Abandonment Loss Allowed for Leasehold Improvements Upon Couple's Eviction from Store

(Parker Tax Publishing July 2016)

The Tax Court held that a couple can take an abandonment loss for leasehold improvements left behind when they were evicted from a store they had been leasing. The couple could also take a loss on property repossessed by the bank and sold at auction. Chowdhury v. Comm'r, T.C. Summary 2016-31.

Background

In January 2009, Nayemul Chowdhury and his wife, Laila, bought a Hfranchise for $10,000. The couple operated this franchise in Queens, N.Y., together with a Submarina franchise that they had also bought. The couple signed a lease for a store in which to operate both franchises and was required to renovate the premises. After operating their franchises for a couple months, the Chowdhurys closed the store for renovation.

The couple invested approximately $120,000 of their own money in the businesses and, in July 2009, obtained a $180,000 Small Business Administration (SBA) loan. The couple spent approximately $225,000 on the renovations and the store reopened in January of 2010. However, the store was not successful and it closed a year later in January 2011. The couple was evicted and they abandoned the leasehold improvements. They also defaulted on the SBA loan and, as a result, the bank repossessed some of the couple's business equipment and sold it at auction. The net proceeds of $9,363 from the auction were applied to the amount the couple owed on the loan.

Nayemul filed for bankruptcy protection in January 2012, and he received a bankruptcy discharge in April 2012. On their Schedule C for 2011, the couple originally reported $70,000 in income and $236,707 in expenses, for a net loss of $166,707. However, the couple and the IRS subsequently agreed that the couple had no income and no deductible expenses from their business for 2011. The Chowdhurys contended that some of the expenses reported on the 2011 Schedule C should have been reported as losses on the sale or abandonment of property. On Form 4797, Sales of Business Property, the couple reported losses of $33,793 from the abandonment of assets in their franchise activity. The IRS did not allow any of the losses. Records presented to the court relating to the franchise activity were disorganized and incomplete. Before the Tax Court, the Chowdhurys sought to deduct losses from the sale of assets repossessed by their creditor in addition to the abandonment losses.

Analysis

The Tax Court held that the Chowdhurys were entitled to loss deductions resulting from the repossession of the property that was sold at auction and for abandonment losses relating to the leasehold improvements left behind.

The court, citing Estate of Delman v. Comm'r, 73 T.C. 15 (1979), noted that a sale in which the collateral is repossessed from a debtor constitutes a taxable sale or exchange by the debtor of the encumbered property. The debtor's gain or loss on the disposition is measured by the difference between the amount realized on the disposition and the debtor's adjusted basis in the property. In the case of recourse debt, the amount realized is the fair market value of the property repossessed.

In general, the court noted, the Chowdhurys' basis in the repossessed assets is cost, which is then reduced by the amount of depreciation that was allowed or allowable during 2010 and 2011. Because neither the Chowdhurys nor the IRS provided evidence of the fair market value (FMV) of the property repossessed, the court used the $9,363 that the creditor received from selling the property as the FMV and, thus, the amount realized. The court then matched up the invoices for the property purchased for the renovation with the items sold at the auction and concluded that the Chowdhurys had a cost basis for the items sold of $66,052 and determined that the property was eligible for the additional 50 percent depreciation for 2010.

In determining the remaining depreciation on the auctioned property, the court concluded that (1) the property was a seven-year property; (2) the basis for depreciation was $33,026 ($66,052 x 50%); (3) the recovery period was seven years; (4) the half-year convention applied; and (5) the applicable depreciation method was the straight line method. The court left it to the IRS and Chowdhurys to compute the depreciation based on these findings and calculate the resulting loss. The court also noted that the IRS had incorrectly referred to this loss as a capital loss. Losses from the sale of the repossessed business property, the court stated, are losses from the sale of property used in a trade or business and are treated as ordinary losses under Code Sec. 1231.

With respect to the abandonment loss, the court noted that losses resulting from abandonment are sustained during the year of abandonment and are deductible in the tax year in which the abandonment occurs. In order to establish abandonment, the court said, there must be an intention of the owner to abandon the property, coupled with an act of abandonment. The court found that, when the Chowdruys were evicted from the store by their landlord, they abandoned both the leasehold improvements in the store and the Hfranchise. The court said that the amount of the loss for the franchise was the $10,000 basis for the franchise reduced by amortization allowable under Code Sec. 197 for 2009, 2010, and 2011.

With respect to the leasehold improvements, the court reviewed invoices and checks and concluded that the couple abandoned $158,252 of leasehold improvements. To arrive at the Chowdruys adjusted basis for these improvements, the court reduced this amount by the amounts of allowable depreciation for 2010 and 2011. Like the repossessed property, the court found that the leasehold improvements were eligible for the additional 50 percent depreciation in 2010. The court concluded that (1) the property was a 15-year property; (2) the basis for depreciation was $79,126 ($158,252 x 50%); (3) the recovery period was 15 years; (4) the half-year convention applied; and (5) the applicable depreciation method was the straight line method. The court left it to the IRS and Chowdhurys to compute the depreciation and calculate the resulting loss.

Finally, the court rejected the IRS's assertion that the basis of the assets sold and abandoned should be reduced as tax attributes under Code Sec. 108 because of the Chowdhury's discharge in bankruptcy in 2012. According to the court, the basis of the assets repossessed or abandoned in 2011 is not reduced as tax attributes under Code Sec. 108 for the exclusion of discharge of indebtedness income that may have occurred in 2012.

For a discussion of the requirements for the deduction of an abandonment loss, see Parker Tax ¶114,510.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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