Rev. Rul. 80-17

ISSUE Is a resident alien allowed an income tax deduction under section 165 of the Internal Revenue Code as a result of a confiscation of property by a foreign government under the circumstances described below?

The taxpayer, A, is a citizen of foreign country X. A decided to leave X to become a resident of the United States, in order to escape the political conditions existing in X. On May 31, 1978, A left X under a limited exit visa. There was little likelihood that the political conditions in X would change to satisfy A during the period of the exit visa.

X maintains strict control over persons and property leaving and entering its territory. When A departed, A left behind in X property consisting of the assets of a personal service business and stock of a corporation incorporated in X. The law of X provided that any citizen who had not returned to X at the expiration of a limited exit visa would be considered to have abandoned X, and the property of such citizen would be considered nationalized. Although the statutes of X were silent on the subject, it was X's policy to prevent persons out of the country on a limited visa from receiving or otherwise enjoying property or the income from property in X during the period of their absence from X.

On June 1, 1978, A entered the United States and became a resident alien. A did not return to X.

In 1978, after the expiration of A's visa, country X confiscated all of A's property in X.

In the period June 1, 1978, through December 31, 1978, A started and operated a new business in the United States that was unrelated to the property left behind in X. On A's federal income tax return for the 7-month period ending December 31, 1978, A claimed a loss for the 1978 confiscation by X of the property consisting of the assets of the personal service business and the stock.

LAW AND ANALYSIS

Section 165(a) of the Code provides for the deductibility of losses sustained during the taxable year and not compensated for by insurance or otherwise.

Section 165(c) of the Code provides that the deduction for losses in the case of an individual is limited to (1) losses incurred in a trade or business, (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business, and (3) losses of property not connected with a trade or business if such losses arise from fire, storm, shipwreck, or other casualty, or from theft.

Section 873 of the Code provides that a nonresident alien is allowed the deductions provided by section 165(c)(1) and (2), but only if and to the extent that the deductions are connected with income that is effectively connected with the conduct of a trade or business within the United States.

Losses sustained through confiscation or seizure of property under the laws of a foreign country are not casualty or theft losses within the meaning of section 165(c)(3) of the Code. See Powers v. Commissioner, 36 T.C. 1191 (1961). Thus, the instant revenue ruling is limited to determining whether the losses are incurred either in a trade or business under section 165(c)(1) or in a transaction entered into for profit under section 165(c)(2).

A was a nonresident alien until A arrived in the United States and A's property in X had no connection with the conduct by A of a trade or business in the United States. Therefore, because of section 873 of the Code, it follows that if A's loss occurred while A was a nonresident alien, A cannot qualify for a loss deduction under section 165(c)(1) or (2).

When A departed from X on May 31, 1978, with the intention of becoming a resident of the United States, A's reason for doing so was to escape the political conditions existing in X. There was little likelihood that these conditions would change during the period of the exit visa. Based on these facts, it may reasonably be inferred that A intended not to return to X to resume operation and control of the property or recover the income before the expiration of A's visa to the United States. Thus, for practical purposes, A's enjoyment of ownership rights in the property in country X terminated at the time A departed from X. Therefore, the loss of A's property occurred before A became a United States resident alien.

However, even if A is considered to have incurred the loss by reason of the confiscation of the property in X, after A became a resident alien of the United States, a deduction for a section 165(c)(1) or (2) loss is still disallowed under A's circumstances.

Allowance of a loss deduction under both section 165(c)(1) and (2) of the Code have been held by various courts to have the common prerequisite that there be a good faith expectation of profit from the business or investment venture that generated the loss. See Mercer v. Commissioner, 376 F.2d 708 (9th Cir. 1967). The courts reason that a loss deduction is allowed under section 165(c)(1) or (2), if the profit, had there been any, would have been taxable. See Heiner v. Tindle, 276 U.S. 582 (1928), VII-2 C.B. 272 (1928). It reasonably follows that no loss deduction is permitted when the facts indicate that there was little likelihood that the profits would have been taxable had the business produced profits instead of losses. The taxpayer's expectation is not material for this determination.

Thus, two requirements exist for a loss deduction under section 165(c)(1) or (2). There must be a good faith expectation of profit. There must also be a likelihood that if there had been profits instead of losses, they would have been taxable by the United States.

Normally, when a nonresident alien individual changes status to that of citizen or resident of the United States, income from the individual's foreign business and investment property will be subject to United States income tax. A, however, could not receive or otherwise enjoy A's property or the income from such property in X unless A gave up United States residency and returned to X before the visa expired. If A did return to X before the visa expired, A would be subject to X's control and the income from A's property would not be subject to United States taxation because A would be a nonresident alien and the income would not be from a source within the United States. See section 1.871-1 of the regulations.

HOLDING

A is not allowed a reduction for the loss of property in X under section 165(c)(1) or (2) of the Code, because the loss occurred while A was a nonresident alien and such a deduction for a nonresident alien is precluded by section 873. Further, A is not allowed a deduction under section 165(c)(1) or (2) of the Code for the confiscation of the property in X in 1978, because if that property had produced profits, those profits would not have been subject to United States income tax.

Rev. Rul. 62-197, 1962-2 C.B. 66, and Rev. Rul. 64-149, 1964-1 (Part I) C.B. 233, which hold that the confiscation of property of United States citizens or residents by foreign governments is a deductible loss, are distinguishable from the instant situation. In the situations described in those revenue rulings the confiscated property had been owned by a United States citizen or resident prior to the existence of any facts indicating that such property or the income therefrom would be confiscated. Therefore, the loss was incurred by a United States citizen or resident, not a nonresident alien. Furthermore, up until shortly before the loss occurred, there was no indication that the income from the property would not have been subject to United States taxation.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 62-197 and Rev. Rul. 64-149 are distinguished.