United States

Golfing duo finds hazard in attempt to take ordinary abandonment loss

Traps abound in taking abandonment losses

TAX ALERT  | 

In a recent ruling, see TC Memo 2017-114, the U.S. Tax Court held that the Watts brothers, founders of Edwin Watts Golf Shops, had incorrectly claimed that losses arising from the disposition of their partnership interest were ordinary abandonment losses. Siding with the IRS, the court found that the brothers failed to provide documentation or other evidence supporting their position. As a result, the losses were recharacterized as capital losses.

Generally, taxpayers are required to recognize capital gains or losses on the sale or exchange of a partnership interest. However, if a taxpayer abandons an interest in a partnership, with no sale or exchange, they may take an ordinary deduction for the loss.

In order to be eligible for an ordinary abandonment loss, a taxpayer must demonstrate that the disposition of the partnership interest did not constitute a sale or exchange, and that they intentionally and affirmatively abandoned the interest by overt act. Even a de minimis amount of consideration received by the taxpayer can cause the entire transaction to be viewed as a sale, rather than an abandonment. When considering the sale or exchange requirement, taxpayers must also be cognizant of any liabilities they may be relieved of as a result of the disposition, as liability relief may constitute a deemed receipt of consideration, which would trigger sale or exchange classification. In particular, under the provisions of section 752, if a partner is relieved of his share of the nonrecourse liabilities of a partnership, such relief is generally treated as a deemed distribution of cash. That, in turn, is viewed as part of the abandonment transaction, causing it to be viewed as a transfer for consideration equal to the deemed distribution of cash. As a transfer for consideration it would be considered a sale or exchange giving rise to capital, not ordinary, loss treatment.

In delivering their opinion for this case, the court spoke to all of these factors. Specifically, the Tax Court noted that the brothers failed to provide any documentation supporting their position that the disposition of their interest in the partnership in question did not constitute a sale or exchange. When analyzing this, the court explicitly mentioned that the brothers were not able to substantiate their individual share of liabilities, or more importantly lack thereof, in the partnership prior to the disposition. In addition, the court found no documentation or analysis supporting the fact that the brother’s actions had in any way constituted an intentional and overt act of abandonment.

The case highlights the need for taxpayers to meticulously consider and document all facts and circumstances applicable to the potential abandonment of a partnership interest.

Taxpayers considering abandoning an interest in a partnership, or other asset, should make sure to consult their tax advisors regarding the decision.

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