A form of disposition that can result in a deductible loss is “abandonment” where you totally abandon a property. If it is depreciable property, you deduct the property’s remaining adjusted basis as a fully deductible ordinary loss.
According to Reg. 1.167(a)-8, when an asset is permanently retired or scrapped from use in a trade or business, then there is a loss deduction in the amount of the remaining adjusted basis in excess of the estimated salvage value (if any) or the fair market value at the time of the retirement.
If the asset is non-depreciable property (such as land), then an abandonment loss is allowed, provided that there was intent to make a profit and that the transaction arose from a sudden termination of the usefulness of the property or where such property is permanently discarded from use, Reg. 1.165-2(a).
The loss is deductible in the year sustained under IRC 165(a). For this purpose, the tax year in which the loss is sustained is not necessarily the tax year of the overt act of abandonment, or the loss of property title, Reg. 1.165-2(a). There must be a completed transaction or an identifiable event
TIP: Document that the abandonment has occurred, ideally from third party documentation such as from an attorney, Realtor or title company.
An abandonment loss also applies to leasehold improvements the lessor made for the lessee that were abandoned, IRS Pub 544. The same rule appears to apply to the lessee, if the lessee made improvements and then later moved from the leased premises. The remaining basis of the leasehold improvements is then deductible as an ordinary loss.
TIP 1: The abandonment loss is an ordinary loss, even if the property is a capital asset, such as land, Reg. 1.165-2(b), IRS Pub. 544. (But see the alert 1 below.)
TIP 2: The abandonment is a fully taxable disposition that will trigger the use of suspended passive losses.
ALERT 1: If the abandoned property is foreclosed on, the gain may be a capital gain even for depreciable property. Also, in the event of a foreclosure, you may incur a taxable gain, IRS Pub. 544.
ALERT 2: You cannot deduct an abandonment loss for a personal-use property, such as a primary or second home, Reg. 1.262-1(b)(4); Reg. 1.1659(a). However, see the planning strategies in the previous chapter on deducting losses on personal-use real property (such as a residence).
You claim deductible abandonment losses on IRS Form 4797, Page 1, Part II. See IRS Pub 544 for further reference.
UPDATE: The loss on an abandoned investment is deducted as an ordinary loss, the Tax Court says in a case where a couple gave up the $25, 000 they paid for a franchise. The franchisor had flooded their area with stores, and many of them were losing money. When the franchisor refused to return the $25,000, they figured they were better off walking away from the deal than investing more of their funds in a venture that was likely to be in the red (Alami El Moujahid, TC Memo. 2009-42).