In general, property held by a taxpayer (whether held for personal use or used in a trade or business) is considered a capital asset. This distinction is important because the sale of a capital asset may have preferential tax treatment if it’s held for more than one year. The top tax rate on long-term capital gains is 20% while the top tax rate on ordinary income is 39.6% in 2017.
Assets Not Considered Capital Assets
Certain assets, however, are specifically excluded from the definition of a capital asset. Such assets excluded from capital asset treatment are:
- Accounts receivables acquired in the ordinary course of business
- Certain self-created intangibles
Self created intangibles that are not excluded are:
- Literary, musical, or artistic compositions
- Letters or memoranda, or similar property which is held either by the taxpayer who created the property.
2018 Tax Changes
The Tax Cuts and Jobs acts includes a provision amending section 1221(a)(3) of the Tax Code to exclude patents, inventions, models or designs (whether or not patented), and any secret formulas from being treated as capital assets. Thusly, any such asset that is sold after December 31, 2017 will not receive capital gain/loss treatment.
Although patents are excluded from the definition of capital assets after 2017, qualified holder’s may still receive preferential tax treatment from the disposition of a patent to an unrelated party.
The Tax Cuts and Jobs acts does not include sec. 3312 of the House bill which would have repealed the special rule for sale or exchange of patents. Section 1235 of the Tax Code provides that a transfer of all substantial rights to a patent by any holder shall be considered the sale or exchange of a capital asset held for more than one year. This is true regardless of whether or not payments are payable periodically or contingent on the productivity, use, or disposition of the property transferred.
A holder is defined as any individual whose efforts created such property or any party who provided financial backing to the creator of such property.
Therefore, even though a patent will no longer be considered a capital asset there may be an exception which would allow the sale of such assets to be treated as a capital asset for tax purposes.
The change in the tax treatment of patents, inventions, designs, and secret formulas increases the after-tax cost of such property. Due to the elimination of preferential long-term capital gains rates on the sale of such assets, the net effect would result in additional taxes due.
However, there may be an exception for qualified holders who realize a taxable gain on the disposition of a patent after 2017.
This article is for educational purposes only and should not be relied upon as tax, legal financial or other paid professional services. Consult with an advisor to see how you'd be personally impacted by the material in this article. Photo Copyright: <a href='https://www.123rf.com/profile_bennyartist'>bennyartist / 123RF Stock Photo