Title: Character of Post-Sale Expenditures
IRC Sections: 162, 1221, 1231
Date Produced: 3/98
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Taxpayer, a partnership, sold personal and improved
real property in 1996. TP agreed to make various improvements to the property
subsequent to the sale. The improvements were made in 1997.
What is the proper tax treatment of the expenses
incurred in 1997 and how are those expenses treated on the partnership tax
The expenses are treated as an additional cost
of the sale and have the same character (capital, ordinary, or Section 1231)
as if the expenses had been incurred at the time of the sale.
This question is a clear example of what has
come to be referred to as the Arrowsmith Doctrine. In Arrowsmith v. Comr.,
344 U.S. 6 (1952), the taxpayers were shareholders of a corporation
engaged in the business of mineral extraction. The corporation was liquidated.
Some years later, a governmental authority forced the taxpayerspresumably
under some theory of transferee liabilityto incur substantial costs related
to an environmental problem caused by the corporation's mineral extraction
operation. The taxpayers argued that the additional costs should be ordinary
expenses. The court observed that if the expenses had been incurred at the
time of liquidation, they simply would have reduced the proceeds of liquidation
and thus reduced the taxpayer's capital gain therefrom. The expenses should
not change their character simply because they were incurred in a later
has been applied in a wide variety of circumstances and I see no reason
the case should not apply here.
Clearly, if the expenses had been incurred prior
to the sale, they would simply have represented an additional cost of the
sale and thus decreased whatever gain was recognized on the sale (on increased
any loss). Given the type assets you mentioned in your memorandum, I would
suspect that any gain or loss from the saleafter consderation of any Section
1245 or 1250 recapturewould be Section 1231 gain or loss. It seems to me
that these additional expenses would be treated as Section 1231 loss.
Mechanically speaking, I would put the expenses
as a cost on Form 4797 as against zero proceeds and attach a white-paper
schedule explaining that these costs are post transaction costs and are
being handled in accordance with the Arrowsmith decision. I would also include
the case citation in the scheduleS.