Magazine article The CPA Journal

Partnership Abandonment: Why It Still Works and What to Watch out For

Magazine article The CPA Journal

Partnership Abandonment: Why It Still Works and What to Watch out For

Article excerpt

Consider the following scenario: an individual has entered into a limited partnership that he knows is going bad, and he believes his investment will not be recovered. With careful planning, accelerating these losses into the current year to offset ordinary income could provide significant tax savings. The Internal Revenue Code (IRC) is littered with traps, however, so careful navigation is required to avoid unintended consequences, such as triggering capital loss treatment.

How to Abandon

Abandoning a limited partnership can lock investment losses into the current year, providing just the relief clients need. The courts have stated that a limited partnership interest may be abandoned under IRC section 165 if the following occur:

* The owner affirmatively intends to abandon the interest;

* There is an affirmative act of abandonment; and

* The intent and affirmative act are communicated to all interested parties [Echols v. Comm'r., 935 F.2d 703 (5th Cir. 1991),].

Revenue Ruling 93-80 (1993-2 C.B. 239) further states that "to establish the abandonment of an asset, a taxpayer must show intent to abandon the asset, and must overtly act to abandon the asset." The defining case in this regard is CRST, Inc. v. Comm'r [92 T.C. 1249, 1257 (1989)]. In this case, the court stated: "Where the taxpayer has not relinquished possession of an item there must be a concurrence of the act of abandonment and the intent to abandon, both of which must be shown from the surrounding circumstances, in order to determine if a loss has occurred in the year of the deduction. ... Mere intention to abandon alone is not sufficient to accomplish abandonment."

One can surmise that intent to abandon can be reflected by the owner's expectation of no remuneration either now or in the future. To effect the abandonment, however, the taxpayer must also clearly show the willful, affirmative act of abandonment. The Echols case gives some guidance on communicating the intent and act of abandonment. The Fifth Circuit held that the taxpayers showed their intent to abandon when they called a meeting of the partners and informed them they would not contribute any additional funds to the partnership. The court stated that this was "a clear and unequivocal indication to (the partners) and the world that taxpayers were walking away from their ownership interest in the partnership." At the same meeting, the taxpayers tendered their title to their partnership interest to "anyone . who would 'step forward and assume' the non-recourse payment on the Partnership's obligation." The court held that this constituted a willful, affirmative act of abandonment, and that these actions in concert "were more than sufficient to constitute an abandonment."

Capital versus Ordinary Loss

A capital transaction exists when a taxpayer sells or exchanges for consideration a capital asset. Under IRC section 741, a partnership is considered a capital asset (other than in IRC section 751 matters related to inventory and unrealized receivables), and thus, the sale of a partnership interest would trigger capital gain or loss treatment. When a taxpayer abandons a partnership, however, does an ordinary loss automatically occur? The answer seems to be, "It depends." Both the asset and abandonment must first be further defined.

Under Revenue Ruling 93-80, ordinary loss can occur from the abandonment of partnership interest under IRC section 165(a). …

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