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Under sec165, a taxpayer generally is entitled to claim an ordinary loss upon abandoning business property or property held for the production of income. The statutory premise underlying sec165 is that when a taxpayer abandons property, no capital loss arises since the abandonment does not constitute a sale or exchange of the property. A significant exception exists to the rule under sec165, however, in cases where the abandoned property is subject to debt. Specifically, the courts have consistently held that when a taxpayer attempts to abandon encumbered property, a sale or exchange arises and the taxpayer is viewed as having realized an amount equal to the lien on the property, regardless of whether the debt is recourse or nonrecourse.(1) The sale or exchange treatment, in turn, results in the taxpayer's loss being characterized as capital in nature.
In two cases arising within the past several years, Citron v. Comr.(2) and Echols v. Comr.,(3) the IRS litigated attempts by taxpayers to claim abandonment losses with respect to their investments in partnership interests. Both decisions confirm that in order to claim an abandonment loss, the taxpayer must demonstrate a subjective intention to abandon the interest, as well as some affirmative act of abandonment discernible by third parties. In each case, the court concluded that the taxpayer had satisfied the latter test by making unequivocal statements to his partners that he would not contribute additional capital required by the partnership.
In Citron, a majority of the Tax Court concluded that the taxpayer properly claimed an ordinary loss upon abandoning his partnership interest, since no partnership liabilities were allocable to the taxpayer.(4) Thus, the court expressly rejected Rev. Rul. 76-189,(5) in which the IRS took the position that upon the termination of a partnership with no assets, the partners are treated as though they received a distribution under sec731 and, consequently, must claim a capital loss with respect to the unrecovered basis in their partnership interests.
In Rev. Rul. 93-80,(6) the IRS acceded to the Tax Court's rationale in Citron and confirmed that it will no longer follow Rev. Rul. 76-189. That is, the IRS has concluded that a loss from the abandonment or worthlessness...