In Uncategorized on 06/24/2021 at 16:42

Periodic real estate meltdowns furnish the grittier grist that comes to the practitioner’s mill. Even those with thirty (count ‘erm, thirty) years’ experience can get it wrong. Witness Richard S. Hussey, 156 T. C. 12, filed 6/24/21, and his highly-credentialed adviser, whom I’ll call Mike the K.

Richard had twenty-seven (count ’em, twenty-seven) investment properties, and had to unload most of them. He short sold a bunch over a couple years (hi, Judge Holmes).

A “short sale” is one where the purchaser pays less than the outstanding balance of the mortgage for the property, also known as “underwater” property. All the mortgages on the properties were held by the same lender, who issued 1099-Cs for some, but charged off others and treated those unpaid balances as a loan loss reserve. Maybe Richard was personally liable on the notes as restated, and deficiency judgments were possible, hence the reserve. But that reserve was created in Year Two, so no discharge of debt in that year. Also no 1099-Cs for Year Two, although that isn’t necessarily dispositive.

Richard and Mike the K want to throw the basis adjustment to offset immediate CoD taxable gain one year forward into Year Two, using Section 1017(a). There’s no doubt Section 108(c)(2)(B) allows the treatment, if Section 1017(b)(3)(f)(iii) doesn’t anchor it to year of sale.

Judge Colvin finds that it does.

“Petitioner points out that section 1017(a) states generally that  basis reductions resulting from the discharge of QRPBI [Qualified Real Property Busines Indebtedness, and this is] are made the year after the debt is discharged. If section 1017(a) applies here, the basis adjustments at issue would, as petitioner contends, be made in [Year One]. However, section 1017(b)(3)(F) provides three additional rules which govern reduction of basis following discharge of QRPBI. First, real property, the aggregate bases of which are considered under section 108(c)(2)(B), includes only depreciable real property. Sec. 1017(b)(3)(F)(i). Second, the depreciable real property may not be held as inventory. Sec. 1017(b)(3)(F)(ii).” 156 T. C. 12, at pp. 10-11. (Footnote omitted, but it says specifics override generals).

OK so far.

But when Richard sold the properties, the debt was discharged. And that’s what Section 1017(b)(3(F)(iii) says mandates basis reduction in year of sale.

Judge Colvin checks out the House Report, to make sure.

If the taxpayer disposes of real property (in the transaction that gave rise to the discharge or otherwise) prior to the first day of the next taxable year, then the reduction in basis of such property is made as of the time immediately before the disposition. 15-H.R. Rept. No. 103-111, at 623-624 (1993), 1993 U.S.C.C.A.N. 378, 854-855 (emphasis added).” 156 T. C. 12, at pp. 14-15. (Footnotes omitted).

Note the cited House Report is online behind some kind of subscription wall. Here’s the link; use at your own risk. I make no guaranty, warranty, or representation of any kind whatsoever, however denominated, as to safety, accuracy, adequacy, fitness for purpose, merchantability, quality, or anything else. Sue them, not me.

No forwarding of basis reduction for Richard. And IRS wants accuracy chops.

Richard claims he knows nothing of tax or accounting, and Judge Colvin buys it. He didn’t like the return his usual preparer did, so found a CPA who turned him onto to Mike the K, thirty-year veteran tax attorney. And he gave Mike the K everything he asked for. So Richard claims good faith reliance.

IRS claims Mike the K was less than spectacular.

“Respondent points out that there are errors on petitioner’s returns prepared by the K Firm. For example, the bases in real properties retained by petitioner in 2013 had not been reduced on petitioner’s 2013 return even though they should have been under Mr. K’s analysis. Respondent also points out that petitioner’s home was erroneously listed as an investment property sold in 2013 and then recorded that it had been sold again in 2014 when reporting debt cancellation on a Form 982. Respondent contends these errors show that petitioner was not acting in good faith. We disagree. We do not believe petitioner is responsible for detecting errors of this nature in the reporting of complicated tax transactions.” 156 T. C. 12, at p. 23.

And IRS argues, with no basis in the record, that Richard went shopping for tax advice to suit, and that Richard should have realized that Mike the K’s advice was too good to be true. Yes, but; the latter assumes Richard was sharp enough to know about Section 1017(b)(3)(f)(iii), which he wasn’t.

No chops for Richard.


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