The Internal Revenue Service has recently reversed course regarding federal income tax treatment for banks for certain costs associated with OREOs ("other real estate owned"). The newer guidance should liberalize the ability of banks to take immediate deductions with respect to certain costs associated with OREOS. The IRS has released a Chief Counsel Memorandum stating that a bank that acquires OREOs through foreclosure or deed-in-lieu with respect to a loan originated by the bank is not considered to acquire the OREO for resale within the meaning of §263A of the Internal Revenue Code (which Code Section requires capitalization of certain costs). This Chief Counsel Memorandum partially contradicts a memorandum issued last June.
This newer guidance means that, for OREOs acquired under the circumstances addressed in the new memorandum (that is, OREO acquired in connection with a loan originated by the bank), legal fees and other costs incurred to acquire the OREO through foreclosure as well as costs incurred while carrying the OREO prior to sale (including real estate taxes, insurance, repairs, maintenance, capital improvements, and utilities), should be fully deductible either when paid or incurred depending on the bank’s method of accounting. This is in contrast to the previous guidance which held that such costs had to be capitalized in whole or in part under §263A and recovered only when computing gain or loss on the sale of the OREO.
The newer Chief Counsel Memorandum concludes that the foreclosure activities and subsequent sale of the OREO are an extension of the bank’s lending activities, which are generally exempted from the provisions of §263A by the underlying Treasury regulations.
Banks that have capitalized such costs should consider filing a claim for refund of income taxes prior to the expiration of the statute of limitations for the tax year or years in which such costs were capitalized.