In Tucker [11/21/16], a single-owner S Corporation was in the business of real estate acquisition, development, and sales. It was solvent at the beginning of 2008, when it had bank recourse mortgages which it used to buy real property. In 2007 and 2008, the local residential real estate market sharply declined, and it had no sales or revenue in 2008. At the end of 2008, it closed its office, dismissed its employees, and stopped making payments on its mortgages, insurance premiums, and taxes. At that time, it owned 13 mortgaged properties with an aggregate FMV of around $6.8 million, and an aggregate mortgage balance of around $8.6 million. Six of the properties were under water. A real estate appraiser stated that there was value to all properties, and some demand for them. During 2009 - 2010, the corporation was relieved of a number of the liabilities under foreclosure lawsuits through varying cash payments it made or through sale of the properties. For two of the properties, the corporation completed a residence on the property and sold the property to help lessen damages. The corporation reported a loss of about $10.8 million on its 2008 federal income tax return, around $8.9 million of which was attributable to a write down of its real estate inventory to its 12/31/08 current market value. Its owner claimed a $6.78 flowthrough loss on his 2008 individual income tax return, generating a 2008 NOL of more than $6.7 million which he carried back to generate almost $2 million of refunds. The IRS asserted that the corporation’s loss was only $1.5 million.
Section 165 allows deductions for losses from “closed and completed transactions,” which include an asset’s being abandoned or becoming worthless. The Tax Court applied the general rule that, when a taxpayer’s real property is secured by a recourse obligation, the taxpayer is not entitled to a loss deduction until the year of the foreclosure sale, regardless of abandonment or worthlessness. The 11th Circuit agreed with the Tax Court. It also agreed that even though the corporation had closed its office, dismissed its employees, and stopped making payments on its obligations by 12/31/08, the record showed it continued to develop and sell the properties throughout 2009 and 2010. The 11th Circuit stated that Section 165 law permits a loss claim in the year that the amount of the loss becomes readily ascertainable. It stated that the corporation’s total losses were not ascertainable or fixed at the end of 2008, as none of the homes had been formally foreclosed upon or sold. The corporation was not entitled to a loss deduction on its real estate properties secured by recourse loans until the year of the foreclosure sale of a property. Click here for a copy of the complete 11th Circuit Court decision.