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I need assistance determining the basis of an intangible…

I need assistance determining the...
I need assistance determining the basis of an intangible asset that is a brand name and may possibly be sold in the near future.
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Answered in 11 minutes by:
10/19/2017
Lane
Lane, JD, CFP, MBA, CRPS
Category: Capital Gains and Losses
Satisfied Customers: 14,655
Experience: Have been providing Financial and Tax advice for 30 years.Concentration in Corporations, Estate, Income Tax and Business Planning
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Intangible assets include goodwill, patents, copyrights, trademarks, trade names, and franchises. The basis of an intangible asset is usually the cost to buy or create it.

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You cannot attribute costs to the basis that were already used as expenses for the business (salary, operating expenses, etc)

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If you buy a franchise, trademark, or trade name, the basis is its cost, unless, again, you can deduct your payments as a business expense.

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See this from IRS Publication 551:

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If you acquire a trade or business, allocate the consideration paid to the various assets acquired. Generally, reduce the consideration paid by any cash and general deposit accounts (including checking and savings accounts) received. Allocate the remaining consideration to the other business assets received in proportion to (but not more than) their fair market value in the following order.

1. Certificates of deposit, U.S. Government securities, foreign currency, and actively traded personal property, including stock and securities.

2. Accounts receivable, other debt instruments, and assets you mark to market at least annually for federal income tax purposes.

3. Property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held primarily for sale to customers in the ordinary course of business.

4. All other assets except section 197 intangibles, goodwill, and going concern value.

5. Section 197 intangibles except goodwill and going concern value.

6. Goodwill and going concern value (whether or not they qualify as section 197 intangibles).

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If the brand name was trademarked, especially early on, the basis may be zero (with the exception of legal costs TO trademark)

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Question:

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Is this the ONLY asset being sold? and is it a legal trademark or other formalized/codified name (such as a trade name or DBA at the state level?

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Also, just to provide some context, Goodwill, patents, copyrights, licenses, franchises, etc. all fall under the category of intangible assets. These assets do not possess any physical substance but are of great importance to any business over the long term.

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Goodwill is a premium paid over the fair value of assets during the purchase process of a company. Hence, it is tagged to a company or business and cannot be sold or purchased independently.

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Whereas other intangible assets like licenses, patents, etc. can be sold and purchased independently.

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Goodwill is perceived to have an indefinite life (as long as the company operates) while other intangible assets have a definite useful life and are amortized over those years.

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SO again, what's the protection here (trade name? Corporation reserved name in a given state?) And CAN this be separated from the other assets of the company (and still have value)?

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Customer reply replied 9 months ago
Thank you. I am aware of all of this. Yes, the brand name along with franchisor rights are all that is being sold, no tangible assets. I know that all of the expensed items over the years cannot be included in basis. If someone is willing to pay 7 million dollars for a brand name, it is obviously worth something?
Customer reply replied 9 months ago
The question here is what? How is goodwill determined if there aren't any physical assets being sold?

The seller and the buyer simply must report the sale (and agree on how the price is allocated) on form 8594, Asset Acquisition Statement.

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There are seven general asset classes and are taxed according to rules in 26 USC.

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(What's interesting is that the buyer and the seller will not necessarily agree on the reporting because, depending on the type of asset, the buy or the seller (one of the two) usually take the higher tax hit.

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Here's how the various asset classes are taxed:

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Non-Stock ("asset") Sales

Value placed on Tangible Personal Property (trade fixtures, furniture, equipment):

  • Seller: If held more than one year, the gains in excess of depreciation are long-term capital gain; otherwise ordinary income
  • Buyer: Establishes basis, depreciate per IRS schedules

Value placed on Leasehold Improvements:

  • Seller: If held more than one year, the gains in excess of depreciation are long-term capital gain; otherwise ordinary income
  • Buyer: Establishes basis, depreciate per IRS schedules

Value placed on Premise Lease savings (if the lease is at below market rent, it is an intangible asset):

  • Seller: If held for more than one year, is long-term capital gain
  • Buyer: Amortize value over 15 years

Value placed on Covenant Not to Compete (include time and distance of covenant):

  • Seller: Ordinary income as received
  • Buyer: Amortize over 15 years

Value placed on Training/Consultation (include schedule of time, hours, etc.):

  • Seller: Ordinary income as received
  • Buyer: Expense out as paid

Value placed on Registered Vehicles (do not include in Tangible Personal Property above):

  • Seller: If held more than one year, the gains in excess of depreciation are long-term capital gain; otherwise ordinary income
  • Buyer: Establishes basis, depreciate per IRS schedules

Value placed on Liquor License (include license type and number; is an intangible asset):

  • Seller: If held for more than one year, is long-term capital gain
  • Buyer: Amortize over 15 years

Value placed on Customer List:

  • Seller: Ordinary income as received
  • Buyer: Amortize over 15 years

Value placed on Goodwill:

  • Seller: If held for more than one year, is long-term capital gain
  • Buyer: Amortize over 15 years

Value placed on Buildings:

  • Seller: If held more than one year, the gains in excess of depreciation are long-term capital gain; otherwise ordinary income
  • Buyer: Establishes basis, depreciate per IRS schedules

Value placed on Land:

  • Seller: If held more than one year, the gains in excess of depreciation are long-term capital gain; otherwise ordinary income
  • Buyer: No immediate tax impacts

Value placed on Inventory:

  • Seller: Ordinary income, to the extent that it is over basis
  • Buyer: Treated as "cost of goods sold" upon sale of products
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Well, cost bases and value are two different things. The BEST determination of value is what s disinterested 3rd party will pay for the asset.

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There are various ways to approach the valuation of a brand and many of them are debatable. The concept of value can often be a difficult concept to understand. This is often because value means different things to different people and so it’s not an objective concept, and the valuation is determined by the use of it.

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The brand is valued using the sum of individual costs or values of brand assets and liabilities. It’s the accumulation of the costs that have been incurred to build the brand since inception. Items you would include when evaluating costs include historical advertising, promotion expenditures, the cost of campaign creation, licensing and registration costs.
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You could use this method whether you have just created a brand or you’ve gone through the process of re-developing the brand.

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But again, for TAX basis, you'd simply add up the real costs, that can be attributed directly to building the brand, that hasn't ALREADY been deducted as a business expense.

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Besides like-kind sales (a version of the willing buyer valuation method), there are also income based methods.

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This method is often referred to as the “in-use” approach. It considers the valuation of future net earnings that directly attribute to the brand to determine the value of the brand in its current use.
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The brand value using this method is equal to present value of income, cash flows, or cost savings actually or hypothetically due to the asset

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If you're asking about VALUING the brand, that can many times be more art than science.

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The Chartered Financial Analyst way would be to use a model that discounts cash flows attributable to the brand (again, requiring an assumption about price of the widgets being sold (or service) with the brand subtracted from the income generated without the brand ... and then capitalizing. But again, riddled with assumptions.

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What IRS will be interested in is ACTUAL sales price, how the price was allocated to the various assets, and actual costs to generate it for the seller's tax basis.

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Please let me know what questions you have from here.

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Please let me know if you have ANY questions at all

If this has helped, and you DON’T have other questions … I'd appreciate a positive rating, using the stars on your screen, and then clicking “submit" – That’s the only way I’ll be credited for the work.

But if you need more on this, please let me know.

Lane

I hold a law degree (J.D.), with concentration in Tax Law, Estate law & Corporate law, an MBA in finance, a BBA, and CFP & CRPS (Chartered Retirement Plans Specialist) designations, as well - I’ve been providing financial, Social Security/Medicare, estate, corporate, non-profit, and tax advice 1986

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Customer reply replied 9 months ago
Thank you! So the income based approach may make the most sense here? I suppose that is something I should be able to figure out. I am assuming, also, that there are easy to use formulas out there to assist me in that approach...

There has been a good deal of academic work (simply BECAUSE there's no real standardized approach) ... let me see what I can find.

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Alex Batchelor, earlier in his career, at Interbrand, writing in Brands and Branding, explained the concept of brand valuation as follows:

‘The value today of a brand’s future earnings is a function of how high these earnings are, and of how likely it is that they will be achieved. It should thus take into consideration three things about the brand:

1. its financial performance (in order to identify its true net earnings)

2. its marketing strength and its competitive advantage over other brands (to establish security of demand)

3. its legal position (to prove that it is a separable property).’

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Looks like International Organization for Standardization (ISO) has issued a start at standardization:

http://brandfinance.com/images/upload/iso_10668_overview.pdf

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Here's a very good overview:

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https://iiprd.wordpress.com/2016/12/10/brand-valuation-approaches-and-methods/

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Customer reply replied 9 months ago
I wonder if hiring a Valuation expert would make sense... yikes.

In my own opinion, the place to start would be to make a claim (through historical evidence or other statistically sound evidence such as polling customers about whether they bought BECAUSE of a brand) about the additional income that can be generated by the owner

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Then using the period of time that the brand adds that value (also possibly an assumption, but could be something finite, like the length of a patent), discount that cash flow using the Net Present Value NPV formula.

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You discount rate might be the costs of capital (borrowing costs to finance the purchase)

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Excel has an NPV function, HP and other financial Calculators have it. NPV itself is a given in terms of acceptance in valuation.

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The problem comes in the assumptions.

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http://www.investopedia.com/ask/answers/021115/what-formula-calculating-net-present-value-npv-excel.asp

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On the valuation expert, yes. But even there I'd be sure to use a CFA or someone with the sophistication to model this accurately.

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OR someone that does this specifically

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https://ipmetrics.net/valuation.html

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http://www.millwardbrown.com/mb-global/what-we-do/strategy/brand-valuation

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here's one more: http://brandfinance.com/

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Hope this helps.

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Would appreciate a positive rating so I can be compensated.

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Customer reply replied 9 months ago
Thanks so much for your help! :) 5 Stars for sure... I hope I can revert back to all of this information...

Thanks much. Yes, just bookmark the address

Lane
Lane, JD, CFP, MBA, CRPS
Category: Capital Gains and Losses
Satisfied Customers: 14,655
Experience: Have been providing Financial and Tax advice for 30 years.Concentration in Corporations, Estate, Income Tax and Business Planning
Verified
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