That is, abandon hope of taking an ordinary loss if you abandon property subject to a mortgage, recourse or non-recourse.

That’s Judge Gerber’s take on Drucella T. Malonzo, 2013 T. C. Sum Op. 47, filed 6/10/13, a “don’t quote me” that furnishes a good refresher on FMV-exceeds-basis situations.

Drucella bought a house in Sacramento, CA, resided there for a while, moved to San Francisco and rented out the house, earning income and taking depreciation. But when her tenant left and no new tenant appeared, Drucella stopped paying her mortgage. The lender foreclosed and sent Drucella a 1099-A, Acquisition or Abandonment of Secured Property.

Drucella claimed ordinary loss, IRS claimed capital gain. They’re fighting over a $737 deficiency in tax, but Drucella’s loss would be well into six figures, if she can get it.

She can’t.

Judge Gerber: “Petitioner purchased the property, depreciated it, and, after her inability to rent it out, walked away when her mortgage obligation was in excess of the value of the property and also in excess of her adjusted basis in the property. Here, like the taxpayer in Crane [Crane v. Com’r, 337 U. S. 1(1947)], petitioner claimed depreciation based on her basis or cost. Even though she walked away from the property with the intention of no longer making payments on the mortgage, the subsequent foreclosure of the mortgage loan securing the property constituted a ‘sale or exchange’. See sec. 1.1001-2(a)(1), Income Tax Regs.” 2013 T. C. Sum. Op. 47, at p. 6.

Drucella’s position ignores the mortgage indebtedness, and Judge Gerber won’t. When Drucella walked, she’s deemed to have sold even though the mortgage exceeded the FMV of the property. She took depreciation, which IRS adds back to her basis, and calculates the gain. See page 4 of the opinion for the arithmetic.