Writing off a tax loss on a franchise

Dear Tax Talk,
I purchased a franchise for $150,000 in 2005. I am trying to sell it for as low as $10,000. If I am successful, can I write off the $140,000 loss?
— Bill

Dear Bill,
The franchise might not have been successful, but at least you’re hoping the sale will be. The purchase of a franchise right is subject to the allowance for amortization under Section 197.

Section 197 allows the acquirer of certain intangible property to recover the acquisition cost on a straight line basis over 15 years. The concept of amortization is similar to depreciation, except amortization is the term used for intangible assets where depreciation applies to tangible property.

Under the tax law, the amount of depreciation or amortization allowed is considered an adjustment to the basis of the property subject to depreciation or amortization.

If a taxpayer fails to claim the appropriate deduction, the basis of the intangible or tangible property is still similarly reduced to take into account the amount allowable. Hence, since you acquired the franchise in 2005, you should have claimed $10,000 in annual amortization. (In 2005, the deduction should have been prorated based on the number of months.)

Assume then that you should have claimed $10,000 for each year — 2005 to 2009 — and that the total accumulated amortization allowable is $50,000. Your basis is then only $100,000; should you succeed in selling the franchise for $10,000 your loss for tax purposes is $90,000. This loss is considered an ordinary loss under Section 1231 and would be reported on Form 4797, Part 1.

If you or your accountant has failed to claim the Section 197 amortization, you should consider amending your business income tax returns for the year to take into account the additional $10,000 deduction.

Although it may be too late to amend 2005, as the statute of limitations may preclude it, the other tax years should be open. Amending your returns will help maximize your tax deduction and you’ll avoid losing most of the amortization deductions to which you were entitled.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

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