IRS Switches Positions, Says Banks Can Deduct Foreclosure Expenses

Charles E. Hodges II & Susan S. Hu (both of Kilpatrick Townsend & Stockton, Washington, D.C.), IRS Changes Position on Deductibility of Expenses Incurred by Banks on Foreclosed Properties:

[B]anks are stuck paying all the expenses and taxes associated with the foreclosed properties. The tax treatment of these on-going expenses associated with the foreclosure of a bank's "other real estate owned" (OREO) remained unclear until recently. Some banks deducted the expenses in the year that they were incurred and took an immediate tax benefit, while others capitalized those expenses.

In June of 2012, the IRS took the position in a Field Attorney Advice Memorandum that OREO expenses should be capitalized. See FAA20123201F. The IRS argued that foreclosed homes were capital assets subject to capitalization under § 263A. ...

[In February of 2013,] the IRS reconsidered its earlier position and ultimately agreed that the OREO expenses could be currently deductible. The IRS set forth its new position in a memo cited as AM2013-001. ... The AM considered cases in which a bank, in the ordinary course of its lending business, secures each loan with the purchased property. The IRS found that under Reg. § 1.263A-1(b)(13), the banks' origination of loans is not considered the acquisition of property for resale within the meaning of § 263A(b)(2)(A). Rather, the IRS concluded that solely taking title to and possession of mortgaged property from defaulted borrowers in an effort to mitigate loss is an extension of the primary activity of originating loans, not reselling properties. Consequently, AM2013-001 concluded that the OREO properties were not properties acquired for resale within the meaning of § 263A(b)(2).