In Uncategorized on 12/27/2012 at 19:57

And You’d Better Slice It Right

That’s the lesson for John J. Norman, Jr., and M. Elizabeth Norman, 2012 T. C. Memo. 360, filed 12/27/12, as taught by Chief Judge Thornton.

JJ was a real estate broker. He and Liz wanted to buy a house in historic Warrenton, VA. The property they found had land, lots of land, under starry skies above, so, taking the advice of Bob Fletcher and Cole Porter from their 1934 hit, rather than fencing it in, they thought they might subdivide and develop it.

After much palaver with their sellers, who had the same idea but gave up on it, and after feasibility studies and an abortive hook-up with a professional developer, JJ and Liz having meanwhile bought the house with a hefty mortgage (which exceeded the Section 163(h) magic $1.1 million number for principal residence interest), the development deal runs aground on local political shoals regarding traffic on the local access road.

Unhappily for JJ and Liz, neither the contract of sale at acquisition, nor the terms of the hefty mortgage, allocated price or mortgage proceeds between house and land, and development land.

JJ and Liz wanted to take the interest on the mortgage debt above the $1.1 million as investment interest, and even though their other investment income didn’t cover, they could carry the unused portion forward.

IRS said no; no business use of the land, and no allocation between investment property indebtedness and principal residence. CJ Thornton finds a business purpose for something, but without knowing what land was involved, nor what debt, if any, covered investment land, there cannot be any allocation, and thus no investment interest.

JJ and Liz offered no expert testimony on the relative values of whatever land they wanted to ascribe to investment as opposed to principal residence, relied on conversations with the seller pre-contract (that were not embodied in the contract), and the mortgage made no reference to development or other use of the property.

IRS does concede the accuracy penalty, though.

Bottom line– what your contract and mortgage say, or don’t say, is the story you’re stuck with. See my blogpost “Buying Trouble”, 1/18/12.


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