Worthless Partnership Interests & Intangible Assets

We each value our limited time on this planet in our present life forms differently based on what “things” are “worth” to us. If you really believe you “need”some “thing” you might find yourself going to the end of the Earth and back to get it.

Today’s post attempts to summarily address the tax implications of “worth” from the bottom up asking what it means for something like a partnership interest or an intangible asset to have no value whatsoever or be deemed worthless.

As with the concept of “worth” there are many forms and variations of “worthlessness.” When it comes to tangible physical assets one person’s garbage is another person’s treasure. Assessing worth or value can be a slippery slope involving many moving pieces and parts including traditionally the laws of supply and demand.

To write off an asset as worthless for income tax purposes according to Reg. Sec. 1.166-3(a) & IRC 166 a loss of property is deductible in the year that you properly consider the asset worthless.

The substantiation needed to support the claim on the tax return that an asset is worthless is documentation of an”identifiable event” or completed transaction valuing the property as worthless.

Interestingly enough however this “identifiable event” need not necessarily rise to the threshold of title transfer or abandonment in order for the property to be considered worthless for tax purposes which can be particularly significant in cases involving partnership interests.

What it takes for a partnership interest to be deemed worthless for tax purposes is really a moving target.

In one of my most recent case files one partner refused to contribute additional funds to the partnership necessary for insuring the ongoing efficacy of the entity in question. Additionally3 other factors were present allowing for my client’s partnership interest to be deemed worthless and written off:

  • the partner in question offered her partnership interest to no avail to the other partners and also to anyone else who would assume the non-recourse obligation.
  • the partnership’s only remaining independent source of income at the time was insufficient to service the debt and pay back taxes; and,
  • the partnership’s only asset was an industrial warehouse that was IMHO dilapidated beyond repair with a fair market value less than the remaining balance on the non-recourse mortgage that encumbered the partnership

In following the fact pattern of the specific case it is easy to see that the partnership was indeed truly worthless in all regards. However the facts and circumstances of each partnership must be considered in aggregate when making the determination that a partnership interest is indeed worthless.

For example it can be effectively argued that just because a partnership is managed poorly with present negative capital accounts, it still may not necessarily be considered worthless. There are many other considerations including timing of losses and even prevailing statutes impacting operations to consider.

As many people in the software development industry have learned the hard way, applying generally accepted accounting principles to write off the capitalized cost of acquiring and developing software does NOT necessarily control the treatment of those costs for federal income tax purposes.

When it comes to loss deductions on disposition of amortizable intangible assets under IRC 197 such as software development, goodwill or trade name there are even more considerations in need of examination.

For example, no loss can be recognized when you dispose of an amortizable section 197 intangible asset deemed worthless if any other amortizable section 197 intangible acquired in the same transaction or series of related transactions is not also deemed worthless at the same time.

This also applies to 197 intangibles transferred into your entity and applies to any event rendering the asset worthless including abandonment.

This means that the cost of many section 197 intangibles must continue to be amortized over the prescribed 15-year period even if they become worthless for any reason or are abandoned before the end of the 15-years.

Further complicating matters there is a loss dis-allowance rule regarding the disposition of a Code Sec. 197 (f)(5) intangibles that requires adjusting basis. I will be blogging about this in a future post.

Bottom line is this – in no event is the termination of one or more customers from an acquired customer list or the worthlessness of some information from an acquired data base considered the disposition of a separately acquired section 197 intangible.