The Taxation of ‘Abandoning Ship’ — An Examination of Disney’s Abandonment of the Galactic Starcruiser Adventure
On May 18, 2023, Disney announced that they are shutting down the Galactic Starcruiser Adventure, a two-night immersive experience where guests live like they are in a Star Wars adventure. A stay in this hotel room ranged between $6,000 to $20,000 for a family of four and proved too costly to operate. Just days after this announcement, Disney Parks and Resorts chairman Josh D’Amoro stated that Disney would receive a $150 million tax write-off in each of Q3 and Q4 of 2023, for a combined write-off of $300 million due to this business decision. This eyebrow-raising figure has made many ask why closing an expensive attraction can lead to such a positive financial outcome. While this example relates primarily to Disney, the U.S. economy struggles through extended periods of high inflation and high-interest rates. Undoubtedly, Disney is not alone in this situation. Associate Professors of Accounting Nathan Goldman and Christina Lewellen examine the issue.
Overview of Tax Loss Treatment of an Unprofitable Business Venture
Goldman still recalls that his accounting professor, C.J. Skender of UNC-Chapel Hill, used to always say, “Taxes make the good times not as good and the bad times not as bad.” In profitable times, companies must pay the government a rather sizable portion of the income they earn (21% for regular corporations). For instance, if in 2023 Disney earns $100 million on one of its business segments, the company will pay $21 million out of the cash it generated from those operations to the U.S. federal government. However, suppose Disney was to incur an annual loss on this business segment of $100 million instead. In that case, this loss can offset taxable income from their other business segments, generating up to a $21 million reduction in the company’s total tax bill. The tax benefit from the loss depends on how much income they have from their other operations. The company can use the entire $21 million tax benefit from the loss if their taxable income from other business operations is at least as much as the loss (at least $100 million).
Taxation of Property
Property has its own set of tax rules because the usage of property occurs over many years. For instance, when you buy a car, the intention is that you drive it for many years before disposing of it. Tax rules state that for a property that is expected to last more than one year, the tax write-off from the cost of the property must be recouped over many years. Although a company will often pay for the property when it is purchased, the actual usage of the property takes place over many years, leading to the concept of depreciation. Depreciation allows companies to incur an expense on their tax return for each year of the asset’s tax life.
While tax laws for personal property assets (i.e., vehicles, equipment, furniture and fixtures, etc.) commonly allow companies to receive large tax depreciation write-offs in the year of purchase, which is referred to as “accelerated depreciation,” real estate is depreciated for tax purposes using straight-line treatment over many years (39 years for most commercial buildings). While the company might pay for the building up front, it then receives long-run tax benefits over the tax life of the building. This act means that for a building that costs $100 million, the company will receive tax write-offs of approximately $2.5 million per year for the 39-year depreciable period, resulting in approximately $525,000 per year in tax savings at the 21% tax rate.
While the IRS sets the number of years over which the tax write-off from an asset purchase will occur, it is not rare when those years must be cut short. For instance, if the company decides that it no longer intends to use an asset and it cannot be sold, it can immediately receive a tax write-off of the remaining tax basis of the asset through an asset abandonment (§1.168). The asset’s tax basis is the amount of the asset’s cost that has not yet been depreciated. In the case of the $100 million building, if the company decides to demolish the building after 10 years of use, it can immediately deduct the remaining tax basis. This treatment is akin to a tax loss on the undepreciated cost of the abandoned property that can offset other business income. The amount of tax savings from the write-off of the abandoned asset will be the amount of the tax basis multiplied by the company’s tax rate. An added bonus to this decision is that it accelerates the tax write-off. While the company still loses money on the asset that is no longer useful, the special tax abandonment rules help make the “bad times not so bad.” Due to the time-value of money, saving money on taxes now vs. in the future is almost always a better financial decision if the company determines the investment is no longer viable.
Disney’s Galactic Starcruiser Tax Situation
We do not know the exact amount that Disney paid for the Galactic Starcruiser property. However, estimates have the costs to be around $350 million. This hotel comprises not just a large piece of real estate (i.e., the land and the buildings), but also thousands of individual assets (beds, chairs, equipment, machinery, etc.) These individual assets likely have much shorter tax lives (three to seven years) compared to the tax life of the building (39 years). Disney constructed the asset, spent this money over several years, and concluded with the opening of the attraction/hotel on March 1, 2022. Tax rules specify that the company would be able to start depreciating the property in the year it is placed into service. Therefore, when Disney announced that they would close the doors to this attraction and abandon their assets on September 30, 2023, the company would have taken one year of tax depreciation. The company would normally have had to depreciate the cost of the property over many future years. However, with the abandonment of the property, it can use the asset abandonment rules (§1.168) to expense the undepreciated costs in 2023. Therefore, Disney effectively depreciated the project’s entire cost over two years.
The Disney chairman estimates that Disney has approximately $300 million remaining on their tax basis. This notion means the company can expense the entire $300 million undepreciated cost to reduce other taxable income on its 2023 tax return. Given that Disney pays a corporate income tax rate of 21%, the decision to abandon the assets will yield a net tax benefit to Disney of $63 million. It is important to note that the asset abandonment rules only apply to those assets that are being abandoned. Disney has not been forthcoming about the exact plans for the individual assets that comprise the hotel. For instance, if Disney simply moved the beds from this hotel to another hotel on its property or if it sold some of the machinery, those assets would not be eligible to be treated as an abandoned asset. Thus, that portion of the hotel’s property could not be written off. Based on the publicly available information, it is not clear how Disney came up with their $300 million amount for write-off, and what their plans are for the individual assets that comprise this hotel.
While a $63 million tax benefit sounds appealing, recall that they spent $350 million on the property, and these tax savings reduce the total out-of-pocket cost. Thus, ignoring the tax savings from prior depreciation, the $63 million Disney will receive in tax benefits also means that it will have $237 million that is essentially not recovered ($350 million minus the tax benefit of $63 million less any prior depreciation incurred). This statistic means that the unprofitable investment cost Disney a substantial amount of money. The cost-benefit analysis made by Disney likely suggests it is the most fiscally responsible decision. In other words, if the asset is incurring more expenses than revenues, it may be better to shut it down and get all of the depreciation now rather than over the next 30+ years. When making this investment, Disney likely assumed it would earn that money via revenues over the many years that the building would be depreciated (upwards of 39 years for a building). However, from a financial reporting perspective, those funds can now be best characterized as a loss to the corporation. While taxes make the “bad times not as bad,” it is important to remember that their tax benefit doesn’t tell the whole story of the sizable loss that appears to have resulted from an unprofitable overall business investment.
Non-Tax Costs (and Benefits)
Taxes and business strategy require considering both tax and non-tax costs and benefits. For instance, when constructing this hotel that costs more for its visitors to partake in than their typical visitors can afford, Disney may have valued the spillover benefits it receives from being able to advertise such a lavish accommodation. Like a business class seat on a transatlantic flight, Disney was able to market such a fancy way to experience the park, which appears to have had some spillover benefits to the company.
Furthermore, other factors may have contributed to Disney’s decision to abandon this investment. Disney continues to battle with the state of Florida over its stances on the LGBTQIA+ community. Recently, Florida removed Disney’s special tax status associated with the Reedy Creek Improvement District, which previously provided Disney with the freedom and flexibility to self-govern its amusement parks in Florida. While removing this District may have resulted in Disney paying less in taxes, it is also now subject to more stringent bureaucratic processes for infrastructure, like building roads or enhancing its amusement parks. In response, Disney has recently pulled out of a $1 billion investment where it had planned to move a substantial amount of its operations to the state of Florida. In the shadow of such an announcement, it leaves one to question whether closing this hotel is just another way for Disney to continue lowering their investment in the state of Florida due to increasing political friction.
Many companies in the U.S. are facing potential losses on capital investments due to varying factors, including political turbulence, changing market demands and changes in employment. The money has already been spent. However, if assets become effectively useless, time-value of money considerations may make the corporation’s tax benefit from abandoning said assets the most preferential current financial decision. The Galactic Starcruiser is a great example of this choice, and it underscores a situation that likely many U.S. corporations are facing in the crosshairs of high inflation and rising interest rates. Companies can abandon or dispose of assets in a number of ways, and the tax benefits of these choices depend on many factors, including the form of the business, the method of disposal and the undepreciated tax basis of the asset, among other factors. In some cases, companies can actually owe tax upon abandoning or disposing of assets. Therefore, when considering “abandoning ship” for an unprofitable asset, companies should be sure to understand the tax implications of the disposal before finalizing the transaction.