In Uncategorized on 11/13/2012 at 23:47

See my blogpost “Passive Aggressive”, 8/8/12, for the story of Joe Veriha.

And now Part Deux, the story of Francis J. Dirico and Jennifer Dirico, 139 T. C. 16, filed 11/13/12, and Frank’s self-rented land and radiophone towers.

Frank was a tinkerer with radios, and in the early cellphone days he ran what was called SMR, “…a pre-cellular-telephone-technology, push-to-talk radio system with some telephone capabilities.  Before the cellular telephone industry matured, SMR was an attractive technology, offering party-line or intercom-like services to such users as security companies, plumbers, electricians, construction companies, and tow-truck and rubbish companies.” 139 T. C. 16, at p. 5. SMR was a good business until cellphones took over, and Frank had to give up some frequencies to the cellphone providers.

Frank had a wholly-owned Sub S, that leased land and communications towers that Frank owned and built, to various SMR and cellphone operators. Frank had some losses and some profits from leases of towers, and some losses from leases of raw land with no towers.

Frank’s Sub S ICE, “is liable for repairs except those ‘required because of the fault or negligence of * * * [the licensee] or its designated maintenance company’, in which event the ‘licensee’ becomes responsible for the repairs.  ICE, as lessor or ‘licensor’, generally maintained each tower, made sure that it was painted and that the lights were working, picked up papers and other debris, plowed snow, etc.” 139 T. C. 16, at p. 8.

At first Frank worked a six-day week on the tower business, but subsequently slacked off. He reported the rents he got from his Sub S as passive, but the Sub S reported all its income as “ordinary business income”. IRS, using Section 469, recharacterized all Frank’s profitable rental activity as non-passive, but left his losses as passive.

It’s the old story: income from rental of tangible personal property is passive, regardless of material participation, and that applies to income from a Sub S passed through to the taxpayer. But the self-rental rule, Reg. 1.469-2(f)(6), would make the income active if the operation of the towers by the Sub S was a “trade or business.”

Judge Halpern finds the tower operations were not a trade or business. “…the fundamental fact that ICE’s leasing of towers and land to unrelated third parties was a rental activity within the meaning of section 469(j)(8) and section 1.469-1T(e)(3)(i), Temporary Income Tax Regs., supra. The few services that ICE provided in connection with its rentals (e.g., painting the towers, making sure the lights worked, plowing the snow around the towers) were equivalent to the services routinely provided by any lessor or landlord in order to make premises habitable by a lessee.  They were no more than supportive of ICE’s rental activities and did not turn those activities into trade or business activities as defined in section 1.469-4(b)(1), Income Tax Regs.  More importantly, ICE’s performance of those services did not bring its tower leasing activities within any of the exceptions to the definition of a rental activity that are described in section 1.469-1T(e)(3)(ii)(A)-(F), Temporary Income Tax Regs., supra.” 139 T. C. 16, at pp. 22-23.

So since all of Frank’s income from the tower leases is passive, he can offset his losses against his gains, as he was in no trade or business, either individually or through his Sub S.

As for the land-only leases, IRS claims that the 30% test of Reg. 1.469-2T(f)(3), that rental of property less than 30% of whose unadjusted basis is subject to depreciation per IRC 167 cannot be passive, knocks Frank out on the land leases, as land cannot be depreciated.

Frank says IRS raised this on brief, and therefore is untimely. He thought that since all his properties were grouped, more than 30% of the whole unadjusted basis of all his properties was subject to depreciation, so he put in no evidence on the land-only leases.

Judge Halpern: “…petitioners may have been surprised by respondent’s argument, but they were not prejudiced.  The issue respondent raises (application of the 30% test to the land-only rentals) presents an issue of law.  The fact that there were three land-only rentals in each of the years in issue is not in dispute.  Therefore, we fail to see what additional evidence petitioners were prevented from introducing in refutation of respondent’s argument (i.e., it is beyond dispute that 100% of each of those rentals consisted of nondepreciable land).  Moreover, any surprise to petitioners was mitigated by their ability to address the merits of respondent’s argument in their reply brief, which, in fact, they did.” 139 T. C. 16, at pp. 34-35.

So it’s a question of law, and both sides got an opportunity to argue the law.

And the law is you can’t mix-and-match rentals of land with personal property and rentals of land only. So IRS wins that one.

But what was the personal property Frank was renting? Was it the cellphone tower? If so, why did Frank’s lawyers not introduce evidence, if such is the case, that the towers were so affixed to the realty that they could not be removed without damaging the realty? If, as I suspect, at common law the towers would be fixtures (and therefore real property), why not group all the real property leases as one passive activity?


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