Caution: sec. 1234A may apply to an abandonment loss.

• Author: Sonnenberg, Erik K.

Change the character of a loss from ordinary to capital, and a taxpayer runs the risk of deferring or even failing to realize a tax benefit. While the general rules regarding characterization of gains or losses are well-known, more obscure statutory provisions can change an otherwise ordinary gain or loss into a capital gain or loss.

In Pilgrim's Pride Corp., 141 T.C. No. 17 (2013), the Tax Court applied one such provision, Sec. 1234A, to rechar-acterize a $98.6 million ordinary loss under Sec. 165(a) as a capital loss under Sec. 165(f). Given the Tax Court's broad reading of Sec. 1234A, taxpayers should consider the holding in Pilgrim's Pride as they analyze the character of gains or losses attributable to the cancellation, expiration, or other termination of a right or obligation.

For example, taxpayers should consider the applicability of Sec. 1234A to the abandonment of partnership interests, termination fees incurred in conjunction with a merger, payments received for waiving a contract provision, or any other circumstance in which the taxpayer "walks away" from a right or obligation with respect to property that is (or on acquisition would be) a capital asset.

The Transaction

In 1999, Gold Kist Inc. (GK Co-op) purchased $98.6 million of third-party securities in connection with an asset purchase agreement. The securities subsequently declined in value. In 2004, after various negotiations, the third party offered to redeem the purchased securities for $20 million. GK Co-op rejected the cash redemption offer and instead voluntarily and irrevocably surrendered the securities to the third party.

On its federal income tax return, GK Co-op reported a $98.6 million ordinary loss deduction under Sec. 165(a) and Regs. Sec. 1.165-2(a) (an abandonment loss). In 2009, Pilgrim's Pride Corp., as successor in interest to GK Co-op, received a notice of deficiency claiming the loss should be capital, not ordinary. Pilgrim's Pride Corp. filed a petition with the Tax Court in 2010. The case was decided Dec. 11, 2013.

Legal Authorities

Sec. 165: Sec. 165(a) allows as a deduction any loss sustained during the tax year that is not compensated for by insurance or otherwise. Regs. Sec. 1.165-2(a) allows taxpayers to claim an abandonment loss under Sec. 165(a) for losses arising from the sudden termination of the usefulness of any nondepreciable property in the taxpayer's business when the property is permanently discarded from use. However, Sec. 165(f)...