Capital gains may be realized on some forms of intangible property. Intangible assets are non-physical assets, which include patents and licenses. A capital gain occurs when an asset is sold for a higher price than what it was purchased for, and those gains are considered taxable by the Internal Revenue Service (IRS). Although there are some intangible properties that could be subject to capital gains taxes, others may not be taxable according to the IRS.

Key Takeaways

  • Capital gains may be realized on some forms of intangible property when the asset is sold for a higher price than its purchase price.
  • Patents and musical compositions are examples of intangible properties that are taxed at the capital gains rate.
  • However, some intellectual properties are taxed at the ordinary income tax rate as a result of the Tax Cuts and Jobs Act of 2017.

Understanding Capital Gains on Intangible Property

The Internal Revenue Service has complex guidelines that determine whether property is subject to capital gains taxes and may be counted as a financial loss if losses occur. These guidelines may be used for tax planning purposes.

Intangible assets or properties derive their value from intellectual content or other non-physical attributes. The IRS classifies assets into two categories: capital and non-capital. A capital asset is anything that a company or person owns, such as a computer, furniture, building, and car. Non-capital assets are usually intangible properties, such as patents.

Typically, the sale or trade of a capital asset is taxed at the capital gain or loss tax rate. Conversely, the sale or trade of a non-capital asset is taxed at the ordinary gain or loss tax rate. The ordinary income tax rate is usually higher than the capital gains tax rate, depending on the specific situation and taxpayer. 

Below are examples of intangible assets and properties that could be taxed at the more favorable capital gains tax rate, as well as other examples that might get taxed as ordinary income.

Please note that there are circumstances when property–intangible or tangible–used in a business can be treated as either capital or ordinary, which is why it's important to consult a tax professional.

Patents

A patent is an example of intangible property that could have a potentially high value. A patent provides an inventor or creator with exclusive rights to the invention's process and design for a specified period of time. A patent could be established for a process, design, pattern, trade secret, formula, and invention.

Patents may be licensed by or sold to another party for use. Income from patent licenses and sales may be treated differently by the IRS. Licensing a patent to another does not forfeit all rights to the property and simply permits usage of the patent. As such, income from licenses does not usually result in capital gains income. However, the sales of a patent may result in capital gains income.

Musical Compositions

Income from the sale of musical compositions results in capital gains for sellers. Buyers of these rights may use the costs as deductions on an annual basis to recover costs. The income from the sale is taxed at the capital gains tax rate.

Customer Loyalty

Although customer loyalty may result in substantial revenue earned for a business, loyalty cannot be assigned a monetary value. As such, the increased revenue as a result of customer loyalty cannot be treated as a capital gain.

Special Considerations

Intangible property is treated differently depending on the specific asset class and the relationship of the buyer to the seller. Closely related buyers and sellers do not realize capital gains and losses, for example.

It's important to note that the Tax Cuts and Jobs Act (TCJA) passed in 2017 removed the favorable tax treatment for some intellectual properties. In other words, income from the sale of these properties might be taxed as ordinary income instead of the more favorable capital gains tax rate.

Musical compositions, as stated above, are the exception to the TCJA change and are taxed at the capital gains rate. However, those who are selling other intellectual properties should consult a tax professional because the gains or income may get taxed at the ordinary income tax rate.