Stalled real estate developments aren’t a deductible expense until they’re abandoned

Real Estate Tax Talk

Over the last several years many planned real estate development projects have been unsuccessful because of poor market conditions.

In some cases, an abandoned project can at least result in a tax loss that can be deductible against other income. But not always. There are strict requirements you must meet to take such a loss.

Real estate development image via Shutterstock.
Real estate development image via Shutterstock.

This is what a New York couple that tried to develop 90 acres discovered. Albert Chen, a retired civil engineer, and his wife, Nai-Fen, a real estate agent, purchased the land in Greenville, N.Y., back in 1980. Around 2003, they decided to develop and subdivide the property into 15 to 20 individual lots on which single homes would be built.

Over the next several years they hired land use professionals to help them prepare a subdivision plan to submit to the town planning board. Preliminary approval for the plan was obtained in 2005.

After this, the Chens didn’t seem to do much, other than submit several revised plans to the planning board, for which final approval was never obtained. They made no marketing efforts to solicit contracts, and received no offers from prospective buyers.

Nevertheless, the Chens deducted their expenses as business expenses on their taxes. The IRS denied their deductions for 2009, claiming that the Chens’ activities did not rise to the level of a business.

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The tax court agreed, concluding their development activities were still in the planning and exploratory phase. No business, no business deductions. At most, the Chens’ expenses were startup or preopening expenses incurred before a business begins.

In some cases, an abandoned real estate development project can at least result in a tax loss that can be deductible against other income. But not always."

But there could still be one way the Chens could deduct their losses: as an abandonment loss. When a taxpayer abandons a transaction entered into for profit because property used in the transaction has suddenly become useless, expenses incurred in the year of abandonment become immediately deductible as an abandonment loss for that year.

The Chens claimed they were entitled to such an abandonment loss because they completely abandoned their development project in 2009. They testified that such abandonment became necessary due to a severe decline in the housing market, and a change in the New York wetlands laws that reduced the amount of land they could develop.

Abandonment of an asset involves actual intent on the part of the owner to abandon it coupled with an affirmative act to carry out that intention. A taxpayer does not necessarily need to relinquish legal title to the property, but the mere non-use of property is not sufficient.

The tax court said that to be entitled to an abandonment loss a taxpayer must satisfy three tests:

1. The property was permanently discarded from use in the taxpayer’s business.

2. It was no longer useful in the taxpayer’s business.

3. The usefulness in the taxpayer’s business suddenly terminated.

The Chens flunked all three tests. The tax court ruled that the couple failed to show that the change in the wetlands land use laws required complete abandonment of their development efforts. Indeed, after the law change, the Chens continued to seek preliminary approval of their subdivision plans.

Moreover, despite the severe decline in the housing market in 2009, the Chens said in correspondence with the IRS that they would revive efforts to develop the land if the economy approve. No abandonment, no abandonment loss. (Chen v. Comm’r, T.C. Summary 2014-6.)

Stephen Fishman is a tax expert, attorney and author who has published 20 books, including “The Real Estate Agent’s Tax Deduction Guide,” “Working for Yourself,” “Deduct It!” and “Working with Independent Contractors.” His website can be found at fishmanlawandtaxfiles.com.


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