CCA 200029054: Closing a restaurant held for sale does not create a deductible loss

Plain-English summary

A restaurant operator closed underperforming locations and offered some for sale. It claimed losses at closure based on the gap between each restaurant's tax basis and estimated sale value, even when a sale had not occurred by year-end. Chief Counsel advised that closure alone did not retire the property under the depreciation regulations: the restaurants were held for sale, rather than sold, abandoned, or moved to a supplies or scrap account. Counsel also found no sudden, unexpected loss of usefulness that would support an abnormal retirement. The advice noted litigation risks because the regulations' examples of retirement may be read as illustrative.

Ruling snapshot

• Question: May the operator deduct a loss when it closes a restaurant that remains unsold at year-end?
• Outcome: Advice given: no deduction on the stated closure facts.
• Key authorities: IRC §§ 165 and 167; Treas. Reg. §§ 1.165-2(c) and 1.167(a)-8.

Full text (IRS public release)

                             DEPARTMENT OF THE TREASURY
                                 I NTERNAL REVENUE SERVI CE
                                    WASHINGTON, D.C. 20224


                                                  May 23, 2000

Number: 200029054
Release Date: 7/21/2000
WTA-N-109918-00                                           CC:DOM:FS

UILC: 167.10-00
      165.00-00

  INTERNAL REVENUE SERVICE NATIONAL OFFICE FIELD SERVICE ADVICE

MEMORANDUM FOR COMPLIANCE DIRECTOR, INDUSTRY SPECIALIZATION
               PROGRAM

FROM:                  Deborah A. Butler
                       Assistant Chief Counsel, Field Service
                       CC:DOM:FS

SUBJECT:               Losses Upon Closure of Restaurant Units

This Field Service Advice responds to your memorandum dated February 7, 2000.
Field Service Advice is not binding on Examination or Appeals and is not a final
case determination. This document is not to be cited as precedent.

ISSUE

A taxpayer closes restaurants that are no longer economically viable and offers
them for sale. May the taxpayer deduct losses upon a restaurant’s closure if the
taxpayer has not sold the restaurant by year-end?

CONCLUSION

Because there has been no retirement of the property under Treas. Reg.
§ 1.167(a)-8, the taxpayer may not deduct losses upon closure of a restaurant that
it has not sold by year-end.

FACTS

A taxpayer who operates multiple restaurant units closes those that are no longer
economically viable. Once the taxpayer determines a restaurant is performing
poorly, it considers all feasible options for making the restaurant profitable before
making the decision to close it.

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When the taxpayer decides to close a restaurant, it fires the workforce and notifies
employees the closure is permanent. The taxpayer then disconnects all utilities,
returns or transfers to other facilities the food, liquor, and smallwares, cleans up the
site, posts a "closed" sign, and boards up the windows. Heavier equipment and
other building contents generally remain on the premises intact so that the site can
be marketed as a restaurant business.

Generally upon closure, the taxpayer moves the restaurant from an active
depreciation account to one that shows the property as inactive. In addition, the
taxpayer immediately either makes plans to sell the restaurant, to convert it to
another concept, or, where the restaurant was leased, to sublease it before the end
of the taxable year. For those restaurants for sale that were not sold by year-end
(the subject of the discussion below), the taxpayer deducts losses incurred at the
time it closes the restaurant and permanently withdraws it from operations.
Typically, the taxpayer claims losses for the excess of basis over the estimated
realizable value of each restaurant.

LAW AND ANALYSIS

I.R.C. § 165(a) provides that there shall be allowed as a deduction any loss
sustained during the taxable year and not compensated for by insurance or
otherwise. Treas. Reg. § 1.165-2(c) cross-references Treas. Reg. § 1.167(a)-8 for
determining the allowance of section 165(a) losses arising from the permanent
withdrawal of depreciable property from use in the trade or business or in the
production of income.

Treas. Reg. § 1.167(a)-8(a) addresses gains and losses on retirement. It provides
that the term “retirement” means the permanent withdrawal of depreciable property
from use in the trade or business. The withdrawal may be made in several ways.
For example, the withdrawal may be made by selling or exchanging the asset, or by
actual abandonment. In addition, the asset may be withdrawn from productive use
without disposition as, for example, by being placed in a supplies or scrap account.

Treas. Reg. § 1.167(a)-8(a)(3) provides that a taxpayer may take a loss for an
abnormal retirement. Treas. Reg. § 1.167(a)-8(b) defines normal and abnormal
retirements and provides that the determination of such shall be made on a facts
and circumstances basis. Generally, a retirement shall be considered normal
unless the taxpayer can show that the withdrawal of the asset was due to a cause
not contemplated in setting the applicable depreciation rate. A retirement is
considered abnormal if the asset is withdrawn earlier than the taxpayer customarily
retires similar assets, or under other circumstances. For example, the abnormal
retirement may occur when the asset has been damaged by casualty or has lost its
usefulness suddenly as the result of an extraordinary obsolescence.

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Although a retirement deduction must be claimed under section 165, the regulation
that applies to determine whether the taxpayer may actually take the deduction is
Treas. Reg. § 1.167(a)-8. Treas. Reg. § 1.165-2(c); Coors Porcelain Co. v.
Commissioner, 52 T.C. 682, 692 (1969), aff’d, 429 F.2d 1 (10th Cir. 1970). Treas.
Reg. § 1.167(a)-8(a) provides examples of permanent withdrawals that are
retirements. They are: a sale or exchange, an actual abandonment, or placement
in a supplies or scrap account.

The taxpayer of course did not sell or exchange the restaurant. Neither did it
abandon the restaurant upon closure. Rather, the taxpayer prepared the restaurant
for future sale. Thus, for there to be a retirement under Treas. Reg. § 1.167(a)-
8(a), the taxpayer must have placed it in a supplies or scrap account.

Upon closure of the restaurant, the taxpayer moved it from an active depreciation
account to one that shows the property as inactive. Nevertheless, this transfer to
an inactive account does not satisfy the regulation's requirement that the account
be a supplies or scrap account. A restaurant held for sale is not the type of
property placed in these accounts. That is, the taxpayer's restaurant is not a
supply item, and the taxpayer does not intend to scrap the building but rather
intends to sell it. Accordingly, the taxpayer does not have a retirement under
Treas. Reg. § 1.167(a)-8(a).

Treas. Reg. § 1.167(a)-8(a)(3), however, provides for loss recognition where there
is an abnormal retirement. Thus, for there to be any possibility here of a
retirement---permanent withdrawal from use in the trade or business, the taxpayer’s
retirement would have to be an abnormal one as defined under Treas. Reg.
§ 1.167(a)-8(b). Dell v. Commissioner, T.C. Memo. 1985-246. To claim an
abnormal retirement, the taxpayer must show that the “loss arose from the sudden,
unexpected termination of the usefulness of the property (as through a casualty or
extraordinary obsolescence.)” De Cou v. Commissioner, 103 T.C. 80, 89 (1994).

An example of an obsolescence can be found in Tanforan Co., Inc. v. United
States, 313 F. Supp. 796 (N.D. Calif. 1970), aff’d, 462 F.2d 605 (9th Cir. 1972).
There the taxpayer’s race track became obsolete because of several factors,
including legislation affecting the race track industry, the necessity of making
expensive repairs and improvements, and the condemnation of a prime area of the
taxpayer’s already-inadequate parking lot. Tanforan, however, is distinguishable
from the present situation, because any efforts by that taxpayer to continue to use
its property would have been fruitless. In addition, the primary events leading to
that taxpayer’s terminating the use of its property all occurred during the same brief
time period. Those events could not have been “reasonably anticipated.”
Tanforan, at 802.

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In the present situation, there always was the possibility the taxpayer would
continue its restaurant’s operation. Yet, there was nothing sudden or unexpected
about the taxpayer’s decision to close the restaurant. Because of the restaurant’s
poor performance, the taxpayer studied the restaurant’s economic viability and
made considerable efforts to improve its performance. Furthermore, the possibility
of the restaurant’s closure existed for some time because of the taxpayer’s
knowledge of the restaurant’s poor performance. It was only after the taxpayer’s
considerable efforts to improve the restaurant’s viability that it finally determined
the restaurant did not meet its operating standards, had to be closed, and offered
for sale. Simple nonuse of a restaurant does not meet the requirements of an
abnormal retirement. Dell v. Commissioner. There was no casualty here, nor was
there an extraordinary obsolescence under Treas. Reg. § 1.167(a)-8(b).
Accordingly, the taxpayer cannot take a loss deduction upon closure of a
restaurant.

CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS

There are some litigation hazards of which you should be aware. First, Treas. Reg.
 § 1.167(a)-8(a) several times uses the phrase “for example” when defining
retirement. Generally, the regulation has been interpreted as applying only to the
specific examples enumerated therein. It is conceivable, however, that a taxpayer
could argue, and convince a court, that the list of examples is merely illustrative,
that another situation may also satisfy the definition.

It also is conceivable a taxpayer may convince a court that its discontinued use of
an underperforming restaurant is abnormal because Treas. Reg. § 1.167(a)-8(b)
likewise uses the “for example” phrase. That regulation’s mention of an asset’s
being withdrawn earlier than customary “or under other circumstances” could be
equally problematic. Furthermore, the regulation provides that the deermination
shall be made on a facts and circumstances basis. These factors, coupled with the
De Cou opinion’s statement that the regulation is “clear that damages caused by a
casualty is just one example of an abnormal retirement,” at 89, also could pose a
hazard.

Please call if you have any further questions.