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Tax: Related to Abandonments

Tax: Related to Abandonments

With the situation of the economy, a lot of taxpayers have issues paying rent on their mortgage and other debts. Many people had no choice but to abandon their property or go through foreclosures. Even though these measures could remove the taxpayer's financial burden, most often do not care about the tax implications. 

Abandoning a property used to secure a debt through the tax implication is a factor of many things. Also, it depends on the purpose of the abandoned property or if the party was liable personally for the debt. 

For a debtor liable for a loan on an abandoned property, we classify such a loan as recourse debt. It usually has no tax implication except the repossession or foreclosure process is completed and the property's purpose, whether for personal or business use. The repossession is classified as a sale, and there must be a loss or profit from the transaction. The amount realized is the debt left just before the transfer or the asset's lower fair market value.  Generally, the realized value will include all proceeds that come from the transaction. In estimating gain or loss, the money realized is compared with the debtor's basis in the property.


Three-prong test

To be eligible as a taxpayer to claim a deduction for an abandoned property (mainly intangible assets like partnership interest), the taxpayer must prove the following:

  • The  owner of the property before it was abandoned

  • An intention to leave (abandon) the property

  • Action is taken to abandon the property indeed.

When talking about partnership interest, it is ideal to have a partnership agreement copy that reflects the time the taxpayer was a partnership in the deal. Other documents like schedules K-1 that the taxpayer gets from the partnership is also vital. Also, purchase agreements and other documents used when the taxpayer joined the partnership are essential. These are the documents that best prove the ownership of a taxpayer in a partnership interest.

Determination and proof of the second and third criteria are usually tied to what happened during the abandonment. As a result, proving them could be difficult. For the abandonment of a tangible asset, for instance, one needs to express manifestation as proof. 


How taxes Applies to Abandonment Losses 

IRS publication 544 revealed that abandonment losses from investment property or business could be deducted as ordinary losses provided the abandonment is not classified as an exchange or a sale. Properties held for personal use cannot be removed. Properties secured by debt have special rules guiding them. 

The tax treatment that applies depends on 

  1. Whether the taxpayer is liable for the debt personally (recourse)

  2. Whether the taxpayer is not personally liable (non-recourse)

The classification of abandonment losses occurs as an ordinary loss. As a result, its reporting will be on the second part, the tenth line of Form 4797 (Business Property sales). Worthy of note is that gains coming from property abandonment provided that the taxpayer's amount is more than the adjusted basis of the taxpayer in the property. 

Without a doubt, proper planning and meticulous documentation are vital if a taxpayer wants to claim a deduction for an abandoned property like an intangible property. In this case, the tangible property can be relinquished physically, while reliable documents must prove the abandonment of any intangible property. 


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