Originally published on Passive Activities and Other Oxymorons on June 29th, 2011.
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IN RE: DOES, Cite as 107 AFTR 2d 2011-XXXX, 05/20/2011
I remember the first tax course I ever took. It was at Qunisigamond Community College. The instructor was an attorney and he told a story about a client coming on a large pile of cash in his deceased father's house. The clients attitude was "Who's gonna know ?". I forget the rest of the story except that it didn't have a happy ending. As technology improves, there will be more and more ways that they are "gonna know". The IRS lost this skirmish, but it should be a heads up to people who have made transfers of real estate for less than full consideration.
The essence of the case is pretty well summed up in the John Does who are being defended:
United States taxpayers, who during any part of the period January 1, 2005, through December 31, 2010, transferred real property in the State of California for little or no consideration subject to California Propositions 58 or 193, which information is in the possession of the State of California Board of Equalization, sent to BOE by the 58 California counties pursuant to Propositions 58 and 193.
The IRS has recently realized “a pattern of taxpayers failing to file Forms 709” for real property transfers between non-spouse related parties. The IRS has thus launched a “Compliance Initiative” to investigate those taxpayers who have failed to file Forms 709. As a part of this Compliance Initiative, the government has sought to capture data from states and counties regarding real property transfers taking place between non-spouse family members for little or no consideration during the period of January 1, 2005, through December 31, 2010.
Increases in California property taxes are limited to 2% per year unless there is a transfer of the property. If the transfer is to a child or a grandchild it does not count and will not trigger a reassessment. In order to qualify for this treatment you need to file a form either BOE-58-G or BOE-58-AH, which you can get from your assessors office. Sometimes it can be downloaded. The existence of these forms is pretty convenient for the IRS because they think that maybe if you filed one of them then maybe you should have filed Form 709, which also can be downloaded, but I suggest that you might want to use a professional.
California has argued that their privacy laws prevent them from just turning the forms over to the IRS. It all gets kind of lawerly from here. The short answer is that the Court has initially refused to enforce the John Doe summons against the state because the IRS has not shown that it can't gather the information in some other way. The denial is without prejudice so they may be back.
The lawyerly stuff actually sounds pretty interesting :
It bears mention here as well, however, that, should the United States choose to renew its Petition, this Court has serious concerns about the fact that the United States seeks to utilize the power of a federal court to sanction the issuance of a John Doe Summons upon a state. Indeed, the Court's own review of the case law has revealed no other circumstances on par with the United States' current request. As such, prior to resubmitting the Petition, the United States is cautioned that it must address, inter alia, the following issues:
(1)) Whether a state is a “person” as that word is used in 26 U.S.C. §§ 7602(a) and 7609(f);
(2)) Whether a state's sovereign immunity precludes issuance of a John Doe Summons;
(3)) Whether, assuming a state is subject to the Court's power to issue a John Doe Summons, the United States must exhaust all administrative remedies prior to proceeding in federal court; and
(4)) Whether the United States should be required to attempt to pursue any and all state court remedies prior to seeking relief in federal court.
The Government is strongly advised to be thorough in any future briefing since it will be asking this Court to make a decision ex parte without the benefit of any similar briefing from the state.
The practical take away to me though is that it might be a good idea to see if you kinda of sorta forgot to file the gift tax return because you were so busy with those complicated forms the assessor wanted. Before long, one way or the other, I think they are "gonna know".
Showing posts with label real estate. Show all posts
Showing posts with label real estate. Show all posts
Monday, July 14, 2014
Sunday, July 13, 2014
IRS Disses Doggie Diplomas and Other Developments
Originally published on Passive Activities and Other Oxymorons on June 22nd, 2011.
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FISHER v. U.S., Cite as 107 AFTR 2d 2011-XXXX, 04/19/2011
There has already been a partial decision in this case which I mentioned in a previous post. The government got summary judgement on whether a restrictions on transferability discount would apply to a single asset family limited partnership. Apparently that was not the end of the story. After all there are still discounts for lack of marketability (even if they let you sell the damn thing nobody would want to buy it anyway) and minority interest. This particular decision, which is also not the end of the story is about evidence. The taxpayers want to bring into evidence what the IRS was originally willing to allow. The IRS doesn't think that relevant.
The present Motion in Limine seeks to preclude Plaintiff from introducing evidence of the minority interest and lack of marketability discounts used by the IRS in arriving at the February 13, 2006 assessments. See generally dkt. no. 101. The United States contends that because this case involves a de novo review of the fair market value of the property at issue, the calculations of the IRS at the administrative stage are irrelevant. Id. at 4. Plaintiff contends that evidence should be allowed in rebuttal if Mark Mitchell, CPA (“Mitchell”), the United States' expert, testifies that the minority discount should be seven percent rather than the nineteen percent purportedly used by the IRS in the February 13, 2006 assessment. Dkt. No. 105 at 3.
In this case, introduction of evidence of the minority interest discount used by the IRS in the February 13, 2006 assessment is irrelevant. The issue is what the correct minority interest discount is, not what it was previously determined to be. Accord. Janis, 428 U.S. at 440; see also R.E. Dietz Corp. v. United States, 939 F.2d 1, 4 [68 AFTR 2d 91-5238] (2d Cir. 1991) (“The factual and legal analysis employed by the Commissioner is of no consequence to the district court.”). The previously used minority interest discount has no baring on factfinder's de novo determination of the property's fair market value. Because evidence of the previously used minority interest discount is irrelevant, it must be excluded.
This reminds me a little of the Levy case. They were starting with a 30% discount and took it to a jury which allowed them 0%. (It was also a refund case so being stuck with the 30% was actually as bad as it could get.) In that case the taxpayers were trying to keep out the amount the family actually ultimately received.
Private Letter Ruling 201117036
This was an organization formed to provide credit counselling services that was denied exempt status.
Based on the information you provided in your application and supporting documentation, you are not operated for exempt purposes under section 501(c)(3) of the Code. An organization cannot be recognized as exempt under section 501(c)(3) unless it shows that it is both organized and operated exclusively for charitable, educational, or other exempt purpose. You failed to meet the operational test of section 1.501(c)(3)-1(a)(1) and section 1.501(c)(3)-1(c)(1) of the Regulations because you are organized for substantial private and commercial purposes, and operate in the same manner as a private commercial entity.
To qualify under IRC section 501(c)(3), an organization cannot have a non-exempt purpose that is more than insubstantial. Your primary activity is the provision of pre-bankruptcy certification and post-bankruptcy counseling for fees. You devote most of your time and activities to selling bankruptcy certifications to the general public under the guise of financial counseling. You have not shown that you are operated exclusively to educate individuals for the purpose of improving or developing their capabilities. Rather, the fact that no educational materials will be provided unless the client registers for a counseling session is an indication of operation for a primarily business purpose. Your primary focus is to expand your client base and to issue bankruptcy certificates as quickly as possible in order to generate revenue. Analogous to the organization described in Better Business Bureau of Washington D.C., Inc. v. United States supra, your activities appear to have an underlying commercial motive that distinguishes your educational activities from that carried out by a university or educational institution.
If you want to be recognized as a charity maybe you could kind of like do something charitable.
Private Letter Ruling 201117035
Here the IRS shows its narrow speciesism. Among the possible purposes that qualify for exemption is "education". It turns out, though, that it has to be human beings who are being educated. Doggy University (the name I made up for the anonymous ORG in this ruling) does not qualify.
ORG holds dog obedience training classes, and awards the dogs a degree after completion of the course and also award, them prizes at the shows events. While the owners received some instruction as to the training of the dogs, it is the dog that is primary object of the training.
The nature of obedience training requires that the owner of the dog appear at the classes so that the dog is trained to respond to his owner's commands. While the owner receives some instruction in how to give commands to his dog, it is the dog that is the primary object of the training. The dog is also the primary object of the subsequent training in sporting and show events. Therefore, the organization's training program for dogs is not within the meaning of educational as defined in the regulations.
Dog training in the manner you describe is not exempt purposes as described in IRC section 501(c)(3), because the organization's training program for dogs as well as its dog shows is not within the meaning of educational as defined in the regulations . In fact, you primarily serve the private interests of the dog owners and thus not operated exclusively for 501(c)(3) purposes.
Private Letter Ruling 201117011
Taxpayer was granted 120-day extension from date this letter was issued, to make election under Code Sec. 469(c)(7)(A); to treat all of his interests in rental real estate as single rental real estate activity effective stated year.
Rental activities are "per se" passive. There is an exception for people in real estate trades or businesses if they meet certain requirements. They still have to materially participate in the properties. Absent the election to aggregate the material participation standard can be challenging when there are multiple properties. Taxpayers who have failed to make the election can sometimes get relief with a late election as the taxpayer in this ruling did.
____________________________________________________________________________
FISHER v. U.S., Cite as 107 AFTR 2d 2011-XXXX, 04/19/2011
There has already been a partial decision in this case which I mentioned in a previous post. The government got summary judgement on whether a restrictions on transferability discount would apply to a single asset family limited partnership. Apparently that was not the end of the story. After all there are still discounts for lack of marketability (even if they let you sell the damn thing nobody would want to buy it anyway) and minority interest. This particular decision, which is also not the end of the story is about evidence. The taxpayers want to bring into evidence what the IRS was originally willing to allow. The IRS doesn't think that relevant.
The present Motion in Limine seeks to preclude Plaintiff from introducing evidence of the minority interest and lack of marketability discounts used by the IRS in arriving at the February 13, 2006 assessments. See generally dkt. no. 101. The United States contends that because this case involves a de novo review of the fair market value of the property at issue, the calculations of the IRS at the administrative stage are irrelevant. Id. at 4. Plaintiff contends that evidence should be allowed in rebuttal if Mark Mitchell, CPA (“Mitchell”), the United States' expert, testifies that the minority discount should be seven percent rather than the nineteen percent purportedly used by the IRS in the February 13, 2006 assessment. Dkt. No. 105 at 3.
In this case, introduction of evidence of the minority interest discount used by the IRS in the February 13, 2006 assessment is irrelevant. The issue is what the correct minority interest discount is, not what it was previously determined to be. Accord. Janis, 428 U.S. at 440; see also R.E. Dietz Corp. v. United States, 939 F.2d 1, 4 [68 AFTR 2d 91-5238] (2d Cir. 1991) (“The factual and legal analysis employed by the Commissioner is of no consequence to the district court.”). The previously used minority interest discount has no baring on factfinder's de novo determination of the property's fair market value. Because evidence of the previously used minority interest discount is irrelevant, it must be excluded.
This reminds me a little of the Levy case. They were starting with a 30% discount and took it to a jury which allowed them 0%. (It was also a refund case so being stuck with the 30% was actually as bad as it could get.) In that case the taxpayers were trying to keep out the amount the family actually ultimately received.
Private Letter Ruling 201117036
This was an organization formed to provide credit counselling services that was denied exempt status.
Based on the information you provided in your application and supporting documentation, you are not operated for exempt purposes under section 501(c)(3) of the Code. An organization cannot be recognized as exempt under section 501(c)(3) unless it shows that it is both organized and operated exclusively for charitable, educational, or other exempt purpose. You failed to meet the operational test of section 1.501(c)(3)-1(a)(1) and section 1.501(c)(3)-1(c)(1) of the Regulations because you are organized for substantial private and commercial purposes, and operate in the same manner as a private commercial entity.
To qualify under IRC section 501(c)(3), an organization cannot have a non-exempt purpose that is more than insubstantial. Your primary activity is the provision of pre-bankruptcy certification and post-bankruptcy counseling for fees. You devote most of your time and activities to selling bankruptcy certifications to the general public under the guise of financial counseling. You have not shown that you are operated exclusively to educate individuals for the purpose of improving or developing their capabilities. Rather, the fact that no educational materials will be provided unless the client registers for a counseling session is an indication of operation for a primarily business purpose. Your primary focus is to expand your client base and to issue bankruptcy certificates as quickly as possible in order to generate revenue. Analogous to the organization described in Better Business Bureau of Washington D.C., Inc. v. United States supra, your activities appear to have an underlying commercial motive that distinguishes your educational activities from that carried out by a university or educational institution.
If you want to be recognized as a charity maybe you could kind of like do something charitable.
Private Letter Ruling 201117035
Here the IRS shows its narrow speciesism. Among the possible purposes that qualify for exemption is "education". It turns out, though, that it has to be human beings who are being educated. Doggy University (the name I made up for the anonymous ORG in this ruling) does not qualify.
ORG holds dog obedience training classes, and awards the dogs a degree after completion of the course and also award, them prizes at the shows events. While the owners received some instruction as to the training of the dogs, it is the dog that is primary object of the training.
The nature of obedience training requires that the owner of the dog appear at the classes so that the dog is trained to respond to his owner's commands. While the owner receives some instruction in how to give commands to his dog, it is the dog that is the primary object of the training. The dog is also the primary object of the subsequent training in sporting and show events. Therefore, the organization's training program for dogs is not within the meaning of educational as defined in the regulations.
Dog training in the manner you describe is not exempt purposes as described in IRC section 501(c)(3), because the organization's training program for dogs as well as its dog shows is not within the meaning of educational as defined in the regulations . In fact, you primarily serve the private interests of the dog owners and thus not operated exclusively for 501(c)(3) purposes.
Private Letter Ruling 201117011
Taxpayer was granted 120-day extension from date this letter was issued, to make election under Code Sec. 469(c)(7)(A); to treat all of his interests in rental real estate as single rental real estate activity effective stated year.
Rental activities are "per se" passive. There is an exception for people in real estate trades or businesses if they meet certain requirements. They still have to materially participate in the properties. Absent the election to aggregate the material participation standard can be challenging when there are multiple properties. Taxpayers who have failed to make the election can sometimes get relief with a late election as the taxpayer in this ruling did.
Thursday, June 12, 2014
Group Home Qualifies for 27.5 Year Life
Originally published on Passive Activities and Other Oxymorons on January 26th, 2011.
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CCA 201049026
I always thought of group homes as something that would be run on a not for profit basis. According to the blurb for this book I was wrong:
This guide gives concise, step by step instructions for starting a group home. The demand for group homes far exceeds the supply in a lot of areas in the US. Because of the aging baby boomers, demand is likely to continue to grow as government and individuals look for cost effective alternatives to assisted living and retirement homes.
Regardless of that, this CCA caught my eye. These are just excerpts from it, but they get the main point across pretty well.
House used to operate adult home care business that cares full-time for adults who can't live on their own qualifies as IRC Sec(s). 168(e)(2) residential rental property, and consequently owners should determine depreciation for portion of house leased as dwelling units by its customers of adult home care business, but not portion of house that is owner-occupied, using a 27.5-year recovery period or 40-year recovery period if alternative depreciation system of IRC Sec(s). 168(g) applies.
In the facts in this advice, the rental units are bedroom apartments used to provide living accommodations within a building, and are not units in an establishment more than one-half of the units in which are used on a transient basis. Therefore, the rental units are dwelling units for purposes of § 168(e)(2). All units and associated common areas in the building, including the portions occupied by the taxpayers, are dwelling units, and no portion of the building is rented or used for commercial purposes outside of the taxpayers' adult home care business. Consequently, 100 percent of the gross rental income from the building is rental income from dwelling units, even after taking into account the use of the dwelling unit by the taxpayers. In applying the 80-percent test in this case, the $2,000.00 per month allocated to the services that the taxpayers provide for their residents does not constitute gross rental income from the building because the services (24 hour supervision and care for the residents, laundry service, maid service, transportation) are other than those usually or customarily rendered in connection with the mere rental of rooms 1. Thus, in this case, the building is residential rental property. case), it is unimportant whether a particular cost for services is included in rental income or not, as 100 percent of gross rental income from the building is necessarily rental income from dwelling units.
This Chief Counsel Advice does not address whether § 280A limits the taxpayers' deductions for the use of a portion of their residence for business purposes.
In addition, the term “dwelling unit” is defined differently under § 280A(f)(1) than under § 168(e)(2)(A)(ii)(I). The conclusions in this Chief Counsel Advice concerning whether the bedroom apartments used in the taxpayers' business are dwelling units are limited to the analysis under § 168, and no inference should be drawn from this Chief Counsel Advice that these bedroom apartments are dwelling units for purposes of § 280A.
Upkeep of the house and landscaping are services customarily rendered in connection of the rental of rooms, and a portion of the monthly $2000 charge must be allocated to these services and included in both gross rental income from the building and rental income from dwelling units. The exclusion of charges for services other than those usually or customarily rendered in connection with the mere rental of rooms is relevant in the application of the 80 percent test only in the case of a building or structure containing both rental dwelling units and commercial rental space other than dwelling units. In the case of a building or structure comprised solely of dwelling units and associated areas (such as the instant
____________________________________________________________________________
CCA 201049026
I always thought of group homes as something that would be run on a not for profit basis. According to the blurb for this book I was wrong:
This guide gives concise, step by step instructions for starting a group home. The demand for group homes far exceeds the supply in a lot of areas in the US. Because of the aging baby boomers, demand is likely to continue to grow as government and individuals look for cost effective alternatives to assisted living and retirement homes.
Regardless of that, this CCA caught my eye. These are just excerpts from it, but they get the main point across pretty well.
House used to operate adult home care business that cares full-time for adults who can't live on their own qualifies as IRC Sec(s). 168(e)(2) residential rental property, and consequently owners should determine depreciation for portion of house leased as dwelling units by its customers of adult home care business, but not portion of house that is owner-occupied, using a 27.5-year recovery period or 40-year recovery period if alternative depreciation system of IRC Sec(s). 168(g) applies.
In the facts in this advice, the rental units are bedroom apartments used to provide living accommodations within a building, and are not units in an establishment more than one-half of the units in which are used on a transient basis. Therefore, the rental units are dwelling units for purposes of § 168(e)(2). All units and associated common areas in the building, including the portions occupied by the taxpayers, are dwelling units, and no portion of the building is rented or used for commercial purposes outside of the taxpayers' adult home care business. Consequently, 100 percent of the gross rental income from the building is rental income from dwelling units, even after taking into account the use of the dwelling unit by the taxpayers. In applying the 80-percent test in this case, the $2,000.00 per month allocated to the services that the taxpayers provide for their residents does not constitute gross rental income from the building because the services (24 hour supervision and care for the residents, laundry service, maid service, transportation) are other than those usually or customarily rendered in connection with the mere rental of rooms 1. Thus, in this case, the building is residential rental property. case), it is unimportant whether a particular cost for services is included in rental income or not, as 100 percent of gross rental income from the building is necessarily rental income from dwelling units.
This Chief Counsel Advice does not address whether § 280A limits the taxpayers' deductions for the use of a portion of their residence for business purposes.
In addition, the term “dwelling unit” is defined differently under § 280A(f)(1) than under § 168(e)(2)(A)(ii)(I). The conclusions in this Chief Counsel Advice concerning whether the bedroom apartments used in the taxpayers' business are dwelling units are limited to the analysis under § 168, and no inference should be drawn from this Chief Counsel Advice that these bedroom apartments are dwelling units for purposes of § 280A.
Upkeep of the house and landscaping are services customarily rendered in connection of the rental of rooms, and a portion of the monthly $2000 charge must be allocated to these services and included in both gross rental income from the building and rental income from dwelling units. The exclusion of charges for services other than those usually or customarily rendered in connection with the mere rental of rooms is relevant in the application of the 80 percent test only in the case of a building or structure containing both rental dwelling units and commercial rental space other than dwelling units. In the case of a building or structure comprised solely of dwelling units and associated areas (such as the instant
Saturday, June 7, 2014
Oh What a Tangled Web We Weave
Originally published on Passive Activities and Other Oxymorons on January 3rd, 2011.
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BENNETT v. U.S., Cite as 106 AFTR 2d 2010-6321, 12/09/2010
I had a friend who was in some financial difficulties. As part of his strategy, he transferred some assets to his father with the expectation of getting them back at some point. His father died. My friend did not have a good relationship with his step mother. He said he called her up every once in a while to remind her about the assets. It was always good for a laugh on her part. At his expense.
Timothy Bennett, at least as I can tell from the facts in the case, has not lost his father nor does he have a difficult step mother complicating his transactions. Still it is a mess. Mr. Bennett purchased a house from his father. His mother, who was divorced from his father, was in the real estate business. The plan was for her to rent the house for $600 per month plus pay the real estate taxes.
Just before the closing, Joanne Bennet (mom), the real estate genius, had a brainstorm. Since she was living there she could qualify for a Michigan homestead exemption if her name were also on the title. So even though Timothy Bennett provided all the consideration the house was deeded to Timothy Bennett and Joanne Bennett as co-owners. It was just a formality.
Timothy Bennett later testified that he relied on Joanne Bennett as his real estate agent, mother and fiduciary to handle the purchase transaction. He testified that he believed that by signing the homestead affidavit, or “homesteading,” Joanne Bennett was simply attesting to the fact that she planned to live at the property.
It later turned out that putting Mom on the title fortuitously had another benefit :
In the summer of 2005, Timothy Bennett and his wife Ann Marie Bennett divorced. As part of the judgment in his divorce case, Timothy Bennett represented that the Cooley Beach property was jointly owned by Joanne Bennett and himself. The parties agreed that his interest in it was not marital property.
Once the divorce was out of the way Mr. Bennett decided that it would be better if the property were totally in his name. Once again family help was available :
In September 2005, Timothy Bennett asked his brother, Kevin Bennett, an attorney, to draft a quitclaim deed conveying the Cooley Beach property from Timothy Bennett and Joanne Bennett as tenants in common to Timothy Bennett and Joanne Bennett as joint tenants with rights of survivorship. The quitclaim deed was executed and recorded with the Oakland County Register of Deeds on December 13, 2005.
In June 2006, the parties prepared another quitclaim deed conveying the property from Timothy Bennett and Joanne Bennett to Timothy Bennett alone. It was executed and recorded with the Oakland County Register of Deeds on August 8, 2006. Through this quitclaim deed, Timothy Bennett and Joanne Bennett granted their interest in the Cooley Beach property to Timothy Bennett alone. The deed states that it was executed for the full consideration of one dollar, but both Timothy Bennett and Joanne Bennett testified that no consideration was given in exchange for this transfer. He further testified that he was merely trying to “clean up the title” to the property in the wake of his divorce. .) “I was trying to get everything straightened out so I could move on with the title.... [Joanne Bennett] should never have been on [the deed] to start with.”
Joanne Bennett's financial situation was not good. She seldom paid the $600 monthly rent and did not pay the real estate taxes. Timothy found out about the real estate taxes not being paid and paid them himself. It turned out that rent and real estate taxes were not the only things that Joanne Bennett was not paying :
Joanne Bennett did not file federal income tax returns between 1999 and 2007. IRS account transcripts show that the IRS began contacting Joanne Bennett in 2002, requesting that she file her delinquent federal income tax returns. In early 2007, after she had transferred the Cooley Beach property to Timothy Bennett and upon the urging of a friend, Joanne Bennett filed her delinquent tax returns. No payments were made with these returns.
Ms. Bennett had other bills too and ended up in bankruptcy. An initial review by IRS Officer Lynsey Taulbee determined that her delinquent taxes were uncollectible, but management thought there should be some checking for other assets:
After discovering the June 30, 2006 quitclaim deed, and reviewing utilities and maintenance bills, Taulbee concluded that the Cooley Beach property had been transferred to Timothy Bennett as Joanne Bennett's nominee. Officer Taulbee filed a Notice of Federal Tax Lien and recorded it in the Oakland County Register of Deeds office on March 23, 2009.
According to their testimony this was the first that Timothy learned of his mother's income tax problems. Family solidarity had found a limit. He asked her to leave so he could get some paying tenants in. Unrelated paying tenants.
The case is a suit for "quiet title" on the property. Both sides were asking for summary judgement. Mr. Bennett's motion was dismissed. The IRS was granted summary judgement on the issue of Joanne Bennett's having an interest in the property.
Essentially Mr. Bennett's argument is that he and his mother were just trying to chisel on property taxes and hoodwink his ex-wife. They weren't trying to pull the wool over the IRS's eyes. The legal analysis is fairly complicated and I'm not going to get into it. The case is not resolved at this point. I think the lesson to be learned here is that when Ms. Bennett had her brainstorm about the property taxes, she should have reflected on that fact that she was delinquent on her income tax filing. Perhaps it would not be fair for Mr. Bennett to lose this property to his mother's income tax problems. Of course the assessors in the town and his ex-wife might find it to be poetic justice.
____________________________________________________________________________
BENNETT v. U.S., Cite as 106 AFTR 2d 2010-6321, 12/09/2010
I had a friend who was in some financial difficulties. As part of his strategy, he transferred some assets to his father with the expectation of getting them back at some point. His father died. My friend did not have a good relationship with his step mother. He said he called her up every once in a while to remind her about the assets. It was always good for a laugh on her part. At his expense.
Timothy Bennett, at least as I can tell from the facts in the case, has not lost his father nor does he have a difficult step mother complicating his transactions. Still it is a mess. Mr. Bennett purchased a house from his father. His mother, who was divorced from his father, was in the real estate business. The plan was for her to rent the house for $600 per month plus pay the real estate taxes.
Just before the closing, Joanne Bennet (mom), the real estate genius, had a brainstorm. Since she was living there she could qualify for a Michigan homestead exemption if her name were also on the title. So even though Timothy Bennett provided all the consideration the house was deeded to Timothy Bennett and Joanne Bennett as co-owners. It was just a formality.
Timothy Bennett later testified that he relied on Joanne Bennett as his real estate agent, mother and fiduciary to handle the purchase transaction. He testified that he believed that by signing the homestead affidavit, or “homesteading,” Joanne Bennett was simply attesting to the fact that she planned to live at the property.
It later turned out that putting Mom on the title fortuitously had another benefit :
In the summer of 2005, Timothy Bennett and his wife Ann Marie Bennett divorced. As part of the judgment in his divorce case, Timothy Bennett represented that the Cooley Beach property was jointly owned by Joanne Bennett and himself. The parties agreed that his interest in it was not marital property.
Once the divorce was out of the way Mr. Bennett decided that it would be better if the property were totally in his name. Once again family help was available :
In September 2005, Timothy Bennett asked his brother, Kevin Bennett, an attorney, to draft a quitclaim deed conveying the Cooley Beach property from Timothy Bennett and Joanne Bennett as tenants in common to Timothy Bennett and Joanne Bennett as joint tenants with rights of survivorship. The quitclaim deed was executed and recorded with the Oakland County Register of Deeds on December 13, 2005.
In June 2006, the parties prepared another quitclaim deed conveying the property from Timothy Bennett and Joanne Bennett to Timothy Bennett alone. It was executed and recorded with the Oakland County Register of Deeds on August 8, 2006. Through this quitclaim deed, Timothy Bennett and Joanne Bennett granted their interest in the Cooley Beach property to Timothy Bennett alone. The deed states that it was executed for the full consideration of one dollar, but both Timothy Bennett and Joanne Bennett testified that no consideration was given in exchange for this transfer. He further testified that he was merely trying to “clean up the title” to the property in the wake of his divorce. .) “I was trying to get everything straightened out so I could move on with the title.... [Joanne Bennett] should never have been on [the deed] to start with.”
Joanne Bennett's financial situation was not good. She seldom paid the $600 monthly rent and did not pay the real estate taxes. Timothy found out about the real estate taxes not being paid and paid them himself. It turned out that rent and real estate taxes were not the only things that Joanne Bennett was not paying :
Joanne Bennett did not file federal income tax returns between 1999 and 2007. IRS account transcripts show that the IRS began contacting Joanne Bennett in 2002, requesting that she file her delinquent federal income tax returns. In early 2007, after she had transferred the Cooley Beach property to Timothy Bennett and upon the urging of a friend, Joanne Bennett filed her delinquent tax returns. No payments were made with these returns.
Ms. Bennett had other bills too and ended up in bankruptcy. An initial review by IRS Officer Lynsey Taulbee determined that her delinquent taxes were uncollectible, but management thought there should be some checking for other assets:
After discovering the June 30, 2006 quitclaim deed, and reviewing utilities and maintenance bills, Taulbee concluded that the Cooley Beach property had been transferred to Timothy Bennett as Joanne Bennett's nominee. Officer Taulbee filed a Notice of Federal Tax Lien and recorded it in the Oakland County Register of Deeds office on March 23, 2009.
According to their testimony this was the first that Timothy learned of his mother's income tax problems. Family solidarity had found a limit. He asked her to leave so he could get some paying tenants in. Unrelated paying tenants.
The case is a suit for "quiet title" on the property. Both sides were asking for summary judgement. Mr. Bennett's motion was dismissed. The IRS was granted summary judgement on the issue of Joanne Bennett's having an interest in the property.
Essentially Mr. Bennett's argument is that he and his mother were just trying to chisel on property taxes and hoodwink his ex-wife. They weren't trying to pull the wool over the IRS's eyes. The legal analysis is fairly complicated and I'm not going to get into it. The case is not resolved at this point. I think the lesson to be learned here is that when Ms. Bennett had her brainstorm about the property taxes, she should have reflected on that fact that she was delinquent on her income tax filing. Perhaps it would not be fair for Mr. Bennett to lose this property to his mother's income tax problems. Of course the assessors in the town and his ex-wife might find it to be poetic justice.
Monday, June 2, 2014
Ready, Fire, Aim
Originally published on Passive Activities and Other Oxymorons on December 29, 2010.
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JAMES A. HILL, JR. v. COM TC Memo 2010-268
There were a number of issues in this case, not all of them interesting. For example, you have to report your share of S corporation income even though you don't receive any distributions. One issue was of some interest though. M. Hill and his wife had formed an LLC to purchase property that they intended to develop. The LLC was treated as an S corporation. (This gets me a little suspicious of the quality of the advice they were getting. One of my themes is that the partnership form is generally superior, particularly in real estate, but I don't have enough facts to second guess them here.) Mr. Hill also filed a schedule C for his real estate brokerage business.
Mr. Hill found a likely property for Parkwood and contracted to buy it. At the closing things got a little complicated::
Petitioner attended the real estate closing on February 7, 2003, in his dual capacity as broker and as the purchaser's representative. At the closing, Robert Garrison (Mr. Garrison), the closing attorney, credited to Real Estate North's account $10,000 in earnest money that Real Estate North had been holding in escrow from Parkwood. Mr. Garrison also tendered a check to petitioner, payable to Real Estate North, for $90,000. Petitioner informed Mr. Garrison that he did not want to accept a commission on the sale, and he asked Mr. Garrison to redraft the closing agreement to eliminate Real Estate North's commission. Mr. Garrison refused to redraft the closing documents. Instead, he asked petitioner to endorse the $90,000 check to Mr. Garrison's escrow account. Mr. Garrison then applied the $90,000 to the purchase price of the Huntington Park property. A February 7, 2003, closing statement signed by petitioner indicates that Real Estate North received a $100,000 commission in the transaction. Petitioner, however, did not report the $100,000 commission on his 2003 Form 1040, U.S. Individual Income Tax Return.
The IRS determined that Mr. Hill should recognize the $100,000 commission as income on his schedule C. Mr. Hill argued that he should be able to treat it as having been used to reduce his cost of the property purchased.
The Court sided with the IRS :
First, the record is clear that petitioner did, in fact, realize the commission. Petitioner testified that he asked Mr. Garrison to redraft the closing documents to eliminate the commission, but Mr. Garrison refused. Whatever discussions occurred at the closing, the fact remains that petitioner was tendered a $90,000 commission check and signed the closing statement affirming that Real Estate North received a $100,000 commission in the transaction. The commission was not subject to any limitations or restrictions. Thus, the commission was income when tendered. .....The fact that petitioner did not deposit the check into his or Real Estate North's bank account is immaterial. Petitioner cannot alter the tax consequences of the transaction by claiming, after the fact, that he did not want to accept the commission. ....
Second, both this Court and the U.S. Court of Appeals for the Eleventh Circuit have rejected the argument that a commission paid to a broker or agent who is purchasing for his own account is a purchase price reduction and is not income to the recipient. ..... Thus, even if petitioner had not received the $100,000 commission but instead transferred his rights to the money to Parkwood, the transfer would constitute an anticipatory assignment of income. ......
Finally, we note that “the Commissioner may bind a taxpayer to the form in which the taxpayer has cast a transaction.” ........Petitioner deliberately structured the purchase of the Huntington Park property so that Real Estate North would receive a $100,000 commission. Petitioner cannot avoid paying tax on the income by attempting, after the fact, to recharacterize the commission.
The moral of the story is to not wait till closing to do the tax structuring of a transaction.
.
____________________________________________________________________________
JAMES A. HILL, JR. v. COM TC Memo 2010-268
There were a number of issues in this case, not all of them interesting. For example, you have to report your share of S corporation income even though you don't receive any distributions. One issue was of some interest though. M. Hill and his wife had formed an LLC to purchase property that they intended to develop. The LLC was treated as an S corporation. (This gets me a little suspicious of the quality of the advice they were getting. One of my themes is that the partnership form is generally superior, particularly in real estate, but I don't have enough facts to second guess them here.) Mr. Hill also filed a schedule C for his real estate brokerage business.
Mr. Hill found a likely property for Parkwood and contracted to buy it. At the closing things got a little complicated::
Petitioner attended the real estate closing on February 7, 2003, in his dual capacity as broker and as the purchaser's representative. At the closing, Robert Garrison (Mr. Garrison), the closing attorney, credited to Real Estate North's account $10,000 in earnest money that Real Estate North had been holding in escrow from Parkwood. Mr. Garrison also tendered a check to petitioner, payable to Real Estate North, for $90,000. Petitioner informed Mr. Garrison that he did not want to accept a commission on the sale, and he asked Mr. Garrison to redraft the closing agreement to eliminate Real Estate North's commission. Mr. Garrison refused to redraft the closing documents. Instead, he asked petitioner to endorse the $90,000 check to Mr. Garrison's escrow account. Mr. Garrison then applied the $90,000 to the purchase price of the Huntington Park property. A February 7, 2003, closing statement signed by petitioner indicates that Real Estate North received a $100,000 commission in the transaction. Petitioner, however, did not report the $100,000 commission on his 2003 Form 1040, U.S. Individual Income Tax Return.
The IRS determined that Mr. Hill should recognize the $100,000 commission as income on his schedule C. Mr. Hill argued that he should be able to treat it as having been used to reduce his cost of the property purchased.
The Court sided with the IRS :
First, the record is clear that petitioner did, in fact, realize the commission. Petitioner testified that he asked Mr. Garrison to redraft the closing documents to eliminate the commission, but Mr. Garrison refused. Whatever discussions occurred at the closing, the fact remains that petitioner was tendered a $90,000 commission check and signed the closing statement affirming that Real Estate North received a $100,000 commission in the transaction. The commission was not subject to any limitations or restrictions. Thus, the commission was income when tendered. .....The fact that petitioner did not deposit the check into his or Real Estate North's bank account is immaterial. Petitioner cannot alter the tax consequences of the transaction by claiming, after the fact, that he did not want to accept the commission. ....
Second, both this Court and the U.S. Court of Appeals for the Eleventh Circuit have rejected the argument that a commission paid to a broker or agent who is purchasing for his own account is a purchase price reduction and is not income to the recipient. ..... Thus, even if petitioner had not received the $100,000 commission but instead transferred his rights to the money to Parkwood, the transfer would constitute an anticipatory assignment of income. ......
Finally, we note that “the Commissioner may bind a taxpayer to the form in which the taxpayer has cast a transaction.” ........Petitioner deliberately structured the purchase of the Huntington Park property so that Real Estate North would receive a $100,000 commission. Petitioner cannot avoid paying tax on the income by attempting, after the fact, to recharacterize the commission.
The moral of the story is to not wait till closing to do the tax structuring of a transaction.
.
Monday, May 19, 2014
Flipping Properties
Originally published on Passive Activities and Other Oxymorons on December 15, 2010
_________________________________________________________________
Wendell V. Garrison, et ux. v. Commissioner, TC Memo 2010-261
This case addresses an important issue that I run into from time to time. How do you distinguish between investing in real estate or acquiring for use in a trade or business as opposed to being in the business of buying and selling real estate ? If you are a pure investor your gain on sale will be capital gain, your loss will be capital loss and your expenses will be itemized deductions subject to a variety of limitations depending on which ones we are talking about. If you are holding the property as a rental your gain will be a capital gain (with gain attributable to accumulated depreciation subject to a special rate) and your deductions will go against adjusted gross income. If you have a net loss, it may be suspended by the passive activity loss rules. Loss on the sale of a rental property is ordinary. If you are in the business of buying and selling real estate all income and loss is ordinary and subject to self employment tax.
There is, of course, more to it than that. Investors and rental property holders can do tax deferred like-kind exchanges. Someone in the business of buying and selling can shelter some their income with a Keogh or SEP or something like that. Not that they ever will. Real estate flippers will only stop when they die or own all the real estate in the world (I used to include bankruptcy as another end point, but that is really just a brief interruption). I am also leaving out owning the real estate involved in a business that you operate. Frequently that ends up being a rental situation, although there are some special rules.
Wendell and Sharon Garrison filed returns that fell somewhere between investor and rental operation. They didn't claim any operating expenses, but reported sales of property on Form 4797, which is the form for reporting sale of assets used in a trade or business (which for this purpose includes rental). They claimed capital gain treatment. Since most of the sales were short term I wonder what difference this made. It can make a big difference to someone who has capital loss carryovers, but based on the rest of the facts that didn't seem that likely. More significantly they did not pay self-employment tax on their earnings.
It seems like Mr. Garrison, more or less, shot himself in the foot:
Petitioner husband testified: “I'm in the business of buying material, fixing houses and reselling them.”
Still the court got into the factors to consider.
Typically, the factors in making this determination include:
(1) The taxpayer's purpose in acquiring the property;
(2) the purpose for which the property was subsequently held;
(3) the taxpayer's everyday business and the relationship of the income from the property to the total income;
(4) the frequency, continuity, and substantiality of sales of property;
(5) the extent of developing and improving the property to increase the sales revenue;
(6) the extent to which the taxpayer used advertising, promotion, or other activities to increase sales;
(7) the use of a business office for the sale of property;
(8) the character and degree of supervision or control the taxpayer exercised over any representative selling the property;
(9) the time and effort the taxpayer habitually devoted to the sales.
Petitioners engaged in at least 15 sales over 3 years, and most of the sales occurred within 4 months after they purchased the property.
That pretty much summed it up. The case also got into substantiation of expenses. They had nothing so the additional expenses they claimed were not allowed. The Cohan Rule was not even mentioned.
My own rough guideline in this area is that when you do your third renovation sale your in the business of buying and selling property, particularly if the first two did not have any rental activity. If you are doing this to scale it is worth consulting the Phelan decision (Timothy J. Phelan, et ux. v. Commissioner, TC Memo 2004-206). By isolating different activities in different entities it is possible to get capital gains treatment on some of the economic return from a development even though related entities might be doing ordinary income type activities. In order for this type of thing to work though it is critical that the entities be treated with respect. As with family limited partnerships, the devil is in the details.
_________________________________________________________________
Wendell V. Garrison, et ux. v. Commissioner, TC Memo 2010-261
This case addresses an important issue that I run into from time to time. How do you distinguish between investing in real estate or acquiring for use in a trade or business as opposed to being in the business of buying and selling real estate ? If you are a pure investor your gain on sale will be capital gain, your loss will be capital loss and your expenses will be itemized deductions subject to a variety of limitations depending on which ones we are talking about. If you are holding the property as a rental your gain will be a capital gain (with gain attributable to accumulated depreciation subject to a special rate) and your deductions will go against adjusted gross income. If you have a net loss, it may be suspended by the passive activity loss rules. Loss on the sale of a rental property is ordinary. If you are in the business of buying and selling real estate all income and loss is ordinary and subject to self employment tax.
There is, of course, more to it than that. Investors and rental property holders can do tax deferred like-kind exchanges. Someone in the business of buying and selling can shelter some their income with a Keogh or SEP or something like that. Not that they ever will. Real estate flippers will only stop when they die or own all the real estate in the world (I used to include bankruptcy as another end point, but that is really just a brief interruption). I am also leaving out owning the real estate involved in a business that you operate. Frequently that ends up being a rental situation, although there are some special rules.
Wendell and Sharon Garrison filed returns that fell somewhere between investor and rental operation. They didn't claim any operating expenses, but reported sales of property on Form 4797, which is the form for reporting sale of assets used in a trade or business (which for this purpose includes rental). They claimed capital gain treatment. Since most of the sales were short term I wonder what difference this made. It can make a big difference to someone who has capital loss carryovers, but based on the rest of the facts that didn't seem that likely. More significantly they did not pay self-employment tax on their earnings.
It seems like Mr. Garrison, more or less, shot himself in the foot:
Petitioner husband testified: “I'm in the business of buying material, fixing houses and reselling them.”
Still the court got into the factors to consider.
Typically, the factors in making this determination include:
(1) The taxpayer's purpose in acquiring the property;
(2) the purpose for which the property was subsequently held;
(3) the taxpayer's everyday business and the relationship of the income from the property to the total income;
(4) the frequency, continuity, and substantiality of sales of property;
(5) the extent of developing and improving the property to increase the sales revenue;
(6) the extent to which the taxpayer used advertising, promotion, or other activities to increase sales;
(7) the use of a business office for the sale of property;
(8) the character and degree of supervision or control the taxpayer exercised over any representative selling the property;
(9) the time and effort the taxpayer habitually devoted to the sales.
Petitioners engaged in at least 15 sales over 3 years, and most of the sales occurred within 4 months after they purchased the property.
That pretty much summed it up. The case also got into substantiation of expenses. They had nothing so the additional expenses they claimed were not allowed. The Cohan Rule was not even mentioned.
My own rough guideline in this area is that when you do your third renovation sale your in the business of buying and selling property, particularly if the first two did not have any rental activity. If you are doing this to scale it is worth consulting the Phelan decision (Timothy J. Phelan, et ux. v. Commissioner, TC Memo 2004-206). By isolating different activities in different entities it is possible to get capital gains treatment on some of the economic return from a development even though related entities might be doing ordinary income type activities. In order for this type of thing to work though it is critical that the entities be treated with respect. As with family limited partnerships, the devil is in the details.
Sunday, May 18, 2014
Nothing From Nothing Is Nothing
Originally published on Passive Activities and Other Oxymorons on December 6, 2010.
CCA 201047021
This one is of somewhat limited interest and difficult to bring to any length so I'm making it a bonus post. When someone dies their tax carryovers, capital loss carryovers for examples, die with them. If there are assets, a new taxpayer is "born", the decedent's estate. Estates are something of a hybrid between individuals and partnerships. If they retain income the estate pays tax on a compressed version of the individual tax table (same rates, smaller brackets). If income is distributed it is taxed to the beneficiaries. Net capital losses, however, are carried forward. Ultimately estates terminate. When they do carryovers are flowed through to the beneficiaries.
What happens if an estate goes bankrupt and never distributes anything to anybody ? In this particular case the decedent had substantial unpaid income tax liabilities. A settlement was entered into whereby all assets of the estate after administrative expenses went to the United States. The IRS position outlined in CCA 201047021 is that since the United States was the one suffering from the losses in this case, the empty handed beneficiaries don't even get a flow through of the capital losses on the estate's termination.
Section §1.642(h)-3(a) states carryovers and excess deductions pass only to “beneficiaries succeeding to the property of the estate or trust” who are “those beneficiaries upon termination of the estate or trust who bear the burden of any loss for which a carryover is allowed....” In the present case, the individual beneficiaries of the Estate should no longer be considered beneficiaries after the Estate entered into the Settlement Agreement to transfer all the proceeds of the Estate to the United States. This is a distinguishable situation from that set forth in the allocation example. Beneficiaries in that example received a loss carryover despite not receiving any property, but could have received property if the estate had sufficient funds. Here, as a legal matter, the individual beneficiaries could no longer receive anything. Any losses incurred by the Estate were to the detriment of the United States rather than the individual beneficiaries. Therefore, the Estate's beneficiaries should not be entitled to any of the Estate's unused loss carryovers under § 642(h)(1).
It will be interesting to see whether there will be more to read about this in the future. A CCA is not authority, so if the dollars are big enough the beneficiaries may contest it.
CCA 201047021
This one is of somewhat limited interest and difficult to bring to any length so I'm making it a bonus post. When someone dies their tax carryovers, capital loss carryovers for examples, die with them. If there are assets, a new taxpayer is "born", the decedent's estate. Estates are something of a hybrid between individuals and partnerships. If they retain income the estate pays tax on a compressed version of the individual tax table (same rates, smaller brackets). If income is distributed it is taxed to the beneficiaries. Net capital losses, however, are carried forward. Ultimately estates terminate. When they do carryovers are flowed through to the beneficiaries.
What happens if an estate goes bankrupt and never distributes anything to anybody ? In this particular case the decedent had substantial unpaid income tax liabilities. A settlement was entered into whereby all assets of the estate after administrative expenses went to the United States. The IRS position outlined in CCA 201047021 is that since the United States was the one suffering from the losses in this case, the empty handed beneficiaries don't even get a flow through of the capital losses on the estate's termination.
Section §1.642(h)-3(a) states carryovers and excess deductions pass only to “beneficiaries succeeding to the property of the estate or trust” who are “those beneficiaries upon termination of the estate or trust who bear the burden of any loss for which a carryover is allowed....” In the present case, the individual beneficiaries of the Estate should no longer be considered beneficiaries after the Estate entered into the Settlement Agreement to transfer all the proceeds of the Estate to the United States. This is a distinguishable situation from that set forth in the allocation example. Beneficiaries in that example received a loss carryover despite not receiving any property, but could have received property if the estate had sufficient funds. Here, as a legal matter, the individual beneficiaries could no longer receive anything. Any losses incurred by the Estate were to the detriment of the United States rather than the individual beneficiaries. Therefore, the Estate's beneficiaries should not be entitled to any of the Estate's unused loss carryovers under § 642(h)(1).
It will be interesting to see whether there will be more to read about this in the future. A CCA is not authority, so if the dollars are big enough the beneficiaries may contest it.
Saturday, May 17, 2014
More On Lien Releases
Originally published on Passive Activities and Other Oxymorons on December 4, 2010.
IRSIG SBSE-05-1010-054
My Monday post on PMTA 2010-058 seems to have been my first scoop. It concerns the IRS position on aspects of releasing liens to facilitate short sales. The idea is that a lien on a property with a first mortgage far in excess of value is worthless and should be released. The IRS was taking the position, though, that they were superior to carve-outs for transfer taxes. This creates a Catch-22 that would prevent the short sale unless the taxpayer/owner could come up with the transfer taxes. The statement (PMTA stands for Program Manager Technical Assistance) retreats from that position and recognizes that the transfer taxes are really coming out of the first lienholder. It also mentioned homeowners associations dues as something that the first lienholder might decide to allow to be cleared.
All week long nobody else seems to have picked up on this. I found an attorney in Florida who has a blog dedicated to short sales, who wrote me that he had been in "shouting matches" on this very issue. He wrote a post on it, crediting me with the discovery. I also found that there is a lot of misinformation out there on this issue with many in the blogosphere believing that the IRS has a super priority that can never be released. Really astounding when you consider how reliable random websites and blogs are on most other issues. (My son tells me that irony doesn't come across well in text. What do you think ?)
I also found that subsequent to the PMTA there is another IRS document which I am reproducing in full since it is pretty crisp:
IRSIG SBSE-05-1010-054
Certificates of Discharge in Short Sale Situations
October 4, 2010
Control Number: SBSE-05-1010-054
Expiration Date: October 5, 2011
Impacted : IRM 5.12.3
MEMORANDUM FOR DIRECTORS, COLLECTION AREA OPERATIONS DIRECTOR, ADVISORY, INSOLVENCY, AND QUALITY
FROM:
Frederick W. Schindler /s/ Frederick W. Schindler Director,
Collection Policy
SUBJECT:
Certificates of Discharge in Short Sale Situations
The purpose of this memorandum is to issue interim guidance for processing and approving requests for certificates of discharge in short sale situations. The impacted section of IRM 5.12.3 , Certificates Relating to Liens, will be revised to include the information in this memorandum. Please ensure that this information is distributed to all affected employees in your organization.
The authority of the Internal Revenue Service (IRS) to issue a certificate of discharge of property subject to the federal tax lien is found in Internal Revenue Code (IRC) section 6325(b). Among other conditions, the IRS may issue a certificate of discharge when the interest of the United States in the such property is determined to have no value ( section 6325(b)(2)(B)).
A short sale occurs when the senior lien holder agrees to accept less than the total amount owed as satisfaction for its lien claim. For example, a bank has a priority mortgage claim for $600,000, but, due to the significant decline in the real property market, the bank agrees to a sale of the mortgaged property for $300,000. Because the senior lien attaches to all the equity in the property, generally the lien interest of the United States in short sale properties is valueless. Therefore, applications for discharge for properties subject to short sales should be considered under IRC 6325(b)(2)(B).
To facilitate the sale of the property in these situations, the senior lien holder might negotiate the payment of expenses to be taken from its settlement amount. In certain situations, these expenses might be greater than normal closing costs allowed by the IRS and might include creditors that would otherwise be junior to Certificates of Discharge in Short Sales the IRS. This action by the senior lien holder to carve proceeds out of its priority claim to pay these expenses does not create an equity interest on the part of the taxpayer which may be reached by the IRS lien. Provided there is no fraudulent aspect to the payment distribution and the lien interests of the IRS in other properties of the taxpayer is not being harmed, the IRS has no authority to require payment of the sum that otherwise would have gone to the senior lien holder.
Following the previous example, the bank determines that out of the $300,000 sales price, it will allow $15,000 of expenses to be paid. Most of the $15,000 is for normal closing costs, but $5,000 of it is for a homeowner's association fee, which is junior in priority to the IRS, and $2,000 is for state transfer taxes. Because the payments made for the homeowner's association fee and the state transfer taxes are made from proceeds attributable to the bank's priority lien interest and the interest of the IRS in the property to be discharged is valueless, the IRS cannot condition discharge upon payment of any part of the amount going to these expenses.
Therefore, upon receiving an application for discharge of a property subject to a short sale, follow standard procedures outlined in IRM 5.12.3 to investigate the statements made in the application regarding the transfer, encumbrances on the property, property values, and proposed distribution of the proceeds. Additional documentation to complete the investigation may be requested if the information has not otherwise been provided. Presuming no issues are identified, the discharge application can be approved following existing IRM procedures.
In normal (non-short) sale situations, where the lien claim of the bank is fully paid and the federal tax lien attaches to surplus proceeds, the IRS's lien interest must be satisfied in accordance with IRC 6325(b) before the property can be discharged from the lien. Creditors junior to the IRS interest are not entitled to payment from the proceeds before the IRS lien interest is fully paid.
If you have any questions, please contact me, or a member of your staff may contact Kyle Romick, Senior Program Analyst.
I have to admit that I don't know what IRSIG stands for. SBSE is small business self employment. This would be more embarrassing except for the fact that IRS employees testifying in Tax Court on internal documents that have been put in evidence sometimes can't explain what their codes mean.
IRSIG SBSE-05-1010-054
My Monday post on PMTA 2010-058 seems to have been my first scoop. It concerns the IRS position on aspects of releasing liens to facilitate short sales. The idea is that a lien on a property with a first mortgage far in excess of value is worthless and should be released. The IRS was taking the position, though, that they were superior to carve-outs for transfer taxes. This creates a Catch-22 that would prevent the short sale unless the taxpayer/owner could come up with the transfer taxes. The statement (PMTA stands for Program Manager Technical Assistance) retreats from that position and recognizes that the transfer taxes are really coming out of the first lienholder. It also mentioned homeowners associations dues as something that the first lienholder might decide to allow to be cleared.
All week long nobody else seems to have picked up on this. I found an attorney in Florida who has a blog dedicated to short sales, who wrote me that he had been in "shouting matches" on this very issue. He wrote a post on it, crediting me with the discovery. I also found that there is a lot of misinformation out there on this issue with many in the blogosphere believing that the IRS has a super priority that can never be released. Really astounding when you consider how reliable random websites and blogs are on most other issues. (My son tells me that irony doesn't come across well in text. What do you think ?)
I also found that subsequent to the PMTA there is another IRS document which I am reproducing in full since it is pretty crisp:
IRSIG SBSE-05-1010-054
Certificates of Discharge in Short Sale Situations
October 4, 2010
Control Number: SBSE-05-1010-054
Expiration Date: October 5, 2011
Impacted : IRM 5.12.3
MEMORANDUM FOR DIRECTORS, COLLECTION AREA OPERATIONS DIRECTOR, ADVISORY, INSOLVENCY, AND QUALITY
FROM:
Frederick W. Schindler /s/ Frederick W. Schindler Director,
Collection Policy
SUBJECT:
Certificates of Discharge in Short Sale Situations
The purpose of this memorandum is to issue interim guidance for processing and approving requests for certificates of discharge in short sale situations. The impacted section of IRM 5.12.3 , Certificates Relating to Liens, will be revised to include the information in this memorandum. Please ensure that this information is distributed to all affected employees in your organization.
The authority of the Internal Revenue Service (IRS) to issue a certificate of discharge of property subject to the federal tax lien is found in Internal Revenue Code (IRC) section 6325(b). Among other conditions, the IRS may issue a certificate of discharge when the interest of the United States in the such property is determined to have no value ( section 6325(b)(2)(B)).
A short sale occurs when the senior lien holder agrees to accept less than the total amount owed as satisfaction for its lien claim. For example, a bank has a priority mortgage claim for $600,000, but, due to the significant decline in the real property market, the bank agrees to a sale of the mortgaged property for $300,000. Because the senior lien attaches to all the equity in the property, generally the lien interest of the United States in short sale properties is valueless. Therefore, applications for discharge for properties subject to short sales should be considered under IRC 6325(b)(2)(B).
To facilitate the sale of the property in these situations, the senior lien holder might negotiate the payment of expenses to be taken from its settlement amount. In certain situations, these expenses might be greater than normal closing costs allowed by the IRS and might include creditors that would otherwise be junior to Certificates of Discharge in Short Sales the IRS. This action by the senior lien holder to carve proceeds out of its priority claim to pay these expenses does not create an equity interest on the part of the taxpayer which may be reached by the IRS lien. Provided there is no fraudulent aspect to the payment distribution and the lien interests of the IRS in other properties of the taxpayer is not being harmed, the IRS has no authority to require payment of the sum that otherwise would have gone to the senior lien holder.
Following the previous example, the bank determines that out of the $300,000 sales price, it will allow $15,000 of expenses to be paid. Most of the $15,000 is for normal closing costs, but $5,000 of it is for a homeowner's association fee, which is junior in priority to the IRS, and $2,000 is for state transfer taxes. Because the payments made for the homeowner's association fee and the state transfer taxes are made from proceeds attributable to the bank's priority lien interest and the interest of the IRS in the property to be discharged is valueless, the IRS cannot condition discharge upon payment of any part of the amount going to these expenses.
Therefore, upon receiving an application for discharge of a property subject to a short sale, follow standard procedures outlined in IRM 5.12.3 to investigate the statements made in the application regarding the transfer, encumbrances on the property, property values, and proposed distribution of the proceeds. Additional documentation to complete the investigation may be requested if the information has not otherwise been provided. Presuming no issues are identified, the discharge application can be approved following existing IRM procedures.
In normal (non-short) sale situations, where the lien claim of the bank is fully paid and the federal tax lien attaches to surplus proceeds, the IRS's lien interest must be satisfied in accordance with IRC 6325(b) before the property can be discharged from the lien. Creditors junior to the IRS interest are not entitled to payment from the proceeds before the IRS lien interest is fully paid.
If you have any questions, please contact me, or a member of your staff may contact Kyle Romick, Senior Program Analyst.
I have to admit that I don't know what IRSIG stands for. SBSE is small business self employment. This would be more embarrassing except for the fact that IRS employees testifying in Tax Court on internal documents that have been put in evidence sometimes can't explain what their codes mean.
Thursday, May 15, 2014
Phelan Decision Showed How To Get Capital Gains Treatment While Engaging In Development Acitvity
I wrote this quite a few years ago, but a recent case Boree v Com TC Memo 2014-85 has brought the issue of dealer versus investor to the fore. There will be piece on Boree on my forbes blog passive activities soon and this provides a supplement. If you want capital gains treatment for a land sale, Boree is more or less a what not to do case. Phelan, on the other hand shows how to make it happen.
I remember a time long ago when among young people, myself being one of them, when there would be discussion on “how far” one could go and still technically remain a virgin. Imagining the various gradations could be quite stimulating. Contemplating Phelan v. Commissioner, TC Memo 204-206 might bring similar feelings to those, myself among them, who struggle with the question of when an investor in real estate is no longer an investor. Why is the question important?
The most obvious reason and the one that was the concern in the Phelan case is the favorable rate for capital gains. The investor gets the favorable rate and loses it if he crosses over into being a developer or dealer. Even more significant the investor can avoid gain recognition by structuring the sale of one property and the purchase of another as a like-kind exchange under Code section 1031. If there are losses, it might be more favorable to be a developer or dealer, who will get ordinary loss treatment. Even in this area, the investor can come out better in some circumstances. Deductions may be allowed that would otherwise be suspended under the passive activity loss rules. In general, however, dealer developer status will be more favorable in loss situations. Nobody goes in expecting to lose, though, so planning will be to gain favorable treatment for sale.
If you buy land and don’t do anything but pay taxes and liability insurance, when a prospective buyer happens to notice the land (without any help from you), the resulting sale will be a capital gain. If, on the other hand, your sole source of livelihood is buying land, improving it and subdividing in order to sell as quickly as possible, the resulting sales will be ordinary income. There is a lot of room between the two extremes. The IRS and the taxpayer often differ as to whether the imaginary line has been crossed. Such was the Phelan case.
The Phelan brothers were involved in both real estate development and construction. Along with their partner they formed a single purpose entity (Jackson Creek Land Corporation-JCLC) to own the particular tract of land in question (which they designated Jackson Creek). JCLC was considered a partnership for income tax purposes. The court found the formation and operation of this single purpose entity very significant. It also noted that the Phelan’s real estate business conducted thorough other entities concerned commercial real estate rather than residential real estate projects, such as Jackson Creek.
The transactions involved in the Jackson Creek project were rather complex. The property was part of a larger tract that had been acquired by a developer (the Regency Group) in the 1980’s. In 1987 the developer entered into an agreement with Triview. Triview was a political subdivision of the state of Colorado, with the authority to levy taxes, issue bonds and assess fees. Regency, Triview and the adjacent town of Monument entered into an agreement obligating each of them to make infrastructure improvements and in the case of Regency pay fees. Monument annexed the land of the project to become part of the town, but the various agreements stayed in force. Shortly, thereafter Regency filed for bankruptcy.
Phelan acquired the property from J&L Higby trust which had acquired it form Regency. Shortly after acquiring the property in 1994, Phelan deeded the land to JCLC. The transfers were all subject to the various infrastructure agreements.
JCLC performed a Preliminary Geological Investigation on the land and finalized a development plan with Monument that allowed for the commencement of construction.
JCLC first capital gain transaction was in 1998 when it agreed to sell 102 acres (a bit les than 10% of the acreage) to Elite properties in three separate closings. JCLC agreed to cause Triview to make certain improvements and to make others itself. All the work ended up being done by Triview, including the portion that JCLC was supposed to do itself.
The next capital gain transaction was with Vision Development Corporation, an entity owned by the same people who owned JCLC in the same proportion. Vision was formed to do development work on 46.5 acres in order to prepare it for sale to a home builder. The plot now thickens. Triview it develops is in default on its bonds. Through a series of transactions involving other entities controlled by the Phelans, the bonds were refinanced and additional bonds were purchased. Presumably this is what allowed Triview to complete the infrastructure improvements it was obligated to perform...There was, however, no direct link between the two events.
Finally Vision and JCLC entered into a revolving loan agreement which would allow Vision to make improvements on a 184 acre parcel for sale to homebuilders.
The attached time line might help to clarify the transaction history.
Looking at it through the jaundiced eye of a revenue agent, it would appear that three people got together, bought some land cut it into pieces and directly or indirectly made substantial improvements. The court, however, ruled that the sales by JCLC produced capital gains.
The factors that the court considered in arriving at its opinion
- JCLC was formed with the investors knowing that the various pieces to allow its ultimate development were basically in place and expected the property to appreciate.
- The offer from Elite was unsolicited
- None of the owners of JCLC held broker’s licenses
- JCLC did not advertise or hire representatives.
- Although JCLC promised Elite that Triview would do certain things, this only gave Elite recourse against JCLC.
- JCLC had no employees. Although it was obligated to make improvements if Triview did not.
- The risks and rewards associated with the purchase of bonds by related parties were not directly tied to the Jackson Creek project.
- With respect to the sale to Vision, even though JCLC owners were not personally liable, they protected their interest in the balance of the land by carving off the portion going to Vision. This was a valid non-tax motivation for the transaction.
- The four year holding period and limited number of sales.
The court did not consider the geological survey, gaining approval for the final development plan and the limited subdivision sufficient to create a trade or business.
In considering the implications of this decision, there are two things to keep in mind. One is that the tax court emphasized that it was using principles from the tenth circuit. The other is that the involvement of the various entities with a quasi-governmental is an unusual circumstance. Nonetheless, it appears that you can go pretty far and still remain an investor.
Note
It can be pretty challenging to follow the decision. You might find this timeline helpful or not.
Note
It can be pretty challenging to follow the decision. You might find this timeline helpful or not.
Phelan Time-Line
July 27,1993- Centre Development Corporation formed to purchase a shopping center. Owned by Phelan, his brother and third party name Oldach,40/40/20.
1994 – Real estate agent inform Phelan of 1050 acres in Regency Park soon to be listed
1994 – Phelan, his brother and one other person Oldach) form Jackson Creek Land Company (a Colorado Limited Liability Corporation). Phelan and his brother each own 40%, Oldach owns 20%. Sole JCLC was to acquire Regency Park. None of the three owners held real estate licenses.
October 31, 1994 – Phelan buys 1050 acres for 2.9 Million Sale was subject to several infrastructure agreements with governmental agencies. (Triview Metropolitan District
December 7, 1994 – Phelan quitclaims property to JCLC for 2.9 million. Property is renamed Jackson Creek.
1996 (???)- Elite express no interest in developing 46.5 acres for sale to Keller Homes.
1996- Phelan brothers and Oldach form Vision Development Corp. Same 40/40/20 split
1996 – Preliminary Geological Survey
1996- Triview in default on bond 4.8 Million principal and 3.0 million interest.(bonds issued in 1987)
1996- Center Development (owned by JCLC owners) purchase defaulted bonds from Mass Development and Kemper. Uses margin loan and 1.5 Million borrowed from utility companies
1997 – Elite properties approaches JCLC to acquire part of the property
August 18, 1997 – P&S between JCLC and Elite properties
September 22, 1997 -, Centre and JCLC borrowed the 1.5 Millon from Colorado National Bank (CNB) to refinance loan from utilities. Guaranteed personally, by brothers and Colorado Structures (see below 1998) and mortgage of JCLC property, JCLC named as a borrower but receives none of the proceeds.
1998 – Utility companies purchase 1.5 million of new Triview bonds
1998- Colorado Structures purchases new Triview bonds from utilities
August 18, 1997 – P&S with Elite
January 5, 1998 – JCLC sells 46.5 acres to VDC for 1.6 million Partnership return reflects LTCG of 50k. Purpose of VDC was to develop 46.5 acres for sale to Keller Homes.
1998- Colorado Structures, which is owned 49% by Phelan brothers 51% by ESOP does 117Million of construction business. None of it is residential
March 19, 1998 – Revised P&S. Elite to purchase 102 acres in three separate closings. JCLC required to cause Triview to make some infrastructure improvements and JCLC to do others at its own expense. (Ultimately they were all done by Triview)
June 15th 1998 – First closing $792,880 – reported on partnership return as LTCG
1999- Colorado Structures purchases new Triview bonds
1999 – Second closing with Elite
2000- Third closing with Elite
Sunday, December 4, 2011
IRS To Stop Lousing Up Short Sales
PMTA 2010-058
This was originally published on PAOO on November 29th, 2010.
For the latest on this see my follow-up post
When I was a kid, my father worked on Wall Street. He was a Senior Order Clerk. I'm not sure whether his job still exists. It was not particularly lucrative, but I got these insights into high finance through the jokes that he used to tell me. Most of them I didn't "get" until I was in my thirties. One of my favorites is the little ditty "He who sells what isn't hissen, buys it back or goes to prison." That was about short sales as the term relates to securities.
The term means something else in real estate. If a property has a fair market value lesser than the mortgage, the secured party might let the property be sold for an amount lesser than the mortgage. This avoids the need for foreclosure. The owner may or may not remain liable for the balance, the discharge of which may or may not be a taxable event. Such is not the topic of this post.
When I was buying a condo, I found that buying property on a short sale tended to be fraught with delay. You would think that the pressure to sell would create pressure to move things along, but the pressure is not sufficient to overcome bureaucratic inertia. Not surprisingly people who have trouble paying their mortgages frequently have trouble paying their taxes. So it is not unusual for a property with an upside down mortgage to have IRS liens against it. In order for the property to transfer the IRS must release its lien.
Typically the first mortgage will have been in place before the IRS filed its liens. So the value of the lien is the lesser of the tax obligation or the taxpayers equity in the property. In the case of a short sale the latter amount is 0. So the IRS should release its worthless lien and let life go on. That is not what has happened though. Even though the IRS is behind the first mortgage, they are, or at least, believe they are ahead of everybody else :
Applications for Discharge Which Include Requests for Payment of Real Estate Transfer Tax....In cases where a filed notice of federal tax lien has perfected the interest of the United States in such property, the Service is asked to issue a certificate of discharge of federal tax lien to allow payment of the state's claim at closing. It is the Service's position that such taxes have no priority status under I.R.C. §6323(b)(6) against the filed notice of federal tax lien. ... Priority of the federal tax lien is defined exclusively in I.R.C. §6323. Under no circumstances will a discharge of federal tax lien be issued for less than the full value of the Service's claim on the equity in the subject property. The transfer tax will not be accorded priority status or treated as an expense of sale. Applications that include such provisions will be rejected.
Under this interpretation, the taxpayer/property owner has to come up with the transfer taxes in order to move the transaction on.
PMTA 2010-058 finds the above interpretation to be erroneous:
We disagree with the conclusion that the designation by the senior lienholder of some of its proceeds to be used to pay real estate transfer taxes in connection with short sales of real property somehow creates an equity interest in the property on the part of the taxpayer. Rather, these are expenses that the senior lienholder agrees to carve out of its priority lien claim as a matter of business prudence in order to facilitate the sale. Because this does not create an equity interest on behalf of the taxpayer that is subject to the federal tax lien, the authority of the Service to issue a certificate of discharge is under section 6325(b)(2)(B), where the interest in the United States is valueless. The Service has no authority under section 6325(b)(2)(B) to require payment of the sum that otherwise would be applied to junior real estate transfer taxes as a condition of discharge. Because the interest of the United States is valueless, the result would be the same even if the senior lienholder was choosing to use a portion of its mortgage proceeds to pay a junior creditor of the taxpayer (such as payment of homeowner's association fees).
Essentially they are saying that the carve-out for transfer taxes is coming out of the banks secured interest and does not create some sort of equity that makes the IRS lien worth something. This document a letter to the director of collection policy (PMTA stands for Program Manager Technical Assistance) was dated September 17, 2010, but only recently came up on RIA. I haven't seen anything else on this so I am making this a bonus post in the interest of timeliness. If you are involved in a short sale that is hanging because of the IRS, it might be a useful reference.
The letter was sent to the Director of Collection Policy for Small Business/ Self Employed. It was copied to Special Counsel of the National Taxpayer Advocate Program, Assistant Division Counsel (SBSE) and Associate Area Counsels for Ft. Lauderdale and Jacksonville. So this may be a problem that is peculiar to Florida although the principle is of general interest.
P.S.
In the comments below you will see feedback from Richard Zaretsky, an attorney specializing in short sales and related matters. He indicated to me that he has had shouting matches with the IRS on this issue. He has a blog dedicated to short sales. I've seen some misinformation on websites that would lead you to believe that an IRS lien will kill the possibility of a short sale. The relevant section of the Code is 6325(b)(2)(B) which indicates a lien with no value can be released and that in determining the lien's value other liens with priority will be taken into account.
This was originally published on PAOO on November 29th, 2010.
For the latest on this see my follow-up post
When I was a kid, my father worked on Wall Street. He was a Senior Order Clerk. I'm not sure whether his job still exists. It was not particularly lucrative, but I got these insights into high finance through the jokes that he used to tell me. Most of them I didn't "get" until I was in my thirties. One of my favorites is the little ditty "He who sells what isn't hissen, buys it back or goes to prison." That was about short sales as the term relates to securities.
The term means something else in real estate. If a property has a fair market value lesser than the mortgage, the secured party might let the property be sold for an amount lesser than the mortgage. This avoids the need for foreclosure. The owner may or may not remain liable for the balance, the discharge of which may or may not be a taxable event. Such is not the topic of this post.
When I was buying a condo, I found that buying property on a short sale tended to be fraught with delay. You would think that the pressure to sell would create pressure to move things along, but the pressure is not sufficient to overcome bureaucratic inertia. Not surprisingly people who have trouble paying their mortgages frequently have trouble paying their taxes. So it is not unusual for a property with an upside down mortgage to have IRS liens against it. In order for the property to transfer the IRS must release its lien.
Typically the first mortgage will have been in place before the IRS filed its liens. So the value of the lien is the lesser of the tax obligation or the taxpayers equity in the property. In the case of a short sale the latter amount is 0. So the IRS should release its worthless lien and let life go on. That is not what has happened though. Even though the IRS is behind the first mortgage, they are, or at least, believe they are ahead of everybody else :
Applications for Discharge Which Include Requests for Payment of Real Estate Transfer Tax....In cases where a filed notice of federal tax lien has perfected the interest of the United States in such property, the Service is asked to issue a certificate of discharge of federal tax lien to allow payment of the state's claim at closing. It is the Service's position that such taxes have no priority status under I.R.C. §6323(b)(6) against the filed notice of federal tax lien. ... Priority of the federal tax lien is defined exclusively in I.R.C. §6323. Under no circumstances will a discharge of federal tax lien be issued for less than the full value of the Service's claim on the equity in the subject property. The transfer tax will not be accorded priority status or treated as an expense of sale. Applications that include such provisions will be rejected.
Under this interpretation, the taxpayer/property owner has to come up with the transfer taxes in order to move the transaction on.
PMTA 2010-058 finds the above interpretation to be erroneous:
We disagree with the conclusion that the designation by the senior lienholder of some of its proceeds to be used to pay real estate transfer taxes in connection with short sales of real property somehow creates an equity interest in the property on the part of the taxpayer. Rather, these are expenses that the senior lienholder agrees to carve out of its priority lien claim as a matter of business prudence in order to facilitate the sale. Because this does not create an equity interest on behalf of the taxpayer that is subject to the federal tax lien, the authority of the Service to issue a certificate of discharge is under section 6325(b)(2)(B), where the interest in the United States is valueless. The Service has no authority under section 6325(b)(2)(B) to require payment of the sum that otherwise would be applied to junior real estate transfer taxes as a condition of discharge. Because the interest of the United States is valueless, the result would be the same even if the senior lienholder was choosing to use a portion of its mortgage proceeds to pay a junior creditor of the taxpayer (such as payment of homeowner's association fees).
Essentially they are saying that the carve-out for transfer taxes is coming out of the banks secured interest and does not create some sort of equity that makes the IRS lien worth something. This document a letter to the director of collection policy (PMTA stands for Program Manager Technical Assistance) was dated September 17, 2010, but only recently came up on RIA. I haven't seen anything else on this so I am making this a bonus post in the interest of timeliness. If you are involved in a short sale that is hanging because of the IRS, it might be a useful reference.
The letter was sent to the Director of Collection Policy for Small Business/ Self Employed. It was copied to Special Counsel of the National Taxpayer Advocate Program, Assistant Division Counsel (SBSE) and Associate Area Counsels for Ft. Lauderdale and Jacksonville. So this may be a problem that is peculiar to Florida although the principle is of general interest.
P.S.
In the comments below you will see feedback from Richard Zaretsky, an attorney specializing in short sales and related matters. He indicated to me that he has had shouting matches with the IRS on this issue. He has a blog dedicated to short sales. I've seen some misinformation on websites that would lead you to believe that an IRS lien will kill the possibility of a short sale. The relevant section of the Code is 6325(b)(2)(B) which indicates a lien with no value can be released and that in determining the lien's value other liens with priority will be taken into account.
Friday, November 25, 2011
What's It Worth To Say Your Wine is From Long Island ?
CCA 201040004
This was originally published on October 29th, 2010.
One of the greatest sources of tax controversy is whether something is depreciable (in the case of intangible assets we say amortizable.) Land is one of the primary examples of non-depreciable property. So if someone comes up with a way to write off even some of the cost of land it is worth paying attention to. Land is by it's nature non-fungible, but frankly some land is more non-fungible than other land. At the most extreme end of this non-fungibility is land that you grow grapes on to make wine.
It so happens that my favorite beverage is Mountain Dew. The various chemicals that go into making it can come from just about anywhere and they probably do. It doesn't work that way with wine. There is something called the Napa Declaration on Place. It is a bunch of "Whereas's" like :
Whereas, it is generally acknowledged that there are a handful of truly extraordinary places on earth from which great wine is consistently produced.
finishing up with :
Therefore, be it resolved that we, as some of the world’s leading wine regions, join together in supporting efforts to maintain and protect the integrity of these place names, which are fundamental tools for consumer identification of great winegrowing regions and the wines they produce.
I was kind of vaguely aware of this, but I always thought it had to do with that weird country where they eat snails and think Jerry Lewis was a good actor. It turns out that the same thing goes on in the United States.. A geographic region can be designated an American viticultural area (AVA), by the Alcohol and Tobacco Tax and Trade Bureau (“TTB”) of the United States Department of the Treasury. Once that happens you can't put that place name on the wine bottle label unless 85% of the grapes come from that region.
The Chief Counsel has determined that the designation is a "license, permit, or other right granted by governmental unit and isn't interest in land". This makes it an intangible asset covered by Section 197, which means it can be amortized over 15 years. This is a taxpayer friendly ruling, so I am inclined to like it, but it is really a little challenging to wrap my head around. You buy some land in Napa Valley or Mendocino or, I kid you not, Long Island (Check the list)on which grapes grow and you get to allocate some of the cost to the right to stamp Long Island on the label and write that portion off over 15 years.
The Chief Counsel noted a problem with the ruling:
We have concerns about how a taxpayer would value the right to use an AVA designation. It is unclear whether the value of the right to use an AVA designation attaches to an acquisition of a particular vineyard within an AVA. The benefit in value from the right to use an AVA designation accrues to all land whose highest and best use is as a vineyard within such designated viticultural area. Consequently, all of the closest comparable vineyards share the same intangible benefit thereby making an appraiser's determination of the increment of value assigned to the intangible benefit and finding comparable vineyards outside of the particular AVA factually difficult.
My study of labels is limited to making sure that I don't make the mistake of buying Diet Mountain Dew, a wretched tasting concoction often hazardously located adjacent to the good stuff. I would hazard a guess though that stamping Southeastern New England on your wine bottles is not going to make them fly off the shelves and that there are probably very few AVA designations that have any value.
Nonetheless the concept is very interesting. There have been discussions about whether the names of landmark buildings might be separate intangible assets. Do the owners of the Empire State Building get royalties on all the little chachkies that are shaped like their building ? That would seem to have the makings of a 197 intangible.
This was originally published on October 29th, 2010.
One of the greatest sources of tax controversy is whether something is depreciable (in the case of intangible assets we say amortizable.) Land is one of the primary examples of non-depreciable property. So if someone comes up with a way to write off even some of the cost of land it is worth paying attention to. Land is by it's nature non-fungible, but frankly some land is more non-fungible than other land. At the most extreme end of this non-fungibility is land that you grow grapes on to make wine.
It so happens that my favorite beverage is Mountain Dew. The various chemicals that go into making it can come from just about anywhere and they probably do. It doesn't work that way with wine. There is something called the Napa Declaration on Place. It is a bunch of "Whereas's" like :
Whereas, it is generally acknowledged that there are a handful of truly extraordinary places on earth from which great wine is consistently produced.
finishing up with :
Therefore, be it resolved that we, as some of the world’s leading wine regions, join together in supporting efforts to maintain and protect the integrity of these place names, which are fundamental tools for consumer identification of great winegrowing regions and the wines they produce.
I was kind of vaguely aware of this, but I always thought it had to do with that weird country where they eat snails and think Jerry Lewis was a good actor. It turns out that the same thing goes on in the United States.. A geographic region can be designated an American viticultural area (AVA), by the Alcohol and Tobacco Tax and Trade Bureau (“TTB”) of the United States Department of the Treasury. Once that happens you can't put that place name on the wine bottle label unless 85% of the grapes come from that region.
The Chief Counsel has determined that the designation is a "license, permit, or other right granted by governmental unit and isn't interest in land". This makes it an intangible asset covered by Section 197, which means it can be amortized over 15 years. This is a taxpayer friendly ruling, so I am inclined to like it, but it is really a little challenging to wrap my head around. You buy some land in Napa Valley or Mendocino or, I kid you not, Long Island (Check the list)on which grapes grow and you get to allocate some of the cost to the right to stamp Long Island on the label and write that portion off over 15 years.
The Chief Counsel noted a problem with the ruling:
We have concerns about how a taxpayer would value the right to use an AVA designation. It is unclear whether the value of the right to use an AVA designation attaches to an acquisition of a particular vineyard within an AVA. The benefit in value from the right to use an AVA designation accrues to all land whose highest and best use is as a vineyard within such designated viticultural area. Consequently, all of the closest comparable vineyards share the same intangible benefit thereby making an appraiser's determination of the increment of value assigned to the intangible benefit and finding comparable vineyards outside of the particular AVA factually difficult.
My study of labels is limited to making sure that I don't make the mistake of buying Diet Mountain Dew, a wretched tasting concoction often hazardously located adjacent to the good stuff. I would hazard a guess though that stamping Southeastern New England on your wine bottles is not going to make them fly off the shelves and that there are probably very few AVA designations that have any value.
Nonetheless the concept is very interesting. There have been discussions about whether the names of landmark buildings might be separate intangible assets. Do the owners of the Empire State Building get royalties on all the little chachkies that are shaped like their building ? That would seem to have the makings of a 197 intangible.
They Also Serve
James F. Moss, et ux. v. Commissioner, 135 T.C. No. 18, Code Sec(s) 469; 6662.
This was originally published on October 8th, 2010.
God doth not need
Either man's work or his own gifts. Who best
Bear his mild yoke, they serve him best. His state
Is kingly: thousands at his bidding speed,
And post o'er land and ocean without rest;
They also serve who only stand and wait
So this is another post about a development in the passive activity loss rules. The rules require us to group our trade or business activities into different buckets depending on our level of participation. Losses in the passive activity bucket can be used against gains from passive activities, but a net loss is suspended until the related activity is fully disposed of. A special feature of the rules is that rental activities are "per se" passive. Persons who are in real estate trades or businesses can be exempted from this "per se" passive rule. They may need to make a special election to take advantage of this benefit.
I've discussed the election in a previous post. I've also discussed the biggest problem, people have, which is proving how they spend their time. James Moss has introduced a new angle. Mr. Moss worked full time at a nuclear power plant. The total hours worked at this job for 2007 came to 1900. Included in his work hours were 200 to 300 hours of "call out" or "standby time". Apparently, this was time where he had to be ready to go in, if they needed him. Maybe it was the days when Homer Simpson was working alone, but I'm pretty sure that's a different power plant.
Mr. Moss also rented out some property that he owned. There was a four unit apartment building and three single family homes. He apparently kept meticulous track of his time. (His "day job" involved planning the maintenance activities of a nuclear power plant, so the habits there may have carried over). He spent 507.75 hours working on his properties and 137.75 hours travelling two and fro for a grand total of 645.50 hours. The court noted that the IRS did not say that Mr. Moss failed to make the election to group his properties, so they figured he must have.
You guys who know all the answers, I need you to slow down here. Mr. Moss has done better than most real estate exception wannabees in tax court. The court isn't calling his time records a ballpark guesstimate and they are giving him credit for the election. It doesn't make him win, but he deserves a cheer. Sadly, one of the necessary, though not sufficient, conditions is that you have 750 hours in a real estate trade or business. So by his own meticulous records Mr. Moss loses. He has another argument, though. All the time that he wasn't working at the power plant, he was "on-call" for his tenants. That should easily put him over the 750 hours. OK wise guys. He actually has to beat 1900 hours, because another condition is that you spend more time in real estate than anything else. Well by my reckoning the "on-call" theory could be another 6,000 hours.
Sadly the tax court wouldn't buy it. So he has to pay the tax. He also got hit with an accuracy related penalty. He proffered two arguments. The first was that the penalty should be waived, because the IRS mistreated him. Sadly we don't get the details. The other was reliance on his CPA, but it is indicated that he did not tell his CPA how many hours he worked.
First reader to identify the poem above can chose the topic of a future post.
This was originally published on October 8th, 2010.
God doth not need
Either man's work or his own gifts. Who best
Bear his mild yoke, they serve him best. His state
Is kingly: thousands at his bidding speed,
And post o'er land and ocean without rest;
They also serve who only stand and wait
So this is another post about a development in the passive activity loss rules. The rules require us to group our trade or business activities into different buckets depending on our level of participation. Losses in the passive activity bucket can be used against gains from passive activities, but a net loss is suspended until the related activity is fully disposed of. A special feature of the rules is that rental activities are "per se" passive. Persons who are in real estate trades or businesses can be exempted from this "per se" passive rule. They may need to make a special election to take advantage of this benefit.
I've discussed the election in a previous post. I've also discussed the biggest problem, people have, which is proving how they spend their time. James Moss has introduced a new angle. Mr. Moss worked full time at a nuclear power plant. The total hours worked at this job for 2007 came to 1900. Included in his work hours were 200 to 300 hours of "call out" or "standby time". Apparently, this was time where he had to be ready to go in, if they needed him. Maybe it was the days when Homer Simpson was working alone, but I'm pretty sure that's a different power plant.
Mr. Moss also rented out some property that he owned. There was a four unit apartment building and three single family homes. He apparently kept meticulous track of his time. (His "day job" involved planning the maintenance activities of a nuclear power plant, so the habits there may have carried over). He spent 507.75 hours working on his properties and 137.75 hours travelling two and fro for a grand total of 645.50 hours. The court noted that the IRS did not say that Mr. Moss failed to make the election to group his properties, so they figured he must have.
You guys who know all the answers, I need you to slow down here. Mr. Moss has done better than most real estate exception wannabees in tax court. The court isn't calling his time records a ballpark guesstimate and they are giving him credit for the election. It doesn't make him win, but he deserves a cheer. Sadly, one of the necessary, though not sufficient, conditions is that you have 750 hours in a real estate trade or business. So by his own meticulous records Mr. Moss loses. He has another argument, though. All the time that he wasn't working at the power plant, he was "on-call" for his tenants. That should easily put him over the 750 hours. OK wise guys. He actually has to beat 1900 hours, because another condition is that you spend more time in real estate than anything else. Well by my reckoning the "on-call" theory could be another 6,000 hours.
Sadly the tax court wouldn't buy it. So he has to pay the tax. He also got hit with an accuracy related penalty. He proffered two arguments. The first was that the penalty should be waived, because the IRS mistreated him. Sadly we don't get the details. The other was reliance on his CPA, but it is indicated that he did not tell his CPA how many hours he worked.
First reader to identify the poem above can chose the topic of a future post.
You Don't Need a Matchmaker at the Family Reunion
This was originally published on September 29th, 2010.
I have these silly rules that I make up and then go ahead and break all the time. One is to not use the word only in association with any sum of money greater than $4.00 (Yes there is a decimal point. Four dollars). Another is to rule out of the discussion the concepts of "making sense" and "being fair" when discussing what the tax rules actually are. I compound this latter rule by not paying much attention to theories about what the tax laws should be. This comes from some hard experience I had in 1987, trying to keep straight what actually made it into the Tax Reform Act of 1986 as opposed to the "Treasury II Proposals".
I somewhat relax the "making sense" and "being fair" proscriptions for purpose of enunciating one of my general rules of tax planning. "Any clever idea you have has been thought of and probably ruled against." An extension of this is that most of the thing that you think don't make sense actually do make sense. They are there to squelch an abusive transaction dreamed up by someone even more clever than you are. All of this is just me apologizing for saying that the Eleventh Circuit's decision in Ocmulge Fields v. Com (106 AFTR 2d 2010-5820) makes sense.
The case concerns like-kind exchanges, a topic which I discuss here and there. At issue is the application of the related party resale rules. Suppose you owned two companies (Call them Highoco and Lowco)and each one owned a piece of real estate worth $1,000,000. Further suppose that the basis of one property (High-B)was $900,000 and the other (Low-B) was $100,000. Along comes buyer who perversely is willing to pay $1,000,000 for Low-B, but has no interest in High-B. Wouldn't it be nice if you could move the basis in High-B over to Low-B ? Well you can. Highco and Lowco can do a like-kind exchange. Highco's basis in Low-B will be $900,000, its basis in the property that it surrendered. Clever.
Unfortunately, if Highco disposes of Low-B within two years of the exchange Lowco has to recognize gain.
There is another set of rules involving like-kind exchanges. Since the person that has the property you want is rarely the person who wants your property many exchanges use qualified intermediaries. The qualified intermediary receives the money from the sale of your property and uses it to purchase another property. You have 45 days from the date of sale to identify the target property and you must receive it within 180 days of the sale (If the sale is later in the year you may have to extend your tax return in order to have the full 180 days).
Ocmulgee Fields Inc decided that they should go the qualified intermediary route. The hired Security Bank of Bibb County to serve as qualified intermediary. The bank received the proceeds for the sale of Ocmulgee's property known as Wesleyan Station to the McEachern Family Trust. Ocmulggee then searched high and low for a replacement property. They used up all of six days. Finally they identified a Barnes and Nobles. It just kind of happened, sort of by coincidence, that the Barnes and Nobles was owned by a company named Treaty Fields. Come to find out, Treaty Fields was pretty much owned by the same people as owned Ocmulgee.
Seems like since they already were acquainted with one another, they did not really need a qualified intermediary. Just as well they used one, though, since it got them out of that nasty related party resale rule. Well that's what they thought. It's not what the IRS thought, though. And the Tax Court and the Eleventh Circuit agreed with the IRS. Treaty Fields, surprise, surprise, had higher basis in the Barnes and Nobles than Ocmulgee had in the Weslyan property. But that's not all. Ocmulgee was a C corp and Treaty Fields was a partnership.
I would have been awfully upset if Ocmulgee won this case. Not because I root for the IRS. I would have been upset at myself for not telling my own clients about such an obvious end run around the related party resale rules. The resale rules have this nice little ending (1031(f)(4)), which disallows any exchange which is a part of a transaction or series of transactions to avoid the purposes of the resale rules. It reads:
This section shall not apply to any exchange which is part of a transaction (or series of transactions) structured to avoid the purposes of this subsection
Read by itself, it doesn't make a lot of sense. What it says is that you can't fix a bad exchange by throwing in a couple of extra seemingly good ones.
I have these silly rules that I make up and then go ahead and break all the time. One is to not use the word only in association with any sum of money greater than $4.00 (Yes there is a decimal point. Four dollars). Another is to rule out of the discussion the concepts of "making sense" and "being fair" when discussing what the tax rules actually are. I compound this latter rule by not paying much attention to theories about what the tax laws should be. This comes from some hard experience I had in 1987, trying to keep straight what actually made it into the Tax Reform Act of 1986 as opposed to the "Treasury II Proposals".
I somewhat relax the "making sense" and "being fair" proscriptions for purpose of enunciating one of my general rules of tax planning. "Any clever idea you have has been thought of and probably ruled against." An extension of this is that most of the thing that you think don't make sense actually do make sense. They are there to squelch an abusive transaction dreamed up by someone even more clever than you are. All of this is just me apologizing for saying that the Eleventh Circuit's decision in Ocmulge Fields v. Com (106 AFTR 2d 2010-5820) makes sense.
The case concerns like-kind exchanges, a topic which I discuss here and there. At issue is the application of the related party resale rules. Suppose you owned two companies (Call them Highoco and Lowco)and each one owned a piece of real estate worth $1,000,000. Further suppose that the basis of one property (High-B)was $900,000 and the other (Low-B) was $100,000. Along comes buyer who perversely is willing to pay $1,000,000 for Low-B, but has no interest in High-B. Wouldn't it be nice if you could move the basis in High-B over to Low-B ? Well you can. Highco and Lowco can do a like-kind exchange. Highco's basis in Low-B will be $900,000, its basis in the property that it surrendered. Clever.
Unfortunately, if Highco disposes of Low-B within two years of the exchange Lowco has to recognize gain.
There is another set of rules involving like-kind exchanges. Since the person that has the property you want is rarely the person who wants your property many exchanges use qualified intermediaries. The qualified intermediary receives the money from the sale of your property and uses it to purchase another property. You have 45 days from the date of sale to identify the target property and you must receive it within 180 days of the sale (If the sale is later in the year you may have to extend your tax return in order to have the full 180 days).
Ocmulgee Fields Inc decided that they should go the qualified intermediary route. The hired Security Bank of Bibb County to serve as qualified intermediary. The bank received the proceeds for the sale of Ocmulgee's property known as Wesleyan Station to the McEachern Family Trust. Ocmulggee then searched high and low for a replacement property. They used up all of six days. Finally they identified a Barnes and Nobles. It just kind of happened, sort of by coincidence, that the Barnes and Nobles was owned by a company named Treaty Fields. Come to find out, Treaty Fields was pretty much owned by the same people as owned Ocmulgee.
Seems like since they already were acquainted with one another, they did not really need a qualified intermediary. Just as well they used one, though, since it got them out of that nasty related party resale rule. Well that's what they thought. It's not what the IRS thought, though. And the Tax Court and the Eleventh Circuit agreed with the IRS. Treaty Fields, surprise, surprise, had higher basis in the Barnes and Nobles than Ocmulgee had in the Weslyan property. But that's not all. Ocmulgee was a C corp and Treaty Fields was a partnership.
I would have been awfully upset if Ocmulgee won this case. Not because I root for the IRS. I would have been upset at myself for not telling my own clients about such an obvious end run around the related party resale rules. The resale rules have this nice little ending (1031(f)(4)), which disallows any exchange which is a part of a transaction or series of transactions to avoid the purposes of the resale rules. It reads:
This section shall not apply to any exchange which is part of a transaction (or series of transactions) structured to avoid the purposes of this subsection
Read by itself, it doesn't make a lot of sense. What it says is that you can't fix a bad exchange by throwing in a couple of extra seemingly good ones.
Thursday, November 10, 2011
Real estate election relief
This was originally published on PAOO on September 6th, 2010.
When I titled this blog Passive Activities and Other Oxymorons, it was by no means, because I intended to write only on the passive activity loss rules. If I was going to totally devote myself to one tax topic it would be the capital account maintenance rules of 704(b) (That blog would be titled "Minimum Gain - Maximum Pain"). Fortunately, I once saw the slides of a presentation of someone else who is passionate about those rules. I think they also had a thing for 704(c). One of the slides practically screamed "There is no such thing as negative basis". I feel a certain bond with that person, but I'm really not anxious to meet with them.
At any rate the passive activity loss rules do seem to be cropping up quite a bit. In a recent case which I'm thinking doesn't merit its own post (Gregory J. Bahas, et ux. v. Commissioner, TC Summary Opinion 2010-115) Linda Bahas tried to use the real estate professional exception. She hadn't made the aggregation election and the services she provided were as an employee not as a business owner. Other than that Mrs. Lincoln how did your enjoy the play ? At least she didn't have to put up with the court telling her she was ballpark guestimating her time.
There is some good news, though. A quick review of the context might be in order first. The passive activity loss rules were created more or less out of whole cloth by the Tax Reform Act of 1986. They require us to sort trade or business activities into those in which we materially participate and those in which we don't. One of the concepts in the rules is that rental activities are per se passive. This may have been an example of someone getting their notions about reality from watching TV infomercials about making a fortune in real estate with no capital and very little work. Regardless, my philosophy about tax rules is that they are what they are. In the early 1990's relief from the per se passive rule was granted to real estate professionals.
In order for this relief to be effective, though, it is frequently necessary for them to elect to aggregate all their real estate activities. Without the election they would have to establish material participation in each property. Donald Trask (TCM 2010-78) was able to establish that he spent enough time to be considered a real estate professional, but he had not made the election and his time was spread over 33 properties.
PLR 201033015 was addressed to taxpayers who were qualified, but had failed to make the election. Since they had relied on a tax preparer who had failed to advise them of the necessity of making the election, the service granted them an extension of time to make it.
If you have been posting negative numbers from real estate investments to your return on the theory that you or your spouse is a real estate professional, you should make sure that you have made the election. If not you may want to consider requesting relief. Furthermore, I generally believe in keeping tax returns indeefinitely, but if you must dispose of some of them, be sure to keep the return for the year that you made the election. It is relevant for all future returns in which you are claiming its effect and I know from experience that you cannot rely on the IRS to preserve it for you.
When I titled this blog Passive Activities and Other Oxymorons, it was by no means, because I intended to write only on the passive activity loss rules. If I was going to totally devote myself to one tax topic it would be the capital account maintenance rules of 704(b) (That blog would be titled "Minimum Gain - Maximum Pain"). Fortunately, I once saw the slides of a presentation of someone else who is passionate about those rules. I think they also had a thing for 704(c). One of the slides practically screamed "There is no such thing as negative basis". I feel a certain bond with that person, but I'm really not anxious to meet with them.
At any rate the passive activity loss rules do seem to be cropping up quite a bit. In a recent case which I'm thinking doesn't merit its own post (Gregory J. Bahas, et ux. v. Commissioner, TC Summary Opinion 2010-115) Linda Bahas tried to use the real estate professional exception. She hadn't made the aggregation election and the services she provided were as an employee not as a business owner. Other than that Mrs. Lincoln how did your enjoy the play ? At least she didn't have to put up with the court telling her she was ballpark guestimating her time.
There is some good news, though. A quick review of the context might be in order first. The passive activity loss rules were created more or less out of whole cloth by the Tax Reform Act of 1986. They require us to sort trade or business activities into those in which we materially participate and those in which we don't. One of the concepts in the rules is that rental activities are per se passive. This may have been an example of someone getting their notions about reality from watching TV infomercials about making a fortune in real estate with no capital and very little work. Regardless, my philosophy about tax rules is that they are what they are. In the early 1990's relief from the per se passive rule was granted to real estate professionals.
In order for this relief to be effective, though, it is frequently necessary for them to elect to aggregate all their real estate activities. Without the election they would have to establish material participation in each property. Donald Trask (TCM 2010-78) was able to establish that he spent enough time to be considered a real estate professional, but he had not made the election and his time was spread over 33 properties.
PLR 201033015 was addressed to taxpayers who were qualified, but had failed to make the election. Since they had relied on a tax preparer who had failed to advise them of the necessity of making the election, the service granted them an extension of time to make it.
If you have been posting negative numbers from real estate investments to your return on the theory that you or your spouse is a real estate professional, you should make sure that you have made the election. If not you may want to consider requesting relief. Furthermore, I generally believe in keeping tax returns indeefinitely, but if you must dispose of some of them, be sure to keep the return for the year that you made the election. It is relevant for all future returns in which you are claiming its effect and I know from experience that you cannot rely on the IRS to preserve it for you.
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