• Taxpayer Has Capital Loss Rather Than Ordinary Loss upon Abandoning Stock
  • April 17, 2014
  • Law Firm: Loeb Loeb LLP - Los Angeles Office
  • In Pilgrim’s Pride Corporation v. Commissioner (December 2013), the taxpayer owned stock in another company for which it had paid $98.6 million. The company did not do well and offered to buy back the stock for $20 million. The taxpayer determined that if it abandoned the stock rather than selling it, it could claim an ordinary tax loss rather than a capital loss and the ordinary loss would result in tax saving to it in an amount greater than the $20 million the company had offered for the shares. Consequently, the taxpayer abandoned the shares and transferred them back to the company for no consideration.

    The basis for deducting an ordinary loss from what is clearly a capital asset derives from the sale or exchange rule. In order for a capital asset to give rise to a capital gain or loss, it must be transferred in a transaction that is treated as sale or exchange. Where an asset is abandoned for no consideration, courts have held that there is no sale or exchange. The tax regulations also recognize this concept, and Treas. Reg. Section 1.165-2 allows an ordinary loss where property is abandoned under certain circumstances. The regulation does not apply, however, where the loss is incurred on a sale or exchange of the property.

    While it appeared that this taxpayer should get an ordinary loss since an abandonment is generally not treated as a sale or exchange, the Tax Court thought otherwise. The Tax Court on its own initiative asked the parties to consider whether IRC Section 1234A might supply a “deemed” sale or exchange where an abandonment occurs. Section 1234A provides that gain or loss from the cancellation, lapse, expiration or other termination of rights to property which is or would be upon acquisition a capital asset in the hands of the taxpayer is a capital gain or loss. In effect, Section 1234A provides a statutory sale or exchange for certain transactions that are not otherwise considered a sale or exchange.

    The court’s holding represents a significant extension of the scope of IRC Section 1234A, which most people thought was intended to prevent taxpayers from recognizing ordinary loss when options lapsed. If this decision stands up on appeal, assuming it is appealed, the concept of being able to get an ordinary loss by abandoning a capital asset will be virtually eliminated.