The Hidden Tax Traps In Abandonments
Abandonments in bankruptcy have been a serious problem for debtors for several years. Eighth and Ninth Circuit Courts of Appeal decisions have established the “deflection” theory as the governing rule on abandonments. Under that theory, the debtor bears the income tax consequences on abandoned property as the creditor takes the property to satisfy the debt. That approach has been criticized as inequitable and as an interference with the debtor’s fresh start. However, the deflection theory is made even more painful for the debtor by the fact that the debt on abandoned assets has been characterized as nonrecourse debt. That means the entire difference between income tax basis and debt is gain (or loss); there is no discharge of indebtedness income.