Mansion Property Was Never Actually Used in a Rental Activity, Loss Was Capital

The question of whether real estate was or was not a capital asset in the hands of the taxpayer became an issue in the case of Keefe v. Commissioner, TC Memo 2018-28.  While the issue can arise with other assets, real estate investments are generally large enough that the question of whether a gain or loss on sale is capital, §1231 or ordinary is often a very significant issue, with high stakes involved.

In this case, the taxpayer was looking at a seven-figure loss on the sale of a historic waterfront mansion they had acquired to restore and attempt to rent in Newport, Rhode Island.  The restoration ended up taking much longer than anticipated and was far costlier.  Although they talked with a real estate agent about renting out the property to wealthy individuals who were expected to pay $75,000 a month for the property during peak season, it was never actually rented out.

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Tax Court Resolves a "Kind of Conundrum Only Tax Lawyers Love" in Sale of Rental

In the case of Simonsen v. Commissioner, 150 TC No. 8, the Tax Court reaffirmed its previously stated position regarding a short sale when a nonrecourse debt is involved.  As well, for the first time the Court also addressed the reportable gain/loss on a property converted to rental use that was sold for less than its original cost but more than its date of conversion fair market value.

The couple in question had purchased a townhouse in San Jose in 2005 for $695,000.  They lived in that home for five years, during which the real estate crisis hit.  In 2010 they relocated to Southern California and began renting the townhouse.  At the time it was converted to a rental the fair value had declined to $495,000.

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Set of Questions and Answers Released on Reporting and Paying Section 965 Transition Tax for 2017

The IRS announced the publication of a set of questions and answers related to the tax imposed under IRC §965 under changes made by the Tax Cuts and Jobs Act in News Release IR-2018-53.  The questions and answers are published in the form of a frequently asked question document (FAQ) on the IRS website at:

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Offshore Voluntary Disclosure Program to End on September 28, 2018

The Offshore Voluntarily Disclosure Program (OVDP) will end on September 28, 2018 the IRS announced in News Release IR-2018-52.  The program offers an option for taxpayers with undisclosed foreign assets to report those assets with a reduced penalty.

The IRS has offered three OVDP programs since 2009, though the program has become less generous following the revisions in 2011 and 2014.  Over that time the agency reported that 56,000 taxpayers used one of the programs and that the programs collected over $11.1 billion in back taxes, interest and penalties.

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Employees Wages Included Fees Charged by International CPA Firm to Prepare U.S. and Foreign Tax Returns

How much should an employee recognize as income when his/her employer provides the employee with tax preparation services?  That was the question addressed by Chief Counsel Advice 201810007.

The employer in this case had U.S. citizens that were given work assignments in various other countries, with employees also being relocated from time to time.  As is often the case in such situations, the employer decided to provide a “tax equalization” program.  Under such a program, the employer agrees to compensation employees in such a fashion that their after-tax income will not fluctuate as they move from taxing regime to taxing regime.

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Tax Court Rejects Taxpayer's Reconstruction of Real Estate Hours

When taxpayers attempt to reconstruct their hours in activities from memory when they receive an exam notice to sustain their burden of proving qualification as a real estate professional, the result is rarely a successful defense of that assertion.  Many of the problems are illustrated in the case of Pourmirzaie v. Commissioner, TC Memo 2018-26.

The taxpayers did have several rental properties.  The Court listed them as follows:

  • A four-unit residential property in San Jose, California (San Jose property);
  • A single-family condominium in San Diego, California, in which petitioners owned a partial interest (San Diego property);
  • A single-family residence in Tucson, Arizona (Tucson property);
  • A single-family condominium in Bremerton, Washington (Bremerton property); and
  • A single-family residence in Discovery Bay, California (Discovery Bay property).

The taxpayers did not maintain any sort of log or calendar of the work performed on these properties during the years in question.  Nevertheless, on their tax returns for the year in question they took the position that Mrs. Pourmirzaie was a real estate professional. 

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Tenants' Inability to Handle Trash Matters Helped Architect Qualify as Real Estate Professional

His tenants’ inability to deal with taking out the trash appears to have been a key factor in allowing the taxpayer in Franco v. Commissioner, TC Summary Opinion 2018-9 to qualify as a real estate professional.

Jose Franco is a licensed architect and he ran a small architectural business for the year in question.  Normally this would create a significant issue for Mr. Franco to be classified as a real estate professional, since Mr. Franco was not contending that his architectural work was a real property trade or business. 

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Tax Court Rules Roth IRA Did Not Actually Own the Stock of FSC

The Tax Court took a different approach in their attempt to dismantle a Roth IRA based tax shelter in the case of Mazzei v. Commissioner, 150 TC No. 7 than the approach the Sixth Circuit turned thumbs down on in the case of Summa Holdings Inc. v. Commissioner, 848 F.3d 779 (6th Cir. 2017).

In this case the taxpayers’ Roth IRAs had formed a Foreign Sales Corporation (FSC), a mechanism that Congress created for a period of time to attempt to give a tax break to taxpayers selling products overseas.  Under the provisions of the law applicable to FSCs, it could receive commissions from a manufacturer exporting goods even if it performed no services.  These commissions were subject to a significantly lower rate of tax than applied on regular corporations.

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Male Sterilization/Contraception Coverage Not Covered by Preventive Care Exception for HDHP Policies

The IRS issued guidance that may put at risk the ability of individuals in certain states to participate in health savings accounts (HSAs) beginning in 2020 in Notice 2018-12.

As Tax Analysts reported in covering this Notice, several states, including California, Illinois, Maryland, and Vermont, prohibit cost-sharing for insurance coverage of male sterilization and contraception services.  But only Vermont has a “carve-out” for HSA-qualified high deductible health plans (HDHPs).

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Battery Added in Later Year to Solar Energy System Ruled to Qualify for Credit

In Private Letter Ruling 201809003 the IRS ruled that a taxpayer who added a storage battery to an existing solar energy system for which a credit had been claimed in a prior year qualified for the solar device credit under IRC §25D(a)(1).  But the IRS noted that there was an important factor in the facts the taxpayer provided that allowed for the credit.In Private Letter Ruling 201809003 the IRS ruled that a taxpayer who added a storage battery to an existing solar energy system for which a credit had been claimed in a prior year qualified for the solar device credit under IRC §25D(a)(1).  But the IRS noted that there was an important factor in the facts the taxpayer provided that allowed for the credit.

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Tax Court Disagrees With US District Court Over Potential Tax Exemption for Sale of Gravel

The Tax Court and U.S. District Court were considering the same basic issue for different years for the same taxpayers.  The courts came to opposite conclusions in the issue.  The United States District Court for the Western District of New York ruled in 2017 that the taxpayers in Perkins v. United States, No. 1:16-cv-00495, plausibly stated a claim for exemption from taxation for the 2010 sale of gravel based on two treaties between the United States and the Seneca Nation.  But in a case looking at the same two cases, the Tax Court decided in the case of Perkins v. Commissioner, 150 T.C. No. 6 that no exemption was available to the taxpayers under those treaties for sales of gravel in other years.

Alice Perkins is an enrolled member of the Seneca Nation and had received permission from the Seneca Nation to remove and sell gravel from lands held by Nation.  She and her husband lived on Seneca property.  For the years in question they sold gravel which they had mined from Seneca lands.

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S Corporations Not Exempted from Applicable Partnership Interest Rule of IRC §1061

The IRS issued guidance promised by Treasury Secretary Steven Mnuchin in his testimony in February before the Senate Finance Committee regarding the carried interest rules added in IRC §1061 by the Tax Cuts and Jobs Act.  Notice 2018-18 provides guidance on regulations the IRS plans to issue in this area.

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IRS Releases Online W-4 Calculator and 2018 Form W-4

The IRS released the revised W-4 Withholding Calculator on their website on February 28 along with the revised 2018 version of Form W-4.  The revision arrived slightly later than promised by Treasury Secretary Steven Mnuchin who testified on February 15 that the calculator would be out within a week.

The revised calculator takes into account changes made by the Tax Cuts and Jobs Act.  The calculator works for most individuals, but the IRS warns that it is not meant for taxpayers with more complex situations.

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Taxpayer's Taking of Funds from IRA to Send to Soon to Be Former Spouse Was Not a Tax Free Transfer of the IRA

While it is possible to transfer some or all of an IRA account tax free to the soon to be ex-spouse pursuant to a divorce, certain rules need to be followed.  In the case of Kirkpatrick v. Commissioner, TC Memo 2018-20, the taxpayer discovered that a failure to follow these procedures can be a very costly mistake.

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Partnership Did Not Hold Land for Development, Nor Sell It in the Ordinary Course of Its Trade or Business, So Gain Was Capital

In the case of Sugar Land Ranch Development LLC et al. v. Commissioner, TC Memo 2018-21, the IRS challenged the taxpayer’s treatment of gain from the sale of land.  The taxpayer had treated the gain as capital gain from the sale of investment property.  But the IRS argued that the property was held for sale to customers in the ordinary course of business and that the gain should be treated as ordinary gain.

To qualify for capital gain treatment, the gain must arise from the sale of an asset that is a capital asset in the hands of the taxpayer.  What is a capital asset is defined, under the IRC, by what is not a capital asset.  All assets held by a taxpayer are capital assets unless one of the exclusions, found at IRC §1221(a), applies.

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IRS Is Able to Process Returns with Some, But Not All, Benefits Retroactively Restored for 2017

In News Release IR-2018-33 the IRS announced that it was now able to begin accepting returns claiming certain tax benefits retroactively restored for 2017 by the Bipartisan Budget Act of 2018.  The three benefits that the IRS is now ready to accept returns containing are the following:

  • Exclusion from gross income of discharge of qualified principal residence indebtedness (often, foreclosure-related debt forgiveness),
  • Mortgage insurance premiums treated as qualified residence interest, and
  • Deduction for qualified tuition and related expenses.

These provisions had expired at the end of 2016 and Congress had not enacted legislation to extend them for an additional year until the passage of the Bipartisan Budget Act on February 9.

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AICPA Writes Treasury Regarding §199A Issues Requiring Immediate Guidance

The AICPA Tax Executive Committee has sent a letter to the Treasury Department and the IRS outlining areas the Institute believes require immediate guidance for IRC §199A added to the law by the Tax Cuts and Jobs Act.  The list is not a short one—the summary table at the end of the document shows 29 separate items which require guidance, with six requiring immediate guidance and 23 that will also require guidance, presumably before returns begin to be filed for years that IRC §199A applies to.

The letter breaks the requested guidance into six broad areas for which information is needed.  These areas are:

  • Definition of section 199A Qualified Business Income
  • Aggregation method for calculation of QBI of pass-through businesses
  • Deductible amount of QBI for a pass-through entity with business in net loss
  • Qualification of wages paid by an employee leasing company
  • Application of section 199A to an owner of a fiscal year pass-through entity ending in 2018
  • Availability of deduction for Electing Small Business Trusts (ESBTs)

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IRS Issues News Release to Clarify That Loans a Bank Calls a Home Equity Loan May Still Be Deductible as Mortgage Interest After TCJA

In News Release IR-2018-32 the IRS sought to deal with what appears to be a widespread misunderstanding of how the home mortgage interest deduction works under the revisions passed as part of the Tax Cuts and Jobs Act.  The IRS points out that merely because a lender refers to a loan as a “home equity” loan, that does not mean the interest will not be deductible in 2018, so long as proceeds of the loan are used to acquire or substantially improve the residence.

Under IRC §163(h)(3)(F), only “acquisition indebtedness” (as defined by IRC §163(h)(3)(B)) will be deductible, and “home equity” indebtedness (as defined by IRC §163(h)(3)(C)) will not be.  Too many taxpayers, reporters and, in this author’s experience, even tax advisers are ignoring the “as defined by” clauses above and instead go directly to using loan labels to determine deductibility.

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Oddity Is Not Absurdity, So Eleventh Circuit Upholds Ordinary Income Treatment

In September of 2016 we wrote about the case of CRI-Leslie LLC et al. v. Commissioner, 147 T.C. No. 8 where the Tax Court found that, since a §1231 asset is effectively, per §1221(a)(a), not a capital asset, a $9.7 million gain was not a capital gain, but rather was ordinary income.  You can read about the details of this case in the original post.

The taxpayer, not happy with the Tax Court's decision, appealed the case to the Eleventh Circuit. And many advisers, seeing this result as odd and not something Congress could have meant to result, may agree.  But it turns out the law allows for odd results.

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Despite Having No Adjustment in Prior Two Exams, Taxpayer's Use of Gross Profit Method Found to Significantly Misstate Income

A taxpayer’s appeal of a Tax Court decision upholding an IRS assessment regarding a method that had survived two prior IRS audit failed to win relief from the First Circuit Court of Appeals in the case of Transupport, Inc. v. Commissioner, CA1, No 17-1265.

The taxpayer in this case is a wholesaler of engine and engine parts used in military vehicles.  The issue in this case involved a portion of the business where the taxpayer bought parts in bulk from the U.S. Government and resold them.

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