Rev. Rul. 79-2

ISSUE

Are the various costs incurred by a trust and other shareholders under the circumstances described below deductible under section 165 of the Internal Revenue Code of 1954?

FACTS

A trust was created pursuant to the last will and testament of a decedent. Among the assets that comprised the trust corpus were shares of stock of the M Corporation, a privately owned company, that were held by the decedent as an investment. In December, 1975, the trustees of the trust met with the other shareholders of the M Corporation and they decided that they would make a public offering of not more than one-third of their combined holdings of M Corporation stock. M Corporation was not to participate in the public offering. The registration statement was to be filed in the name of M Corporation. During the ensuing months, legal, accounting, registration, and printing fees were paid by the shareholders preparatory to making the offering, which was scheduled for May 1, 1976. In May, 1976, however, the offering was postponed due to unfavorable market conditions. On July 1, 1976, the shareholders abandoned their plan to publicly sell a portion of their stock holdings in M Corporation. The product of all the expenses incurred in preparation for the offering was totally without residual value on December 31, 1976, and thereafter.

LAW AND ANALYSIS

Section 641(b) of the Code provides that taxable income of an estate or trust shall be computed in the same manner as taxable income of an individual.

Section 212 of the Code provides that in the case of an individual, there is allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income; for the management, conservation, or maintenance of property held for the production of income; or in connection with the determination, collection, or refund of any tax.

However, section 263 of the Code provides, in part, that no deduction shall be allowed for any amount paid out for permanent improvements or betterments made to increase the value of any property or estate. Section 1.263(a)-2(e) of the Income Tax Regulations states that commissions paid in selling securities are an offset against the selling price except in the case of dealers in securities.

Costs incurred in preparation for public offering of stock are considered costs incurred to sell the offered stock. Davis v. Commissioner, 151 F.2d 441 (8th Cir. 1945). In Woodward v. Commissioner, 397 U.S. 572 (1969), 1970-1 C.B. 56, the Supreme Court of the United States stated that: "It has long been recognized, as a general matter, that costs incurred in the acquisition or disposition of a capital asset are to be treated as capital expenditures."

Therefore, the trust and the other shareholders were required to capitalize the expenditures made by them in connection with the proposed offering scheduled for May 1, 1976. These capitalized expenditures were an intangible asset, separate from the stock, that would have offset the proceeds of the contemplated sale of the stock under section 1.263(a)-2(e) of the regulations.

Section 165(a) of the Code allows as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. Section 1.165-2(a) of the regulations, pertaining to obsolescence of nondepreciable property, states that a loss incurred in a transaction entered into for profit and arising from the sudden termination of the usefulness in such transaction of any nondepreciable property, in a case in which such transaction is discontinued or when such property is permanently discarded from use therein, shall be allowed as a deduction under section 165(a) of the Code for the taxable year in which the loss is actually sustained.

The expenditures, in the instant case, for the proposed public offering created an intangible asset that became worthless when the offering was abandoned.

HOLDING

The trust and other shareholders may deduct as losses, under section 165 of the Code, the amount of their capitalized expenditures in preparation for the proposed offering in 1976, the year the proposed public offering was abandoned. Compare Rev. Rul. 67-125, 1967-1 C.B. 31, and Rev. Rul. 73-580, 1973-2 C.B. 86.