Tax Secret for Inventors

An important but little-understood section of the Tax Code can provide important tax savings for inventors, when they sell or exchange a patent or pending patent application.

If an inventor sells or exchanges his or her invention, the proceeds from the sale can be treated as “long term capital gain.”  As long as you meet some particular requirements, defined in the code section.

Some important points to consider – this tax treatment applies not just to granted patents, but also to pending applications, and even to potential patent rights (with no patent ever being filed).  Furthermore, it includes not only utility patents, but also rights to design patents.

For example, a product designer might charge a fee for assignment of his or her potential rights as an inventor for any utility or design patent rights he or she may develop.  This holds true whether or not any application is ever filed, or if the application is filed and rejected.  This fee for sale of these prospective rights should be treated as long term capital gain.

There are many tricks and traps in this section.  For example, the assignment from the inventor must be to an unrelated party/corporation; if you assign the rights to a corporation held by the inventor, and then to a third party, this would not qualify for treatment as long term capital gain.

Similarly, if a non-inventor is to receive the benefit of this section, he or she must acquire their rights before the invention is “reduced to practice.”

It is best to seek the advice of an experienced patent attorney to make sure to qualify.

Tax Code  – 26 U.S. Code § 1235 provides the following:

(a) General

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 capital asset held for more than 1 year, regardless of whether or not payments in consideration of such transfer are—

(1) payable periodically over a period generally coterminous with the transferee’s use of the patent, or

(2) contingent on the productivity, use, or disposition of the property transferred.

(b) “Holder” defined

For purposes of this section, the term “holder” means—

(1) any individual whose efforts created such property, or

(2) any other individual who has acquired his interest in such property in exchange for consideration in money or money’s worth paid to such creator prior to actual reduction to practice of the invention covered by the patent, if such individual is neither—

(A) the employer of such creator, nor

(B) related to such creator (within the meaning of subsection (d)).

(c) Effective date

This section shall be applicable with regard to any amounts received, or payments made, pursuant to a transfer described in subsection (a) in any taxable year to which this subtitle applies, regardless of the taxable year in which such transfer occurred.

(d) Related persons

Subsection (a) shall not apply to any transfer, directly or indirectly, between … [family members, certain corporations, and other specified related persons].

Eric Karich -Patent Attorney  800-949-0255 Eric Karich founded Karich & Associates in 1998 to help inventors and entrepreneurs with protecting their inventions and launching start-up companies to commercialize their products.  Call or email to arrange a free consultation. To receive our free quarterly email newsletter to keep up on recent developments in patent law, send an e-mail to with “newsletter” in the subject line.