Preface: Proper tax counsel and planning can result in significant tax savings in certain instances.

 

Abandonment of Partnership Interests: Tax Planning for Ordinary Losses

Partnership interests, like any investment, sometimes become more complex than initially planned. Egressing that investment with optimized tax planning can sometime lead to big tax savings for clients. Typically, partnership interests are considered capital assets, e.g. like ownership of stock in SkyPeople Fruit Juice, divestment of that asset via sale is often a capital gain or loss. For certain investors in complex tax situations, an angle is abandonment of the partnership interest.

Why would an investor apply abandonment of partnership interest to an investment? Because the loss deduction on abandonment can be an ordinary loss deduction versus a capital loss. Therefore, the tax attributes are significantly greater, e.g. capital losses are limited deductions of $3,000 per year against ordinary gains, while ordinary losses are deductible in entirety, with possible thresholds of creating net operating loss carryforwards. Simply, ordinary losses accelerate the harvesting of tax deductions.

Abandonment of partnership interests are commonly applicable only when the fair market value of the partnership investment interest is less than investment basis, e.g. you invested $61,000,000 in an oil and gas exploration partnership and you’ve deducted $40,000,000 of pass-through losses already, but if the investment is worth say $400,000, you’ve got some serious tax planning ahead of you. Properly planning for abandonments is good, but thinking ahead and avoiding it is best, yet, sometimes that is not an option. Say nothing risked, nothing gained?

IRC 165(a) requires two threshold questions be met for the ordinary loss deduction on partnership interests. 1. Does the partnership have economic substance, and was it intended to earn a profit, i.e. signed partnership agreement, checking account, tax filings, and book and records? 2. Can the partner prove they owned an interest in the partnership? If these two questions are answered yes, then the partner may be able to take an ordinary loss for the partnership interest. The tax courts require the test for worthless interests to be both objective and subjective. This requires a tax expert to document tax positions for defense in audit. An abandonment of a partnership interest is defined as a permanent disposition, not sold, never to be used again, or retrieved. This is a two-part test. 1. The taxpayer must show intent to abandon, subjectively, and 2. Must show affirmative action of abandonment, objectively.

Certain tax attributes for the ordinary loss deduction in abandonment of partnership interests, most importantly, avoiding reduced liabilities. If your partnership K-1 show nonrecourse debt or recourse debt, your ordinary loss deduction will be disallowed in audit. In the tax court case Hirsh and Weiss the loss on abandonment of investment was only ordinary, because, as they convinced the tax courts, the partnership liabilities were not cancelled at the time of abandonment.

In the tax court case involving Pilgrims Pride, with a successor interest in Gold Kist Incorporated, the deduction of an investments in abandonment of an investment interest, passed tax court challenges as an allowable ordinary loss.

The fact’s surrounding Pilgrims Pride, successor interest in Gold Kist, involved a $98.6m investment in Southern States Cooperative, Inc. When Gold Kist suggested a price of $31.5 to redeem the investment, they were countered with a $20m settlement from Southern States. Pilgrims tax counsel therefore advised the abandonment of the investment for an ordinary loss deduction of $98.6m, reducing taxable income on Pilgrims filing a multiplier of the applicable tax rate. Result: a greater tax attribute than the $20m counter offer. Even though in the tax courts, rigorously challenged on the ordinary loss tax attributes, Pilgrims Prides tax counsel position held,  and Pilgrim Pride, successor Gold Kist won the tax case. USTC Pilgrims Pride Corporation, Successor in Interests to Pilgrim’s Pride Corporation of Georgia, formerly known as Gold Kist Subsidiaries, Petitioner-Appellant V. Commission of Internal Revenue, Respondent-Appelant V. Commission or Internal Revenue Respondent-Appellee, US Court of Appeals, Fifth Circuit, 2015-1 U.S.T.C. 50,2011 (Feb 25, 2015).

This blog is for entertainment purposes only, and is not written to be construed as tax advice or tax counsel for any personal or business tax planning. Knowing what you now know, ordinary loss deductions on certain abandonment or a worthless disposition of an investment interest is achievable with proper tax counsel. If you have questions in regards to tax attribute planning for your complex investments, do not make assumptions. Talk with your trusted tax counsel…and like it is said, remember the Pilgrim man and don’t give up.