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Developer's Losses in Real Estate Downturn Don't Translate into Deductible Losses

(Parker Tax Publishing December 2016)

The Eleventh Circuit affirmed the Tax Court and held that a real estate developer could not deduct losses resulting from the housing crisis because the properties had not been abandoned as of the end of the year the loss was taken. Because the properties were encumbered by recourse debt, the loss deductions could not be taken before the year a foreclosure sale occurs, regardless of whether the property was abandoned by or became worthless to the mortgagor in a prior year. Tucker v. Comm'r, 2016 PTC 489 (2016).


Harvey Tucker was the president, director, and sole shareholder of Paragon Homes Corporation, a Florida S corporation in the business of real estate acquisition, development, and sales. Paragon took out recourse mortgages with several banks, including Platinum Bank, Branch Banking & Trust Co. (BB&T), Wachovia Bank, and Fidelity Bank. Tucker personally guaranteed the mortgage loans on Paragon's properties.

In 2007 and 2008, the residential real estate market went into sharp decline. According to Tucker, Paragon was essentially out of business and insolvent by the end of 2008. Paragon had no sales and no revenue and, as a result, stopped operations at the end of 2008. Tucker claimed that at the end of 2008, he owed more than $2 million on Paragon's "underwater" properties. Paragon closed its office, dismissed its employees, and stopped making payments on its mortgages, insurance premiums, and taxes. At the close of 2008, Paragon had approximately $12,000 in its bank accounts. According to Tucker, Paragon's real estate inventory - individually and in the aggregate - was "worthless" as of December 31, 2008, because "prices had fallen through the floor. There was no demand and we couldn't generate any sales." However, in 2009, Paragon initiated the process to build a single-family home on one of its properties and, in 2010, sold a property and used the proceeds to satisfy a mortgage loan with one of its lenders.

Although Tucker and Paragon were relieved of all mortgage obligations with Platinum Bank and BB&T at the end of 2009, they were both still personally liable for mortgage loans with Fidelity and Wachovia at that time. In order to protect his personal assets from creditors, Tucker established a family limited partnership, the Harvey L. Tucker Family LLLP (Tucker LLLP). In December of 2009, Paragon transferred $400,000 to Tucker and he used the money to fund Tucker LLLP. On December 28, 2009, Paragon directly transferred $358,255 to Tucker LLLP.

In 2010, Fidelity and Wachovia filed foreclosure suits against Tucker and Paragon with respect to certain properties. Several months later, proceeds from certain property sales were used to repay in full the mortgage loans held by Fidelity.

At the end of 2008, Paragon wrote down the value of its real property holdings and claimed a loss deduction under Code Sec. 165, which flowed through to Tucker's personal tax return. Tucker justified the write down by arguing that Paragon abandoned the properties in 2008 or, in the alternative, that the properties became worthless. Tucker claimed a net operating loss deduction for 2008 as a result of the pass through of losses from Paragon and elected to carryback the loss to his 2003 through 2006 tax returns. The IRS disallowed these deductions and Paragon's write down of its real property holdings in 2008 and the case went to the Tax Court.

Deducting Property Losses

Under Code Sec. 165, a deduction is allowed for losses stemming from closed and completed transactions, which may include abandonment of an asset or an asset becoming worthless. Case law provides that, to show abandonment of an asset, there must be (1) an intention on the part of the owner to abandon the asset; and (2) an affirmative act of abandonment. Additionally, the abandonment must occur in the tax year for which the deduction is claimed. Mere nonuse alone is not sufficient to accomplish abandonment. A Code Sec. 165 loss for the worthlessness of mortgaged property requires worthlessness of the taxpayer's equity in the property. When a taxpayer's real property is secured by a recourse obligation, no loss deduction is available until the year of a foreclosure sale, regardless of whether the taxpayer claims to have abandoned the property in a prior year or claims the property became worthless in a prior year.

Tucker's Arguments

Tucker argued that Paragon's investments in its properties were "closed and completed" at the end of 2008 because it was impossible for Paragon to spend additional money on its properties or to ever pay any money towards any deficiency judgment obtained by the banks at that time or thereafter. Tucker argued that any money subsequently invested in the properties or paid to the banks came from his own pocket, not from Paragon, because he was personally liable for the mortgage loans as a result of his guaranties. In essence, Tucker argued that the facts and circumstances of his case distinguished it from other cases involving recourse loans and, thus, the general rule precluding a loss deduction until foreclosure in cases involving recourse debt should not apply.

Tax Court's Decision

The Tax Court held that Tucker had not met his burden of establishing the abandonment or worthlessness of the properties by the end of 2008; thus, he was not entitled to a deduction for the decline in the value of Paragon's properties in 2008. Paragon was personally liable for the mortgage loans regardless of whether it could pay, the court noted. This meant that the banks could go after Paragon for the remainder of the debt if the proceeds from foreclosure were inadequate to cover Paragon's debt obligations. A taxpayer's equity in mortgaged property for which the taxpayer is personally liable, the court said, is not worthless before a foreclosure sale because the property continues to have some value which, when determined by the sale, bears directly upon the extent of the owner's liability for a deficiency judgment. The court thus concluded that Paragon's properties continued to have value before their respective foreclosure sales in 2009 and 2010 even if, as Tucker claimed, Paragon had no additional funds to reimburse its lenders. Furthermore, the court observed, Paragon had funds in 2008 that Tucker transferred a year later to Tucker LLLP, as a way to preclude reimbursement to lenders.

Arguments on Appeal

Tucker appealed and argued that abandonment of the properties was indicated by Paragon closing its office, dismissing its employees, and stopping payments on its obligations by December 31, 2008. According to Tucker, Reg. Sec. 1.165-1(d) supported his taking a loss in 2008 because the regulation provides that a loss is treated as sustained during the tax year in which the loss occurs as evidenced by closed and completed transactions and as fixed by identifiable events occurring in such tax year. According to Tucker, the 2008 market crash was just such an event.

Eleventh Circuit Affirms Tax Court

The Eleventh Circuit affirmed the Tax Court's decision. The Tax Court's finding that there was no indication that any of Paragon's properties were abandoned by the end of 2008 was not clearly erroneous. Paragon continued to develop and sell the properties throughout 2009 and 2010, the court noted. Tucker also funneled more than $800,000 of his personal money into Paragon's business account in order to facilitate construction on the properties. And Paragon never offered to reconvey the properties back to the mortgagees in lieu of foreclosure. Instead, the Eleventh Circuit observed, Paragon signed settlement agreements with Platinum and BB&T in late 2009 and these overt acts did not indicate to the court an intention to abandon the properties.

In reaching its conclusion, the Eleventh Circuit cited the decision in Comm'r v. Green, 126 F.2d 70 (3d Cir. 1942), a case involving a loss deduction on the abandonment of real property. In Greene, the Third Circuit explained that whether a mortgage at issue is a recourse mortgage is of "fundamental importance" to resolving the case. That is because where the mortgagor retains liability for the debt, the property continues until the foreclosure sale to have some value which, when determined by the sale, bears directly upon the extent of the owner's liability for a deficiency judgment. The Eleventh Circuit noted that Tucker was seeking to evade this general rule by relying on his novel interpretation of Reg. Sec. 1.165-1(d).

While the court found case law support for Tucker's contention that market events can sufficiently "fix" a loss such that a deduction could be taken in the year that the loss occurs, none of those cases involved recourse loans or a nominally defunct business that continued to develop and sell the allegedly worthless asset after its alleged dissolution. Moreover, the court observed, Tucker could point to no case law supporting his "tortured and novel" reading of the regulation. The thrust of the regulation, the court said, is that a taxpayer may only claim a deduction under Code Sec. 165(a) in the year that the amount of the loss becomes readily ascertainable and the total losses to Paragon were not ascertainable or fixed at the end of 2008.

The court also addressed Tucker's contention that his actions after 2008 were intended to protect himself from his creditors and personal obligations on the mortgages, and that he did not act to protect or save Paragon. The court noted there was no case law support for an argument that Tucker's subjective intention to act purely for his own protection was sufficient to meet his burden of showing he had an abandonment loss. And, the court observed, his argument that Paragon was essentially defunct and out of business by the end of 2008 was belied by the evidence indicating that Paragon continued taking part in transactions after 2008.

For a discussion of the deductibility of real estate losses where property is underwater and abandoned, see Parker Tax ¶114,520.

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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