Win Some, Lose Some: Basis of Property Sold Reduced Due to Lack of Documentation, But Sales Price was Lender's Bid in Foreclosure Sale

In the case of Breland v. Commissioner, TC Memo 2019-59[1] (May 29, 2019) two different issues were decided by the Tax Court:

  • Did the taxpayers properly substantiate the basis of property sold by producing only a Form 8824 from a prior return when the property was obtained as part of a like-kind exchange?

  • What was the actual sales price and cancellation of debt resulting from the foreclosure sale of the taxpayer’s properties?

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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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Taxpayer's Loss Generated Using a Family Limited Partnership Formed With Assets Contributed to S Corporation Lacked Economic Substance

An attempt to combine the concepts of valuation discounts for family limited partnership often used in estate planning with a short-lived S corporation to create an income tax benefit was not looked upon positively by the Tax Court in the case of Smith v. Commissioner, TC Memo 2017-218.

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Extension of Variable Prepaid Forward Contracts Did Not Trigger Gain Recognition

Rev. Rul. 2003-7 provides that variable prepaid futures contracts (VFPCs) represent “open transactions” that are not subject to tax until the contract is finally settled and do not represent constructive sales of the stock under IRC §1259.  The case of Estate of McKelvey v. Commissioner148 T.C. No. 13 looks at whether an extension of the VFPC represents either a taxable settlement of the contract or a constructive sale of the related shares under IRC §1259, a question not previously addressed by the Tax Court.

Under a variable prepaid forward contract, a taxpayer agrees to pledge a certain amount of stock in exchange for receiving a payment of cash.  The contract provides that, at a specified date in the future the taxpayer will deliver either a number of shares of stock (either from the original pledged group or other shares the taxpayer has) or a cash payment.  The number of shares to be delivered varies over a specified range of shares, based on the price of the stock on the date the transaction is closed.  The shares that are pledged represent the maximum number that may need to be delivered.  As well, the party pledging the shares would retain the right to close out the contract at any time before the final settlement date, either by transferring shares or cash.

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Court Finds Modification to Sublicense May Be a Sale, Does Not Agree with IRS That Taxpayer is Blocked from Arguing the Point

One day after the Tax Court invoked the Danielson case to reject a taxpayer’s attempt to argue substance over form to restructure an agreement for tax purposes in Makric Enterprises, Inc. v. Commissioner, TC Memo 2016-44, the Court turned down the IRS’s attempt to argue the same case should block a taxpayer from arguing a transaction represented a sale of its interests in rights to a chemical compound.

In the case of Mylan, Inc. and Subsidiaries v. CommissionerTC Memo 2016-45 the IRS was arguing for summary judgement, based on the Danielson decision, that the taxpayer had to treat its transaction as a license agreement generating ordinary income and not a sale of its rights generating capital gains.

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Agreement Holding Subsidary Rather Than Parent Stock Sold Held Binding by Tax Court, a Very Costly Result for the Sellers

Details matter in tax law, especially when the taxpayer was involved in setting up the details.  In the case of Makric Enterprises, Inc. v. Commissioner, TC Memo 2016-44 a failure to make sure that the right corporation was sold as part of the agreement proved very expensive to the taxpayers—in the amount of $2,839,780.

There were two corporations involved in this matter—one of which was a holding company (Makric Enterprises, Inc.) whose only asset was the stock of a wholly owned subsidiary (Alpha Circuits, Inc.).  A third party became interested in buying the business conducted by Alpha.

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