Treatment of web domain ownership & reselling for tax purposes: Capital asset, or not?

Question

I run a web publishing business. I buy a large number of domains — and occasionally sell one, although not frequently. Some domains are developed into websites, which bring in advertising revenue, while others are "parked," and yet others are on hold with no specific goal in mind, but eventually I would like to have all of them developed.

Advertising is currently my only income, so I am considered self-employed. I have accumulated a sizable portfolio of domains in 3 years, and the tax issues are starting to make me nervous.

There is virtually no guidance from the IRS on how to treat domains, so I have been on my own for the past 3 years, scavenging webmaster forums for information. Most CPAs I know are not equipped to assist with these issues. From what I have gathered, the main issue with owning domains is to decide whether to treat them as assets or expenses.

I have chosen from the beginning to treat them as assets for two reasons. First, if I end up selling one of them for a significant profit, I will presumably only owe capital gains tax on the profit, as opposed to ordinary income tax on the entire sale price.

Further to that point, I am carrying a large capital loss (several times my annual income) from my stock trading past. With the maximum allowed deduction against regular income being only $3,000 a year, I will never have any tangible tax relief from that loss, and the only way "out" is to produce sizable capital gains.

What I feel uneasy about is the requirement to amortize domains, since they are considered intangible property. The articles I have read are not consistent about how to amortize domains: some say 9 years, others say 15, yet others say you pick the number of years yourself. For me, it would be best to write off these purchases as quickly as possible, because I technically owe quarterly taxes while at the same time paying off loans taken out to buy these assets in the first place. Amortizing over 9 years allows very little to deduct from the gross income, and I have almost nothing left if I pay both Uncle Sam every quarter and my lenders.

What is the best way to lower my short-term tax liability, while still being able to pay only capital gains taxes in case of a future sale?

Answer 1

I must say that this is a question that you should hire a professional tax adviser (EA/CPA licensed in your State) to answer. It is way above our amateurs' pay-grade.

That said, I'll tell you what I personally think on the issue. I'm not a licensed tax adviser, and nothing that I write here can be used in any way as a justification for any action. Read the full disclaimer in my profile.

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I believe you're right to treat those as assets. You bought them as an investment, and you intend to sell them for profit. Here the good news for you end.

As we decided to define the domains as an asset, we need to decide what type of asset it is.

I believe you're holding a Sec. 197 asset. This is because domain is essentially akin to franchise and trademark, and as such falls under the Sec. 197 definition.

That means that your amortization period is 15 years. Your expenses related to these domains should also be amortized, on the same schedule. When you sell a domain, you can deduct the portion that you have not yet deducted from the amortization schedule from your proceeds.

Keep in mind passive loss limitations, since losses from assets held as investment cannot offset Schedule C income.

Answer 2

As others have said, please talk to a professional adviser.

From my quick research, domain names can only be amortized as 197 intangible if it's used for the taxpayer's business. For example, if Corp A pays $200,000 for corpa.com and uses that to point to their homepage, they can amortize it over 15 years as a 197 intangible. (Please refer to this IRS memo https://www.irs.gov/pub/irs-wd/201543014.pdf.)

The above memo does not issue any guidance in your case, where domains are purchased for investment or resale.

Regarding domain names, the U.S. Master Depreciation Guide (2016) by CCH says:

Many domain names are purchased in a secondary market from third parties [...] who register names and resell them at a profit. These cost must be capitalized because the name will have a useful life of more than one year. The costs cannot be amortized because a domain name has no useful life.

So your decision to capitalize is correct, but your amortization deductions may be challenged by the IRS.

When you sell your domain, the gain will be determined by how you treat these assets. If you treat your domains as 197 intangibles, and thus had ordinary deductions through amortization, your gain will be ordinary.
If you treated them as capital assets, your gain will be a capital gain.

Very conceptually, and because the IRS has not issued specific guidelines, I think holding domain names for resale is similar to buying stock of a company. You can't amortize the investment, and when you sell, the gain or loss is a capital gain/loss.