Tax

Undone Deals: Taxes and Abandoned Capital Transactions

Treating expenses for deals that go awry.
Robert WillensSeptember 7, 2001

Not surprisingly, expenses incurred in connection with capital transactions are considered capital expenditures and, hence, may not be deducted. For example, costs incurred in the acquisition or disposition of a capital asset — prototypical capital transactions — are capital expenditures that are, respectively, added to the basis of the asset acquired or subtracted from the proceeds of disposition. Generally, if the capital transaction is abandoned after the expenses were incurred, the accumulated expenses may be deducted, under the authority of Sec. 165, as a loss.

Here’s an example. In Rev. Rul. 79-2, the shareholders of a corporation decided that they would make a public offering of their stock. Expenses were incurred. Later, however, due to unfavorable market conditions, the shareholders abandoned their plan. The ruling says that costs incurred in preparation for a public offering are costs incurred to sell the offered stock, and that costs incurred in the disposition of a capital asset are, inherently, capital expenditures. These capital expenditures, however, were an intangible asset that would have offset the proceeds of sale (had the offering succeeded). The intangible asset became worthless when the offering was (conclusively) abandoned.

Accordingly, the shareholders may deduct, as a loss under Sec. 165, the amount of their capitalized expenses. These expenses did not have to be permanently capitalized to the basis of the stock to which the expenses pertained.

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Obviously, the ruling provides a favorable outcome. On the other hand, loss treatment is only appropriate in cases where the transaction, out of which the expenses arose, is conclusively abandoned. For example, in LTR949402004, a corporation put itself up for sale. Towards that, investment bankers conducted an auction of that company. The bankers identified seven possible acquirers, and the corporation incurred expenses in exploring a possible acquisition with each one. The corporation’s stock was eventually sold to one of the prospective acquirers. But the corporation sought to deduct, under the abandonment doctrine, the expenses attributable to the ”failed” acquisitions. After all, company management argued, it explored seven transactions, six of which were abandoned.

The IRS didn’t agree. The revenue authority held that all of the taxpayer’s expenses were capital expenditures and that loss treatment, for any part of the expenses, was improper.

It’s true that where a taxpayer engages in multiple transactions, the costs properly allocable to the abandoned transactions may be deducted. But if those proposals are part of a single transaction — and only one of those proposals can be completed — no loss deduction is proper unless the entire transaction is abandoned.