Transaction Not Abandoned

X , a real estate limited liability company, incurred expenses totaling $669,126 in 1997 in connection with its attempt to acquire suitable property from S for development by R. After an unsuccessful zoning meeting in November 1997, the parties executed mutual cancellation instructions for escrow on the 1996 purchase agreement. X did not attempt to renegotiate a new purchase agreement at that time. X contacted its CPA a few days after the hearing, telling him that the transaction would not go forward. X also instructed the accountant to do a final accounting to determine how much cash in the partnership was available to distribute to investors. Subsequently, Ss real estate broker approached X and they agreed to another modified offer, resulting in a new purchase agreement on Jan. 15, 1998. X deducted the $669,126 expended on the project on its 1997 return as a Sec. 165(a) abandonment loss.

Analysis

Sec. 165(a) permits a deduction for any loss sustained during the tax year that was not compensated for by insurance or otherwise. Under Regs. Sec. 1.165-1(b) and (d), the loss must be evidenced by a closed and completed transaction, fixed by identifiable events. For an abandonment loss, a taxpayer must show (1) an intention to abandon the asset and (2) an affirmative act of abandonment. If the taxpayer has not relinquished possession of an asset, 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. Abandonment of an intangible property interest should be accomplished by some express manifestation. Claiming an abandonment loss on a tax return for the year at issue is not a sufficient overt act.

X argues that the escrow cancellation and conversation with its accountant demonstrate abandonment. Other facts, however, are inconsistent with a finding that X abandoned the project in 1997. Although X believed that the project was dead as of November, 1997, escrow on the 1996 purchase agreement was not canceled until almost six weeks later, on Dec. 29, 1997. In addition, X continued to pay marketing fees and management overhead for December 1997 and January 1998. It did not make a formal notification to investors that the project or partnership would be abandoned in 1997. In fact, X did not meet with investors until early January 1998, when it required their approval to enter into a new purchase agreement.

X relies on Chevy Chase Land Co., 72 TC 481 (1979), in which the Tax Court allowed an abandonment loss for the costs of negotiating a prospective long-term lease on an unimproved tract of land and for an unsuccessful attempt to rezone the land. The rezoning was inextricably tied to the lease transaction and was limited to the construction of a specified type of department store for the lessee. When the rezoning effort failed, the lessee exercised its rights and terminated the entire transaction. The facts are distinguishable from the instant case, however, because X was successful in obtaining a new purchase agreement just two weeks after the cancellation of escrow on the 1996 purchase agreement.

Although a remote possibility of future use does not necessarily preclude abandonment, Regs. Sec. 1.165-1(b) requires that substance, not mere form, govern in determining a deductible abandonment loss. In substance, Xs sole business purpose was to engage in predevelopment activities to acquire property for R. Although the unfavorable November 1997 zoning meeting and cancellation of escrow on the 1996 purchase agreement slowed Xs progress, they did not prevent an agreement to acquire the property in early January 1998. An otherwise abandoned expenditure, if part of an integrated plan that is implemented, is not an abandonment loss.

 In substance, the 1996 purchase agreement was merely a step in Xs continuing and successful attempts to acquire the subject property for R. Accordingly, it did not sustain a deductible abandonment loss in 1997.

FRGC Investment, LLC, TC Memo 2002-276