Caution: Sec. 1234A May Apply to an Abandonment Loss

By Erik Sonnenberg, CPA, Washington

Editor: Annette B. Smith, CPA

Gains & Losses

Change the character of a loss from ordinary to capital, and a taxpayer runs the risk of deferring or even failing to realize a tax benefit. While the general rules regarding characterization of gains or losses are well-known, more obscure statutory provisions can change an otherwise ordinary gain or loss into a capital gain or loss.

In Pilgrim's Pride Corp., 141 T.C. No. 17 (2013), the Tax Court applied one such provision, Sec. 1234A, to recharacterize a $98.6 million ordinary loss under Sec. 165(a) as a capital loss under Sec. 165(f). Given the Tax Court's broad reading of Sec. 1234A, taxpayers should consider the holding in Pilgrim's Pride as they analyze the character of gains or losses attributable to the cancellation, expiration, or other termination of a right or obligation.

For example, taxpayers should consider the applicability of Sec. 1234A to the abandonment of partnership interests, termination fees incurred in conjunction with a merger, payments received for waiving a contract provision, or any other circumstance in which the taxpayer "walks away" from a right or obligation with respect to property that is (or on acquisition would be) a capital asset.

The Transaction

In 1999, Gold Kist Inc. (GK Co-op) purchased $98.6 million of third-party securities in connection with an asset purchase agreement. The securities subsequently declined in value. In 2004, after various negotiations, the third party offered to redeem the purchased securities for $20 million. GK Co-op rejected the cash redemption offer and instead voluntarily and irrevocably surrendered the securities to the third party.

On its federal income tax return, GK Co-op reported a $98.6 million ordinary loss deduction under Sec. 165(a) and Regs. Sec. 1.165-2(a) (an abandonment loss). In 2009, Pilgrim's Pride Corp., as successor in interest to GK Co-op, received a notice of deficiency claiming the loss should be capital, not ordinary. Pilgrim's Pride Corp. filed a petition with the Tax Court in 2010. The case was decided Dec. 11, 2013.

Legal Authorities

Sec. 165: Sec. 165(a) allows as a deduction any loss sustained during the tax year that is not compensated for by insurance or otherwise. Regs. Sec. 1.165-2(a) allows taxpayers to claim an abandonment loss under Sec. 165(a) for losses arising from the sudden termination of the usefulness of any nondepreciable property in the taxpayer's business when the property is permanently discarded from use. However, Sec. 165(f) states that losses from the sale or exchange of capital assets are capital rather than ordinary losses and are subject to the capital loss limitation rules in Secs. 1211 and 1212 (see also Regs. Sec. 1.165-2(b)). Sec. 165(g)(1) provides that if any security that is a capital asset becomes worthless during a tax year, the resulting loss is treated as a loss from the sale or exchange of a capital asset on the last day of the year. Sec. 165(g)(3) provides an exception to the treatment above for worthless securities of certain affiliated corporations.

Sec. 1234A: Sec. 1234A was revised in 1997 to provide, in part, that "gain or loss attributable to the cancellation, lapse, expiration, or other termination of (1) a right or obligation (other than a securities futures contract, as defined in section 1234B) with respect to property which is (or on acquisition would be) a capital asset in the hands of the taxpayer . . . shall be treated as gain or loss from the sale of a capital asset."

Regs. Sec. 1.165-5(i): Prior to March 12, 2008, taxpayers could claim ordinary loss deductions under Regs. Sec. 1.165-2(a) for the abandonment of stock and other securities. On March 11, 2008, the IRS published Regs. Sec. 1.165-5(i) (T.D. 9386), which requires securities abandoned after that date to be treated in the same manner as worthless securities under Regs. Secs. 1.165-5(a) and (b)-that is, generally, ordinary loss treatment applies if the stock or security is not a capital asset in the hands of the taxpayer, and capital loss treatment applies if the stock or security is a capital asset. The abandonment at issue in Pilgrim's Pride occurred prior to March 12, 2008; therefore, Regs. Sec. 1.165-5(i) did not apply.

Rev. Rul. 93-80: Rev. Rul. 93-80 provides that a loss incurred on the abandonment or worthlessness of a partnership interest is an ordinary loss if sale or exchange treatment does not apply. If there is an actual or deemed distribution to a partner in connection with the abandonment, or if the transaction otherwise is in substance a sale or exchange, the partner's loss is capital.

The Tax Court's Decision

In opening and reply briefs, neither Pilgrim's Pride Corp. nor the IRS raised the applicability of Sec. 1234A, but the Tax Court ordered the parties to file supplemental briefs addressing the provision. While the specifics of the argument are beyond the scope of this item, the Tax Court focused on interpreting the meaning of the phrase "right or obligation . . . with respect to property" in Sec. 1234A.

The IRS argued that the language applies broadly to all property rights; thus, Sec. 1234A applies to the loss arising from the abandonment of securities. Pilgrim's Pride argued Sec. 1234A should be narrowly applied to only contractual or other derivative rights to property, and not to property rights inherent in the ownership of the property. Therefore, Sec. 1234A should not apply to the abandonment of the securities.

The Tax Court considered four issues:

  • The plain meaning of the phrase "right or obligation . . . with respect to property";
  • The legislative history of Sec. 1234A;
  • The consistency of Sec. 1234A with the 2008 amendment to Regs. Sec. 1.165-5(i); and
  • The consistency of Sec. 1234A with Rev. Rul. 93-80.

The court held that the phrase "right or obligation . . . with respect to property" should be read to include "property rights inherent in intangible property as well as ancillary or derivative contractual rights." Importantly, the court found that this interpretation was consistent with the legislative history of the 1997 amendment to Sec. 1234A, which extended the application of Sec. 1234A from personal property of a type that is actively traded to all property (Taxpayer Relief Act of 1997, P.L. 105-34, §1003(a)(1)).

The court further concluded that Regs. Sec. 1.165-5(i) gives effect to, and is consistent with, Sec. 1234A because it is Sec. 165(g)(3)—not Regs. Sec. 1.165-5(i)—that creates an exception to Sec. 1234A. The court also found that there was no conflict with Rev. Rul. 93-80 because the ruling is clear that if a statutory provision treats a transaction as a sale or exchange, the resulting loss is capital.

The Tax Court therefore held that the taxpayer was not entitled to an ordinary deduction under Regs. Sec. 1.165-2(a) because the taxpayer's loss should be treated as a loss from the sale or exchange of a capital asset pursuant to Sec. 1234A. Accordingly, the taxpayer was entitled to a capital loss under Sec. 165(f).


Pilgrim's Pride is the first case in which a court applied Sec. 1234A to the abandonment of securities. While Regs. Sec. 1.165-5(i) eliminates the issue for securities abandoned on or after March 12, 2008, it raises the question of how Sec. 1234A may apply to other abandonments. The abandonment of partnership interests pursuant to Rev. Rul. 93-80 and termination fees incurred in connection with an abandoned merger transaction are examples of when Sec. 1234A may be found to apply. At the same time, the application of Sec. 1234A could be much broader, and taxpayers should consider the impact of the decision in Pilgrim's Pride on both prior and future tax positions.


Annette Smith is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington.

For additional information about these items, contact Ms. Smith at 202-414-1048 or

Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.

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