Section 1.197-2: Anti-Churning Triggers, Related-Party Test, and Gain Election

The anti-churning rules in Section 197 of the Internal Revenue Code block you from taking the 15-year amortization deduction on goodwill and similar intangibles that were not amortizable before Section 197 was enacted on August 10, 1993. They exist to stop taxpayers from shuffling a pre-1993 intangible to a related party, stepping up its basis, and converting a historically non-deductible asset into a stream of deductions without a real change in ownership or use. The rules bite harder than most people expect, mainly because the related-party threshold is set at 20 percent rather than the usual 50.

Which Intangibles the Rules Reach

The anti-churning rules apply to intangibles described in Section 197(d)(1)(A) or (B), which is primarily goodwill and going concern value, and to any other intangible for which amortization would not have been allowed under the law in effect before Section 197.¹ If the intangible was already depreciable or amortizable in the transferor’s hands under prior law, the anti-churning rules do not apply, and the transferee can amortize under the ordinary Section 197 rules.

The relevant window of history is the transition period: July 25, 1991, through August 10, 1993. Whether an intangible existed, and who held or used it, during that window drives the entire analysis.²

The Three Triggers That Deny Amortization

If any one of three conditions is met, amortization is denied in full. The denial is not partial, and there is no proration.

Prior Holding by You or a Related Party

Amortization is denied if the intangible was held or used at any point during the transition period by the taxpayer or a related person, and the taxpayer acquires it after enactment.² This is the broadest trigger because it catches situations where you effectively already controlled the asset before the law changed.

No Change in User

Amortization is also denied if the intangible is acquired from someone who held it during the transition period and, as part of the transaction, the user of the intangible does not change.² Formal title can change hands; if the same operators keep exploiting the asset, the transaction fails this test.

Use Rights Granted Back to a Prior Holder

The third trigger applies when the taxpayer acquires the intangible and then grants the right to use it to a person (or someone related to that person) who held or used the intangible during the transition period.² This stops roundtrip arrangements where the asset nominally changes owners but returns to its prior user through a license or similar instrument.

The 20-Percent Related-Party Test

The related-party definition here is more aggressive than the one you see elsewhere in the tax code. Sections 267(b) and 707(b)(1) normally use a 50-percent ownership threshold. For anti-churning purposes, Congress dropped that to 20 percent.² Two parties are related if the same persons own more than 20 percent of the stock of a corporation or the capital or profits interest of a partnership.

The test is applied immediately before or immediately after the acquisition of the intangible, so restructuring ownership after closing does not help if the relationship existed at the moment of transfer. Parties are also treated as related if they are engaged in trades or businesses under common control within the meaning of Section 41(f)(1), which captures controlled groups of corporations and commonly controlled businesses that may share no formal ownership tie.²

Constructive Ownership

The 20-percent threshold is applied after the constructive ownership rules under Section 267(c) attribute stock and partnership interests across family members, partners, and entities. Stock owned by a corporation is attributed proportionally to its shareholders. Stock owned by one partner can be attributed to other partners. Family attribution rolls in ownership held by a spouse, siblings, ancestors, and lineal descendants.

This is where taxpayers get caught. Someone directly holding 5 percent of a company can be treated as owning 25 percent once stock held by a spouse and a partnership is attributed. The IRS does not need to show any intent to avoid the rules. The attribution rules apply mechanically, and once they push ownership over 20 percent, the deduction is gone.

The Gain Recognition Election

The main planning escape from the anti-churning rules is the gain recognition election under Section 197(f)(9)(B). It is available only in a narrow case: when the parties are related solely because of the reduced 20-percent threshold.³ If the parties would also be related under the ordinary 50-percent standard, the election is off the table.

The trade is simple in concept and expensive in execution. The transferor recognizes gain on the disposition and pays tax on it at the highest applicable marginal rate, regardless of whether the gain would otherwise qualify for lower capital gains rates.² In exchange, the transferee gets to amortize the acquired intangible over 15 years. For 2026, that highest rate is 37 percent for individuals and a flat 21 percent for C corporations. Any other federal income tax on the same gain is credited against the amount owed under the election.

Partnerships and S corporations make the election at the entity level, but each partner or shareholder picks up tax at the highest rate on their allocated share of the gain. The election must be filed by the due date (including extensions) of the transferor’s federal return for the year of the disposition, requires a formal election statement attached to the return, and must be communicated to the transferee. Once made, it binds the taxpayer and every party whose tax liability is affected.³

Other Ways Out

A few narrower exceptions can save the deduction without triggering the gain recognition election.

If the intangible was already depreciable or amortizable in the transferor’s hands under prior law, the anti-churning rules do not apply. They target only assets that became amortizable because of Section 197.¹
Acquiring the intangible from a tax-exempt entity generally takes the transaction outside the anti-churning rules, unless the entity was using the intangible in an unrelated trade or business subject to tax.³
Taxpayers who were locked into a written binding contract in effect on August 10, 1993, and still in effect at acquisition could elect to apply pre-Section-197 law to that property, avoiding being pulled into the new regime involuntarily.⁴

Partnership Transfers and Section 743(b) Step-Ups

Partnerships generate the hardest fact patterns. A single intangible can carry different tax results for different partners, depending on who bought in, when, and from whom.

When someone purchases a partnership interest, the partnership’s inside basis in its assets does not automatically change. A Section 743(b) adjustment can bridge the gap between what the new partner paid and their share of inside basis, but only if a Section 754 election is in effect or the partnership has a substantial built-in loss exceeding $250,000.³ Without one of these, the purchasing partner gets no basis step-up at all.

When a Section 743(b) adjustment does apply and is allocated to goodwill or going concern value that existed during the transition period, the anti-churning rules enter the picture. The regulation treats the basis increase as a separate, newly acquired asset in the purchasing partner’s hands. If the buying partner is not related to the selling partner under the 20-percent standard, the step-up is generally amortizable over 15 years. If they are related, that portion of the step-up is frozen and generates no deduction.⁵

There is a further trap. If the selling partner remains a direct user of the intangible after the transfer, through a license or continued operational role, the anti-churning rules can apply to the entire basis adjustment regardless of the ownership percentage.³

Contributions raise their own issue. When a partner contributes a pre-1993 intangible to a partnership, Section 721 provides nonrecognition and Section 723 gives the partnership a carryover basis equal to the contributor’s adjusted basis. Because the intangible was non-amortizable in the contributor’s hands, the carryover basis stays non-amortizable in the partnership’s hands. Any basis increase tied to the contribution is itself subject to the anti-churning rules and can prevent non-contributing partners from amortizing their share.

What Happens If You Get It Wrong

Two collateral problems make a mistake here especially painful.

First, Section 197 disallows losses on the piecemeal disposition of intangibles from the same acquisition. If you sell or abandon a single Section 197 intangible while keeping others acquired in the same transaction, you cannot recognize a loss on the one you disposed of. The unrecognized loss is added to the basis of the retained intangibles.² You cannot sell the churned goodwill, book the loss, and walk away while keeping the customer list. The loss sits locked up until every retained intangible from that deal is disposed of or becomes worthless.³

Second, claiming amortization on an intangible that fails the anti-churning rules creates an underpayment that can trigger the Section 6662 accuracy-related penalty of 20 percent of the underpayment attributable to a substantial understatement. For individuals, a substantial understatement exists when the understatement exceeds the greater of 10 percent of the tax due or $5,000.⁶ A high-value goodwill deduction disallowed retroactively over several years can clear these thresholds easily. Adequate disclosure and reasonable-cause defenses can soften the hit, but only with documentation showing the anti-churning analysis was actually performed and a defensible position reached.

The Anti-Abuse Backstop

Regulation 1.197-2(j) gives the IRS broad authority to recharacterize or disregard any transaction structured to circumvent the anti-churning rules.³ It reaches beyond the three statutory triggers. If a series of steps looks designed to move a pre-1993 intangible to a new owner with amortization while preserving the economic arrangement of the prior owner, the IRS can collapse the whole chain and deny the deduction.

Multi-step transactions that route an intangible through an intermediary before it lands with the intended buyer draw particular attention. Any transfer involving an intangible that existed during the transition period needs a documented, non-tax business purpose on the record before the ink dries, not after an auditor starts asking.

1
Internal Revenue Service. Revenue Ruling 2004-49 – Amortization of Goodwill and Certain Other Intangibles
2
Office of the Law Revision Counsel. 26 U.S. Code 197 – Amortization of Goodwill and Certain Other Intangibles
3
eCFR. 26 CFR 1.197-2 – Amortization of Goodwill and Certain Other Intangibles
4
eCFR. 26 CFR 1.197-1T – Certain Elections for Intangible Property (Temporary)
5
Internal Revenue Service. TD 8907 – Application of the Anti-Churning Rules for Amortization of Intangibles in Partnerships
6
Office of the Law Revision Counsel. 26 U.S. Code 6662 – Imposition of Accuracy-Related Penalty on Underpayments