In Uncategorized on 09/11/2014 at 17:29

On background, see my blogpost “The Phone Call”, 4/15/14.

For today’s lesson, we will assume the phone call was received. The recipient had more than one of those cold, clear liquids containing an olive or maybe two, and probably needed every one. She (or he) spent the next morning composing The Letter, the one that we never wish to send, to that august entity, hereinafter known as The Carrier. After receiving the Reservation (and no, it’s not for Caesar’s Palace) from The Carrier, s/he meets a battle-hardened, I’ve-heard-it-all type in a creased striped suit with a rather outré tie (whom s/he will learn to love, eventually), hereinafter known as Claims Counsel. Claims Counsel may be my friend Mark, my other friend Mark, or my friend Marian. Whoever they may be, they’ve heard it all.

After depositions, document exchanges, and that heart-wrenching moment when s/he signs The Stipulation and the General Release, today’s lesson can begin.

And if, Dear Reader, all this is meaningless gibberish to you, thank whatever Higher Power you acknowledge. But be aware–before every storm, there is a calm. They were having drinks on the Titanic before the iceberg.

Judge Chiechi takes up the story of Garey A. Cosentino and Jo-Ann Cosentino, 2014 T. C. Memo. 186, filed 9/11/14, completing today’s hat-trick for me.

Gar and Jo wanted to provide for disabled daughter by hanging onto income-producing real estate. To prevent Uncle Samuel from laying hold of same to daughter’s detriment, Gar and Jo turn to the Section 1031 like-kindness. This they do several times, but each time bootless.

You’ll remember 1031s defer tax, but not if unlike property is involved (known as “boot”). Boot is taxable.

So when their trusted tax adviser suggests a basis-builder to allow Gar and Jo to take out some reduced-tax boot from a booted-up 1031, they jump at the chance.

Until IRS descends, and Gar and Jo discover they participated (unwittingly and unknowingly) in an abusive tax shelter, whereupon tax, interest and penalties fall from Federal and State.

Gar and Jo make The Phone Call. The scenario above set forth is played out, and Gar and Jo have a solatium to the tune of $375K.

Are their problems over? Hardly. IRS claims it’s taxable.

No, says Judge Chiechi. “Where the recovery represents damages for lost profits or other items taxed as ordinary income, it is taxable as ordinary income. Where the recovery represents a replacement of capital destroyed or damaged, it generally does not constitute taxable income to the extent that it does not exceed the basis of the destroyed or damaged property.” 2014 T. C. Memo. 186, at p. 19 (Citations omitted).

IRS argues that recoveries like Gar and Jo got were in cases where the taxpayers overpaid, the SOL ran, and they got back what they overpaid from the unhappy preparer. Gar and Jo underpaid.

“…an amount paid to a taxpayer in order to compensate the taxpayer for a loss that the taxpayer suffered because of the erroneous advice of the taxpayer’s tax consultant generally is a return of capital and is not includible in the taxpayer’s income.” 2014 T. C. Memo. 186, at p. 31. (Citations omitted).

You saw the magic word? “Generally”. Here’s the rest.

“That exception is that, under the so-called tax benefit rule, an amount paid to a taxpayer in order to compensate the taxpayer for a loss that the taxpayer suffered because of the erroneous advice of the taxpayer’s tax consultant is includible in the taxpayer’s income to the extent that it compensates the taxpayer for amounts that the taxpayer had deducted.” 2014 T. C. Memo. 186, at pp. 31-32. (Citation omitted).

And Gar and Jo got some of that $375K because they claimed amounts greater than what they could prove that they lost.  I’m sure The Carrier didn’t care, as long as they got out of the case. But Judge Chiechi cares.

So there will be an extensive Section 155 beancount, with taxable and non-taxable portions of the $375K chopped up pro rata.

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