Fifth Circuit Court Concludes That Abandonment of Capital Assets Does Not Generate Capital Loss

In Pilgrim's Pride Corp. v. Commissioner, No. 14-60295 (5th Cir. 2015), the Fifth Circuit held that section 1234A(1) of the Internal Revenue Code (the "Code") does not apply when a taxpayer abandons a capital asset.

In Pilgrim's Pride, a predecessor to the taxpayer had been unable to negotiate the redemption of securities with the issuer and decided to abandon the securities without consideration. By doing so, the taxpayer generated a $98.6 million ordinary tax loss and more than $20 million in tax savings. The IRS asserted, and the tax court agreed, that section 1234A(1) of the Code applied to the abandonment of the securities and treated it as a deemed sale or exchange of capital assets that was taxable as a capital loss. Section 1234A(1) of the Code generally addresses the U.S. federal income tax treatment of various forms of terminating derivatives.

Reversing the tax court, the Fifth Circuit concluded that, under a plain reading of the statute, section 1234A(1) of the Code applies only to the terminations of "rights or obligations with respect to capital assets" and not "to the termination of ownership of the capital asset itself." Accordingly, the Fifth Circuit rejected the government's argument that section 1234A(1) of the Code applies indirectly when an asset is abandoned because that abandonment terminates rights that are inherent to the asset.

The court also rejected the government's alternative argument that, because the securities were no longer of use to the taxpayer, they should have been treated as "worthless" within the meaning of section 165(g) of the Code (and therefore treated as a capital loss) even though both parties had stipulated that the securities were worth at least $20 million.

See: Pilgrim's Pride Corp. v. Commissioner.