IRS Finally Agrees that AVAs are Amortizable as IRC § 197 Assets
October 13, 2010
In 1993 Congress enacted IRC § 197 which provides for 15-year amortization for goodwill and certain other intangibles including trade names. To qualify, the intangible must be acquired after the date of enactment (August 10, 1993) and must not be created by the taxpayer.
As many of you know, almost immediately after IRC § 197 was enacted, I maintained that appellations qualify as IRC § 197 assets. One asset that a buyer of a vineyard within the boundaries of an existing appellation acquires is an undivided interest in an amortizable IRC § 197 trade name - commonly referred to as the "appellation" or "AVA." An appellation is no different than any other trade name other than it is shared with other owners or growers with properties within the appellation or AVA boundaries.
When buying the assets of a business, buyers traditionally attempt to identify and allocate as much as possible of their cost to assets that will produce a tax benefit through amortization, depreciation, or other costs such as inventory. Although trade names specifically are amortizable under IRC § 197, some in the industry have questioned whether appellations fall within the provisions of IRC § 197. Until now, the IIRS has not publicly or privately ruled on the issue.
New IRS Chief Counsel Memorandum
The national office of the IRS just released a Chief Counsel Memorandum (CCM) concluding:
For §197 purposes, the right to use an AVA designation is a license, permit, or other right granted by a governmental unit and is not an interest in land. Therefore, the right to use an AVA designation is a §197 intangible and the amount of the vineyard's purchase price allocated by Taxpayer to the right to use the AVA designation is an amortizable §197 intangible.
The CCM clearly distinguishes an appellation from an interest in land. Interests in land that are excluded from §197 include easements, riparian rights, mineral rights, zoning variances, farm allotments, air rights, life estates, etc.
The CCM determined that appellations qualify as IRC § 197 assets based on IRC § 197(d)(1)(D) which treats as a IRC § 197 intangible “any license, permit, or other right granted by a governmental unit.” Vineyards seeking to establish an appellation petition the Alcohol Tax and Trade Bureau (“TTB”) of the United States Department of Treasury. The CCM notes that the appellation is a right that the TTB, an agency of the government, grants.
The CCM recognizes the difficulty in valuing an appellation and admits that valuation may be “factually difficult” since all vineyards in an appellation share the same benefit from the appellation. Further, they caution that “only if there was a factual showing of some clear premium, such as a recognized and marketable trade name to a taxpayer’s vineyard, would an intangible asset be recognized.” We believe that concerns regarding valuation should not deter taxpayers from claiming amortization for the value of an acquired appellation. PwC has extensive experience in establishing the value as discussed below. Clients of PwC and other vineyards have claimed amortization for acquired appellations; and to date the deductions have not been overturned by the IRS.
Action Plan: Automatic Change in Method of Accounting
The status of appellations as §197 amortizable assets is now clear. Some taxpayers did not allocate purchase price to appellations because they were uncertain the IRS would accept the position absent published guidance. The good news is that for those taxpayers who acquired vineyards after the effective date of IRC 197 (August 10, 1993) and did not assign value to an appellation, an automatic change in method of accounting is available. This means taxpayers may deduct in the year for which they file the request 100% of the accumulated amortization that could have been taken from the acquisition date to the year of change.
The first step in claiming a deduction for an appellation is determining the value of the appellation. A competent, well-supported valuation is an important part of sustaining the value allocated to an acquired appellation and the corresponding amortization deduction.
Most likely, appraisals and valuations completed at the time of the acquisition do not segregate appellation value from land value. Typically, vineyard appraisers assign value to depreciable assets such as vines, trellis, irrigation, and buildings and allocate the balance to land. Land of course is not depreciable or amortizable.
A number of years ago, PwC developed an approach to quantifying the value of individual appellations that we believe is sound. It is based on using publicly available information such as the "Massachusetts Price Book" to identify the premium associated with a particular appellation. From this data, we develop a value using a foregone royalty approach, a common and well accepted means of valuing trade names. Since royalties for the use of trade names are common, comparables abound.
As an added benefit to an appellation appraisal, we frequently discover depreciable assets when inspecting a property that were not identified and valued at the time they were acquired. They are also often “buried" in land value. These include depreciable assets such as drainage tile or ditches, fences, ponds/wells, roads, bridges and wind machines. All of these, plus appellation, may be "fixed" and a cumulative deduction taken under the automatic change in method of accounting mentioned above.
Should you have any questions or need assistance in making the change, please call.
Greg Scott is a partner with PricewaterhouseCoopers, LLP in San Francisco