordinary
course of business with customers.
Thus, the amount paid or incurred for
customer-based intangibles includes, for
example, any portion of the purchase
price of an acquired trade or business
attributable to the existence of a cus-
tomer base, a circulation base, an unde-
veloped market or market growth, insur-
ance in force, the existence of a
qualification to supply goods or services
to a particular customer, a mortgage
servicing contract (as defined in para-
graph (c)(11) of this section), an invest-
ment management contract, or other re-
lationship with customers involving the
future provision of goods or services.
(See, however, the exceptions in para-
graph (c) of this section.) In addition,
customer-based intangibles include the
deposit base and any similar asset of a
financial institution. Thus, the amount
paid or incurred for customer-based in-
tangibles also includes any portion of
the purchase price of an acquired finan-
cial institution attributable to the value
represented by existing checking ac-
counts, savings accounts, escrow ac-
counts, and other similar items of the
financial institution. However, any por-
tion of the purchase price of an acquired
trade or business attributable to accounts
receivable or other similar rights to
income for goods or services provided
to customers prior to the acquisition of a
trade or business is not an amount paid
or incurred for a customer-based intan-
gible.
(7)Supplier-based intangibles. Sec-
tion 197 intangibles include any
supplier-based intangible. A supplier-
based intangible is the value resulting
from the future acquisition, pursuant to
contractual or other relationships with
suppliers in the ordinary course of busi-
ness, of goods or services that will be
sold or used by the taxpayer. Thus, the
amount paid or incurred for supplier-
based intangibles includes, for example,
any portion of the purchase price of an
acquired trade or business attributable to
the existence of a favorable relationship
with persons providing distribution ser-
vices (such as favorable shelf or display
space at a retail outlet), the existence of
a favorable credit rating, or the exist-
ence of favorable supply contracts. The
amount paid or incurred for supplier-
based intangibles does not include any
amount required to be paid for the
goods or services themselves pursuant to
the terms of the agreement or other
relationship. In addition, see the excep-
tions in paragraph (c) of this section,
including the exception in paragraph
(c)(6) of this section for certain rights to
receive tangible property or services
from another person.
(8)Licenses, permits, and other
rights granted by governmental units.
Section 197 intangibles include any li-
cense, permit, or other right granted by
a governmental unit (including, for pur-
poses of section 197, an agency or
instrumentality thereof) even if the right
is granted for an indefinite period or is
reasonably expected to be renewed for
an indefinite period. These rights in-
clude, for example, a liquor license, a
taxi-cab medallion (or license), an air-
port landing or takeoff right (sometimes
referred to as a slot), a regulated airline
route, or a television or radio broadcast-
ing license. The issuance or renewal of
a license, permit, or other right granted
by a governmental unit is considered an
acquisition of the license, permit, or
other right. (See, however, the excep-
tions in paragraph (c) of this section,
including the exceptions in paragraph
(c)(3) of this section for an interest in
land, in paragraph (c)(8) of this section
for an interest under a lease of tangible
property, and in paragraphs (c)(6) and
(13) of this section for certain rights
granted by a governmental unit. See
paragraph (b)(10) of this section for the
treatment of franchises.)
(9)Covenants not to compete and
other similar arrangements. Section 197
intangibles include any covenant not to
compete, or agreement having substan-
tially the same effect, entered into in
connection with the direct or indirect
acquisition of an interest in a trade or
business or a substantial portion thereof.
For purposes of this paragraph (b)(9), an
acquisition may be made in the form of
an asset acquisition (including a quali-
fied stock purchase that is treated as a
purchase of assets under section 338), a
stock acquisition or redemption, and the
acquisition or redemption of a partner-
ship interest. An agreement requiring the
performance of services or the provision
of property or the use of property (other
than property of the acquired trade or
business) does not have substantially the
same effect as a covenant not to com-
pete to the extent that the amount paid
under the agreement represents reason-
able compensation for the services actu-
ally rendered or for the property or use
of the property actually provided.
(10)Franchises, trademarks, and
trade names. (i) Section 197 intangibles
include any franchise, trademark, or
trade name. The termfranchiseincludes
any agreement that provides one of the
parties to the agreement with the right
19

to distribute, sell, or provide goods,
services, or facilities, within a specified
area. (See section 1253(b)(1).) The term
includes distributorships or other similar
contractual arrangements pursuant to
which the transferee is permitted or
licensed to operate or conduct a trade or
business within a specific area. The term
trademarkincludes any word, name,
symbol, or device, or any combination
thereof, adopted and used by a manufac-
turer or merchant to identify goods or
services and distinguish them from those
manufactured or sold by others. The
termtrade nameincludes any name
used by a manufacturer or merchant to
identify or designate a particular trade
or business or the name or title used by
a person or organization engaged in a
trade or business. A license, permit, or
other right granted by a governmental
unit is a franchise if it otherwise meets
the definition of a franchise. A trade-
mark or trade name includes any trade-
mark or trade name arising under statute
or applicable common law, and any
similar right granted by contract. The
renewal of a franchise, trademark, or
trade name is treated as an acquisition
of the franchise, trademark, or trade
name.
(ii) Notwithstanding the definitions
provided in paragraph (b)(10)(i) of this
section, any amount that is paid or
incurred on account of a transfer, sale,
or other disposition of a franchise, trade-
mark, or trade name and that is subject
to section 1253(d)(1) is not included in
the basis of a section 197 intangible.
(See paragraph (g)(5) of this section.)
(11)Contracts for the use of, and
term interests in, other section 197
intangibles. Section 197 intangibles in-
clude any right under a license, contract,
or other arrangement providing for the
use of property that would be a section
197 intangible under any provision of
this paragraph (b) (including this para-
graph (b)(11)) after giving effect to all
of the exceptions provided in paragraph
(c) of this section. Section 197 intan-
gibles also include any term interest
(whether outright or in trust) in such
property.
(12)Other similar items. Section 197
intangibles include any other intangible
property that is similar in all material
respects to the property specifically de-
scribed in section 197(d)(1)(C) and
paragraphs (b)(3) through (7) of this
section. (See paragraph (g)(4) of this
section for special rules regarding cer-
tain reinsurance transactions.)
(c)Section 197 intangibles; excep-
tions. The termsection 197 intangible
does not include property described in
section 197(e). The following rules and
definitions provide guidance concerning
property to which the exceptions apply:
(1)Interests in a corporation, part-
nership, trust, or estate. Section 197
intangibles do not include an interest in
a corporation, partnership, trust, or es-
tate. Thus, for example, amortization
under section 197 is not available for
the cost of acquiring stock, partnership
interests, or interests in a trust or estate,
whether or not the interests are regularly
traded on an established market. (See
paragraph (g)(3) of this section for spe-
cial rules applicable to property of a
partnership when a section 754 election
is in effect for the partnership.)
(2)Interests under certain financial
contracts. Section 197 intangibles do not
include an interest under an existing
futures contract, foreign currency con-
tract, notional principal contract, interest
rate swap, or other similar financial
contract, whether or not the interest is
regularly traded on an established mar-
ket. However, this exception does not
apply to an interest under a mortgage
servicing contract, credit card servicing
contract, or other contract to service
another person’s indebtedness, or an
interest under an assumption reinsurance
contract. (See paragraph (g)(4) of this
section for the treatment of assumption
reinsurance contracts. See paragraph
(c)(11) of this section and § 1.167(a)–
14(d) for the treatment of mortgage
servicing rights.)
(3)Interests in land. Section 197 in-
tangibles do not include any interest in
land. For this purpose, an interest in
land includes a fee interest, life estate,
remainder, easement, mineral right, tim-
ber right, grazing right, riparian right,
air right, zoning variance, and any other
similar right, such as a farm allotment,
quota for farm commodities, or crop
acreage base. An interest in land does
not include an airport landing or takeoff
right, a regulated airline route, or a
franchise to provide cable television
service. The cost of acquiring a license,
permit, or other land improvement right,
such as a building construction or use
permit, is taken into account in the same
manner as the underlying improvement.
(4)Certain computer software—(i)In
general. Section 197 intangibles do not
include any interest in computer soft-
ware that is (or has been) readily avail-
able to the general public on similar
terms, is subject to a nonexclusive li-
cense, and has not been substantially
modified for the user. Computer soft-
ware will not be considered to have
been substantially modified if its cost
does not exceed the greater of 125
percent of the price at which the un-
modified version of the software is
readily available to the general public or
$2,000. For the purpose of determining
whether computer software has been
substantially modified—
(A) Integrated programs acquired in a
package from a single source are treated
as a single computer program; and
(B) Any cost incurred to install the
computer software is not treated as a
cost of the software.
(ii)Separately acquired software.
Section 197 intangibles do not include
an interest in computer software that is
not acquired as part of a purchase of a
trade or business within the meaning of
paragraph (e) of this section.
(iii)Other exceptions. Neither section
197 nor section 167(f) apply in the
following cases:
(A) Any amount of the cost of an
interest in computer software that is
included, without being separately
stated, in the cost of the hardware or
other tangible property will be treated as
part of the cost of the hardware or other
tangible property.
(B) Any amount of the cost of an
interest in computer software that would
be deductible under any provision other
than section 167(f) or 197 may be
deducted and is not required to be
capitalized.
(iv)Computer software defined. For
purposes of this section, computer soft-
ware is any program or routine (that is,
any sequence of machine-readable code)
that is designed to cause a computer (as
defined in section 168(i)(2)(B)(ii)) to
perform a desired function or set of
functions, and the documentation re-
quired to describe and maintain those
programs. It includes all forms and
media in which the software is con-
tained, whether written, magnetic, or
otherwise. Computer programs of all
classes, for example, operating systems,
executive systems, monitors, compilers
and translators, assembly routines, and
utility programs as well as application
programs, are included. Computer soft-
ware also includes any incidental and
ancillary rights that are necessary to
effect the acquisition of the title to, the
ownership of, or the right to use the
computer software, and that are used
only in connection with that specific
computer software. Such incidental and
20

ancillary rights are not included in the
definition of trademark or trade name
under paragraph (b)(10)(i) of this sec-
tion. For example, a trademark or trade
name that is ancillary to the ownership
or use of a specific computer software
program in the taxpayer’s trade or busi-
ness and is not acquired for the purpose
of marketing the computer software is
included in the definition of computer
software and is not included in the
definition of trademark or trade name.
Computer software does not include any
data or information base described in
paragraph (b)(4) of this section unless
the data base or item is in the public
domain and is incidental to a computer
program. For this purpose, a copyrighted
or proprietary data or information base
is treated as in the public domain if its
availability through the computer pro-
gram does not contribute significantly to
the cost of the program. For example, if
a word-processing program includes a
dictionary feature used to spell-check a
document or any portion thereof, the
entire program (including the dictionary
feature) is computer software regardless
of the form in which the feature is
maintained or stored.
(v)Readily available to the general
public. Computer software will be
treated as readily available to the gen-
eral public if the software may be
obtained on substantially the same terms
by a significant number of persons that
would reasonably be expected to use the
software. The requirements of this para-
graph (c)(4)(v) can be met even though
the software is not available through a
system of retail distribution.
(5)Certain interests in films, sound
recordings, video tapes, books, or other
similar property. Section 197 intangibles
do not include any interest (including an
interest as a licensee) in a film, sound
recording, video tape, book, or other
similar property (such as the right to
broadcast or transmit a live event) if the
interest is not acquired as part of a
purchase of a trade or business. A film,
sound recording, video tape, book, or
other similar property includes any inci-
dental and ancillary rights (such as a
trademark or trade name) that are neces-
sary to effect the acquisition of title to,
the ownership of, or the right to use the
property and are used only in connec-
tion with that property. Such incidental
and ancillary rights are not included in
the definition of trademark or trade
name under paragraph (b)(10)(i) of this
section. For purposes of this paragraph
(c)(5), computer software (as defined in
paragraph (c)(4)(iv) of this section) is
not treated as other property similar to a
film, sound recording, video tape, or
book. (See section 167 for amortization
of excluded intangible property or inter-
ests.)
(6)Certain rights to receive tangible
property or services. Section 197 intan-
gibles do not include any right to re-
ceive tangible property or services under
a contract or from a governmental unit
if the right is not acquired as part of a
purchase of a trade or business. Any
right that is described in the preceding
sentence is not treated as a section 197
intangible even though the right is also
described in section 197(d)(1)(D) and
paragraph (b)(8) of this section (relating
to certain governmental licenses, per-
mits, and other rights) and even though
the right fails to meet one or more of
the requirements of paragraph (c)(13) of
this section (relating to certain rights of
fixed duration or amount). (See
§ 1.167(a)–14(c)(1) and (3) for appli-
cable rules.)
(7)Certain interests in patents or
copyrights. Section 197 intangibles do
not include any interest (including an
interest as a licensee) in a patent, patent
application, or copyright that is not
acquired as part of a purchase of a trade
or business. (See § 1.167(a)–14(c)(4)
for applicable rules.)
(8)Interests under leases of tangible
property—(i)Interest as a lessor. Sec-
tion 197 intangibles do not include any
interest as a lessor under an existing
lease or sublease of tangible real or
personal property. In addition, the cost
of acquiring an interest as a lessor in
connection with the acquisition of tan-
gible property is taken into account as
part of the cost of the tangible property.
For example, if a taxpayer acquires a
shopping center that is leased to tenants
operating retail stores, any portion of the
purchase price attributable to favorable
lease terms is taken into account as part
of the basis of the shopping center and
in determining the depreciation deduc-
tion allowed with respect to the shop-
ping center. (See section 167(c)(2).)
(ii)Interest as a lessee. Section 197
intangibles do not include any interest
as a lessee under an existing lease of
tangible real or personal property. For
this purpose, an airline lease of an
airport passenger or cargo gate is a lease
of tangible property. The cost of acquir-
ing such an interest is taken into ac-
count under section 178 and § 1.162–
11(a). If an interest as a lessee under a
lease of tangible property is acquired in
a transaction with any other intangible
property, a portion of the total purchase
price may be allocable to the interest as
a lessee based on all of the relevant
facts and circumstances.
(9)Interests under indebtedness—(i)
In general. Section 197 intangibles do
not include any interest (whether as a
creditor or debtor) under an indebted-
ness in existence when the interest was
acquired. Thus, for example, the value
attributable to the assumption of an
indebtedness with a below-market inter-
est rate is not amortizable under section
197. In addition, the premium paid for
acquiring a debt instrument with an
above-market interest rate is not amor-
tizable under section 197. See section
171 for rules concerning the treatment
of amortizable bond premium.
(ii)Exceptions. For purposes of this
paragraph (c)(9), an interest under an
existing indebtedness does not include
the deposit base (and other similar
items) of a financial institution. An
interest under an existing indebtedness
includes mortgage servicing rights, how-
ever, to the extent the rights are stripped
coupons under section 1286.
(10)Professional sports franchises.
Section 197 intangibles do not include
any franchise to engage in professional
baseball, basketball, football, or any
other professional sport, and any item
(even though otherwise qualifying as a
section 197 intangible) acquired in con-
nection with such a franchise.
(11)Mortgage servicing rights. Sec-
tion 197 intangibles do not include any
right described in section 197(e)(7)
(concerning rights to service indebted-
ness secured by residential real property
that are not acquired as part of a
purchase of a trade or business). (See
§ 1.167(a)–14(d) for applicable rules.)
(12)Certain transaction costs. Sec-
tion 197 intangibles do not include any
fees for professional services and any
transaction costs incurred by parties to a
transaction in which all or any portion
of the gain or loss is not recognized
under part III of subchapter C of the
Internal Revnue Code.
(13)Rights of fixed duration or
amount. (i) Section 197 intangibles do
not include any right under a contract or
any license, permit, or other right
granted by a governmental unit if the
right—
(A) Is acquired in the ordinary course
of business and not as part of a pur-
chase of a trade or business;
21

(B) Is not described in sections
197(d)(1)(A), (B), (C)(ii), (iv), or (vi),
(E), or (F); and
(C) Either—
(1) Has a fixed duration of less than
15 years; or
(2) Is fixed as to amount and the
adjusted basis thereof is properly recov-
erable (without regard to this section)
under a method similar to the unit-of-
production method.
(ii) See § 1.167(a)–14(c)(2) and (3)
for applicable rules.
(d)Amortizable section 197 intan-
gibles—(1)Definition.Except as other-
wise provided in this paragraph (d), the
termamortizable section 197 intangible
means any section 197 intangible ac-
quired after August 10, 1993 (or after
July 25, 1991, if a valid retroactive
election under § 1.197–1T has been
made), and held in connection with the
conduct of a trade or business or an
activity described in section 212.
(2)Exception for self-created intan-
gibles—(i)In general. Except as pro-
vided in paragraph (d)(2)(iii) of this
section, amortizable section 197 intan-
gibles do not include any section 197
intangible created by the taxpayer (a
self-created intangible).
(ii)Created by the taxpayer—(A)De-
fined. A section 197 intangible is created
by the taxpayer to the extent the tax-
payer makes payments or otherwise in-
curs costs for its creation, production,
development, or improvement, whether
the actual work is performed by the
taxpayer or by another person under a
contract with the taxpayer entered into
before the creation, production, develop-
ment, or improvement occurs. For ex-
ample, a technological process devel-
oped specifically for a taxpayer under
an arrangement with another person pur-
suant to which the taxpayer retains all
rights to the process is created by the
taxpayer.
(B)Contracts for the use of intan-
gibles. A section 197 intangible is not
created by the taxpayer to the extent
that it results from the entry into (or
renewal of) a contract for the use of an
existing section 197 intangible. Thus,
for example, the exception for self-
created intangibles does not apply to
legal and other professional fees in-
curred by a licensee in connection with
the entry into (or renewal of) a contract
for the use of know-how or similar
property.
(C)Improvements and modifications.
If an existing section 197 intangible is
improved or otherwise modified by the
taxpayer or by another person under a
contract with the taxpayer, the existing
intangible and the improvements or
other modifications are treated as sepa-
rate section 197 intangibles for purposes
of this paragraph (d).
(iii)Exceptions. (A) The exception
for self-created intangibles does not ap-
ply to any section 197 intangible de-
scribed in section 197(d)(1)(D) (relating
to licenses, permits or other rights
granted by a governmental unit),
197(d)(1)(E) (relating to covenants not
to compete), or 197(d)(1)(F) (relating to
franchises, trademarks, and trade
names). Thus, for example, capitalized
costs incurred in the development, regis-
tration, or defense of a trademark or
trade name do not qualify for the excep-
tion and are amortized over 15 years
under section 197.
(B) The exception for self-created in-
tangibles does not apply to any section
197 intangible created in connection
with the purchase of a trade or business
(as defined in paragraph (e) of this
section).
(C) If a taxpayer disposes of a self-
created intangible and subsequently re-
acquires the intangible in an acquisition
described in paragraph (h)(4)(ii) of this
section, the exception for self-created
intangibles does not apply to the reac-
quired intangible.
(3)Exception for property subject to
anti-churning rules. Amortizable section
197 intangibles do not include any prop-
erty to which the anti-churning rules of
section 197(f)(9) and paragraph (h) of
this section apply.
(e)Purchase of a trade or business.
Several of the exceptions in section 197
apply only to property that is not ac-
quired in (or created in connection with)
a transaction or series of related transac-
tions involving the acquisition of assets
constituting a trade or business or a
substantial portion thereof. Property ac-
quired in (or created in connection with)
such a transaction or series of related
transactions is referred to in this section
as property acquired as part of (or
created in connection with) a purchase
of a trade or business. For purposes of
section 197 and this section, the applica-
bility of the limitation is determined
under the following rules:
(1)Goodwill or going concern value.
A group of assets constitutes a trade or
business or a substantial portion thereof
if their use would constitute a trade or
business under section 1060 (that is, if
goodwill or going concern value could
under any circumstances attach to the
assets). See § 1.1060–1T(b)(2). For this
purpose, all the facts and circumstances,
including any employee relationships
that continue (or covenants not to com-
pete that are entered into) as part of the
transfer of the assets, are taken into
account in determining whether good-
will or going concern value could attach
to the assets.
(2)Customer-based intangibles.
Whether or not a group of assets is
otherwise described in paragraph (e)(1)
of this section, a group of assets consti-
tutes a trade or business or a substantial
portion thereof if the assets include any
customer-based intangibles (as defined
in paragraph (b)(6) of this section) or
are acquired in a transaction or series of
related transactions that involve the cre-
ation of any customer-based intangibles.
(3)Franchise, trademark, or trade
name—(i)In general. The acquisition of
a franchise, trademark, or trade name
constitutes the acquisition of a trade or
business or a substantial portion thereof.
(ii)Exceptions. For purposes of this
paragraph (e)(3)—
(A) A trademark or trade name is
disregarded if it is included in computer
software under paragraph (c)(4) of this
section or in an interest in a film, sound
recording, video tape, book, or other
similar property under paragraph (c)(5)
of this section; and
(B) A franchise, trademark, or trade
name is disregarded if its value is
nominal or the taxpayer irrevocably dis-
poses of it immediately after its acquisi-
tion.
(4)Acquisitions to be included. The
assets acquired in a transaction (or se-
ries of related transactions) include only
assets (including a beneficial or other
indirect interest in assets where the
interest is of a type described in para-
graph (c)(1) of this section) acquired by
the taxpayer and persons related to the
taxpayer from another person and per-
sons related to that other person. For
purposes of this paragraph (e)(4), per-
sons are related only if their relationship
is described in section 267(b) or 707(b)
or they are engaged in trades or busi-
nesses under common control within the
meaning of section 41(f)(1).
(5)Substantial portion. The determi-
nation of whether acquired assets consti-
tute a substantial portion of a trade or
business is to be based on all of the
facts and circumstances, including the
nature and the amount of the assets
acquired as well as the nature and
amount of the assets retained by the
transferor. The value of the assets ac-
22

quired relative to the value of the assets
retained by the transferor is not determi-
native of whether the acquired assets
constitute a substantial portion of a trade
or business.
(6)Deemed asset purchases under
section 338. A qualified stock purchase
that is treated as a purchase of assets
under section 338 shall be treated as a
transaction involving the acquisition of
assets constituting a trade or business
only if the direct acquisition of the
assets of the corporation would have
been treated as the acquisition of assets
constituting a trade or business.
(f)Computation of amortization de-
duction—(1)In general. Except as pro-
vided in paragraph (f)(2) of this section,
the amortization deduction allowable un-
der section 197(a) is computed as fol-
lows:
(i) The adjusted basis (for purposes
of determining gain) of an amortizable
section 197 intangible is amortized rat-
ably over the 15-year period beginning
on the later of—
(A) The first day of the month in
which the property is acquired; or
(B) In the case of property held in
connection with the conduct of a trade
or business, the first day of the month in
which the active conduct of the trade or
business begins.
(ii) Except as otherwise provided in
this section, adjusted basis is determined
under section 1011 and salvage value is
disregarded.
(iii) Property is not eligible for amor-
tization in the month of disposition.
(iv) The amortization deduction for a
short taxable year is based on the num-
ber of months in the short taxable year.
(2)Treatment of contingent amounts
—(i)Amounts added to basis during
15-year period. Any amount that is
properly included in the basis of an
amortizable section 197 intangible after
the first month of the 15-year period
described in paragraph (f)(1)(i) of this
section and before the expiration of this
period is amortized ratably over the
remainder of the 15-year period. For this
purpose, the remainder of the 15-year
period begins on the first day of the
month in which the basis increase oc-
curs. Any reasonable convention may be
used to determine the month in which
the basis increase incurs, provided that
the method selected is used consistently
for all amortizable section 197 intan-
gibles acquired in the same transaction
(or series of related transactions) and
that it does not result in any amount
being added to basis earlier than the
midpoint of the period (for example,
annual, semi-annual, or quarterly) se-
lected.
(ii)Amounts becoming fixed after ex-
piration of 15-year period. Any amount
that is not properly included in the basis
of an amortizable section 197 intangible
until after the expiration of the 15-year
period described in paragraph (f)(1)(i) of
this section is amortized in full immedi-
ately upon the inclusion of the amount
in the basis of the intangible.
(iii)Time for including amounts in
basis. See § 1.461–1(a)(1) for rules
governing the time at which an amount
may be taken into account by a taxpayer
using the cash receipts and disburse-
ments method, and § 1.461–1(a)(2) for
rules governing the time at which a
liability is incurred and generally taken
into account (for example, by treating
the amount of the liability as a capital
expenditure) by an accrual basis tax-
payer.
(3)Determination of amounts charge-
able to capital account in certain
cases—(i)Covenants not to compete,
rights granted by governmental units,
and contracts for the use of section 197
intangibles—(A)In general. In the case
of a covenant not to compete or other
similar arrangement described in para-
graph (b)(9) of this section, any license,
permit, or other right granted by a
governmental unit or an agency or in-
strumentality thereof described in para-
graph (b)(8) of this section, or a contract
for the use of a section 197 intangible
described in paragraph (b)(11) of this
section, the amount chargeable to capital
account includes all amounts required to
be paid pursuant to the agreement or
right, whether or not any amount would
be deductible under section 162 if the
agreement or right were not a section
197 intangible.
(B)Time for taking amounts into ac-
count. For purposes of this paragraph
(f)(3), in applying the provisions of
§§ 1.461–1(a)(1) (in the case of a tax-
payer using the cash receipts and dis-
bursements method of accounting) and
§ 1.461–1(a)(2) (in the case of a tax-
payer using an accrual method of ac-
counting), all amounts required to be
paid under an agreement described in
paragraph (b)(9) or (11) of this section
shall be treated as amounts payable
under the terms of a debt instrument
issued in exchange for property. Contin-
gent payments made under an agreement
described in paragraph (b)(9) or (11) of
this section will be included in adjusted
basis under the rules of paragraph (f)(2)
of this section.
(ii)Franchises, trademarks, or trade
names and licenses, permits, and other
rights granted by governmental units.
The costs paid or incurred for the
renewal of a franchise, trademark, or
trade name or any license, permit, or
other right granted by a governmental
unit or an agency or instrumentality
thereof are amortized over the 15-year
period that begins with the month of
renewal. Any costs paid or incurred for
the issuance, or earlier renewal, continue
to be taken into account over the re-
maining portion of the amortization pe-
riod that began at the time of the
issuance, or earlier renewal. Any amount
paid or incurred for the protection, ex-
pansion, or defense of a trademark or
trade name and chargeable to capital
account is treated as an amount paid or
incurred for a renewal.
(iii)Certain reinsurance transactions.
See paragraph (g)(4)(ii) of this section
for special rules regarding the adjusted
basis of an insurance contract acquired
through an assumption reinsurance
transaction.
(4)Transactions subject to section
338 or 1060. In the case of a section
197 intangible deemed to have been
acquired as the result of a qualified
stock purchase within the meaning of
section 338(d)(3), the basis shall be
determined pursuant to section 338(b)(5)
and the regulations thereunder. In the
case of a section 197 intangible acquired
in an applicable asset acquisition within
the meaning of section 1060(c), the
basis shall be determined pursuant to
section 1060(a) and the regulations
thereunder.
(g)Special rules—(1)Treatment of
certain dispositions—(i)Loss disallow-
ance rules—(A)In general. No loss is
recognized on the disposition of an
amortizable section 197 intangible ac-
quired in a transaction or series of
related transactions in which the tax-
payer acquired other amortizable section
197 intangibles if, after the disposition,
the taxpayer retains any of the other
amortizable section 197 intangibles, or
the right to use, or an interest in, any of
the other amortizable section 197 intan-
gibles (the retained intangibles). Except
as otherwise provided in paragraph
(g)(1)(iv)(B) of this section, the adjusted
basis of each of the retained intangibles
is increased by the product of the loss
that is not recognized solely by reason
of this rule and a fraction, the numerator
23

of which is the adjusted basis of the
retained intangible on the date of the
disposition and the denominator of
which is the total adjusted bases of all
the retained intangibles on that date. The
abandonment of an amortizable section
197 intangible, or any other event ren-
dering an amortizable section 197 intan-
gible worthless, is treated as a disposi-
tion of the intangible for purposes of
this paragraph (g)(1), and the abandoned
or worthless intangible is disregarded
(that is, it is not treated as a retained
intangible) for purposes of applying this
paragraph (g)(1) to the subsequent dis-
position of any other amortizable section
197 intangible.
(B)Certain nonrecognition transfers.
The loss disallowance rule in paragraph
(g)(1)(i)(A) of this section also applies
when a taxpayer transfers an amortiz-
able section 197 intangible from an
acquired trade or business in a transac-
tion in which the intangible is
transferred-basis property and, after the
transfer, retains other amortizable sec-
tion 197 intangibles from the trade or
business. Thus, for example, the transfer
of an amortizable section 197 intangible
to a corporation in exchange for stock in
the corporation in a transaction de-
scribed in section 351, or to a partner-
ship in exchange for an interest in the
partnership in a transaction described in
section 721, when other amortizable
section 197 intangibles acquired in the
same transaction are retained, followed
by a sale of the stock or partnership
interest received, will not avoid the
application of the loss disallowance pro-
vision to the extent the adjusted basis of
the transferred intangible at the time of
the sale exceeds its fair market value at
that time.
(ii)Separately acquired property.
Paragraph (g)(1)(i) of this section does
not apply to an amortizable section 197
intangible that is not acquired in a
transaction or series of related transac-
tions in which the taxpayer acquires
other amortizable section 197 intan-
gibles (a separately acquired intangible).
Consequently, a loss may be recognized
upon the disposition of a separately
acquired section 197 intangible. How-
ever, the termination or worthlessness of
only a portion of an amortizable section
197 intangible is not the disposition of a
separately acquired intangible. For ex-
ample, neither the loss of several cus-
tomers from an acquired customer list,
the termination of several mortgages
(not qualifying for the exception set
forth in paragraph (c)(11) of this sec-
tion) from an acquired mortgage pool,
nor the worthlessness of only some
information from an acquired data base
constitutes the disposition of a sepa-
rately acquired intangible.
(iii)Disposition of a covenant not to
compete. If a covenant not to compete
or any other arrangement having sub-
stantially the same effect is entered into
in connection with the direct or indirect
acquisition of an interest in a trade or
business, the disposition or worthless-
ness of the covenant or other arrange-
ment will not be considered to occur
until the disposition or worthlessness of
all interests in that trade or business. For
example, a covenant not to compete
entered into in connection with the
purchase of stock continues to be amor-
tized on a 15-year straight-line basis
(even after the covenant expires or be-
comes worthless) unless all the trades or
businesses in which an interest was
acquired through the stock purchase (or
all the purchaser’s interests in those
trades or businesses) also are disposed
of or become worthless.
(iv)Taxpayers under common con-
trol—(A)In general. Except as provided
in paragraph (g)(1)(iv)(B) of this sec-
tion, all persons that would be treated as
a single taxpayer under section 41(f)(1)
are treated as a single taxpayer under
this paragraph (g)(1). Thus, for example,
a loss is not recognized on the disposi-
tion of an amortizable section 197 intan-
gible by a member of a controlled group
of corporations (as defined in section
41(f)(5)) if, after the disposition, another
member retains other amortizable sec-
tion 197 intangibles acquired in the
same transaction as the amortizable sec-
tion 197 intangible that has been dis-
posed of.
(B)Treatment of disallowed loss.If
retained intangibles are held by a person
other than the person incurring the disal-
lowed loss, only the adjusted basis of
intangibles retained by the person incur-
ring the disallowed loss is increased,
and only the adjusted basis of those
intangibles is included in the denomina-
tor of the fraction described in para-
graph (g)(1)(i)(A) of this section. If
none of the retained intangibles are held
by the person incurring the disallowed
loss, the loss is allowed ratably, as a
deduction under section 197, over the
remainder of the period during which
the intangible giving rise to the loss
would have been amortizable, except
that any remaining disallowed loss is
allowed in full on the first date on
which all other retained intangibles have
been disposed of or become worthless.
(2)Treatment of certain nonrecogni-
tion and exchange transactions—(i)In
general—(A)Transfer disregarded. Ex-
cept as otherwise provided in paragraph
(h) of this section, if a section 197
intangible is transferred in a transaction
described in paragraph (g)(2)(ii) of this
section, the transfer is disregarded in
determining—
(1) Whether, with respect to so much
of the intangible’s basis in the hands of
the transferee as does not exceed its
basis in the hands of the transferor, the
intangible is an amortizable section 197
intangible; and
(2) The amount of the deduction un-
der section 197 with respect to such
basis.
(B)Application of general rule.Ifthe
intangible described in paragraph
(g)(2)(i)(A) of this section was an amor-
tizable section 197 intangible in the
hands of the transferor, the transferee
will continue to amortize its adjusted
basis, to the extent it does not exceed
the transferor’s adjusted basis, ratably
over the remainder of the transferor’s
15-year amortization period. If the intan-
gible was not an amortizable section
197 intangible in the hands of the
transferor, the transferee’s adjusted ba-
sis, to the extent it does not exceed the
transferor’s adjusted basis, cannot be
amortized under section 197. In either
event, the intangible is treated, with
respect to so much of its adjusted basis
in the hands of the transferee as exceeds
its adjusted basis in the hands of the
transferor, in the same manner for pur-
poses of section 197 as an intangible
acquired from the transferor in a trans-
action that is not described in paragraph
(g)(2)(ii) of this section. The rules of
this paragraph (g)(2)(i) also apply to any
subsequent transfers of the intangible in
a transaction described in paragraph
(g)(2)(ii) of this section.
(ii)Transactions covered. The trans-
actions described in this paragraph
(g)(2)(ii) are—
(A) Any transaction described in sec-
tion 332, 351, 361, 721, or 731; and
(B) Any transaction between corpora-
tions that are members of the same
consolidated group immediately after the
transaction.
(iii)Certain exchanged-basis prop-
erty. This paragraph (g)(2)(iii) applies to
property that is acquired in a transaction
subject to section 1031 or 1033 and is
permitted to be acquired without recog-
nition of gain (replacement property).
24

Except as otherwise provided in para-
graph (h) of this section, replacement
property is treated as if it were the
property by reference to which its basis
is determined (the predecessor property)
in determining whether, with respect to
so much of its basis as does not exceed
the basis of the predecessor property, the
replacement property is an amortizable
section 197 intangible and the amortiza-
tion period under section 197 with re-
spect to such basis. Thus, if the prede-
cessor property was an amortizable
section 197 intangible, the taxpayer will
amortize the adjusted basis of the re-
placement property, to the extent it does
not exceed the adjusted basis of the
predecessor property, ratably over the
remainder of the 15-year amortization
period for the predecessor property. If
the predecessor property was not an
amortizable section 197 intangible, the
adjusted basis of the replacement prop-
erty, to the extent it does not exceed the
adjusted basis of the predecessor prop-
erty, may not be amortized under section
197. In either event, the replacement
property is treated, with respect to so
much of its adjusted basis as exceeds
the adjusted basis of the predecessor
property, in the same manner for pur-
poses of section 197 as property ac-
quired from the transferee in a transac-
tion that is not subject to section 1031
or 1033. (See paragraph (h) of this
section for the application of the anti-
churning rules.)
(iv)Transfers under section 708(b)-
(1)—(A)In general. Paragraph (g)(2)(i)
of this section applies to transfers of
section 197 intangibles that occur or are
deemed to occur by reason of the termi-
nation of a partnership under section
708(b)(1).
(B)Termination by sale or exchange
of interest. In applying paragraph
(g)(2)(i) of this section to a partnership
that is terminated pursuant to section
708(b)(1)(B) (relating to a sale or ex-
change of an interest), the terminated
partnership is treated as the transferor
and the new partnership is treated as the
transferee with respect to any section
197 intangible held by the terminated
partnership immediately preceding the
termination. (See paragraph (g)(3) of
this section for the treatment of in-
creases in the basis of property of the
terminated partnership under section
743(b).)
(C)Other terminations. In applying
paragraph (g)(2)(i) of this section to a
partnership that is terminated pursuant
to section 708(b)(1)(A) (relating to ces-
sation of activities by a partnership), the
terminated partnership is treated as the
transferor and the distributee partner is
treated as the transferee with respect to
any section 197 intangible held by the
terminated partnership immediately pre-
ceding the termination.
(D)Anti-churning rules. See para-
graph (h) of this section for the applica-
tion of the anti-churning rules.
(v)Distributions to which section
732(d) applies. Paragraph (g)(2)(i) of
this section applies to a distribution of a
section 197 intangible to which section
732(d) (relating to special partnership
basis to transferee) applies. For purposes
of section 197, any increase in the basis
of the distributed intangible under sec-
tion 732(d) is taken into account by a
partner as if the increased portion were
attributable to the partner’s acquisition
of the underlying partnership property
on the date of distribution from the
transferor of the partnership interest or
the deceased partner, as the case may
be. For purposes of the effective date
and anti-churning rules (paragraphs
(d)(1) and (h) of this section), the
intangible is treated as having been
acquired by the transferee partner at the
time of the transfer of the partnership
interest described in section 732(d). For
purposes of determining the amortiza-
tion period under section 197 with re-
spect to any increased basis, however,
the intangible is treated as having been
acquired by the transferee partner at the
time of the distribution described in
section 732(a). (See paragraph (h) of
this section for the application of the
anti-churning rules.)
(vi)Curative and remedial alloca-
tions under section 704(c). For purposes
of paragraph (g)(2)(i) of this section, if
a section 197 intangible is transferred to
a partnership in a transaction described
in section 721, the basis of the intan-
gible in the hands of the transferor
includes the amount of any curative or
remedial allocations of amortization that
are made to a noncontributing partner
with respect to the contributed intan-
gible under the curative or remedial
methods for making allocations under
section 704(c). Thus, for example, if a
contributed intangible is not an amortiz-
able section 197 intangible in the hands
of the transferor, any remedial alloca-
tions of amortization made to a noncon-
tributing partner with respect to the
intangible are not amortizable under
section 197. See § 1.704–3(c) and (d)
for a description of the curative and
remedial methods.
(3)Application of section 754 to ac-
quisitions of an interest in an intangible
held through a partnership. Any in-
crease in the basis of partnership prop-
erty under section 734(b) (relating to the
optional adjustment to the basis of un-
distributed partnership property) or sec-
tion 743(b) (relating to the optional
adjustment to the basis of partnership
property) is taken into account under
section 197 by a partner as if the
increased portion of the basis were
attributable to the partner’s acquisition
of the underlying partnership property
and as if the property were acquired
from the distributee partner on the date
of the distribution (in the case of a basis
increase under section 734(b)) or from
the transferor of the partnership interest
on the date of the transfer (in the case
of a basis increase under section
743(b)). (See paragraph (h) of this sec-
tion for the application of the anti-
churning rules.)
(4)Treatment of certain reinsurance
transactions—(i)In general. Section
197 applies to any insurance contract
acquired from another person through an
assumption reinsurance transaction. For
purposes of section 197, an assumption
reinsurance transaction is—
(A) Any arrangement in which one
insurance company (the reinsurer) be-
comes solely liable to policyholders on
contracts transferred by another insur-
ance company (the ceding company);
and
(B) Any acquisition of an insurance
contract that is treated as occurring by
reason of an election under section 338.
(ii)Determination of adjusted basis—
(A)Acquisitions (other than under sec-
tion 338) of specified insurance con-
tracts. The amount taken into account
for purposes of section 197 as the
adjusted basis of specified insurance
contracts (as defined in section
848(e)(1)) acquired in an assumption
reinsurance transaction that is not de-
scribed in paragraph (g)(4)(i)(B) of this
section is equal to the excess of—
(1) The amount paid or incurred (or
treated as having been paid or incurred)
by the reinsurer for the purchase of the
contracts (as determined under § 1.817–
4(d)(2)); over
(2) The amount of the specified
policy acquisition expenses that are at-
tributable to the reinsurer’s net positive
consideration for the reinsurance agree-
ment (as determined under § 1.848–
2(f)(3)).
(B)Other acquisitions. [Reserved]
25

(5)Amounts paid or incurred for a
franchise, trademark, or trade name.If
an amount to which section 1253(d)
(relating to the transfer, sale, or other
disposition of a franchise, trademark, or
trade name) applies is described in sec-
tion 1253(d)(1)(B) (relating to contin-
gent serial payments), the amount is
deductible under section 1253(d)(1) and
is not included in the adjusted basis of
the intangible for purposes of section
197. Any other amount, whether fixed
or contingent, to which section 1253(d)
applies is chargeable to capital account
under section 1253(d)(2) and is amortiz-
able only under section 197.
(6)Amounts properly taken into ac-
count in determining the cost of prop-
erty that is not a section 197 intangible.
Section 197 does not apply to an
amount that is properly taken into ac-
count in determining the cost of prop-
erty that is not a section 197 intangible.
The entire cost of acquiring the other
property is included in its basis and
recovered under other applicable Inter-
nal Revenue Code provisions.
(7)Treatment of amortizable section
197 intangibles as depreciable prop-
erty—(i)In general. An amortizable
section 197 intangible is treated as prop-
erty of a character subject to the allow-
ance for depreciation under section 167.
Thus, for example, an amortizable sec-
tion 197 intangible is not a capital asset
for purposes of section 1221, but if held
for more than one year, it generally
qualifies under section 1231 as property
used in a trade or business. Also, an
amortizable section 197 intangible is
section 1245 property and section 1239
applies to any gain recognized upon its
sale or exchange between related per-
sons (as defined in section 1239(b)).
(ii)Exceptions and limitations—(A)
Unstated interest and original issue dis-
count rules. In the case of the acquisi-
tion of any amortizable section 197
intangible in a transaction that would
not be treated as the sale or exchange of
property by the person from which the
intangible was acquired, paragraph
(g)(7)(i) of this section shall not apply
(and the amortizable section 197 intan-
gible shall not be treated as property)
for purposes of—
(1) Section 483(c) (relating to pay-
ments on account of the sale or ex-
change of property); and
(2) Section 1274(c) (relating to debt
instruments given in consideration for
the sale or exchange of property).
(B)Treatment of other parties to
transaction. No person shall be treated
as having sold, exchanged, or otherwise
disposed of property in a transaction for
purposes of any provision of the Internal
Revenue Code solely by reason of the
application of paragraph (g)(7)(i) of this
section to any other party to the transac-
tion.
(h)Anti-churning rules—(1)Conver-
sions of existing goodwill, going con-
cern value, and certain other section
197 intangibles. Except as otherwise
provided in this paragraph (h), goodwill,
going concern value, or any other sec-
tion 197 intangible for which a depre-
ciation or amortization deduction would
not have been allowable prior to the
enactment of section 197 may not be
amortized as an amortizable section 197
intangible if the section 197 intangible
is acquired by a taxpayer after August
10, 1993 (or after July 25, 1991, if a
valid retroactive election pursuant to
§ 1.197–1T has been made) and ei-
ther—
(i) The taxpayer or a related person
held or used the intangible or an interest
therein at any time during the transition
period;
(ii) The taxpayer acquired the intan-
gible from a person that held the intan-
gible at any time during the transition
period and, as part of the transaction,
the user of the intangible does not
change; or
(iii) The taxpayer grants the right to
use the intangible to a person (or a
person related to that person) that held
or used the intangible at any time during
the transition period.
(2)Amounts deductible under section
1253(d). For purposes of paragraph
(h)(1) of this section, deductions allow-
able under section 1253(d)(2) or deduc-
tions allowable pursuant to an election
under section 1253(d)(3) (in either case
as in effect prior to the enactment of
section 197) are treated as deductions
allowable for amortization.
(3)Transition period. For purposes of
this paragraph (h), the transition period
begins on July 25, 1991, and ends on
August 10, 1993, except that for taxpay-
ers that made a valid retroactive election
pursuant to § 1.197–1T, the transition
period is July 25, 1991.
(4)Exceptions. The anti-churning
rules of this paragraph (h) do not apply
to—
(i) The acquisition of an intangible
by a taxpayer if the basis of the intan-
gible is determined under section
1014(a); or
(ii) The acquisition of an intangible
by a taxpayer that is an amortizable
section 197 intangible in the hands of
the seller (or transferor), but only if the
acquisition by the taxpayer or sale by
the seller (or transfer by the transferor)
was not part of a transaction or a series
of related transactions in which the
seller (or transferor) previously acquired
the intangible or interest therein.
(5)Special partnership provisions—
(i)Basis increases. In determining
whether the anti-churning rules of this
paragraph (h) apply to any increase in
the basis of partnership property under
section 732, 734, or 743, the determina-
tions are made at the partner level and
each partner is treated as having owned
and used the partner’s proportionate
share of the partnership property. Thus,
for example, the anti-churning rules do
not apply to an increase in the basis of
partnership property under section
743(b) that occurs upon the acquisition
of an interest in a partnership that has
made a section 754 election if the
person acquiring the partnership interest
either is not related to the person trans-
ferring the partnership interest or ac-
quired the interest upon the death of the
former partner. Similarly, the anti-
churning rules do not apply to a con-
tinuing partner’s proportionate share of
an increase in the basis of partnership
property under section 734(b) that oc-
curs upon the distribution of property of
a partnership that has made a section
754 election if the continuing partner is
not related to the distributee partner.
(ii)Curative and remedial allocations
under section 704(c). In determining
whether the anti-churning rules of this
paragraph (h) apply, any curative or
remedial allocation of amortization
made to a noncontributing partner under
the curative or remedial methods for
making allocations under section 704(c)
is treated in the same manner as a
noncurative or nonremedial allocation of
amortization. Thus, for example, if the
anti-churning rules would apply to a
nonremedial allocation of amortization
to a noncontributing partner, the anti-
churning rules apply to any remedial
allocation of amortization. See § 1.704–
3(c) and (d) for a description of the
curative and remedial methods.
(6)Related person—(i)In general.
Except as otherwise provided in para-
graph (h)(6)(iii) of this section, a person
is related to another person for purposes
of this paragraph (h) if—
(A) The person bears a relationship
to that person that would be specified in
section 267(b) (determined without re-
gard to section 267(e)) and, by substitu-
26

tion, section 267(f)(1), if those sections
were amended by substituting 20 per-
cent for 50 percent; or
(B) The person bears a relationship to
that person that would be specified in
section 707(b)(1) if that section was
amended by substituting 20 percent for
50 percent; or
(C) The persons are engaged in
trades or businesses under common con-
trol (within the meaning of section
41(f)(1)(A) and (B)).
(ii)Time for testing relationships. For
purposes of this paragraph (h), a person
is treated as related to another person if
the relationship exists—
(A) In the case of a single transac-
tion, immediately before or immediately
after the acquisition of the intangible
involved; or
(B) In the case of a series of related
transactions, at any time during the
period beginning immediately before the
earliest acquisition and ending immedi-
ately after the last acquisition of any
intangible acquired in the series of
transactions.
(iii)De minimis rule—(A)In general.
Two corporations shall not be treated as
related persons for purposes of this
paragraph (h)(6) if—
(1) The corporations would (but for
the application of this paragraph
(h)(6)(iii)) be treated as related persons
solely by reason of substituting ‘‘more
than 20 percent’’ for ‘‘more than 50
percent’’ in section 267(f)(1)(A); and
(2) The beneficial ownership interest
of one corporation in the stock of the
other corporation represents less than 10
percent of the total combined voting
power of all classes of stock entitled to
vote and less than 10 percent of the
total value of the shares of all classes of
stock outstanding.
(B)Determination of beneficial own-
ership interest. For purposes of this
paragraph (h)(6)(iii), the beneficial own-
ership interest of one corporation in the
stock of another corporation shall be
determined under the principles of sec-
tion 318(a), except that—
(1) In applying section 318(a)(2)(C),
the 50 percent limitation contained
therein shall not be applied; and
(2) Section 318(a)(3)(C) shall be ap-
plied by substituting ‘‘20 percent’’ for
‘‘50 percent’’.
(7)Special rules for entities that
owned or used property at any time
during the transition period and that are
no longer in existence. A corporation,
partnership, or trust that owned or used
property at any time during the transi-
tion period and that is no longer in
existence is deemed to be in existence
for purposes of determining whether the
taxpayer that acquired the property is
related to the corporation, partnership,
or trust.
(8)Special rules for section 338
deemed acquisitions. In the case of a
qualified stock purchase that is treated
as a deemed sale and purchase of assets
pursuant to section 338, the corporation
that is treated as selling its assets as a
result of an election thereunder (old
target) is not considered related to the
corporation that is treated as purchasing
the assets (new target) if stock of old
target meeting the requirements of sec-
tion 1504(a)(2) is, or is deemed to have
been, acquired by purchase after July
25, 1991. See § 1.338–2(d). Thus, for
example, if a corporation (the purchas-
ing corporation) makes a qualified stock
purchase of the stock of another corpo-
ration (target) from unrelated third par-
ties in July 1997, and a section 338
election is made by the purchasing cor-
poration, the deemed asset purchase
shall not be considered as an acquisition
between related persons solely by virtue
of the fact that old target and new target
are treated as the same corporation for
certain other purposes of the Code or
that old target and new target are the
same corporation under the laws of the
state or other jurisdiction of its organi-
zation. However, the anti-churning rules
of this paragraph (h) may nevertheless
apply to a deemed asset purchase result-
ing from a section 338 election because
old target and new target are otherwise
treated as related parties within the
meaning of paragraph (h)(6) of this
section.
(9)Exception to anti-churning rules
where gain is recognized—(i)In gen-
eral. If a taxpayer would not be subject
to paragraph (h) but for the substitution
of 20 percent for 50 percent under
paragraph (h)(6)(i)(A) of this section
and the person (whether or not subject
to Federal income tax) from which the
taxpayer acquires the intangible elects to
recognize gain on the disposition of the
intangible and, notwithstanding any
other provision of the Internal Revenue
Code, agrees to pay an amount that,
when added to any other Federal income
tax, equals the gain on the disposition
multiplied by the highest marginal rate
of tax imposed by section 1 (for indi-
viduals, estates, or trusts) or 11 (for
corporations), whichever is applicable,
for the taxable year in which the gain is
realized by the person from which the
taxpayer acquires the intangible, then
the anti-churning rules described in this
paragraph (h) only apply to the extent
the taxpayer’s adjusted basis in the
intangible exceeds the gain recognized.
(ii)Manner of making election. [Re-
served]
(iii)Determination of highest mar-
ginal rate of tax. For the purpose of
determining the highest marginal rate of
tax applicable to the person from which
the taxpayer acquires the intangible, the
following rules shall apply:
(A)Noncorporate taxpayers.Inthe
case of an individual, estate, or trust, the
highest marginal rate of tax shall be the
highest marginal rate of tax in effect
under section 1, determined without re-
gard to section 1(h).
(B)Corporations and tax-exempt en-
tities. In the case of a corporation or an
entity that is exempt from tax under
section 501(a), the highest marginal rate
of tax shall be the highest marginal rate
of tax in effect under section 11, deter-
mined without regard to any rate that is
added to the otherwise applicable rate in
order to offset the effect of the gradu-
ated rate schedule.
(iv)Special rule for pass-through en-
tities. In the case of a partnership or S
corporation, the election under para-
graph (h)(9)(i) of this section—
(A) Shall be made by the entity
rather than by its owners or members;
and
(B) Shall constitute an election by
each of the owners or members of the
entity (rather than the entity itself) to
pay a tax, determined as provided in this
paragraph (h)(9), on the portion of the
gain properly allocable to each such
owner or member.
(v)Coordination with other provi-
sions—(A)In general. For purposes of
applying any provision of chapter 1 or
chapter 6 of the Code other than section
197(f)(9)(B), both the amount of gain
subject to the tax determined under
paragraph (h)(9)(i) of this section and
the amount of the tax shall be disre-
garded. Thus, for example, the amount
of the gain shall not be reduced by any
net operating loss deduction under sec-
tion 172(a), any capital loss under sec-
tion 1212, or any other similar loss or
deduction. The amount of tax deter-
mined under paragraph (h)(9)(i) of this
section shall not be reduced by any
credit of the taxpayer. In computing the
amount of any net operating loss, capital
loss, or other similar loss or deduction,
or any credit that may be carried to any
taxable year, any gain recognized, and
27

any tax paid, under paragraph (h)(9)(i)
of this section shall not be taken into
account.
(B)Section 1374. No provision of
paragraph (h)(9)(iv) of this section shall
preclude the application of section 1374
(relating to a tax on certain built-in
gains of S corporations) to any gain
with respect to which the election de-
scribed in paragraph (h)(9)(i) of this
section is made. Neither paragraph
(h)(9)(iv) nor paragraph (h)(9)(v)(A) of
this section shall be treated as preclud-
ing a taxpayer from applying the provi-
sions of section 1366(f)(2) (relating to
treatment of the tax imposed by section
1374 as a loss sustained by the S
corporation) in determining the amount
of tax payable under paragraph (h)(9)(i)
of this section.
(C)Procedural and administrative
provisions. For purposes of subtitle F,
the amount determined under paragraph
(h)(9)(i) of this section is treated as a
tax imposed by section 1 or 11, as
appropriate.
(D)Installment method. The gain
subject to the tax determined under
paragraph (h)(9)(i) of this section may
not be reported under the method de-
scribed in section 453(a). Any such gain
that would, but for the application of
this paragraph (h)(9)(v)(D), be taken
into account under section 453(a) shall
be taken into account in the same
manner as if an election under section
453(d) (relating to the election not to
apply section 453(a)) had been made.
(10)Transactions subject to both
anti-churning and nonrecognition rules.
If a person acquires a section 197
intangible in a transaction described in
paragraph (g)(2) of this section from a
person in whose hands the intangible
was an amortizable section 197 intan-
gible, and as a result of the transaction,
the person is or becomes related to any
person described in paragraph (h)(1) of
this section, the intangible ceases to be
an amortizable section 197 intangible in
the hands of the transferee unless the
exception provided in paragraph
(h)(4)(ii) of this section applies. If a
person acquires a section 197 intangible
in anticipation of becoming related to
any person described in paragraph (h)(1)
of this section, the intangible is not an
amortizable section 197 intangible in the
hands of the transferee.
(11)Anti-churning anti-abuse rule.
Section 197 does not apply to any
intangible acquired by a taxpayer if the
taxpayer acquires the intangible in a
transaction one of the principal purposes
of which is to avoid any of the anti-
churning rules for intangibles described
in paragraph (h)(1) of this section. Thus,
for example, if section 197 intangibles
are acquired in a transaction (or series
of related transactions) in which options
to acquire stock are issued to a party to
the transaction, but the option is not
treated as having been exercised for
purposes of paragraph (h)(6) of this
section, this paragraph (h)(11) may ap-
ply to the transaction.
(i) [Reserved].
(j)General anti-abuse rule. The rules
in this section shall be interpreted and
applied as necessary and appropriate to
prevent avoidance of the purposes of
section 197. If one of the principal
purposes of a transaction is to achieve a
tax result that is inconsistent with the
purposes of section 197, the Commis-
sioner can recast the transaction for
Federal tax purposes as appropriate to
achieve tax results that are consistent
with the purposes of section 197, in
light of the applicable statutory and
regulatory provisions and the pertinent
facts and circumstances.
(k)Examples. The following ex-
amples illustrate the application of this
section:
Example 1. Computer software. (i) X purchases
all of the assets of an existing trade or business
from Y. One of the assets acquired is all of Y’s
rights in certain computer software previously
used by Y under the terms of a nonexclusive
license from the software developer. The software
was developed for use by manufacturers to main-
tain a comprehensive accounting system, including
general and subsidiary ledgers, payroll, accounts
receivable and payable, cash receipts and disburse-
ments, fixed asset accounting, and inventory cost
accounting and controls. The software was not
substantially modified for use by Y within the
meaning of paragraph (c)(4)(i) of this section and
was acquired directly by Y from the developer.
The developer does not maintain wholesale or
retail outlets but markets the software directly to
ultimate users. Y’s license of the software is
limited to an entity that is actively engaged in
business as a manufacturer.
(ii) Notwithstanding these limitations, the soft-
ware is considered to be readily available to the
general public for purposes of paragraph (c)(4)(i)
of this section. Accordingly, the software is not a
section 197 intangible.
Example 2. Governmental rights of fixed dura-
tion. (i) City M operates a municipal water
system. In order to induce X to locate a new
manufacturing business in the city, M grants X the
right to purchase water for 16 years at a specified
price. X incurs legal fees and other costs for
professional services in the amount of $10x in
connection with its efforts to obtain these rights.
(ii) The rights granted by M are described in
section 197(e)(4)(B) and paragraph (c)(6) of this
section and, thus, are not a section 197 intangible.
This exclusion applies notwithstanding that the
rights may not qualify for exclusion under section
197(e)(4)(D) and paragraph (c)(13) of this section
or that they also may be described in section
197(d)(1)(D) and paragraph (b)(8) of this section
and, as such, may not be treated as self-created
intangibles eligible for exclusion under section
197(c)(2).
Example 3. Advertising costs. (i) Q manufac-
tures and sells consumer products through a series
of wholesalers and distributors. In order to in-
crease sales of its product by encouraging con-
sumer loyalty to its products and to enhance the
value of the goodwill, trademarks, and trade
names of the business, Q advertises its products to
the consuming public. It regularly incurs costs to
develop radio, television, and print advertisements.
These costs generally consist of employee costs
and amounts paid to independent advertising agen-
cies. Q also incurs costs to run these advertise-
ments in the various media for which they were
developed. Except for the possible application of
section 197, these costs would be ordinary and
necessary expenses deductible under section 162.
(ii) The advertising costs are not subject to
amortization under section 197 pursuant to para-
graph (a)(3) of this section because they are
otherwise deductible.
Example 4. Covenant not to compete acquired
in connection with stock redemption. (i) R, a
corporation, redeems all of its stock owned by A,
an individual. R and A have no business relation-
ships with each other except for the corporate-
shareholder relationship. In connection with the
stock redemption, R and A enter into an agreement
containing a covenant not to compete. Under this
agreement, A agrees that A will not compete with
the business of R within a prescribed geographical
territory for a period of three years after the date
on which the stock redemption is completed. In
exchange for this agreement, R pays A consider-
ation in addition to the amount paid for the stock
redeemed by R.
(ii) Because the agreement was entered into in
connection with the reacquisition by R of its
stock, section 162(k) provides that no deduction
shall be allowed for any amount paid or incurred
pursuant to the agreement. Accordingly, pursuant
to paragraph (a)(4) of this section, section 197
does not apply to these amounts.
Example 5. Substantial portion of trade or
business. (i) S owns and operates 100 restaurants
in various locations. Each of these restaurants is
operated using a well-established trade name made
available to S under the terms of a franchise
agreement with F. S determined to cease operating
one of the franchised restaurants. Accordingly, S
sold to B all of the assets that it had used
exclusively in connection with the operation of its
restaurant at that location. B agreed to extend an
offer of employment to all of the employees at
that location. B acquired no rights to the franchise
or to any of the trademarks or trade names that
had been used by S.
(ii) The transaction between B and S is a
transaction involving the acquisition of assets
constituting a trade or business or a substantial
portion thereof within the meaning of paragraph
(e) of this section, notwithstanding that B did not
acquire a franchise from S or that the assets did
not represent a substantial portion of the assets
used by S in that trade or business.
Example 6. Separate acquisition of franchise. (i)
S is a franchisor of retail outlets for specialty
coffees. On July 1, 1997, G enters into an
agreement with S pursuant to which G is permit-
ted to acquire and operate a store using the S
trademark and trade name at the location specified
in the agreement. G agrees to pay S $100,000
upon execution of the agreement and also agrees
to pay, on a monthly basis throughout the term of
the franchise, a specified percentage of gross sales
28

from the store. The agreement contains detailed
specifications for the construction and operation of
the business, but G is not required to purchase
from S any of the materials necessary to construct
the improvements at the location specified in the
franchise agreement.
(ii) The franchise is a section 197 intangible
within the meaning of paragraph (b)(10) of this
section. The franchise does not qualify for the
exclusion relating to self-created intangibles de-
scribed in section 197(c)(2) and paragraph (d)(2)
of this section because the franchise is described
in section 197(d)(1)(F). In addition, because the
acquisition of the franchise constitutes the acquisi-
tion of an interest in a trade or business or a
substantial portion thereof, the franchise may not
be excluded under section 197(e)(4). Thus, the
franchise is an amortizable section 197 intangible,
the basis of which must be recovered over a
15-year period. However, the amounts to be paid
by G computed as a percentage of gross sales are
not subject to the provisions of section 197 by
reason of section 197(f)(4)(C) and paragraph
(b)(10)(ii) of this section.
Example 7. Acquisition and amortization of
covenant not to compete. (i) As part of the
acquisition of a trade or business from C, B and C
enter into an agreement containing a covenant not
to compete. Under this agreement, C agrees that it
will not compete with the business acquired by B
within a prescribed geographical territory for a
period of three years after the date on which the
business is sold to B. In exchange for this
agreement, B agrees to pay C $90,000 per year for
each year in the term of the agreement. The
agreement further provides that, in the event of a
breach by C of his obligations under the agree-
ment, B may terminate the agreement, cease
making any of the payments due thereafter, and
pursue any other legal or equitable remedies
available under applicable law. Assume that the
amounts payable to C under the agreement repre-
sent the value of C’s obligations to B pursuant to
the covenant and that the present fair market value
of B’s rights under the agreement is $225,000. The
aggregate consideration paid for all assets acquired
in the transaction other than the covenant exceeds
the sum of the amount of Class I assets and the
aggregate fair market value of all Class II and
Class III assets and all Class IV assets other than
the covenant.
(ii) Because the covenant is acquired in an
applicable asset acquisition (within the meaning of
section 1060(c)), the basis of B in the covenant
cannot exceed its fair market value. See § 1.1060–
1T(e)(1). Under section 197(f)(3) and paragraphs
(f)(3)(i) and (4) of this section, the adjusted basis
of B in the agreement, determined as of the date
on which the agreement is entered into, is
$225,000. B’s deduction for amortization with
respect to the amounts to be paid under the
agreement is $1,250 per month, or $15,000 per
year, for each year in the 15-year period beginning
on the date on which the agreement is entered
into. The excess of the amounts payable pursuant
to the agreement over the amount allocated to the
covenant under § 1.1060–1T(e)(1), or $45,000, is
allocated to Class V assets.
Example 8. Breach of covenant not to compete
subsequent to acquisition. (i) The facts are the
same as inExample 7, except that at the end of
the second year of the agreement, C breaches the
agreement by competing against B. B and C enter
into a settlement of all claims arising under the
agreement and the subsequent breach by C by
agreeing that B is not obligated to pay C the final
installment of $90,000.
(ii) Under paragraph (g)(1)(iii) of this section,
the covenant is not treated as having been dis-
posed of (or becoming worthless) because C has
not disposed of all interests in the trade or
business acquired in the same transaction as the
covenant. The covenant is not a contingent income
asset within the meaning of § 1.1060–1T(f)(4)(i).
Accordingly, B must decrease the adjusted basis of
any asset acquired from C by $90,000 at the
beginning of the third year of the agreement in the
manner provided by § 1.1060–1T(f)(3)(i). To the
extent that any decrease is allocated to an amortiz-
able section 197 intangible, B must reduce the
amount of its deduction for amortization under
section 197 accordingly.
Example 9. Loss disallowance rules involving
related persons. (i) Assume that X and Y are
treated as a single taxpayer for purposes of
paragraph (g)(1)(iv) of this section. In a single
transaction, X and Y acquired from Z all of the
assets used by Z in a trade or business. Z had
operated this business at two locations, and X and
Y each desired to acquire the assets used by Z at
one of the locations. Three years after the acquisi-
tion, X sold all of the assets, including amortizable
section 197 intangibles, to an unrelated purchaser
at a loss of $120,000.
(ii) Because X and Y are treated as a single
taxpayer for purposes of the loss disallowance
rules of section 197(f)(1) and paragraph (g)(1) of
this section, X may not recognize its loss on the
sale of the amortizable section 197 intangibles.
Under paragraph (g)(1)(iv) of this section, X must
amortize its disallowed loss under section 197, and
Y may not increase its adjusted basis in its
amortizable section 197 intangibles by the amount
of the realized loss of X that is disallowed. X
must amortize the disallowed loss over the remain-
der of the amortization period for the amortizable
section 197 intangibles it sold. Accordingly, X
must amortize the disallowed loss at the rate of
$10,000 per year (or $833 per month) for each of
the 12 years remaining in the 15-year period.
Example 10. Disposition of retained intangibles
by related person. (i) The facts are the same as in
Example 9, except that 10 years after the acquisi-
tion of the assets by X and Y and seven years
after the sale of the assets by X, Y sells all of the
assets acquired from Z, including amortizable
section 197 intangibles, to an unrelated purchaser.
(ii) Upon the sale of assets by Y, X may
recognize a loss equal to the unamortized loss.
Accordingly, pursuant to paragraph (g)(1)(iv) of
this section, X may recognize a loss in the amount
of $50,000, the amount obtained by reducing the
loss on the sale of the assets at the end of the
third year ($120,000) by the amount of amortiza-
tion allowed for the fourth through the tenth years
($70,000).
Example 11. Acquisition of an interest in part-
nership with no section 754 election. (i) A, B, and
C each contribute $1,500 for equal shares in
general partnership P. On January 1, 1998, P
acquires as its sole asset an amortizable section
197 intangible for $4,500. P still holds the intan-
gible on January 1, 2003, at which time the
intangible has an adjusted basis to P of $3,000,
and A, B, and C each have an adjusted basis of
$1,000 in their partnership interests. D (who is not
related to A) acquires A’s interest in P for $1,600.
No section 754 election is in effect for 2003.
(ii) Pursuant to paragraph (h)(5)(i) of this sec-
tion, there is no change in the basis or amortiza-
tion of the intangible and D merely steps into the
shoes of A with respect to the intangible. D’s
proportionate share of P’s adjusted basis in the
intangible is $1,000, which continues to be amor-
tized over the 10 years remaining in the original
15-year amortization period for the intangible.
Example 12. Acquisition of an interest in part-
nership with a section 754 election. (i) The facts
are the same as in Example 11, except that a
section 754 election is in effect for 2003.
(ii) Pursuant to section 197(f)(9)(E) and para-
graph (h)(5)(i) of this section, for purposes of
section 197, D is treated as if P owns two assets.
D’s proportionate share of P’s adjusted basis in
one asset is $1,000, which continues to be amor-
tized over the 10 years remaining in the original
15-year amortization period. For the other asset,
D’s proportionate share of P’s adjusted basis is
$600 (the amount of the basis increase under
section 743 as a result of the section 754 election),
which is amortized over a new 15-year period
beginning January 2003. With respect to B and C,
P’s remaining $2,000 adjusted basis in the intan-
gible continues to be amortized over the 10 years
remaining in the original 15-year amortization
period.
Example 13. Payment to a retiring partner by
partnership with a section 754 election. (i) The
facts are the same as inExample 11, except that a
section 754 election is in effect for 2003 and,
instead of D acquiring A’s interest in P, A retires
from P. A, B, and C are not related to each other
within the meaning of paragraph (h)(6) of this
section. A receives a payment under section 736
from P of $1,600, all of which is in exchange for
A’s interest in the intangible asset owned by P.
(ii) Pursuant to paragraph (h)(5)(i) of this sec-
tion, because of the section 734 adjustment, P is
treated as having two amortizable section 197
intangibles, one with a basis of $3,000 and a
remaining amortization period of 10 years and the
other with a basis of $600 and a new amortization
period of 15 years.
Example 14. Termination of partnership under
section 708(b)(1)(B). (i) A and B are partners with
equal shares in the capital and profits of general
partnership P. P’s only asset is an amortizable
section 197 intangible, which P had acquired on
January 1, 1994. On January 1, 1999, the asset
had a fair market value of $100 and a basis to P
of $50. On that date, A sells his entire partnership
interest in P to C, who is unrelated to A, for $50.
At the time of the sale, the basis of each of A and
B in their respective partnership interests is $25.
(ii) The sale causes a termination of P under
section 708(b)(1)(B). Under section 708, the trans-
action is treated as if P transfers its sole asset to a
new partnership in exchange for the assumption of
its liabilities and the receipt of all of the interests
in the new partnership. Immediately thereafter, P
is treated as if it is liquidated, with B and C each
receiving their proportionate share of the interests
in the new partnership. The contribution by P of
its asset to the new partnership is governed by
section 721, and the liquidating distributions by P
of the interests in the new partnership are gov-
erned by section 731. However, C does not realize
a special basis adjustment under section 743 with
respect to the amortizable section 197 intangible
unless P had a section 754 election in effect for its
taxable year in which the deemed transfer of the
asset to the new partnership occurred.
(iii) Under section 197, if P had a section 754
election in effect for its taxable year in which the
deemed transfer of the asset to the new partnership
occurred, C is treated as if the new partnership
had acquired two assets from P immediately
preceding its termination. Even though the ad-
justed basis of the new partnership in the two
assets is determined solely under section 723,
because the transfer of assets is a transaction
described in section 721, the application of sec-
29

tions 743(b) and 754 to P immediately before its
termination causes P to be treated as if it held two
assets, for purposes of section 197, at this time.
B’s and C’s proportionate share of the new
partnership’s adjusted basis is $25 each in one
asset, which continues to be amortized over the 10
years remaining in the original 15-year amortiza-
tion period. For the other asset, C’s proportionate
share of the new partnership’s adjusted basis is
$25 (the amount of the basis increase resulting
from the application of section 743 to the sale or
exchange by A of the interest in P), which is
amortized over a new 15-year period beginning in
January 1999.
(iv) If P did not have a section 754 election in
effect for its taxable year in which the sale of the
partnership interest by A to C occurred, the
adjusted basis of the new partnership in the
amortizable section 197 intangible is determined
solely under section 723, because the transfer is a
transaction described in section 721, and P does
not have a basis increase in its section 197
intangible. Under section 197(f)(2) and paragraph
(g)(2) of this section, the new partnership contin-
ues to amortize the amortizable section 197 intan-
gible over the 10 years remaining in the original
15-year amortization period. No additional amorti-
zation is allowable with respect to this asset under
section 197.
Example 15. Disguised sale to partnership. (i)
Assume that E and F are individuals who are
unrelated to each other within the meaning of
paragraph (h)(6) of this section. E has been
engaged in the active conduct of a trade or
business as a sole proprietor since 1990. E and F
form EF Partnership. E transfers all of the assets
of the business, having a fair market value of
$100x, to EF, and F transfers $40x of cash to EF.
E receives a 60 percent interest in EF and the
$40x of cash contributed by F, and F receives a 40
percent interest in EF, under circumstances in
which the transfer by E is treated as a sale of
property to EF under § 1.707–3(b).
(ii) Under § 1.707–3(a)(1), the transaction is
treated as if E had sold to EF a 40 percent interest
in each asset for $40x and contributed the remain-
ing 60 percent interest in each asset to EF in
exchange solely for an interest in EF. Because E
and EF are related persons within the meaning of
paragraph (h)(6) of this section, no portion of any
transferred section 197 intangible that E held
during the transition period (as defined in para-
graph (h)(3) of this section) is an amortizable
section 197 intangible pursuant to paragraph (h)(1)
of this section. Section 197(f)(9)(E) and paragraph
(h)(5) of this section do not apply to any portion
of the section 197 intangible in the hands of EF
because the basis of EF in these assets was not
increased under any of sections 732, 734, or 743.
Example 16. Acquisition by related person in
nonrecognition transaction. (i) A owns a
nonamortizable intangible that A acquired in 1990.
In 1997, A sells a one-half interest in the intan-
gible to B for cash. Immediately after the sale, A
and B, who are unrelated to each other, form
partnership P as equal partners. A and B each
contribute their one-half interest in the intangible
to P.
(ii) P has a transferred basis in the intangible
from A and B under section 723. The nonrecogni-
tion transfer rule under paragraph (g)(2)(i) of this
section applies to A’s transfer of its one-half
interest in the intangible to P, and consequently P
steps into A’s shoes with respect to A’s
nonamortizable transferred basis. The anti-
churning rules of paragraph (h)(1)(i) of this sec-
tion apply to B’s transfer of its one-half interest in
the intangible to P, because A, who is related to P
under paragraph (h)(6) of this section, held B’s
one-half interest in the intangible during the
transition period. Pursuant to paragraph (h)(10) of
this section, these rules apply to B’s transfer of its
one-half interest to P even though the nonrecogni-
tion transfer rule under paragraph (g)(2)(i) of this
section would have permitted P to step into B’s
shoes with respect to B’s otherwise amortizable
basis. Therefore, P’s entire basis in the intangible
is nonamortizable.
Example 17. Acquisition of partnership interest
following formation of partnership. (i) The facts
are the same as in Example 16 except that, in
1996, A formed P with an affiliate and contributed
the intangible to the partnership and except that
thereafter, in an unrelated transaction, B purchases
a 50 percent interest in P. P has a section 754
election in effect.
(ii) For the reasons set forth inExample 14(iii),
B is treated as if P owns two assets. B’s
proportionate share of P’s adjusted basis in one
asset is the same as A’s proportionate share of P’s
adjusted basis in that asset, which is not amortiz-
able under section 197. For the other asset, B’s
proportionate share of the remaining adjusted basis
of P is amortized over a new 15-year period.
Example 18. Acquisition by related corporation
in nonrecognition transaction. (i) The facts are the
same asExample 16, except that P is a corpora-
tion.
(ii) P has a transferred basis in the intangible
from A and B under section 362. Pursuant to
paragraph (h)(10) of this section, the application
of the nonrecognition transfer rule under paragraph
(g)(2)(i) and the anti-churning rules of paragraph
(h)(1)(i) of this section to the facts of this
Example 18is the same as inExample 16. Thus,
P’s entire basis in the intangible is nonamortizable.
Example 19. Acquisition from corporation re-
lated to purchaser through remote indirect interest.
(i) X, Y, and Z are each corporations that have
only one class of issued and outstanding stock. X
owns 25 percent of the stock of Y and Y owns 25
percent of the outstanding stock of Z. No other
shareholder of any of these corporations is related
to any other shareholder or to any of the corpora-
tions. On June 30, 1997, X purchases from Z
section 197 intangibles that Z owned during the
transition period (as defined in paragraph (h)(3) of
this section).
(ii) Pursuant to paragraph (h)(6)(iii)(B) of this
section, the beneficial ownership interest of X in Z
is 6.25 percent, determined by treating X as if it
owned a proportionate (25 percent) interest in the
stock of Z that is actually owned by Y. Thus, even
though X is related to Y and Y is related to Z, X
and Z are not considered to be related for
purposes of the anti-churning rules of section 197.
Example 20. Gain recognition election. (i) B
owns 25 percent of the stock of S, a corporation
that uses the calendar year as its taxable year. No
other shareholder of B or S is related to each
other. S is not a member of a controlled group of
corporations within the meaning of section
1563(a). S has section 197 intangibles that it
owned during the transition period and was not
permitted to amortize or depreciate under any
other provision of the Code. S had a basis of
$25,000 in the intangibles. In 1997, S sells these
intangibles to B for $75,000. S recognizes a gain
of $50,000 on the sale and has no other items of
income, deduction, gain, or loss for the year,
except that S also has a net operating loss of
$20,000 from prior years that it would otherwise
be entitled to use in 1997 pursuant to section
172(b). As part of the transaction with B, S agrees
to make the gain recognition election pursuant to
section 197(f)(9)(B).
(ii) If the gain recognition election had not been
made, S would have taxable income of $30,000
for 1997 and a tax liability of $4,500. As the
result of the election, S must pay a total tax
liability for the year of $17,500 (35 percent of
$50,000), consisting of the sum of its regular tax
liability of $4,500 and the additional amount of
$13,000 pursuant to section 197(f)(9)(B).
(iii) Pursuant to paragraph (h)(9)(v)(A) of this
section, S determines the amount of its net
operating loss deduction in subsequent years with-
out regard to the gain recognized on the sale of
the section 197 intangible to B. Accordingly, the
entire $20,000 net operating loss deduction that
would have been available in 1997 but for the
gain recognition election may be used in 1998,
subject to the limitations of section 172.
(iv) B has a basis of $75,000 in the section 197
intangibles acquired from S. As the result of the
gain recognition election by S, B may amortize
$50,000 of its basis under section 197. The
remaining basis may not be amortized by B.
Example 21. Section 338 election. (i) P corpora-
tion makes a qualified stock purchase of the stock
of T corporation from two shareholders in July
1997, and a section 338 election is made by P.
One of the selling shareholders is an individual
who owns 25 percent of the total value of the
stock of each of the T and P corporation. No other
shareholder of either T or P owns stock in both of
these corporations, and no other shareholder is
related to any other shareholder of either corpora-
tion.
(ii) Old target and new target (as these terms
are defined in § 1.338–1(c)(13)) are members of a
controlled group of corporations under section
267(b)(3), as modified by section 197(f)(9)(C)(i),
and any section 197 intangible held by old target
at any time during the transition period is not an
amortizable section 197 intangible in the hands of
new target. However, a gain recognition election
under paragraph (h)(9)(i) of this section may be
made with respect to this transaction.
(l)Effective dates. This section is
applicable on the date final regulations
are published in the Federal Register,
except that § 1.197–2(c)(13) (exception
from section 197 for separately acquired
rights of fixed duration or amount) is
applicable August 11, 1993 (or July 26,
1991, if a valid retroactive election has
been made under § 1.197–1T).
Margaret Milner Richardson,
Commissioner of Internal Revenue.
(Filed by the Office of the Federal Register on
January 9, 1997, 2:53 p.m., and published in the
isue of the Federal Register for January 16, 1997,
62 F.R. 2336)
Foundations Status of Certain
Organizations
Announcement 97–27
The following organizations have
failed to establish or have been unable
to maintain their status as public chari-
ties or as operating foundations. Accord-
ingly, grantors and contributors may not,
after this date, rely on previous rulings
or designations in the Cumulative List
30

of Organizations (Publication 78), or on
the presumption arising from the filing
of notices under section 508(b) of the
Code. This listing doesnotindicate that
the organizations have lost their status
as organizations described in section
501(c)(3), eligible to receive deductible
contributions.
Former Public Charities. The follow-
ing organizations (which have been
treated as organizations that are not
private foundations described in section
509(a) of the Code) are now classified
as private foundations:
Action Arts, Inc., Pasadena, CA
Alleluia, San Antonio, TX
Americans Back in Charge Foundation,
Washington, DC
Bellaire Club Inc., Bellaire, TX
Bible Stories for the Children of the
World, Inc., Longmont, CO
Biblical Studies Association Inc.,
Mableton, GA
Black Police Officers Selection
Committee, Inc., Houston, TX
Capitol Hill Artists Association, Inc.,
Northglenn, CO
Car Clay Corporation, El Paso, TX
Caring About People, Inc., Boulder, CO
Caring for Children Foundation of
Texas, Inc., Dallas, TX
Center for a New Direction Inc., Ann
Arbor, MI
Central Arizona Refugee Ecumenical
Services, Phoenix, AZ
Central New Mexico Crimestoppers,
Edgewood, NM
Change This World, Austin, TX
Charlotte Edwards Center, Inc., La
Porte, TX
Childbirth Connection, Austin, TX
Children Benefit Foundation, Inc., Mesa,
AZ
Dallas Repertoire Ballet, Dallas, TX
Denvers First Step, Denver, CO
Earthwide Education Center, Inc.,
Camden, NY
East Harlem Community Land Tr Ltd.,
New York, NY
Elmore County Education Foundation,
Inc., Wetumpka, AL
Four Winds Resource Conservation and
Development Area Inc., Quanah, TX
Funston Elementary Parent-Teachers
Organization, Wichita, KS
Hands United in Good Spirit Inc.,
Miami, FL
Harmony Alliance Inc., Phoenix, AZ
Hugs Inc., Oklahoma City, OK
Humanitarian Air Transport Services,
Inc., Sarasota, FL
Human Pursuits the Western Humanities
Concern, Salt Lake City, UT
IAHA Foundation, Austin, TX
Imperial Homes Inc., Los Angeles, CA
Interracial Family & Social Alliance Of
DFW, Dallas, TX
Isleta Club of Albuquerque, Inc.,
Albuquerque, NM
I X L Community Improvement
Association, Oklahoma City, OK
Jackson Area Quality Initiative Inc.,
Jackson, MI
Keller Project Graduation Inc., Keller,
TX
Keresztmama Foundation, Inc., New
York, NY
Lallement Memorial Committee, Boston,
MA
Latinas for Empowerment and
Economic Development, Inc., Albany,
NY
Latvian Renaissance Association, Inc.,
Darien, CT
Law School Foundation, Inc., Southport,
CT
Leadership South, Davidson, NC
Magi Foundation, Houston, TX
Maine Masonic Foundation, Portland,
ME
Major County Senior Citizens, Inc.,
Fairview, OK
Maranatha Ministries, Birmingham, AL
Margaret Bowers Scholarship Fund,
Richmond, TX
Mark Travis Ministries, Inc., Corpus
Christi, TX
Narrow Door Ministries Inc., Wichita,
KS
National Church Residences of
Lawrence Park, PA, Columbus, OH
North Fort Worth Community Arts
Center Incorporated, Fort Worth, TX
Northside Plaza Inc., Houston, TX
Oakland Exploratory Childrens
Museum, Richmond, CA
OBPC,Inc., Denver, CO
Oceanic Foundation, Boulder, CO
Ocoee Kids Incorporated, Ocoee, FL
Oil of Gladness Outreach Ministries,
Inc., Rupert, WV
Oklahoma Dare Officers Association
Foundation, Edmond, OK
Oklahoma Livestock Industry
Foundation, Inc., Stillwater, OK
Oklahoma State Hemophilia
Association, Tulsa, OK
Old Sixth Ward Neighborhood
Association, Houston, TX
Old Town Music Hall Inc., El Segundo,
CA
Olney Midget & Teen League Inc.,
Philadelphia, PA
One Step Forward A Transitional Home
for Battered Women and Children,
Los Angeles, CA
Open Circle, Inc., Santa Fe, NM
Open Door Food Pantry Inc., Mt.
Jackson, VA
Opera Theater Corvallis Inc., Corvallis,
OR
Opportunity Skyway Inc., College Park,
MD
Pacific Communications Inc., Potomac,
MD
Pack Productions, Inc., Brooklyn, NY
Palo Duro Legal Aid, Lubbock, TX
PALSInc., Stockton, CA
Pineywoods Animal Shelter Inc.,
Crockett, TX
Positive I.D. Incorporated, Olney, MD
Pride Production Inc., Pine Bluff, AR
Reality, Inc., Kingman, KS
Reality Theatre, Columbus, OH
San Antonio Local Organizing
Committee, San Antonio, TX
San Antonio Riders Foundation, San
Antonio, TX
San Benito Literacy Center Inc., San
Benito, TX
Sangre De Cristo Independent Living
Center A Non-profit Corporation,
Pueblo, CO
San Tan Historical Society, Inc., Queen
Creek, AZ
School Childrens Assistance Fund,
Canyon, TX
Sharon Affordable Housing, Inc.,
Sharon, CT
Silver Street Assistance Program,
Houston, TX
Smiles Against Cancer Corporation,
Humble, TX
Songmakers Almanac, Boulder, CO
Texas Early Education Heritage Society,
Houston, TX
Texas Enterprise for Housing
Development, Inc., Pharr, TX
Texas Foundation for Educational
Options, Lewisville, TX
Texas Native American Indian
Association, Fort Worth, TX
Texas Public Sculpture Fund, Denton,
TX
Texas Table Tennis Association,
Houston, TX
Texas Tissue Network, Inc., El Paso, TX
Upshur County Crimestoppers, Inc.,
Gilmer, TX
Valley Voice Youth Choir, Kent, WA
Villa Encantada, Inc., Albuquerque, NM
Wilderness Covenant Incorporated,
Tucson, AZ
Wilderness Heritage Society, Inc.,
Georgetown, TX
Wildlife Museum, Inc., Fort Worth, TX
William Owens Ministry, Inc., Tulsa,
OK
If an organization listed above sub-
mits information that warrants the re-
newal of its classification as a public
31

charity or as a private operating founda-
tion, the Internal Revenue Service will
issue a ruling or determination letter
with the revised classification as to
foundation status. Grantors and con-
tributors may thereafter rely upon such
ruling or determination letter as pro-
vided in section 1.509(a)–7 of the
Income Tax Regulations. It is not
the practice of the Service to announce
such revised classification of foundation
status in the Internal Revenue Bulletin.
Scenarios of Disciplinary Actions
From the Office of Director of
Practice
The following scenarios are compos-
ites of matters that have come to the
attention of the Office of Director of
Practice. The scenarios are intended to
inform tax practitioners of the types of
activity that may result in disciplinary
action under Treasury Department Cir-
cular No. 230, Regulations Governing
the Practice of Attorneys, Certified Pub-
lic Accountants, Enrolled Agents, En-
rolled Actuaries, and Appraisers Before
the Internal Revenue Service (a republi-
cation of 31 C.F.R. Part 10). Because
disciplinary matters are resolved on the
basis of their particular facts and cir-
cumstances, these scenarios do not con-
stitute precedent in any matter before
the Director.
Comments concerning the scenarios
should be sent to: Office of Director of
Practice, C:AP:P, Internal Revenue Ser-
vice,1111Constitution Ave., NW, Wash-
ington, DC 20224.
False statements.The practitioner
was engaged by a physician to prepare
the physician’s individual income tax
return. When the physician delivered his
records, he commented to the practitio-
ner that he hoped he could take a
substantial deduction for using his car in
his practice. The practitioner did not ask
for further substantiation and, on the tax
return submitted to the IRS, deducted
various automobile expenses: deprecia-
tion, insurance, maintenance, gas, and
oil. When the tax return was audited,
the physician explained to the IRS audi-
tor that he considered his car to be used
in his practice because he drove it
between his home and office.
Thereafter, the Director called the
practitioner’s attention to possible viola-
tions of Circular 230: lack of due dili-
gence in preparing tax returns in viola-
tion of section 10.22(a); and giving false
information to the Treasury Department
in violation of section 10.51(b). The
practitioner asserted that he was entitled
to place good faith reliance on his
client’s information. However, the prac-
titioner could not cite any authoritative
exception to the general rule that com-
muting expenses are not deductible.
Consequently, the Director considered
the practitioner to be in violation of
section 10.51(b).
Contemptuous conduct.The practi-
tioner called an IRS revenue officer to
discuss his client’s case. The revenue
officer, after listening to the practition-
er’s comments, stated that the client
could still expect enforcement action.
Whereupon, the practitioner said, ‘‘How
about my coming down there and jerk-
ing you around for a while?’’ He added
he ‘‘would not mind kicking down the
door.’’ The revenue officer terminated
the call and notified IRS’ Inspection
Service. Later in the day, the practition-
er called back to apologize.
The Director contacted the practition-
er with regard to possible violations of
Circular 230: attempting to influence an
IRS employee’s official action by use of
a threat, a violation of section 10.51(f);
and contemptuous conduct consisting of
abusive language, a violation of section
10.51(i). In response, the practitioner
offered little in the way of explanation,
stating that he had simply lost his
temper.
The Director determined that the
practitioner’s statements constituted con-
temptuous conduct in violation of sec-
tion 10.51(i). Since this was the only
such instance involving the practitioner
in many years of IRS practice, and in
view of the quick apology, the Director
determined that a reprimand, with a
warning as to future conduct, was the
appropriate sanction.
Due Diligence.The practitioner’s em-
ployees completed clients’ tax returns,
which the practitioner reviewed and
signed as the preparer. In completing a
client’s individual income tax return,
one of the employees accepted the cli-
ent’s characterization of several trips as
business trips. The employee made no
further inquiry and did not request sub-
stantiation. In fact, no business purpose
for the trips could be substantiated. The
practitioner reviewed and signed the tax
return.
The Director contacted the practition-
er, stating that the practitioner may have
violated the regulations in Circular 230:
lack of due diligence in preparing tax
returns in violation of section 10.22(a);
and giving false information to the Trea-
sury Department in violation of section
10.51(b). The practitioner responded that
it would be unfair to hold him respon-
sible for the actions of the employee,
who had disregarded the office policy of
obtaining substantiation for business
trips.
In consideration of the practitioner’s
office policy, and in the absence of a
history of inaccurate returns, the Direc-
tor was satisfied that the practitioner had
not knowingly submitted false informa-
tion. Therefore, the Director resolved in
the practitioner’s favor any question
with regard to a violation of section
10.51(b). However, the practitioner, as
the person who signed the tax return,
could not disclaim responsibility for the
tax return’s accuracy. The Director con-
sidered the practitioner to be in violation
of section 10.22(a) for failing to exer-
cise due diligence.
Knowledge of client’s mistake.The
client completed the practitioner’s tax
return preparation questionnaire, indicat-
ing that he was separated from his
spouse. In reviewing the questionnaire,
the practitioner asked the client whether
he was ‘‘legally separated.’’ The client
replied that he was. The practitioner
prepared the client’s Form 1040, listing
the client’s filing status as single.
Later, the practitioner learned that
although the client and the client’s
spouse had come to terms on a separa-
tion agreement, the agreement had not
been incorporated into a decree of di-
vorce or separate maintenance. The
practitioner, knowing that the client had
declined to file an amended tax return in
a prior year, did not inform the client of
the mistake.
The Director informed the practitioner
that his conduct raised a question re-
garding violation of section 10.21 of
Circular 230, which requires a practition-
er who knows that his client has not
complied with the Federal revenue laws
or has made an error in, or omission
from, a tax return or document to advise
the client of such noncompliance, error,
or omission. The practitioner’s assump-
tion that the client would not file an
amended tax return did not relieve the
practitioner of his duty to advise the
client of errors. The practitioner’s con-
duct violated section 10.21, the Director
found.
32

Announcement of the Disbarment, Suspension, or Consent to Voluntary
Suspension of Attorneys, Certified Public Accountants, Enrolled Agents and
Enrolled Actuaries From Practice Before the Internal Revenue Service
Under 31 Code of Federal Regula-
tions, Part 10, an attorney, certified pub-
lic accountant, enrolled agent or enrolled
actuary, in order to avoid the institution
or conclusion of a proceeding for his
disbarment or suspension from practice
before the Internal Revenue Service,
may offer his consent to suspension
from such practice. The Director of
Practice, in his discretion, may suspend
an attorney, certified public accountant,
enrolled agent or enrolled actuary in
accordance with the consent offered.
Attorneys, certified public accoun-
tants, enrolled agents and enrolled actu-
aries are prohibited in any Internal Rev-
enue Service matter from directly or
indirectly employing, accepting assis-
tance from, being employed by or shar-
ing fees with, any practitioner disbarred
or suspended from practice before the
Internal Revenue Service.
To enable attorneys, certified public
accountants, enrolled agents and en-
rolled actuaries to identify practitioners
under consent suspension from practice
before the Internal Revenue Service, the
Director of Practice will announce in the
Internal Revenue Bulletin the names and
addresses of practitioners who have
been suspended from such practice, their
designation as attorney, certified public
accountant, enrolled agent or enrolled
actuary, and date or period of suspen-
sion. This announcement will appear in
the weekly Bulletin at the earliest practi-
cable date after such action and will
continue to appear in the weekly Bulle-
tins for five successive weeks or for as
many weeks as is practicable for each
attorney, certified public accountant, en-
rolled agent or enrolled actuary so sus-
pended and will be consolidated and
published in the Cumulative Bulletin.
The following individuals have been
placed under consent suspension from
practice before the Internal Revenue
Service:
NameAddressDesignationDate of Suspension
Vlymen, Neal VanSan Diego, CACPAIndefinite from November 1, 1996
Lombardi, TheresaLivonia, MICPANovember 1, 1996 to October 31, 1998
Orfall, WarrenHood River, ORCPANovember 1, 1996 to June 30, 1997
Oberman, JosephHighland Park, ILCPADecember 1, 1996 to August 31, 1997
Gazzola, FrankN. Mankato, MNCPADecember 1, 1996 to November 30, 1997
Tumminello, Anthony G.St. Louis, MOAttorneyDecember 17, 1996 to June 16, 1997
Heffelfinger, Harry N.Buffalo Grove, ILCPADecember 20, 1996 to June 19, 1998
Zintl Jr., Ernst J.Newport, MNCPADecember 23, 1996 to December 22, 1997
Alms, William R.Lake Forest, CACPAJanuary 1, 1997 to March 31, 1997
Smith, Arthur L.Athens, GACPAJanuary 1, 1997 to December 31, 1997
DeGroote Sr., Kevin J.Mesa, AZCPAJanuary 1, 1997 to October 31, 1997
Oliveri, RobertBensalem, PACPAJanuary 1, 1997 to December 31, 1997
Davies, Preston S.Deerfield, ILCPAJanuary 15, 1997 to December 14, 1997
Elbert, David L.Franktown, COCPAIndefinite from January 21, 1997
Smith Jr., Phillip M.Long Beach, CAAttorneyFebruary 1, 1997 to March 31, 1997
Pennington, Richard A.Vandergrift, PACPAFebruary 1, 1997 to January 31, 2000
Tameron, Joseph A.Chandler, AZCPAFebruary 1, 1997 to September 30, 1998
Kalb, Mary C.Kearny, NECPAFebruary 1, 1997 to March 31, 1997
Pritchard, John J.San Diego, CAEnrolled AgentFebruary 1, 1997 to March 31, 1997
Garrett, RichardTorrance, GAEnrolled AgentMarch 1, 1997 to May 30, 1997
Englert, Larry R.Eaton, OHCPAApril 1, 1997 to May 30, 1997
33

Definition of Terms
Revenue rulings and revenue procedures
(hereinafter referred to as ‘‘rulings’’)
that have an effect on previous rulings
use the following defined terms to de-
scribe the effect:
Amplifieddescribes a situation where
no change is being made in a prior
published position, but the prior position
is being extended to apply to a variation
of the fact situation set forth therein.
Thus, if an earlier ruling held that a
principle applied to A, and the new
ruling holds that the same principle also
applies to B, the earlier ruling is ampli-
fied. (Compare withmodified, below).
Clarifiedis used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously
published ruling and points out an es-
sential difference between them.
Modifiedis used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to A but not
to B, and the new ruling holds that it
applies to both A and B, the prior ruling
is modified because it corrects a pub-
lished position. (Compare withamplified
andclarified, above).
Obsoleteddescribes a previously pub-
lished ruling that is not considered de-
terminative with respect to future trans-
actions. This term is most commonly
used in a ruling that lists previously
published rulings that are obsoleted be-
cause of changes in law or regulations.
A ruling may also be obsoleted because
the substance has been included in regu-
lations subsequently adopted.
Revokeddescribes situations where
the position in the previously published
ruling is not correct and the correct
position is being stated in the new
ruling.
Supersededdescribes a situation
where the new ruling does nothing more
than restate the substance and situation
of a previously published ruling (or
rulings). Thus, the term is used to
republish under the 1986 Code and
regulations the same position published
under the 1939 Code and regulations.
The term is also used when it is desired
to republish in a single ruling a series of
situations, names, etc., that were previ-
ously published over a period of time in
separate rulings. If the new ruling does
more than restate the substance of a
prior ruling, a combination of terms is
used. For example,modifiedandsuper-
sededdescribes a situation where the
substance of a previously published rul-
ing is being changed in part and is
continued without change in part and it
is desired to restate the valid portion of
the previously published ruling in a new
ruling that is self contained. In this case
the previously published ruling is first
modified and then, as modified, is su-
perseded.
Supplementedis used in situations in
which a list, such as a list of the names
of countries, is published in a ruling and
that list is expanded by adding further
names in subsequent rulings. After the
original ruling has been supplemented
several times, a new ruling may be
published that includes the list in the
original ruling and the additions, and
supersedes all prior rulings in the series.
Suspendedis used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
Abbreviations
The following abbreviations in current use and
formerly used will appear in material published in
the Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C.—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contribution Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign Corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statements of Procedural Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.
34

Numerical Finding List
1
Bulletin 1997–1 through 1997–12
Announcements:
97–1, 1997–2 I.R.B.63
97–2, 1997–2 I.R.B.63
97–3, 1997–2 I.R.B.63
97–4, 1997–3 I.R.B.14
97–5, 1997–3 I.R.B.15
97–6, 1997–4 I.R.B.11
97–7, 1997–4 I.R.B.12
97–8, 1997–4 I.R.B.12
97–9, 1997–5 I.R.B.27
97–10, 1997–10 I.R.B.64
97–11, 1997–6 I.R.B.19
97–12, 1997–7 I.R.B.55
97–13, 1997–8 I.R.B.38
97–14, 1997–8 I.R.B.38
97–15, 1997–9 I.R.B.23
97–16, 1997–9 I.R.B.23
97–17, 1997–9 I.R.B.23
97–18, 1997–10 I.R.B.67
97–19, 1997–10 I.R.B.68
97–20, 1997–11 I.R.B.22
97–21, 1997–11 I.R.B.23
97–22, 1997–12 I.R.B.47
97–23, 1997–11 I.R.B.23
97–24, 1997–11 I.R.B.24
97–25, 1997–12 I.R.B.47
97–26, 1997–12 I.R.B.48
Notices:
97–1, 1997–2 I.R.B.22
97–2, 1997–2 I.R.B.22
97–3, 1997–1 I.R.B.8
97–4, 1997–2 I.R.B.24
97–5, 1997–2 I.R.B.25
97–6, 1997–2 I.R.B.26
97–7, 1997–1 I.R.B.8
97–8, 1997–4 I.R.B.7
97–9, 1997–2 I.R.B.35
97–10, 1997–2 I.R.B.41
97–11, 1997–2 I.R.B.50
97–12, 1997–3 I.R.B.11
97–13, 1997–6 I.R.B.13
97–14, 1997–8 I.R.B.23
97–15, 1997–8 I.R.B.23
97–16, 1997–9 I.R.B.15
97–17, 1997–10 I.R.B.34
97–18, 1997–10 I.R.B.35
97–19, 1997–10 I.R.B.40
97–20, 1997–10 I.R.B.52
97–21, 1997–11 I.R.B.9
Proposed Regulations:
REG–209040–88, 1997–7 I.R.B.34
REG–209121–89, 1997–11 I.R.B.15
REG–208288–90, 1997–11 I.R.B.14
REG–209494–90, 1997–8 I.R.B.24
REG–208172–91, 1997–10 I.R.B.59
REG–209672–93, 1997–6 I.R.B.15
REG–209729–94, 1997–11 I.R.B.19
REG–209762–95, 1997–3 I.R.B.12
REG–209817–96, 1997–7 I.R.B.41
REG–209824–96, 1997–11 I.R.B.19
REG–209828–96, 1997–6 I.R.B.15
REG–209834–96, 1997–4 I.R.B.9
REG–209839–96, 1997–8 I.R.B.26
Proposed Regulations—Continued
REG–242996–96, 1997–9 I.R.B.18
REG–246018–96, 1997–8 I.R.B.30
REG–247678–96, 1997–6 I.R.B.17
REG–247862–96, 1997–8 I.R.B.32
REG–248770–96, 1997–8 I.R.B.33
REG–249819–96, 1997–7 I.R.B.50
REG–252231–96, 1997–7 I.R.B.52
REG–252233–96, 1997–9 I.R.B.19
REG–252665–96, 1997–12 I.R.B.46
Revenue Procedures:
97–1, 1997–1 I.R.B.11
97–2, 1997–1 I.R.B.64
97–3, 1997–1 I.R.B.84
97–4, 1997–1 I.R.B.96
97–5, 1997–1 I.R.B.132
97–6, 1997–1 I.R.B.153
97–7, 1997–1 I.R.B.185
97–8, 1997–1 I.R.B.187
97–9, 1997–2 I.R.B.56
97–10, 1997–2 I.R.B.59
97–11, 1997–6 I.R.B.13
97–12, 1997–4 I.R.B.7
97–13, 1997–5 I.R.B.18
97–14, 1997–5 I.R.B.20
97–15, 1997–5 I.R.B.21
97–16, 1997–5 I.R.B.25
97–17, 1997–9 I.R.B.15
97–18, 1997–10 I.R.B.53
97–19, 1997–10 I.R.B.55
97–20, 1997–11 I.R.B.10
97–21, 1997–12 I.R.B.44
Revenue Rulings:
97–1, 1997–2 I.R.B.10
97–2, 1997–2 I.R.B.7
97–3, 1997–2 I.R.B.5
97–4, 1997–3 I.R.B.6
97–5, 1997–4 I.R.B.5
97–6, 1997–4 I.R.B.4
97–7, 1997–5 I.R.B.14
97–8, 1997–7 I.R.B.4
97–9, 1997–9 I.R.B.4
97–10, 1997–10 I.R.B.31
97–11, 1997–10 I.R.B.5
97–12, 1997–11 I.R.B.5
97–14, 1997–11 I.R.B.5
97–15, 1997–12 I.R.B.42
Social Security Domestic Coverage Threshold
1997–9, I.R.B.17
Treasury Decisions:
8688, 1997–3 I.R.B.7
8689, 1997–3 I.R.B.9
8690, 1997–5 I.R.B.5
8691, 1997–5 I.R.B.16
8692, 1997–3 I.R.B.4
8693, 1997–6 I.R.B.9
8694, 1997–6 I.R.B.11
8695, 1997–4 I.R.B.5
8696, 1997–6 I.R.B.4
8697, 1997–2 I.R.B.11
8698, 1997–7 I.R.B.29
8699, 1997–6 I.R.B.4
8700, 1997–7 I.R.B.5
8701, 1997–7 I.R.B.23
8702, 1997–8 I.R.B.4
Treasury Decisions—Continued
8703, 1997–8 I.R.B.18
8704, 1997–8 I.R.B.12
8705, 1997–8 I.R.B.16
8706, 1997–9 I.R.B.11
8707, 1997–7 I.R.B.17
8708, 1997–10 I.R.B.14
8709, 1997–9 I.R.B.5
8711, 1997–12 I.R.B.35
8712, 1997–12 I.R.B.4
1
A cumulative list of all Revenue Rulings,
Revenue Procedures, Treasury Decisions, etc.,
published in Internal Revenue Bulletins 1996–27
through 1996–53 will be found in Internal
Revenue Bulletin 1997–1, dated January 6, 1997.
35

Finding List of Current Action on
Previously Published Items
1
Bulletin 1997–1 through 1997–12
*Denotes entry since last publication
Revenue Procedures:
66–3
Modified by
97–11, 1997–6 I.R.B.13
87–21
Modified by
97–11, 1997–6 I.R.B.13
92–20
Modified by
97–1, 1997–1 I.R.B.11
92–20
Modified by
97–10, 1997–2 I.R.B.59
92–90
Superseded by
97–1, 1997–1 I.R.B.11
94–52
Revoked by
97–11, 1997–6 I.R.B.13
96–1
Superseded by
97–1, 1997–1 I.R.B.11
96–2
Superseded by
97–2, 1997–1 I.R.B.64
96–3
Superseded by
97–3, 1997–1 I.R.B.84
96–4
Superseded by
97–4, 1997–1 I.R.B.96
96–5
Superseded by
97–5, 1997–1 I.R.B.132
96–6
Superseded by
97–6, 1997–1 I.R.B.153
96–7
Superseded by
97–7, 1997–1 I.R.B.185
96–8
Superseded by
97–8, 1997–1 I.R.B.187
97–2
Amplified by
97–21, 1997–12 I.R.B.44
Revenue Rulings:
70–480
Revoked by
97–6, 1997–4 I.R.B.4
72–527
Obsoleted by
8704, 1997–8 I.R.B.12
74–59
Revoked by
8708, 1997–10 I.R.B.14
Revenue Rulings—Continued
92–19
Supplemented in part by
97–2, 1997–2 I.R.B.7
96–12
Superseded by
97–3, 1997–1 I.R.B.84
96–13
Modified by
97–1, 1997–1 I.R.B.11
96–22
Superseded by
97–3, 1997–1 I.R.B.84
96–34
Superseded by
97–3, 1997–1 I.R.B.84
96–39
Superseded by
97–3, 1997–1 I.R.B.84
96–43
Superseded by
97–3, 1997–1 I.R.B.84
96–56
Superseded by
97–3, 1997–1 I.R.B.84
1
A cumulative finding list for previously published
items mentioned in Internal Revenue Bulletins
1996–27 through 1996–53 will be found in Inter-
nal Revenue Bulletin 1997–1, dated January 6,
1997.
36