Uncle Bill is somewhat of a hoarder. In truth, the only thing that he has ever abandoned was his first wife…in a Waffle House at 2:15 AM on the outskirts of Norman, Oklahoma. In Bill’s defense, she had tried to stab him. In her defense, he probably deserved it.
When Bill comes to you to chat about IRC § 165 losses—so-called “abandonment” losses—you know he has some hairbrained scheme in his head to stick it to Uncle Sam and to boost your pro bono hours in the coming year. Nonetheless, you know enough not to ask questions. Bill does not divulge the details of his stratagem and subterfuge, and you take cold comfort in plausible deniability.
Deductible Losses, Generally
The Code allows the taxpayer to take a deduction for any loss sustained during the taxable year and not compensated for by insurance or otherwise.[1] The deduction may be taken in an amount up to the adjusted basis of the lost property as provided in IRC § 1011.[2]
Intention and Affirmative Action
IRC § 165 losses have been referred to as abandonment losses to reflect that some act is required, which act evidences a taxpayer’s intent to permanently discard or discontinue use.[3] To establish the abandonment of an asset for purposes of IRC § 165, a taxpayer must show both-
- an intention to abandon the asset, and
- an affirmative act of abandonment.[4]
A deduction is not allowable if a taxpayer intends to hold and preserve property for possible future use or to realize potential future value from the property.[5] Abandonment of an intangible property interest should be accompanied by some express manifestation.[6]
The “identifiable event”[7] must be observable to outsiders and constitute some step which irrevocably cuts ties to the asset.[8] Mere non-use of an asset is not sufficient to establish an act of abandonment.[9] Similarly, internal communications or decisions within a taxpayer’s organization are not sufficient affirmative acts of abandonment.[10]
Closed and Completed Act
A deduction for worthlessness under IRC § 165 is allowable only if there is a closed and completed transaction fixed by identifiable events establishing that the property is worthless in the taxable year for which the deduction is claimed.[11] Although the taxpayer is not required to be an “incorrigible optimist,”[12] a mere diminution in the value of an asset is not sufficient to establish worthlessness.[13] Assets may not be considered worthless, even when they have no liquidated value, if there is a reasonable hope and expectation that they will become valuable in the future.[14]
Timing of the Loss
To be allowable as a deduction under IRC § 165(a), a loss must be evidenced by a closed and completed transaction, fixed by an identifiable event.[15] Except as provided in IRC § 165(h) and Treas. Reg. § 1.165-11, the loss must actually be sustained during the taxable year.[16] A loss is treated as sustained during the taxable year in which the loss occurs, as evidenced by a closed and completed transaction, and as fixed by an identifiable event occurring in such taxable year.[17]
A deduction under IRC § 165(a) is allowed for a loss incurred in a business or in a transaction entered into for profit and arising from the sudden termination of the usefulness in such business or transaction of any non-depreciable property, when such business or transaction is discontinued or when such property is permanently discarded from use therein.[18] Further, the taxable year in which a loss is sustained is not necessarily the taxable year in which the overt act of abandonment, or the loss of title to the property, occurs.[19]
Matters of Title
A taxpayer need not relinquish legal title to property in all cases to establish abandonment, provided there is an intent to abandon and an affirmative act of abandonment.[20] Retention of bare legal title to property does not preclude a deduction under IRC § 165(a) in certain cases in which property has become worthless.[21]
In such cases the courts have adopted the rule that a taxpayer may claim a loss on property without being required to divest legal title if the taxpayer does not intend to hold the property and the taxpayer proves by identifiable events that the property has become worthless.[22] The taxpayer’s conduct in regarding the property as worthless and not intending to preserve or hold it may be the practical equivalent of abandonment.[23]
Abandonment and other transactions that divest the taxpayer’s title are identifiable events that support a closed and completed transaction. Additionally, identifiable events may include other acts or events which reflect the fact that the property is worthless.[24] To the extent that the transactions do not include divestitures of title or abandonment, the essential element for tax purposes is that a particular event destroyed the potential value and usefulness of the asset to the taxpayer.[25]
Specific Examples
A partnership’s insolvency, a third-party developer’s default, and the inability of partners to restructure the underlying debt were identifiable events that evidenced worthlessness.[26] A loss is realized in the year in which coal mining lease expired.[27]An act of Congress rendered motor carrier authorities worthless because all rights associated with the authorities were eliminated.[28] A tax loss may be claimed only when all or a substantial, identifiable, vendible portion of a customer list is terminated permanently, either through extraneous causes or the sudden and involuntary inability of the owner to serve them, and then only if the loss may be adequately measured.[29]
Leaving master recordings on a closet shelf instead of storing them in a necessary climate-controlled environment was tantamount to throwing them in the trash, and, therefore, a loss was allowed.[30] However, the testimony by taxpayer’s president that film was worthless because taxpayer had unsuccessfully submitted it for sale or distribution to all major studios and small distribution companies was not substantial proof of worthlessness.[31]
Footnotes:
[1] IRC § 165(a).
[2] IRC § 165(b); Treas. Reg. § 1.165-1(c).
[3] Gulf Oil Corp. v. Commissioner, 914 F.2d 396, 402 (3d Cir. 1990).
[4] A.J. Indus., Inc. v. United States, 503 F.2d 660, 670 (9th Cir. 1974); CRST, Inc. v. Commissioner, 92 T.C. 1249, 1257 (1989), aff’d, 909 F.2d 1146 (8th Cir. 1990); Rev. Rul. 93-80.
[5] A.J. Indus., 503 F.2d at 670.
[6] Citron v. Commissioner, 97 T.C. 200, 209 (1991); Echols v. Commissioner, 935 F.2d 703, 706-08 (5th Cir. 1991), reh’g denied, 950 F.2d 209 (5th Cir. 1991).
[7] Required by Treas. Reg. § 1.165-1(b) and (d)(1).
[8] United Dairy Farmers, Inc. v. U.S., 267 F.3d 510, 522 (6th Cir. 2001); Corra Resources, Ltd. v. Commissioner, 945 F.2d 224, 226 (7th Cir. 1991).
[9] Standley v. Commissioner, 99 T.C. 259, 272 (1992), aff’d without published opinion, 24 F.3d 249 (9th Cir. 1994); Jones Beach Theatre Corp. v. Commissioner, T.C. Memo. 1966-100.
[10] See Corra Resources, 945 F.2d at 226.
[11] Treas. Reg. § 1.165-1(b) and (d)(1).
[12] U.S. v. S.S. White Dental Manufacturing Co., 274 U.S. 398, 403 (1927).
[13] Proesel v. Commissioner, 77 T.C. 992, 1006 (1981).
[14] See Lawson v. Commissioner, 42 B.T.A. 1103, 1108 (1940); Morton v. Commissioner, 38 B.T.A. 1270, 1278 (1938), aff’d, 112 F.2d 320 (7th Cir. 1940); Rev. Rul. 77-17.
[15] Treas. Reg. § 1.165-1(b).
[16] Treas. Reg. § 1.165-1(a).
[17] Treas. Reg. § 1.165-1(d)(1).
[18] Treas. Reg. § 1.165-2(a).
[19] Id.
[20] See Echols, 935 F.2d at 706; Middleton v. Commissioner, 77 T.C. 310, 322 (1981), aff’d per curiam, 693 F.2d 124 (11th Cir. 1982).
[21] See Helvering v. Gordon, 134 F.2d 685, 689 (4th Cir. 1943), acq., 1951-1 C.B. 2; Rhodes v. Commissioner, 100 F.2d 966, 970 (6th Cir. 1939); Rev. Rul. 54-581.
[22] A.J. Indus., 503 F.2d at 670.
[23] Id.
[24] Proesel, 77 T.C. at 1005.
[25] See Echols, 950 F.2d at 213 (partnership’s insolvency, third party developer’s default, and inability of partners to restructure the underlying debt were identifiable events that evidenced worthlessness); Corra Resources, 945 F.2d at 226-27 (loss realized in the year in which coal mining lease expired); Oak Harbor Freight Lines, Inc. v. Commissioner, T.C. Memo. 1999-291 (an act of Congress rendered motor carrier authorities worthless because all rights associated with the authorities were eliminated); Springfield Productions, Inc. v. Commissioner, T.C. Memo. 1979-23 (testimony by taxpayer’s president that film was worthless because taxpayer had unsuccessfully submitted it for sale or distribution to all major studios and small distribution companies was not substantial proof of worthlessness); Golden State Towel and Linen Service, Ltd. v. United States, 179 Ct. Cl. 300, 310 (1967) (finding that it is only when all or a substantial, identifiable, vendible portion of a customer list is terminated permanently, either through extraneous causes or the sudden and involuntary inability of the owner to serve them, that a tax loss may be claimed, and then only if the loss may be adequately measured).
[26] Echols, 950 F.2d at 213.
[27] Corra Resources, 945 F.2d at 226-27.
[28] Oak Harbor Freight Lines, Inc. v. Commissioner, T.C. Memo. 1999-291.
[29] Golden State Towel and Linen Service, Ltd. v. United States, 179 Ct. Cl. 300, 310 (1967).
[30] Lockwood v. Commissioner, 94 TC 252, 258 (1990).
[31] Springfield Productions, Inc. v. Commissioner, T.C. Memo. 1979-23.
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