Section 1.197-2: Anti-Churning Rules and Related-Party Tests

The Section 197 anti-churning rules block the 15-year amortization deduction for goodwill and similar intangibles when the asset existed during the July 25, 1991 through August 10, 1993 transition period and the acquisition does not produce a genuine change in ownership or use. The rules exist because Section 197 created a brand-new deduction for assets that generated none before, and Congress did not want taxpayers converting previously non-deductible goodwill into an amortizable asset through a paper transfer. The related-party threshold that drives most of the disallowances is set at 20 percent, well below the 50 percent used elsewhere in the code, and that is where most taxpayers get caught.

Which Intangibles Are Actually at Risk

The anti-churning rules do not apply to every Section 197 intangible. They reach intangibles described in Section 197(d)(1)(A) or (B), primarily goodwill and going concern value, along with any other intangible for which amortization would not have been allowed under prior law.¹ If the intangible was already depreciable or amortizable in the transferor’s hands before Section 197 was enacted, the anti-churning rules do not touch it.

That scope matters. Patents and copyrights with definite useful lives were amortizable before 1993, so their transfer generally does not trigger anti-churning. Goodwill, going concern value, workforce in place, and most customer- and supplier-based intangibles were not amortizable at all before Section 197, and those are the assets the rules were built to police.

The Three Conditions That Deny Amortization

Any one of three conditions is enough to disallow amortization. The denial is total, not partial.

The Taxpayer or a Related Party Held the Asset During the Transition Period

Amortization is denied if the intangible was held or used at any time between July 25, 1991 and August 10, 1993 by the taxpayer or a person related to the taxpayer, and the taxpayer acquires it after enactment.² This is the broadest of the three. It catches situations where you effectively already controlled the asset before the law changed and are simply repapering the ownership.

The User Does Not Change

Amortization is also denied if the intangible was acquired from someone who held it during the transition period and the user of the intangible does not change as part of the transaction.² The focus here is substance. Title moves, but the same operator continues exploiting the asset.

Use Rights Return 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 It prevents roundtrip structures where the asset technically changes hands but functionally returns to its prior user through a license or similar arrangement.

The 20-Percent Related-Party Threshold

The anti-churning rules define “related person” more aggressively than the rest of the code. The standard related-party tests under Sections 267(b) and 707(b)(1) 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.

A minority investor with a 21-percent stake in both the buyer and the seller is enough to establish the relationship. The test is applied immediately before or immediately after the acquisition, so restructuring ownership after closing does not help if the relationship existed at the moment of transfer.²

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 not share formal ownership ties.²

Constructive Ownership Makes the Threshold Even Lower

The 20-percent test is applied after constructive ownership rules attribute stock and partnership interests across family members, partners, and entities. Under Section 267(c), stock owned by a corporation is attributed proportionally to its shareholders, and stock owned by one partner is attributed to other partners. Family attribution counts ownership held by a spouse, siblings, ancestors, and lineal descendants as belonging to the individual.

This is where most taxpayers get surprised. Someone who directly owns 5 percent of a corporation can be treated as owning 25 percent once stock held by a spouse and a partnership are attributed. The IRS does not need to prove intent. Mechanical application of the attribution rules is enough to disallow the deduction.

The Gain Recognition Election

The main escape from the anti-churning rules is the gain recognition election under Section 197(f)(9)(B). It works by forcing the transferor to pay a steep tax price so the transferee can amortize the intangible. The election is available only in a narrow band of cases: the parties must be related solely because of the reduced 20-percent threshold.³ If the parties would be related even under the normal 50-percent test, the election is off the table.

When the election applies, the transferor must recognize gain on the disposition and pay tax on that gain at the highest marginal rate, regardless of whether it would otherwise qualify for lower capital gains rates.² For 2026, the highest individual rate is 37 percent and the corporate rate is a flat 21 percent. The transferor pays tax equal to the gain multiplied by the applicable highest rate, with any other federal income tax on the same gain credited against that amount.

For partnerships and S corporations, the entity makes the election rather than the individual owners, but each partner or shareholder pays tax at the highest rate on their allocated share of the gain. The election must be filed by the due date of the transferor’s federal return (including extensions) for the year of the disposition, and it requires both a formal election statement attached to the return and notification to the transferee. Once made, it binds the taxpayer and all parties whose tax liability is affected.³

Other Exceptions Worth Knowing

Intangibles that were already depreciable or amortizable in the transferor’s hands under prior law are outside the anti-churning rules entirely.¹
Acquisitions from a tax-exempt transferor generally avoid the rules, unless the entity was using the intangible in an unrelated trade or business subject to tax.³
If a taxpayer acquired property under a written binding contract that was in effect on August 10, 1993 and remained in effect through the acquisition date, the taxpayer could elect to apply pre-Section-197 law to that property under the temporary regulations.⁴

Partnership Transactions and Section 743(b) Adjustments

Partnership transfers create the most complex anti-churning problems, because a single intangible can end up with different tax treatment for different partners.

When someone buys a partnership interest, the partnership’s inside basis in its assets does not automatically change. A Section 743(b) adjustment bridges the gap between the new partner’s outside basis and their share of inside basis, but only if the partnership has a Section 754 election in effect or has a substantial built-in loss exceeding $250,000.³ Without one of these triggers, the purchasing partner steps into the selling partner’s shoes with no step-up.

When a 743(b) adjustment does apply and is allocated to a goodwill or going concern intangible that existed during the transition period, the anti-churning analysis kicks in. The regulation treats the basis increase as a separate, newly acquired asset for the purchasing partner.⁵

If the purchasing partner is not related to the selling partner under the 20-percent standard, the anti-churning rules generally do not apply to the basis adjustment, and the purchaser can amortize the step-up over a new 15-year period.⁵ If they are related, the basis step-up is frozen and no amortization is allowed on that portion. There is an additional wrinkle: if the selling partner remains a direct user of the intangible after the transfer, through a license or continued operational involvement, the anti-churning rules can apply to the entire basis adjustment regardless of ownership percentage.³

Contributions raise a similar 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 portion stays non-amortizable, and any related basis increase is also subject to the anti-churning rules, which can prevent non-contributing partners from amortizing their share.

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 This catch-all reaches beyond the three statutory triggers. If a series of steps was designed to move a pre-1993 intangible to a new owner with an amortization deduction while preserving the economic arrangement of the prior owner, the IRS can collapse the chain and deny the deduction.

Multi-step transactions that route an asset through an unrelated intermediary before landing with the intended buyer draw particular scrutiny. Any transfer of an intangible that existed during the transition period should have a documented, non-tax business purpose that stands up on its own.

Penalty Exposure If You Get It Wrong

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. For individuals, a substantial understatement exists when the understatement exceeds the greater of 10 percent of the tax due or $5,000. For corporations other than S corporations, the threshold is the lesser of 10 percent of the tax due (or $10,000, if greater) and $10,000,000.⁶ A high-value goodwill amortization stream disallowed retroactively over several years crosses these thresholds quickly. Adequate disclosure and a reasonable-cause defense can mitigate the penalty, but both require contemporaneous documentation showing the anti-churning analysis was actually done.

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