In Uncategorized on 08/28/2012 at 06:03

This is so vexed a question that Patricia A. Flood and Donald J. Flood escape penalties for understating tax in the eponymous T.C. Memo. 2012-243, filed 8/27/12, Judge Morrison doing the vexing.

Don’s a day trader, and claims his real estate operation, which consists of buying and selling vacant lots, is just a sideline. But Don only makes from day trading, during the two years at issue, “$25,901 of gains in 2004 and $24,153 of gains in 2005.” T. C. Memo. 2012-243, at p. 10.

On the other hand, Don and Pat made from their land-grabbing well over $1.75 million. Don claims capital gains; IRS says “No, you’re a dealer, one who sells something in the ordinary course of a trade or business.”

Of course, Don and Pat are self-represented, although they are confronting nearly $600K in deficiency and over $100K in penalty. Pat defaults in Tax Court, neither showing up herself nor giving Don POA, and has judgment entered against her for whatever Don gets. Is Pat going to try for innocent spouse? Stay tuned.

Don fails to respond to IRS’ demand that a 75-paragraph stipulation be deemed admitted, so it is.

That sound you hear is Don’s case going down the drain.

So what is a dealer? That is, one who must report profits from the enterprise as ordinary income, as opposed to capital gains, which carries a preferential rate of tax. Judge Morrison: “The answer depends on whether the Floods held the property primarily for sale to customers in the ordinary course of business or held it, alternatively, as a capital asset.” T. C. Memo. 2012-243, at p. 7.

So here’s how we unpack to which category the lots belong: “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 taxpayer’s 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 sale of property; (8) the character and degree of supervision or control the taxpayer exercised over any representative selling the property; and (9) the time and effort the taxpayer habitually devoted to sales of property. The frequency and substantiality of sales is especially probative.” T. C. Memo. 2012-243, at pp. 8-9 (Citations omitted).

Judge Morrison starts well here, but ends up with something that, if Don had a lawyer or a Tax Court admitted person, might have turned out differently: “Mr. Flood testified that the Floods bought the land for investment purposes. He asserts that the Floods sold lots only to pay real-estate taxes and that they sold only a few of the lots in 2004 and 2005. Although it appears that the Floods sold only some of the lots they owned during the two years at issue, the gains from these sales were spectacular. Even according to the Floods’ tax return for 2005, they sold properties in 2005 for $1,754,135 that they had originally purchased for $631,044. This is a gain of over $1 million. As we explain in parts 3 and 5 below, the actual gain was even greater than that. Furthermore, we surmise that the values of the remaining lots not sold by the Floods in 2004 and 2005 were relatively low compared to the values of the lots that were sold.” T. C. Memo. 2012-243, at p. 9. The parts 3 and 5 referred to are based on the 75-paragraph torpedo.

“Surmise”, Judge? Based on what? The only issue is the nature of the gain on the sale of the lots that were actually sold, not what lots might have been, or could have been, sold. If one accumulated 100 shares of APPL for five years, held all of them at least a year and a day, and yesterday sold 50, could one “surmise” that the value of the remaining 50 shares was “relatively low”?

But Don did sell 40 lots in the second of the two years at issue, although he sold only two in the first. Still, we have some more “surmise”: “(A)lthough many lots remained unsold, the record reveals little about the cost or value of the unsold lots. We surmise that the value was relatively insignificant.” T. C. Memo. 2012-243, at p. 10-11.

How the value of the unsold lots has anything to do with the nature of the lots is still unexplained. Perhaps that is the basis for the “surmise”.

True, Don devoted a lot of effort to his lottery (the selling of lots–sorry, guys), searching public records, sending out mass mailings, and scouring the byways and highways of the Sunshine State to find and harvest the low-hanging fruit. He used a lawyer to draft contracts and enforce them, used a broker whom he supervised to sell lots, advertised lots for sale, had a dedicated website to flog his lots and so is a dealer.

The 75-paragraph “deemed admitted” stipulation buries Don as regards basis in the lots, and torpedoes a number of his other claimed deductions. One can only “surmise” that Don didn’t bother to consult a lawyer or Tax Court admittee, or that he did, and was told that his case was DOA, so he saved the legal fee.

The good news: “We first find that the Floods had reasonable cause for reporting the lots in question as capital assets and that they did so in good faith. The lots are the types of assets that could conceivably be capital assets. Whether they are capital assets is close question.” T. C. Memo. 2012-243, at p. 19. But some of their other torpedoed tax positions are spurious, as Don produces no records, so it’s off to a Rule 155 to sort out the numbers.

I’m going to be a little slow in blogging the next few days, as I’m off to the IRS Nationwide Tax Forum, held this year in my hometown, to get those precious CPE hours. But I’ll be on board as fast as I can; I know all thirty of you are hanging on my every word. Yeah, right.

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