8167 / Does a patent qualify as a capital asset under IRC Section 1221?

Generally, if the transferor is treated as a professional inventor, gain (or loss) from the sale or other disposition of his or her patents does not qualify for capital gain treatment, because the patents will be treated as inventory, rather than as capital assets under IRC Section 1221. Under Section 1221(a)(1), inventory and property held primarily for sale to customers are excluded from the definition of a capital asset. The IRS takes the view that an inventor develops his or her inventions in order to eventually sell these products to customers and, thus, income from their sale should be taxed as ordinary income.

In order to determine whether the inventor holds his or her patents for sale in the course of a trade or business, all of the facts and circumstances of the individual case must be analyzed.¹ The inventor must, essentially, determine whether the number of inventions created, and subsequently sold or licensed, would rise to such a level that it was substantial enough to be treated as inventory or assets held for sale to customers.² While the activity need not occupy all of the inventor’s time, evidence of continuity of sales and sales activity over a period of time is an indicator that the taxpayer is carrying on a trade or business of selling or licensing patents, so that capital gains treatment would be inappropriate.³