Originally published on Passive Activities and Other Oxymorons on May 20th, 2011.
This is one of those things that is interesting to tax nerds and a fairly small number of actual business people. You buy an automobile dealership with multiples lines. Most of what you are paying is attributable to the franchises. That's a Section 197 intangible amortizable over 15 years. But wait a second. Isn't it a number of Section 197 intangibles amortizable over 15 years. What difference does it make ?
Well if everything goes fine, it doesn't make any difference. Everything did not go fine for the Dealer that is the subject of this LAFA (Legal Advice by Field Attorney). Manufacturer terminated some but not all of the franchises that Dealer owned. Dealer wants to write off a proportionate part of its basis in the franchises. The IRS is not allowing it:
Even if the goodwill associated with the W and Y2 franchises became worthless when Manufacturer terminated the franchise agreements, section 197(f)(1) of the Internal Revenue Code 1 prohibits a deduction for worthless amortizable section 197 intangibles, including goodwill, where other amortizable section 197 intangibles purchased as part of the same transaction or series of transactions remain. The amount of any worthless amortizable section 197 intangibles instead is included in the basis of the remaining amortizable section 197 intangibles.
The interesting question is whether better work on the font end of this deal would have allowed a different result:
Dealer makes two principal arguments in support of deducting the goodwill associated with the W and Y2 franchises. First, Dealer claims that the asset purchase agreement separately stated a goodwill value for the W franchise. Dealer reasons that the remainder of the goodwill was, therefore, allocable to the X, Y1, Y2, and Z franchises. We have reviewed the purchase agreement and find no such allocation. The allocation that Dealer provided to you was on a summary sheet that is undated and unsigned. There is no evidence that this summary was ever included in the original agreement.
Charles V. Dumas, who wrote the LAFA, does not think so:
And even if the goodwill was separately stated for each franchise, we believe section 197(f)(1) still applies, as all of the goodwill was acquired in a single transaction or series of related transactions. Dealer even admits that Manufacturer required alignment of certain franchises and considered multiple franchises as one “unit” for franchising purposes.
In the relative ranking of authority a LAFA is not way up there, but dealers in this situation (and I believe there are quite a few) should be cognizant that there may be a challenge to write-off of some franchises when some remain.