Electing to Treat Musical Works as Capital Assets

Regulations

The IRS issued final regulations governing how to elect to treat the sale or exchange of a musical work or copyright in a musical work as a sale or exchange of a capital asset (T.D. 9514).

Under Sec. 1221(a)(3), the definition of capital asset excludes certain property held by a taxpayer whose personal efforts created the property. Property that does count as a capital asset under this provision includes copyrights; literary, musical, or artistic compositions; letters or memoranda; and similar property. Thus, any income from their sale or exchange will be taxed as ordinary income and not at the lower capital gain rates.

These listed types of property are also not considered capital assets if they are held by a taxpayer whose basis in the property is determined by reference to the basis of the property in the hands of the taxpayer whose personal efforts created the property.

Under Sec. 1221(b)(3), however, taxpayers who own a musical composition or copyright in a musical work created by the taxpayer (or transferred to the taxpayer by the work’s creator in a transferred basis transaction) can elect to have gain or loss from the sale or exchange of the musical composition or copyright treated as capital gain or loss.

Under the final regulations, a separate election must be made for each musical composition (or copyright in a musical work) sold or exchanged during the tax year. The election must be made on or before the due date (including extensions) of the income tax return for the tax year of the sale or exchange.

Taxpayers will make the election by treating the sale or exchange as the sale or exchange of a capital asset on Schedule D, Capital Gains and Losses. They will be able to revoke the election within six months of the original due date of their return (excluding extensions) by filing an amended return that treats the sale or exchange as a sale or exchange of property that is not a capital asset. After that six-month period, the election can be revoked only with the consent of the IRS in a letter ruling.

The final regulations apply to elections made in tax years beginning after May 17, 2006.