Deduction of legal fees/Destruction of property

[DaveO]

This is a new one to me.
Client owned a piece of property where she grew plants for propagation. The plants were specific hybrids on which she holds numerous patents. She sold the track of land subject to the condition that she be allowed to remove the plants. Once the new owners took possession they would call the cops every time she attempted to remove the plants charging her with trespassing. The new owners then destroyed the plants and she sued for damages. No award of damages has been made but she has incurred substantial legal expense.

Question: Can she deduct the legal expenses as ordinary and necessary expense in the production of taxable income? Remember that the plants themselves were not inventoried nor were they sold. The plants were only breeding stock. Or, does she have to capitalize the expense against the future damage award if any; bearing in mind the income producing property is destroyed?

I of course want to deduct the legal fees and pick up the damages as income if and when she collects. However I respect the opinions of those on the board and would like to know what you think. Thanks

[Brad Imsdahl]

I don’t think the fact that the plants were capital assets makes any difference. The same could be said about real estate held as investment property where you incur legal fees related to the collection of income. Deduct the legal costs as a current expense and include any damage awards as income when received.

[jainen]

a fair example

>>real estate held as investment property<<

That's not a fair example. She operated a farm, with the plants having the same role as an orchard which is harvested without detroying the trees. She sold the farm but not the plants, and sued to enforce a specific provision of the sale contract. I think the legal fees are a cost of sale. There is an additional loss equal to her adjusted basis in the plants, unless she already subtracted that in reporting the land sale.

I think this is a hard case for her to win after she transferred title. Unless the contract detailed how and when she could remove the plants, the buyers only had to allow her "reasonable" access. She would have to get advance approval, and probably couldn't dig in the ground. Her repeated failure to ask permission would weigh heavily against her.

[Brad Imsdahl]

The legal fees are not a cost of sale because she didn't sell the plants. Under the terms of the sales agreement, she was supposed to be able to recover the plants from the property so that she could re-plant them in a new location, thus continue to use them to generate income from her business.

The legal fees are deductible as current expenses. No question about it.