May 2, 2013
Authored by: Frank Crisafi
The Office of Associate Chief Counsel (Income Tax & Accounting) recently released a memorandum (the “Chief Counsel memorandum) that holds that a bank that acquires OREO through foreclosure proceedings (either through actual proceedings or by deed-in-lieu of foreclosure) with respect to a loan originated by the bank is not considered to acquire the OREO for resale within the meaning of §263A of the Internal Revenue Code and the applicable Treasury Regulations thereunder. This Chief Counsel Memorandum contradicts, at least in part, a memorandum issued last June by Associate Area Counsel (Detroit) (Large Business & International) (the “Area Counsel Memorandum”) that concluded that certain OREO acquired through foreclosure, which was held solely for resale and not for the production of rental or investment income, was considered to be acquired by a bank for resale within the meaning of §263A and the underlying regulations. Accordingly, the previously issued Area Counsel Memorandum concluded that acquisition costs incurred in connection with the foreclosure proceedings, such as legal fees and other direct costs incurred in connection with the foreclosure, as well as certain production costs incurred while holding the property for resale, including real estate taxes, insurance, repairs, maintenance, capital improvements, and utilities, had to be capitalized in whole or in part and in effect recovered as part of the basis of the OREO when computing gain or loss on the sale of the OREO. (Print Version of this Alert Available.)
The rationale for the conclusion in the Area Counsel Memorandum is that the bank clearly acquired the foreclosed property for resale since the federal and state regulations generally restrict the period that OREO may be held by a bank (although extensions can be granted) and also require that banks make good faith efforts to dispose of the OREO. The Area Counsel Memorandum reached this conclusion even though federal and state regulations would not have allowed the bank to otherwise acquire and deal in such property as a business carried on to make a profit. The Chief Counsel Memorandum takes a different view of the activities that generally must be carried on in order for a taxpayer to fall under the capitalization provisions of §263A, which is whether the bank is acquiring property with a view to re-sell it at a profit as part of the bank’s normal business activities. The Chief Counsel Memorandum concludes that the bank is acting in its capacity as a lender and not a traditional reseller of real property. The bank is economically compelled to acquire the property as a last resort to recover funds that it originally loaned in order to minimize its losses.