If you have costs in your business related to intellectual property, the costs may have to be capitalized and amortized for U.S. federal income tax purposes, or you may be able to claim a current year deduction for the costs as research and experimental costs. The tax treatment will generally depend on whether you purchased the right from another person or entity, or you incurred costs in developing the right.
For example, according to the IRS, the costs of obtaining a patent, including attorneys’ fees for making and perfecting a patent application are considered research and experimental costs. These costs can be claimed as a current year deduction or capitalized and amortized. But the costs you incur to purchase a patent from someone else are not considered research and experimental costs. These costs would have to be capitalized as a business asset.
Research and experimental costs for federal income tax purposes are the costs of activities you carry out to obtain information that eliminates uncertainty about the development or improvement of a product. Products would include inventions, patents, formulas, processes, techniques, pilot models, and similar property.
The IRS specifically excludes certain costs from the concept of research and experimental costs. These excluded costs include advertising or promotions; consumer and efficiency surveys; management studies; quality control testing; research regarding literary, historical, or similar projects; and acquisitions of patents, models, production or processes from someone else.
You can elect to deduct research and experimental costs as a current business expense. This election is binding for the year you deduct the costs and for all years after that. To make a change, you would have to get IRS approval. Or you can amortize the research and experimental costs over at least 60 months, starting in the month you begin to obtain an economic benefit from them.
If you elect to amortize your research and experimental costs, you would complete Part VI of Form 4562, Depreciation and Amortization.
The cost of intellectual property rights that are capitalized would be intangible assets. According to the IRS, the basis of an intangible asset is usually the cost to buy or create it.
The tax basis of a patent that you develop would include the research and experimental costs, drawings, models, and attorneys’ and governmental fees. The basis of a patent does not include the value of the inventor’s time.
The basis of a copyright, if you are the author, includes the copyright fees, attorney’s fees, clerical assistance, and cost of plates that remain in your possession. The value of your time as the author is not included in the basis.
According to the IRS, various types of intellectual property are considered Section 197 intangibles provided they are held in connection with the conduct of a trade or business or an activity entered into for profit. These costs are amortized over 15 years and include patents, copyrights, formulas, processes, designs, patterns, know-how, formats, and similar items.
Amortizable section 197 intangibles are considered depreciable personal property under Section 1231. If you sell or dispose of these types of assets, you would follow the section 1231 rules. You would combine all your section 1231 gains and losses for the year. If you have a net section 1231 loss, the loss is ordinary. If you have a net section 1231 gain, the gain is ordinary income up to the amount of any non-recaptured section 1231 losses from previous years. The difference would be a capital gain.
There is a special rule that applies to patents. If you are an individual and you transfer a patent, it is treated for tax purposes as the sale or exchange of an asset held longer than one year, qualifying as a long-term capital gain or loss.
Form 4562, Depreciation and Amortization, IRS
Peter T. Beach and Christopher J. Hamlen, Federal Income Tax Treatment of the Development, Acquisition and Disposition of Intellectual Property, Sheehan Phinney Bass + Green PA
Publication 535, Business Expenses, IRS
Publication 544, Sales and Other Dispositions of Assets, IRS
Publication 551, Basis of Assets, IRS