31.11 Abandonments

On an abandonment of business or investment real estate, you may claim an ordinary loss for the property’s adjusted basis (when abandoned) on Form 4797. However, if the abandoned property is later foreclosed or repossessed, you may realize a gain or loss under the rules for foreclosures or voluntary conveyances to creditors (31.9). For example, if an abandonment loss for mortgaged property is claimed in 2011 but in 2012 the property is foreclosed upon or repossessed by the lender, all or part of the cancelled debt will be treated as an amount realized by you on a sale in 2012. The amount realized depends on whether you were personally liable and the value of the property (31.9). If personally liable, you may also realize ordinary income from cancellation of the debt (31.9).

A loss is not deductible on the abandonment of property held for personal use. If the lender forecloses on the loan or repossesses the property, gain or loss (nondeductible loss) must be figured, and ordinary income from cancellation of debt may be realized (31.9).

Abandoning a partnership interest.

Where real estate values have sharply declined, partnerships may be holding realty subject to mortgage debt that exceeds the current value of the property. Some investors in such partnerships have claimed that they can abandon their partnership interests and claim abandonment losses. In one case, an investor in a partnership holding land in Houston, Texas, argued that he abandoned his partnership interest by making an abandonment declaration at a meeting of partners, and also declaring that he would make no further payments. He offered his interest to the others, who refused his offer. The IRS held that he failed to prove abandonment of his partnership interest or that the partnership abandoned the land. The Tax Court sided with the IRS, emphasizing his failure to show that the partnership abandoned the land. However, the appeals court for the Fifth Circuit reversed and allowed the abandonment loss. It held that the emphasis should be on the partner’s actions, not the actions of the partnership. Although neither state law nor the IRS regulations described how a partnership interest is to be abandoned, the appeals court held that the partner’s acts and declaration were sufficient to effect an abandonment of his partnership interest. The appeals court also held that the loss on the partnership interest could have been sustained on the basis of the worthlessness of his interest. The partnership was insolvent beyond hope of rehabilitation: (1) the partnership’s only asset was land with a fair market value less than the mortgage debt; (2) the partnership had no source of income; and (3) the partners refused to contribute more funds to keep the partnership afloat.

In a subsequent case, the Tax Court held that a doctor had abandoned a movie production partnership interest when he refused to advance any more money or to participate in the venture because he disapproved of the content of the film being produced and feared it might jeopardize his position at a hospital operated by a religious organization. Also, the limited partners had voted to dissolve.