Rev. Rul. 62-197

Advice has been requested concerning the position of the Internal Revenue Service regarding the income tax treatment under the Internal Revenue Code of 1954 of confiscation by the Cuban Government of properties in Cuba owned by United States citizens or domestic corporations. The following situations illustrate some of the problems encountered:

(1) Taxpayer, a United States citizen, owned a home located in Cuba which was used solely as his personal residence. The home was furnished and contained personal items such as furniture, jewelry, and clothing. Taxpayer also owned and kept in Cuba an automobile used solely for personal purposes and had substantial amounts of money and numerous items of jewelry in a safe deposit box in a bank in Cuba. Taxpayer learned that the home and its contents, the automobile, and the contents of the safe deposit box had been seized by the Cuban Government.

(2) Taxpayer, a United States citizen, owned as capital assets securities in a corporation operating exclusively in Cuba and whose corporate assets (all of which are in Cuba) were seized by the Cuban Government.

(3) Taxpayer, a United States citizen, owned two farms in Cuba both held by him for more than six months and operated solely for profit. One was operated for him by a resident manager, the other being rented on a yearly basis. Both properties were intervened in by Cuban officials, resulting in the eviction of his resident manager and the cessation of all payments to him of rents and profits.

(4) Taxpayer, a United States citizen, was the owner of a retail store in Cuba at the time the present government came into power. The business was intervened in during 1959 by officials of the Cuban Government who took over the management of the store, and the taxpayer has since that time received no return from his investment therein. The assets of the business were expropriated by decree in 1960. The property taken included inventory and accounts receivable, both previously reflected in gross income, as well as other property such as real estate, furniture and fixtures, and vehicles. The taxpayer had no other gains or losses arising from sales or other dispositions of property in 1959 or 1960. The taxpayer employed the specific charge-off method with respect to bad debts.

(5) X , a domestic corporation, owned a sugar plantation with a mill, storage buildings and dwellings for the managers and some of the workers. The Cuban Government seized such properties, including harvested crops (previously reported as inventory) and bank accounts, promising payment to the owner in bonds payable out of a fund related to future purchases of sugar by the United States. During the year of seizure, the corporation had sold at a profit a tract of land used in its trade or business and had no other gains or losses arising from sales or other dispositions of property used in its trade or business.

(6) T corporation is a domestic corporation which owns 90 percent of the stock of its subsidiary operating in Cuba. All of the assets of the subsidiary are in Cuba and all have been seized by intervention by the Cuban Government.

(7) M , a domestic corporation, has been filing, for a number of years, consolidated returns with its 100-percent-owned domestic subsidiary, N corporation, which had 85 percent of its assets in Cuba until the expropriation of such assets by the Cuban Government in 1960. For 1960, N corporation had a net operating loss of $8 million and M corporation had a $3 million profit.

(8) R , a domestic corporation, owned for several years 100 percent of S corporation, a domestic subsidiary which operated in Cuba until the expropriation of its Cuban assets in 1959, at which time it also had non-Cuban assets which rendered it solvent. R corporation liquidated S corporation pursuant to the provisions of section 332 of the Code and the Income Tax Regulations thereunder.

(9) Y , a domestic corporation, owned for several years 100 percent of Z , a foreign corporation which for past years has been engaged in business within the United States and which had also conducted business in Cuba until the expropriation of its Cuban assets in 1960. At the time of the exportation of its assets, Z corporation had unused net operating losses attributable to its United States business as well as losses incurred in its Cuban business. Assuming that the requirements of section 367 of the Code were considered satisfied (in view of all other facts and circumstances involved) in an advance ruling issued by the Internal Revenue Service, Y corporation liquidated Z corporation pursuant to the provisions of section 332 of the Code.

Section 165(a) of the Code provides for the deductibility of losses sustained by taxpayers which are compensated for by insurance or otherwise. Under section 165(c), losses in the case of an individual are 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. Under section 641(b) of the Code, the same limitation applies to losses of an estate or trust.

Losses sustained through confiscation or seizure of property under the authority of laws of a foreign country are not casualty or theft losses within the meaning of section 165(c)(3) of the Code. See I.T. 4086, C.B. 1952-1, 29, and William J. Powers v. Commissioner , 36 T.C. 1191 (1961) .

Section 165(g) of the Code provides the general rule that a loss on any security (as defined in such subsection) which becomes worthless during the taxable year and which is a capital asset is treated as a loss from the sale or exchange, on the last day of the taxable year, of a capital asset. Subsection (g) further provides that any security in a corporation affiliated (as defined in such subsection) with a domestic corporation is not treated as a capital asset for this purpose if the 95 percent of stock ownership and 90 percent of gross receipts tests stated therein are met.

Section 166 of the Code provides for the deductibility of certain losses arising from bad debts which become worthless during the taxable year. A deduction is allowed for any business debt which becomes totally or partially worthless and, in the case where it has become partially worthless, to the extent it is not recoverable and is charged off during such taxable year. Such deductions are not allowable where the taxpayer employs a reserve for bad debts. A nonbusiness bad debt is deductible by a taxpayer other than a corporation only if it becomes totally worthless during the taxable year, in which event it is considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than six months.

The basis for determining the amount of the deduction under section 165 or 166 of the Code is the adjusted basis provided in section 1011 of the Code for determining the loss from the sale or other disposition of property.

Pursuant to the provisions of section 873(a) of the Code, nonresident alien individuals are not allowed deductions under sections 165 and 166 of the Code where such deductions are not connected with income from United States sources. The same rule applies under section 882(c)(2) of the Code to foreign corporations.

The Internal Revenue Service recognizes that the Cuban Government has taken discriminatory and arbitrary action against the property in Cuba of United States citizens and corporations, including the taking of such property without any realistic effort to provide for prompt and adequate compensation for such taking. The taking of property without compensation is confiscation. It is no less confiscation because there may be an expressed intent to pay at some time in the future. See 3 Hackworth, Digest of International Law (1942) 656.

Section 1.165-1(b) of the regulations provides that to be allowable as a deduction under section 165(a) of the Code, a loss must be evidenced by closed and completed transactions, fixed by identifiable events, and actually sustained during the taxable year. Only a bona fide loss is allowable. Substance and not mere form shall govern in determining a deductible loss.

Based on the foregoing, it is the position of the Service that acts of confiscation, whether by way of seizure, intervention in, expropriation, or similar taking of property, by the Cuban Government constitute identifiable events which, in the light of all of the circumstances, have resulted in closed and completed transactions notwithstanding promise of indemnification. An act of confiscation has occurred when the taxpayer has been deprived of ownership of property or the normal attributes of ownership, such as receipt of income and control over the operation or use of the property, with little or no chance of being compensated therefor.

In determining when a loss through confiscation has been sustained for Federal income tax purposes, the Service will recognize as the identifiable event evidencing a closed and completed transaction whichever of the acts of confiscation occur first. The burden of proof is upon the taxpayer to establish by whatever evidence is available the occurrence of the act and the date thereof to support a deduction for a loss. An officially published expropriation decree (or similar document) will in general be considered prima facie evidence of Cuban confiscation as of the date of the decree. Naturally, all other evidence which is available to the taxpayer or the Service will be used, to the extent material, in establishing loss and the date thereof.

In situations in which there has been seizure, intervention in, or similar taking of property by Cuban officials followed by expropriation evidenced by an officially published expropriation decree (or similar document), the loss will be considered to have been sustained at the time of the seizure, intervention, or taking rather than at the later date of the decree, provided that there is evidence sufficient to establish that the confiscation took place on the date of seizure, intervention, or taking. In situations in which there is not sufficient evidence to establish that the confiscation took place at a date prior to the date of the officially published expropriation decree (or similar document), the date of the decree will be considered as the date of loss. In situations in which there has been no officially published expropriation decree (or similar document), the date of loss may be established by whatever evidence is available, including evidence of a circumstantial nature.

Applying the foregoing principles to the factual situations presented above, the following represent the position of the Service:

(1) No deduction is allowable for the loss of the personal residence, furnishings, jewelry, clothing and other personal items therein, the automobile, and the money and jewelry in the safe deposit box, since the losses were not incurred in the conduct of a trade or business or incurred in any transaction for profit within the meaning of section 165(c)(1) or (2) of the Code, and do not constitute casualty or theft losses within the meaning of section 165(c)(3).

(2) Under section 165(g) of the Code, the taxpayer has a worthless security loss which is treated as a loss from the sale or exchange on the last day of the taxable year of a capital asset. It is to be noted that if, for example, a domestic corporation had assets outside Cuba (including potential United States tax refund claims resulting from the operation of section 172 or other sections of the Code) which exceeded its liabilities (other than liabilities from which the corporation has been relieved as a result of actions of the Cuban Government), the securities would not be considered worthless for the purposes of section 165(g).

(3) The intervention in both farms gives rise to allowable losses under section 165(c)(1) of the Code, which losses are treated in accordance with the provisions of section 1231 of the Code. Section 1231(a) requires the aggregating of all recognized gains and losses on sales, exchanges, and involuntary conversions of property used in the trade or business (as defined in section 1231(b)) and the recognized gains and losses from involuntary conversions of capital assets held for more than six months. Any resulting gains are considered gains from sales or exchanges of capital assets held for more than six months, but any resulting losses are not considered losses from sales or exchanges of such capital assets. Accordingly, the taxpayer's losses will constitute ordinary losses to the extent they, together with other section 1231 losses, exceed taxpayer's section 1231 gains. It is to be noted that section 1231 would be inapplicable if the farms were held for six months or less.

(4) The taxpayer has sustained losses in 1959 in respect of the enumerated assets. Such losses are deductible as ordinary losses under the provisions of section 165(c)(1) of the Code and in accordance with the provisions of section 1231 of the Code with the exception of the loss on accounts receivable, which is deductible under section 166(a) of the Code.

(5) The seizure by the Cuban Government in this instance constitutes an identifiable event and is a closed and completed transaction establishing the existence of a loss, for Federal income tax purposes, notwithstanding the promise of eventual payment in Cuban bonds. Such loss is deductible under section 165(a) of the Code and, to the extent that the loss exceeds the gain derived from the sale of the tract of land, it is treated as an ordinary loss under section 1231(a) of the Code.

(6) Under section 165(g) of the Code, T corporation has a worthless security loss which is treated as a loss from the sale or exchange, on the last day of the taxable year, of a capital asset. (It is assumed that the subsidiary does not have a potential tax refund claim for any year.) It is to be noted that if T corporation owned 95 percent or more of each class of the outstanding stock of the subsidiary, and the 90 percent gross receipts test of section 165(g)(3)(B) had been met, T corporation would have sustained an ordinary loss under section 165(g)(3).

(7) Pursuant to sections 172 and 1502 of the Code and the regulations thereunder, the consolidated net operating loss of $5 million may be carried back to 1957 and to the extent unused to 1958 and 1959; additionally, any of such loss remaining unused may be carried forward to the five succeeding taxable years, 1961 through 1965, inclusive, assuming N corporation remains a member of the affiliated group for such period.

(8) R corporation may utilize the unused net operating loss of S corporation to the extent provided for under the provisions of section 381(a) and (c)(1) of the Code and the regulations thereunder.

(9) Z corporation's net operating loss attributable to its United States income may be carried over to Y corporation to the extent provided for under section 381 of the Code and the regulations thereunder (especially section 1.381(a)-1(c)). The net operating loss of Z corporation attributable to its Cuban income cannot be carried over to Y corporation pursuant to section 882 of the Code and the regulations thereunder.

If Z corporation were a nonresident foreign corporation, no net operating loss carryover would be allowed in any event, since under section 1.882-3(a)(1) of the regulations Z corporation would not be permitted any loss deductions and consequently would have no loss deductions to be carried over.

In any of the foregoing situations in which losses are allowed, it is assumed that the assets did not represent and were not purchased with unreported taxable income, as might have been the case, for example, if such income had been blocked and the taxpayer had elected to defer the reporting of blocked currency income. For the tax consequences of losses in respect to such blocked currency income, see Mim. 6475, C.B. 1950-1, 50.

Any recoveries by taxpayers taking deductions for losses resulting from actions of the Cuban Government will constitute income in the year of recovery, except as provided in section 111 of the Code and the regulations thereunder where the taxpayers did not obtain tax benefits from the deductions. See also section 1033 of the Code and the regulations thereunder, relating to involuntary conversion of property into similar property.

¹ Also released as Technical Information Release 408, dated November 7, 1962.