Inventor

[appelman]

A new client makes his living as an inventor. His income consists of sale or licensing of patents that have been issued for his work. All or almost all of this income gets favorable capital gains treatment. He has ongoing expenses. Am I right in assuming that he must capitalize these expenses and allocate them in some way as basis for the patents he sells or licenses?

[Davc]

All or almost all of this income gets favorable capital gains treatment.

Not if you're reporting it properly. See TTB 5-17. Capital gain treatment for royalties is available to those who inherit of purchase a patent under limited circumstances.

Am I right in assuming that he must capitalize these expenses and allocate them in some way as basis for the patents he sells or licenses?

No. See TTB tab 5-17

[appelman]

To which part of the question are you saying "NO?"

Let me phrase it a little differently. In 2010 his income consists of the SALE of a self-created patent that was issued some years back, which he wants to report, and I believe is entitled to report as a long-term capital gain. He has current expenses for work that he expects will generate future salable or licensable patents. What can he do with these expenses?

[Burke]

I believe you are correct in treating the sale of the patent as a long-term gain. The expense of developing and registering that patent with the US Patent Office would be expenses capitalized and taken as part of his cost basis. Normally, when a patent is sold, the creator thereafter receives royalties whenever sales are generated by the company involving the product patented. If he "makes his living" as an inventor, then the royalties are what is treated as ord income on Sche C, subj to SE tax. Otherwise, normally, royalties are reported on Sche E. The sale and the royalties, if any, are two different sources of income. He would capitalize expenses to each product under development, IMO.