8163 / What is the character of income received from the sale of intellectual property?

If the payment is made pursuant to a sale of intellectual property, the seller should be entitled to capital gains treatment. The principal inquiry is whether the “sale” can be classified as a sale of the asset or a license. As for patents, Section 1235 provides that a transfer (other than by gift, inheritance, or devise) of property consisting of all substantial rights to a patent, or an undivided interest therein which includes a part of all such rights, by any holder shall be considered the sale or exchange of a long-term capital asset regardless of whether the payments are: (i) payable periodically over a period generally coterminous with the transferee’s use of the patent, or (ii) contingent on the productivity, use, or disposition of the property transferred. Section 1235 excludes employers and relatives of the creator from the definition of holders and instead gives capital gain treatment to “any individual whose efforts created” the patent or certain individuals who acquired an interest in the patent for consideration during the early stages.

The 2017 tax reform legislation provides that gain or loss from the disposition of a self-created patent, invention, model or design, or secret formula or process will be taxed as ordinary income or loss. The election to treat musical compositions and copyrights in music as capital assets was not changed.¹

1.IRC § 1221(a)(3).