As I’ve said before “One sure way to drive a coach bananas is to fail to finish a play.” See my blogpost “Finishing the Play”, 3/26/12.

And today we have two cases out of Tax Court that prove the rule. First up is Stanley Patrick Zurn, 2012 T.C. Mem. 132, filed 5/10/12, Judge Gale calling the play.

Stan never bothered to file four years’ worth of returns (like a certain New York City Mayor), but got an audit notice anyway. Stan raises SOL on brief, but Judge Gale throws that out: in the immortal words of Carole King, “it’s too late baby, now it’s too late”. Judge Gale: “Petitioner did not plead the statute of limitations as an affirmative defense as required by Rule 39. Petitioner did not raise the issue during the evidentiary hearing, nor has he at any time moved to amend the pleadings so as to include this omitted affirmative defense. Petitioner’s failure to plead the statute of limitations in his petition or in an amended pleading constitutes a waiver of the issue. Moreover, petitioner’s raising of the issue for the first time on brief would prejudice respondent, who has been deprived of the opportunity to present relevant evidence, such as evidence that petitioner consented to extend the period of limitations. We decline to consider this issue.” 2012 T.C. Mem. 132, at p. 17 (Citations and footnote omitted.).

Worse,  Stan claims three Section 1031 like-kind exchanges, but has no recorded documents showing acquisition of replacement properties and no documents of any kind showing full payment of purchase price for any of them. He has closing statements from the escrow closings (California properties, so no sit-down closings such as we have back East), and not much else. And in one deal the statement shows what is called a “buyer’s credit”, making the purchase price as stated dubious. Stan never finished the play in any deal, so his 1031s don’t defer gain. But Stan does get something for his trouble– a negligence penalty.

Next is yet another Section 7463 “not for nuthin’”, George Saadian, 2012 T.C. Sum. Op. 44, filed 5/10/12. George and his mom lent a “distant relative”, who was also a compatriot, $200K for a real estate deal, got a promissory note and some payments, but the latter were desultory and never timely. George was reluctant to sue a compatriot, as that was supposedly taboo among compatriots, but finally George had his lawyer send a letter threatening suit.

George never followed through, so no lawsuit, and relative finally avoids the issue by dying. George asks relative’s sons, who were also involved in relative’s business, to make good, but never files claim against estate, and sons were never signatories to the note nor guarantors.

The last meeting with the sons took place the same year George had a big capital gain, and George says the sons told him not to expect payment, so George takes a nonbusiness bad debt deduction for the $200K.

No, says Lew Carluzzo, the STJ with the correctly-spelled first name. “The allowance of a deduction under section 166 [nonbusiness bad debt] requires that the debt to which the deduction relates was a valid debt and that the taxpayer claiming the deduction was the creditor.” 2012 T.C.Sum.Op. 44, at p. 7 (footnote omitted). STJ Lew assumes (without finding) that both prongs of the test are satisfied, although IRS disagrees.

The problem is not whether the debt went south, but when. There is no standard rule, it’s all facts and circumstances (Sir Ed Elgar could have composed a march by that name), but the creditor must use sound business judgment based on what information s/he could reasonably obtain at the time. The mere fact that collection might be difficult or uncomfortable doesn’t mean the debt is worthless.

STJ Lew drives home the point: “Petitioner’s decision not to enforce collection of the debt for personal rather than financial reasons, in and of itself, operates to deny him the deduction here in dispute.” 2012 T.C. Sum. Op. 44, at p. 8.

You have to run out the grounder, even if you know you’ll be thrown out. Finish the play, guys.