What Is an Abandonment Loss and How Do You Claim It?

An abandonment loss is a tax deduction available when a taxpayer gives up rights to certain property by permanently taking it out of service. The Internal Revenue Service (IRS) has specific requirements that must be met to claim this type of loss.

Defining an Abandonment Loss

An abandonment loss can only be claimed for property used in a trade or business or for an investment. Personal-use property, such as a primary residence or a personal vehicle, is not eligible for this deduction. Qualifying assets include tangible property like machinery and buildings, as well as intangible assets like partnership interests or screenplays.

To qualify for the deduction, two primary conditions must be satisfied. First, there must be a clear intent to irrevocably discard the asset so it will not be used again or retrieved for sale. For example, a company board might pass a resolution to permanently stop using a specific piece of manufacturing equipment.

The second condition is an overt act or an identifiable event that confirms the intent to abandon. This action must be a clear, physical step that demonstrates the property has been discarded. For example, the overt act could be the physical dismantling of the machine and its removal to a scrapyard.

Substantiating the Abandonment

Taxpayers are responsible for documenting an abandonment to support the claim to the IRS. The evidence must support both the intent to abandon and the overt act of abandonment. For proving intent, written records like corporate resolutions or internal memos that approve the abandonment are strong evidence.

To substantiate the overt act, taxpayers should gather proof that confirms the physical disposal of the asset. This can include photographs of the property being dismantled, receipts from a disposal company, or records showing the cancellation of insurance and maintenance contracts for the property.

Calculating and Reporting the Loss

The amount of the deductible loss is the property’s adjusted basis at the time it is abandoned. The adjusted basis is calculated as the original cost of the asset, plus the cost of any improvements, minus any depreciation that has been claimed over the years.

An abandonment is not considered a sale or exchange, which means the resulting loss is an ordinary loss, not a capital loss. This distinction is beneficial, as ordinary losses can be used to offset other income, such as wages, without the limitations that apply to capital losses.

However, the tax treatment can differ for certain assets. If a partner is relieved of their share of partnership liabilities when abandoning a partnership interest, it is considered a distribution, and the loss is treated as a capital loss. A loss on a worthless security, such as a stock, is also treated as a capital loss.

The loss is reported in the tax year in which the abandonment occurs. Taxpayers file Form 4797, Sales of Business Property, to report an ordinary loss. For losses treated as capital losses, the loss is reported on Schedule D (Form 1040).