Heir Of Honduran Timber Fortune Wins Large Refund In Tax Court

This post was originally published on Forbes Apr 15, 2015

Jose Lamas Sr.  is quite a guy.  Cuban by birth, he fled in 1963 to Central America, where he is now reputed to be the wealthiest man in Honduras.  He shows up as one of the backers of the 2009 coup that ousted President Maneul Zelaya.  His company in Honduras ( Jose Lamas S. de R.L) appears in reports by environmental activists as logging illegally with the logs passing through Miami based Aljoma Lumber (which was sold to Universal Forest Products in 2007 for $53.5 million).  Back around the turn of the millennium, Aljoma Lumber, under the leadership of his son Jose Antonio Lamas, was not exactly getting kudos as a model employer.

All that makes me kind of sad, because, having previously never heard of Mr. Lamas or the coup and only having the vaguest idea as to where Honduras is, I was really rooting for his son Jose Antonio Lamas (Mr. Lamas), who had served as CEO of Aljoma, as I read TC Memo 2015-59 Jose A. Lamas And Maria E. Lamas v Commissioner of Internal Revenue.  The IRS was trying to deny him a refund of $5,260,964, which was based on a carryback of 2008 personal net operating loss to 2006.  In the IRS view Mr. Lamas had not been "materially participating" in the entities that flowed through losses that created the net operating loss.

Background

Jose Senior had funded businesses for each of his three children, giving one child a controlling stake in each business and minority stakes in the other two.  The three companies Continental Trust Mortgage Corp, Adrimar Investments Corp and Shoma Development Corp were all involved one way or the other in real estate and tangentially related to one another not only by common ownership, but also operationally. The controlling stake in Shoma was with Mr. Lamas's sister Maria and her husband, Masoud Shoajee.

Closely related operationally and with identical ownership to Shoma there was also Greens at Doral LLC, a condominium conversion project.

Some Family Squabbling

So Mr. Lamas had a minority interest in a business venture controlled by his brother-in-law.  Situations like this are why people who read Tax Court decision don't need to watch soap operas. The Daily Business Review, in its coverage of the case,  focused on the family drama

Trouble was brewing for years at Doral-based homebuilder Shoma Development Corp., but an Internal Revenue Service audit and U.S. Tax Court fight brought the family squabble bubbling to the surface.

The Tax Court ended up buying the version of events that supported the position of Mr. Lamas that he needed to throw himself into the affairs of Shoma in order to rescue it from missteps by Shoajee.

Mr. Shojaee, while acting as president of Shoma and Greens, had used Shoma's assets for personal gain and usurped Shoma's business opportunities for another business he controlled. Mr. Shojaee used Shoma to guarantee loans for Masmar, a business that he and his wife owned separately from her family.
Mr. Shojaee made a personal pledge to the University of Miami for $1.5 million, and in exchange for this donation the university was going to name a [*5] facility after Mr. Shojaee. Instead of making this contribution from his personal funds, Mr. Shojaee caused Shoma to donate $1.5 million on his behalf.
Finally, Mr. Shojaee took a business opportunity away from Shoma when he chose to build a real estate project on Shoma land using one of his personally owned companies.

The work included a derivative lawsuit against Mr. Shoajee, work with an advisor to develop financing for Shoma and investors and purchasers of its projects and work as Shoma's treasurer.  All in the Tax Court credited Mr. Lamas with 691 hours working for Shoma and Greens during 2008.

Inconsistent Statements

In the early stages of the audit Mr. Shoajee had supported the view that Mr. Lamas had worked at Shoma on a regular and continuous basis - at least 10 hours a week.  Later Mr. Shoajee would tell the IRS that as a family business, there was no record kept of hours worked by officers and directors.  Then in 2010 a follow-up letter was sent to the IRS that Mr. Lamas had not done much at all for Shoma or Greens.

At trial Mr. Lamas had ten witnesses that supported his material participation.  Of the government's four witnesses, the Tax Court found that only one contradicted his position, that being his brother-in-law.  Oh to be fly on the wall next Thanksgiving.

Lessons

The taxpayer win in this case is encouraging and you really have to wonder why the IRS pushed it so far.  The actual intent of the passive activity loss rules was to kill traditional tax shelters.  That is not what was going on there in any sense.  The take-away from this case is that it would have been a really good idea for Mr. Lamas to have kept a contemporaneous log of his activities on behalf of Shoma.  It is also worth noting that Jose Senior's character building ownership structure of the businesses that he backed back-fired when it came to the passive activity loss rules, since it makes it impossible for someone to group all three as a single activity.  You also have to wonder what Mr. Shoajee was thinking when he sent his follow-up letter to the IRS.  Using the IRS as a weapon in a business dispute is, well, not good business.

Other Coverage

The Passive Activity Loss Rules (Code Section 469) spawn quite a bit of tax litigation, with taxpayers generally losing.  Post-event reconstructions, sometimes referred to as "ballpark guesstimates" are usually scorned by the Tax Court.  And of course, sometimes they don't find the logs credible either.  The typical 469 case usually involves an amateur landlord with a day job.  This case was also unusual in the dollars at stake.

Holland & Knight could not resist patting itself on the back for the win.  Parker Tax Publishing has a good summary of the case.  Joe Kristan noted that allowing Shoma and Greens to be considered a single activity was a very important aspect of the decision.

This case is good news for developers, as this structure is common in that business: a permanent S corporation sets up new LLCs for each development project. This case correctly concludes that they are all part of the same development business.

Stephen Hamilton has a similar focus.

The rest of the tax blogosphere failed to note the admittedly somewhat  tenuous connection to political intrigue and the deforestation of Central America, but that hunt for the story behind the story behind the story is what tends to slow me down a bit.