Section 165(a) Worthless Partnership Interest Deductions…
February 07, 2012
By Dan P. Lynn
With real estate values being depressed, some taxpayers may hold interests in insolvent partnerships. If a taxpayer abandons a partnership interest, depending on specific circumstances, either an ordinary deduction or capital loss may be recognized under Section 165(a). The case law and revenue rulings that provide this treatment also provide that the loss on a worthless partnership interest may be deducted.
In the case of Echols, the taxpayers held an interest in a fledgling real estate partnership where the underlying value of the real estate had decreased below the principal amount of the mortgage note. Furthermore, decreased occupancy made it difficult for the partnership to service debt and the taxpayers refused to loan or contribute additional amounts to the partnership. Ruling in the taxpayers' favor, the US Court of Appeals allowed the taxpayers to take a deduction for the worthlessness of their partnership interest. In this ruling, the Court determined the date of worthlessness was a subjective test ("like beauty, largely in the eyes of the beholder"), however, the determination of whether the partnership was valueless was an objective determination. This ruling appears to provide a fair amount of latitude in terms of determining when to claim a worthlessness deduction and that worthlessness is an objective test.
In situations where interests in insolvent or otherwise worthless partnership interests are held, if facts are similar to Echols or other relevant case law, a loss may be deducted. Furthermore, Echols provides a fair amount of latitude in determining when the interest becomes worthless. This might provide the ability to claim a loss in a year providing greatest tax benefits from a loss. Careful analysis of specific facts and relevant authority is crucial before deducting any losses under Section 165(a).
Dan Lynn is a Tax Partner with Beene Garter and specializes in M&A and transactional tax consulting. He serves clients primarily in the Manufacturing and Continuing Care Retirement Community industries. He can be reached at dlynn@beenegarter.com or (616) 235-5200.