These days, most businesses have some intangible assets. The tax treatment of these assets can be complex.
What makes intangibles so complicated?
IRS regulations require the capitalization of costs to:
- Acquire or create an intangible asset,
- Create or enhance a separate, distinct intangible asset,
- Create or enhance a “future benefit” identified in IRS guidance as capitalizable, or
- “Facilitate” the acquisition or creation of an intangible asset.
Capitalized costs can’t be deducted in the year paid or incurred. If they’re deductible at all, they must be ratably deducted over the life of the asset (or, for some assets, over periods specified by the tax code or under regulations). However, capitalization generally isn’t required for costs not exceeding $5,000 and for amounts paid to create or facilitate the creation of any right or benefit that doesn’t extend beyond the earlier of 1) 12 months after the first date on which the taxpayer realizes the right or benefit or 2) the end of the tax year following the tax year in which the payment is made.
What’s an intangible?
The term “intangibles” covers many items. It may not always be simple to determine whether an intangible asset or benefit has been acquired or created. Intangibles include debt instruments, prepaid expenses, non-functional currencies, financial derivatives (including, but not limited to options, forward or futures contracts, and foreign currency contracts), leases, licenses, memberships, patents, copyrights, franchises, trademarks, trade names, goodwill, annuity contracts, insurance contracts, endowment contracts, customer lists, ownership interests in any business entity (for example, corporations, partnerships, LLCs, trusts, and estates) and other rights, assets, instruments and agreements.
Here are just a few examples of expenses to acquire or create intangibles that are subject to the capitalization rules:
- Amounts paid to obtain, renew, renegotiate or upgrade a business or professional license;
- Amounts paid to modify certain contract rights (such as a lease agreement);
- Amounts paid to defend or perfect title to intangible property (such as a patent); and
- Amounts paid to terminate certain agreements, including, but not limited to, leases of the taxpayer’s tangible property, exclusive licenses to acquire or use the taxpayer’s property, and certain non-competition agreements.
The IRS regulations generally characterize an amount as paid to “facilitate” the acquisition or creation of an intangible if it is paid in the process of investigating or pursuing a transaction. The facilitation rules can affect any type of business, and many ordinary business transactions. Examples of costs that facilitate acquisition or creation of an intangible include payments to:
- Outside counsel to draft and negotiate a lease agreement;
- Attorneys, accountants and appraisers to establish the value of a corporation’s stock in a buyout of a minority shareholder;
- Outside consultants to investigate competitors in preparing a contract bid; and
- Outside counsel for preparation and filing of trademark, copyright and license applications.
Are there any exceptions?
Like most tax rules, these capitalization rules have exceptions. There are also certain elections taxpayers can make to capitalize items that aren’t ordinarily required to be capitalized. The above examples aren’t all-inclusive, and given the length and complexity of the regulations, any transaction involving intangibles and related costs should be analyzed to determine the tax implications.
Need help or have questions?
Contact us to discuss the capitalization rules to see if any costs you’ve paid or incurred must be capitalized or whether your business has entered into transactions that may trigger these rules. You can also contact us if you have any questions.
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FAQs
Capitalized Costs for Intangible Assets
Do you have to Capitalise intangible assets? ›
When intangible assets should be capitalised. FRS102 s18 requires an intangible asset to be capitalised when, and only when: it is probable that the expected future economic benefits attributable to the asset will flow to the company, and. the cost or value of the asset can be measured reliably.
What is a capitalized cost incurred? ›
A capitalized cost is a cost that is incurred from the purchase of a fixed asset that is expected to directly produce an economic benefit beyond one year or a company's normal operating cycle.
What are intangible assets capitalized by US GAAP? ›
Under both IFRS and US GAAP, intangible assets lack physical substance, but meet the definition of an asset (i.e., it is expected to benefit the organization for more than a year). Examples include patents, trademarks, copyrights, right-of-ways (easem*nts), and others.
What is the journal entry for capitalizing intangible assets? ›
When a company purchases or acquirers an intangible asset, they can capitalize the cost of that asset on the balance sheet. The initial entry would be to debit intangible assets for the addition of the asset, and then credit cash for the cash outflow related to the purchase.
How are intangible assets expensed? ›
Tangible assets are expensed using depreciation, and intangible assets are expensed through amortization. Depreciation generally includes a salvage value for the physical asset—the value that the asset can be sold for at the end of its useful life. Amortization doesn't take into account a salvage value.
How are intangible assets treated in accounting? ›
You credit your intangible asset account because it is an asset. Assets are also increased by debit and decreased by credit. You are increasing your expenses and decreasing your assets through the amortization process. This allows you to claim your expenses and reduce your taxable income.
What are the rules for capitalizing costs? ›
To capitalize cost, a company must derive economic benefit from assets beyond the current year and use the items in the normal course of its operations. For example, inventory cannot be a capital asset since companies ordinarily expect to sell their inventories within a year.
When should costs be capitalized or expensed? ›
Capitalizing is recording a cost under the belief that benefits can be derived over the long term, whereas expensing a cost implies the benefits are short-lived. Whether an item is capitalized or expensed comes down to its useful life, i.e. the estimated amount of time that benefits are anticipated to be received.
What are the criteria for capitalizing costs? ›
Any costs that benefit future periods should be capitalized and expensed, so as to reflect the lifespan of the item or items being purchased. Costs that can be capitalized include development costs, construction costs, or the purchase of capital assets such as vehicles or equipment.
As a general rule, capitalization is required for identified intangibles and certain transaction costs. Amounts required to be capitalized are not deducted as a business expense. Instead, the amount is added to the basis of the intangible acquired or created.
Which intangible asset is not amortized? ›
The intangible asset goodwill is not amortized. Goodwill is to be tested periodically for impairment. The amount of any goodwill impairment loss is to be recognized in the income statement as a separate line before the subtotal income from continuing operations (or similar caption).
Can you capitalize legal fees for intangible assets? ›
When an intangible asset is purchased, the cost to capitalize on the balance sheet can include the actual purchase price, legal fees, costs incurred to get the intangible asset ready for use, and other incidental expenses.
Which intangibles Cannot be Capitalised as an asset? ›
Generally, internally generated intangible assets cannot be capitalised. The reason that internally generated intangible assets often cannot be capitalised is that it is difficult to establish the true benefit from the asset or even to establish specific costs that can be attributable to items such as brand names.
What are the rules for capitalizing assets? ›
How Capitalization Works
- Find out the base acquisition cost of the fixed asset.
- Add to the base price any costs related to securing the asset (as outlined by GAAP and IRS policies)
- Set an expected useful life for the fixed asset (in years or months)
- Divide the total cost of the fixed asset (2) by the time factor (3)
Expensing a cost indicates it is included on the income statement and subtracted from revenue to determine profit. Capitalizing indicates that the cost has been determined to be a capital expenditure and is accounted for on the balance sheet as an asset, with only the depreciation showing up on the income statement.
What are the rules for intangible assets? ›
An intangible asset can only be recognised if it is probable that the expected future economic benefits (eg revenue from the sale of products or services) that are attributable to the asset will flow to the entity and the cost of the asset can be measured reliably.
Can intangible assets be depreciated? ›
An intangible asset with a useful life that can be determined with reasonable accuracy may be depreciated using the straight-line method over the asset's useful life. Depreciation is allowed only if the intangible is used in a trade or business or for the production of income.
Does GAAP require intangible assets? ›
US GAAP requires companies to fulfil a number of obligations concerning intangible assets. These include recognizing acquired intangible assets and some internally generated intangible assets derived from development expenditure, on the balance sheet.
Can you put intangible assets on a balance sheet? ›
Intangible assets only appear on the balance sheet if they have been acquired. If Company ABC purchases a patent from Company XYZ for an agreed-upon amount of $1 billion, then Company ABC would record a transaction for $1 billion in intangible assets that would appear under long-term assets.
