Advice to real estate operators who want to swap a leasehold for fee title in a Section 1031 like-kind exchange, a darling of the real estate operators. Thus Judge Marvel opines in VIP’S Industries Inc. & Subsidiaries, 2013 T. C. Memo. 157, filed 6/24/13.

VIP’s had a 21-year leasehold of some land where they built a motel. They tried to swap it for fee interests.

Quick refresher: “Generally, gain or loss realized from the sale or exchange of property is recognized. Sec. 1001(c). Section 1031 provides, however, that no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of a like kind that is to be held either for productive use in a trade or business or for investment. Sec. 1031(a)(1). When money or unqualified property is received in an otherwise qualifying like-kind exchange, a taxpayer’s realized gain is recognized to the extent of the sum of such money and the fair market value of such unqualified property. Sec. 1031(b); sec. 1.1031(a)-1(a)(2), Income Tax Regs. The rationale for nonrecognition of gain or loss on the exchange of like-kind property is that the taxpayer’s economic situation after the exchange is fundamentally the same as it was before the transaction occurred. See Jordan Marsh Co. v. Commissioner, 269 F.2d 453, 455-456 (2d Cir. 1959), rev’g T.C. Memo. 1957-237; Koch v. Commissioner, 71 T.C. 54, 63-64 (1978). As a House report explained: ‘[I]f the taxpayer’s money is still tied up in the same kind of property as that in which it was originally invested, he is not allowed to compute and deduct his theoretical loss on the exchange, nor is he charged with a tax upon his theoretical profit.’ H.R. Rept. No. 73-704 (1934), 1939-1 C.B. (Part 2) 554, 564.” 2013 T. C. Memo. 157, at pp. 7-8.

But like-kind means like kind, and while a thirty-year or more leasehold term is like-kind for fee title purposes per Reg. section 1.1031(a)-1(c), 21 years is too short. And State law has nothing to do with it.

Even though VIP’s owned the improvements, which had a far greater value than the raw land on which they stood, the lease said that the improvements belonged to the landlord on expiry or sooner termination.

No nonrecognition, and tax due. Go long for a leasehold 1031.

Not only are knowledge and sophistication dangerous, but when you know enough to get a money-back guarantee in case your tax maneuver craters, you can’t claim that there was a “non-negligible risk” that the deal would unwind. That’s Judge Gustafson’s less-than-obliging lesson for Lawrence G. Graev and Lorna Graev, in 140 T. C. 17, filed 6/24/13.

It’s another façade easement case. I’ve blogged so many of these that I won’t cite to them here.

Larry was canny; when he bought his historic New York property and was approached by easement-vendor National Architectural Trust (NAT), he “…sent an email to NAT explaining a concern that had arisen:

“‘My accountants have referred me to Notice 2004-41 * * * issued by the IRS on June 30, 2004, in which the IRS has indicated that it will, in ‘appropriate cases’, disallow charitable deductions to organizations that promote conservation easements and may impose penalties and excise taxes on the taxpayer. They have not advised me to abandon this idea, but they have advised me to be very cautious. What are your thoughts especially as it relates to the side letter, etc.’

“(The ‘side letter’ to which Mr. Graev referred was NAT’s comfort letter assuring that it would refund a contribution in the event that the favorable tax results anticipated from a contribution were not achieved.)” 140 T. C. 17, at p. 8.

Moreover, “(O)n his tax returns Mr. Graev listed his occupation as ‘attorney’, and we infer that he is an individual of above-average sophistication who, with the help of his accountants, was capable of identifying tax risks. We find that Mr. Graev did in fact identify non-negligible risks regarding the deductibility of facade easements, as evidenced by his … email and subsequent dealings with NAT.” 140 T. C. 17, at pp. 8-9.

NAT claimed it was SOP for them to give back whatever cash the servient tenant (that’s the owner of the property burdened by the easement, and not a bit player from “Fifty Shares of Grey”) gave them to enforce the easement, get the documentation recorded, etc., if IRS torpedoed the Section 170 façade easement deduction. Moreover, NAT would enter into a recordable revocation of the easement.

IRS claims this made the whole deal conditional, and therefore the thing of beauty was not a joy forever. There is a “non-negligible risk” that the easement would dissolve, the cash get repaid and everything revert to status quo ante.

In simplest terms, “26 C.F.R. section 1.170A-1(e) clarifies that principle: no deduction for a charitable contribution that is subject to a condition (regardless of what the condition might be) is allowable, unless on the date of the contribution the possibility that a charity’s interest in the contribution ‘would be defeated’ is ‘negligible’.” 140 T. C. 17, at p. 22. The charity must keep the donated property; any possibility of defeasance must be “negligible”.

Larry claims the condition argument is “new matter”, as to which IRS has burden of proof, but here there are no disputed facts, so burden of proof is irrelevant.

And Larry knew there was a real risk; he asked his accountants and he insisted upon the “side letter”, giving him his money back and his property free and clear of the easement, if IRS blew up the deal.

Larry claims his valuation of the easement was reasonable, and for this case that isn’t an issue, but there are other ways a façade easement deduction can be blown up other than valuation.

However that may be, “(T)he mere fact that he required the side letter is strong evidence that, at the time of Mr. Graev’s contribution, the risk that his corresponding deductions might be disallowed could not be (and was not) ‘ignored with reasonable safety in undertaking a serious business transaction.’ 885 Inv. Co. v. Commissioner, 95 T.C. at 161.

“Mr. Graev was not alone in his assessment of the risk of disallowance. NAT considered it ‘standard Trust policy’ to return a cash contribution to the extent a deduction therefor was disallowed by the IRS. In numerous instances NAT issued ‘comfort letters’ assuring donors of this policy. The very essence of a comfort letter implies a non-negligible risk; and the author uses the letter to induce the recipient to enter into a transaction.” 140 T. C. 17, at p. 34.

Larry’s arguments under New York Environmental Conservation Law and under Federal tax law avail him not. Whatever the law says, there remains a non-negligible possibility that IRS will blow up the deal and NAT will honor their commitments in the side letter.

Beware of the money-back guarantee.

The following appeared today on the Tax Court website, in red letters: “The U.S. Postal Service (USPS) has informed the Tax Court that due to a mail processing equipment failure at the facility which processes the Court’s First Class mail, First Class mail delivery to the Court has been temporarily suspended. USPS anticipates that delivery will resume at the earliest on Thursday, June 27. Until then, the USPS will deliver only Third Class, Express, and Priority mail. The Court will post advisories if circumstances change.”

No certified or registered either, guys; take out that  old dog-eared copy of Notice 2004-83, 2004-2 C.B. 1030, and send in those petitions.

Federal Express First Overnight delivery service, that is, as Shelby Nash-Hunter learns in a designated hitter, Docket No. 28031-12, filed 6/21/13, Judge Goeke finding that Shelby is a day late and a lot more than a dollar short.

Shelby responds to a SNOD with a letter sent by FedEx First Overnight. The online dispatch date is Day Ninety, so Section 7502 bails out Shelby if Fed Ex First Overnight is one of the chosen few Private Delivery Services (PDSs) blessed by IRS.

Let’s not worry about whether the letter can be deemed to be a petition. We needn’t get there.

Judge Goeke: “In Notice 2004-83, 2004-2 C.B. 1030, an updated list of companies and classes of delivery service that constitute ‘designated delivery service’ for purposes of section 7502 was established by the Commissioner. Notice 2004-83 expressly states that FedEx is not designated with respect to any type of delivery service not expressly identified in its listing. See Scaggs v. Commissioner, T.C. Memo. 2012-258; Austin v. Commissioner, T.C. Memo. 2007-11.” Order, at p. 2.

For more about the Scaggs case, see my blogpost “A Busy Day”, 9/10/12.

Now the IRS has blessed only some of FedEx’s multiplicitous means of getting paper from any place to 400 Second Street, N.W., in Our Nation’s Capital.

Judge Goeke: “Insofar as FedEx is concerned FedEx Priority Overnight, FedEx Standard Overnight, FedEx 2 Day, FedEx International Priority, and FedEx International First are among the delivery services explicitly listed in Notice 2004-83. FedEx Overnight is not explicitly listed in Notice 2004-83 as a ‘designated delivery service’. Thus, the timely mailing/timely filing rule of section 7502 does not apply to FedEx First Overnight.” Order, at p. 2.

Shelby withdraws any opposition to IRS’ motion to dismiss for want of jurisdiction.

I quote myself: “But wouldn’t it be nice if IRS included the approved list in the notice telling taxpayers where, where and how to file a Tax Court petition? Maybe we should add a category to ‘Don’t Ambush the Indians’, 4/7/11, ‘Don’t Ambush the Accountants, Either’, 8/7/11 and ‘Don’t Ambush the IRS’, like ‘Don’t Ambush the Taxpayers’.” From my above-cited blogpost “A Busy Day.”

 Lori Lamb and husband Gary used Gary’s construction business, Gary Lamb Construction, accounts as pocket money for gambling. Being Oklahomans, they patronized the Kickapoo Casino. When the run of play turned against them, Lori and Gary used the Gary Lamb Construction ATM cards to keep them in the game.

 Should be a taxable distribution, right?

Maybe not, and in Lori’s and Gary’s case definitely not. See Lori R. Lamb, 2013 T. C. Memo. 155, filed 6/20/13. Gary’s case is consolidated with Lori’s, so you’ll find them under one caption, Judge Marvel having drawn both this happy couple and their attorney, the redoubtable Freddie, star of my blogpost “How Not To Do It”, 11/20/12.

Freddie’s up to his old tricks, not handing over documents, trying to smuggle in evidence he never told opposing counsel about, and claiming since a paralegal from IRS asked him for documents he didn’t have to produce them, because he had to answer only to another attorney. Freddie’s a real peach.

But Freddie wins one piece of the case.

Judge Marvel: “Although petitioners both testified that they regularly withdrew cash from the business bank accounts for personal gambling purposes, respondent has failed to show that these withdrawals constituted taxable income to them. Respondent [IRS] failed to introduce any evidence regarding the financial status of Gary Lamb Construction or whether Gary Lamb Construction earned any taxable business income during the year in issue. More importantly, respondent failed to introduce any evidence to show that the withdrawals represented taxable income to petitioners during the year in issue, rather than, for example, a nontaxable return of capital or a loan repayment. Accordingly, we are unable to find that petitioners received additional unreported taxable income attributable to their cash withdrawals from the business bank accounts during the year in issue.” 2013 T. C. Memo. 155, at p. 17.

IRS had burden of proof since IRS wild-carded in the deemed distribution argument post-deficiency.

So Freddie gets his clients a Rule 155 for the rest, although it doesn’t look too good for his clients.

You probably won’t win a Rule 161 reconsideration either. That’s Judge Vasquez’s lesson for B.V. Belk, Jr., and Harriet C. Belk, in 2013 T. C. Memo. 154, filed 6/19/13.

Y’all remember B. V. and Miz Harriet? No? Well, see my blogpost “A Thing Of Beauty – Accept No Substitutes”, 1/28/13, wherein I discussed B. V.’s and Miz Harriet’s North Carolina golf course scenic easement, which included a mix-and-match clause. Judge Vasquez upheld IRS’ denial of the $10 million deduction because of the mix-and-match (the donors could swap other properties for the donated property subject to the not-unreasonably-withheld consent of the donee), but B. V. and Miz Harriet want to give it another shot.

But first, the obligatory incantation: ““Reconsideration is not the appropriate forum for rehashing previously rejected legal arguments or tendering new legal theories to reach the end result desired by the moving party.’ Estate of Quick v. Commissioner, 110 T.C. at 441-442.” 2013 T. C. Memo. 154, at p. 6.

B. V. and Miz Harriet argue that Section 170(h)(2)(C) only requires they donate some property, not which specific property. Wrong, says Judge Vasquez, there are no floating easements. The donation of a partial interest (the scenic easement) splits the property into two pieces, namely, the donated and the retained. “Petitioners’ interpretation of the statute would allow the donated portion (i.e., the easement) to encumber any piece of property; it could be the retained portion or another piece of property that the taxpayer owns. This is inconsistent with the taxpayer taking a charitable deduction for giving up part of his or her property (i.e., a partial interest). If the donated portion does not restrict the use of the retained portion, then the taxpayer has retained 100% of the economic value of the property for which he or she is taking a deduction.” 2013 T. C. Memo. 154, at p. 8.

Next, B. V. and Miz Harriet says North Carolina law allows parties to modify contracts by mutual consent, and since the easement document provides for amendment, Tax Court should apply State law here. In support of their position, they cite two PLRs. But of course PLRs have no precedential value for anyone but the taxpayer who obtained them.

And in any case those PLRs permitted limited modifications to the existing servient estate (as the high-priced lawyers call the land burdened by the easement), not a swap meet.

Anyway. since when does State law trump the IRC?

B. V. and Miz Harriet argue they intended to create a scenic easement, and that should control. But Judge Vasquez says he can’t ignore the plain words of the easement that allowed for the mix-and-match.

Judge Vasquez: “It is inappropriate for the Court to ignore provisions included in the conservation easement agreement simply because petitioners planned to deduct the value of the conservation easement agreement. Our interpretation of the parties’ intention is governed by what the parties actually included in the conservation easement agreement. It is well settled that a taxpayer’s expectations and hopes as to the tax treatment of his conduct in themselves are not determinative….” 2013 T. C. Memo. 154, at p. 12. (Citations omitted).

Finally, B. V. and Miz Harriet claim that Tax Court has failed to trust the donee (the charitable organization which can enforce the easement) to protect the scenic easement. No, says Judge Vasquez, because even though any dominant tenant (the one who benefits from an easement, if you went to an expensive law school) can refrain from enforcing its legal rights, either by choice or neglect, that’s nothing to the point when you explicitly provide for a loophole like the swap meet provision in your easement agreement.

In short, B. V. and Miz Harriet, if at first you don’t succeed in Tax Court, pay for the appeal; don’t waste time with reconsiderations.

No, not a law firm, but rather enough activity to create taxable self-employment income for Rollin J. Morehouse and Maureen B. Morehouse, in 140 T. C. 16, filed 6/18/13.

Rolly was a marketing man who inherited some South Dakota farmland and bought some more, but instead of growing, Rollie hired a manager to plant, till and weed ground cover as part of the US Dep’t of Agriculture’s Conservation Reserve Program (CRP). This pays landowners not to grow anything but ground cover on erosion-prone land.

Rollie claims it’s exempt as rent, but IRS says it’s self-employment income subject to FICA.

First, Rollie says he himself did nothing. IRS says that’s not disqualifying, many people carry on businesses through agents, and Judge Marvel agrees.

Next, Rollie claims CRP payments are exempt from SE. IRS says Congress only exempted CRP payments to landowners who receive Social Security, and Rollie doesn’t claim he does.

But was Rollie engaged in a trade or business? The self-employment tax provisions of Section 1401 are to be broadly construed. No question Rollie was in the CRP to make money, and he did.

Judge Marvel: “He negotiated and executed the CRP contracts and, by doing so, obligated himself, as the owner of the properties to satisfy significant contractual obligations regarding planting, maintenance, and use of the properties enrolled in the CRP and compliance with CRP requirements. Although petitioner did not actually perform the planting and maintenance work required by the CRP, he hired an individual, Mr. Redlin, to perform the work according to CRP specifications, purchased necessary materials, such as seed, and provided them to Mr. Redlin, and regularly inspected the properties to ensure that they were being maintained and used in accordance with the CRP contractual obligations. On these facts we find that petitioner engaged in the business of participating in the CRP and managing his CRP properties with the primary intent of making a profit.” 140 T. C. 16, at pp. 20-21.

That Rollie employed Redlin doesn’t mean Rollie wasn’t in business.

And even though USDA called the CRP payments “rent”, that doesn’t make it so. Rent is for use and occupancy of property; USDA could come and inspect, but they didn’t occupy or use the property. Rollie still had command and control. And just because the local USDA people called what Rollie did “farming”, that doesn’t make it so either.

Doing soil conservation is work, making a profit at it is carrying on a business, so Rollie owes SE tax, and Tax Court is unanimous, with no concurrences or dissents.

No, not Dostoyevsky’s 1864 novella, but rather Judge Morrison’s foray into the subterranean depths of underground telephone infrastructure, more about which is to be found in Patrick D. Montgomery and Patricia A. Montgomery, 2013 T. C. Memo. 151, filed 6/17/13, while I was walking the battlefield of First Manassas. Thus this delayed posting.

Pat D’s dad founded a Sub S design company for putting telephone infrastructure in the cold cold ground, which Pat D took over upon Dad’s decease. But the design company couldn’t do the actual construction, so Pat D and Pat A formed a new LLC.

The Pats personally guaranteed a million-dollar loan for the Sub S, which defaulted. The Pats also defaulted, and the lender got a judgment against the Pats for $425K.

The Pats claimed an NOL for the amount of the judgment and also operating losses from the LLC.

IRS claimed Pat A didn’t materially participate in the LLC’s business. IRS loses that one. First, Pat D’s participation helps out Pat A, per Section 469(h)(5).

Judge Morrison takes up the rest: “Both Patricia Montgomery and Patrick Montgomery were integral in the process of setting up and establishing UDI Underground, LLC. The company began in April 2007 with no employees. The Montgomerys hired 250 employees on behalf of UDI Underground, LLC, by the end of 2007. Although the Montgomerys performed some services for Utility Design, Inc., during 2007, this older company already had established its business operations. The Montgomerys spent more of their work time on UDI Underground, LLC, than on Utility Design, Inc. They did not hold any jobs outside the two companies. They credibly testified that they worked thousands of hours for UDI Underground, LLC, during 2007. We find that the Montgomerys participated in UDI Underground, LLC, for more than 500 hours during 2007. On the basis of all the facts and circumstances we also find that the Montgomerys participated in UDI Underground, LLC, on a regular, continuous, and substantial basis during 2007.” 2013 T. C. Memo. 151, at p. 10.

But the Pats had no logs, so how did they prove what they did? “The Montgomerys provided details of the nature of the activities they conducted in starting and managing UDI Underground, LLC. The tasks they described included founding the company, negotiating contracts with AT&T, hiring 250 employees, and conducting daily business. They credibly testified they worked on the business ‘day in and day out.’ They were credible witnesses and were forthcoming with information about their activities regarding UDI Underground, LLC. We find that the proof the Montgomerys provided meets the requirements of section 1.469-5T(f)(4), Temporary Income Tax Regs., supra.” 2013 T. C. Memo. 151, at p. 11.

So testimony might work even when there are no logs or appointment books.

The Pats will get some losses passed through to them. But they founder on the big loss, the $425K judgment.

Section 1366(d)(1) limits S Corp shareholders’ losses to their adjusted basis in their S Corp stock plus their basis in S Corp debt. The Pats can’t prove any basis in their stock (surprising since Pat D inherited it; but as Dad lived in FL, I suspect it was all in a trust to avoid probate. Still, why was no Form 706 filed?).

So they need the judgment from the defaulted loan to show basis in Sub S corp debt.

No dice, says Judge Morrison: “When an S corporation shareholder guarantees a loan by a bank to the S corporation, no debt has been created between the S corporation and the shareholder. However, once the S corporation shareholder pays the bank pursuant to a guarantee, the S corporation becomes indebted to the shareholder. As we held in Underwood v. Commissioner, 63 T.C. at 476, ‘it is the payment by the guarantor of the guaranteed obligation that gives rise to indebtedness on the part of the debtor to the guarantor. The mere fact that the debtor defaults and thereby renders the guarantor liable is not sufficient.’”  2013 T. C. Memo. 151, at p. 18 (Citations omitted).

Had the Pats taken out the loan, made the S Corp assume the loan obligations as primary obligor, and stepped back as guarantors, that might have worked even if they defaulted, but there is nothing in the record to support that the Pats did anything like that. See 2013 T. C. Memo. 151, at p. 19, footnote 6.

Sometimes straight forward isn’t the way forward, especially underground.

No, not the would-be risqué line of my misspent youth (what a flop that was!), but Special Trial Judge His Honor Lewis (Love That Name) R. Carluzzo letting Al J. (“Big Al”) Schneider III, executor of the estate of Al J. Schneider, Jr., know that he has world enough and time to deal with the IRS’ amended answer and the additional tax and penalties IRS wishes to strew around.

The story is a designated hitter, Estate of Al J. Schneider, Jr., Deceased, Al J. Schneider, III, Executor, Docket No. 4556-10, filed 6/13/13.

The case had been on for trial twice, but each side got an adjournment (which Tax Court calls a continuance), and no date and time certain has been fixed for the main event.

STJ Lewis gives the usual Section 6214(a) bow, stating that IRS has the burden of proof as to the matters pled in the amendment, to wit, the increased deficiency and the penalties. I’d warn Big Al that he shouldn’t get too elated; the Section 6214(a) waltz usually ends with “I decide based upon the preponderance of the evidence, without regard to the burden of proof.”

Howbeit, here’s STJ Lewis: “We acknowledge petitioner’s claims of unfair surprise and prejudice, and appreciate petitioner’s point about the timing of the motion. Nevertheless,we do not share petitioner’s view that respondent’s motion should be denied on those grounds. After all, leave to amend a pleading is ‘to be given freely when justice so requires.’ Rule 41(a).

“According to petitioner, the expert report relied upon by respondent relevant to the matters covered in the amendment to answer was received on January 23, 2013. Petitioner will have had sufficient time to review and respond to that report by the time that the trial, if any, in this case is held.” Order, at pp. 1-2. (Citations omitted).

Apparently Big Al is peeved because IRS waited from January, when they had their expert’s report, until April, when they made their motion to amend. As IRS held back amending, I’d guess Big Al’s trial strategy did not contemplate addressing the increased potential liability or, perhaps, the need to engage other experts to rebut.

Now STJ Lewis says, “you’ve had the report, and trial isn’t next week, so go prepare.”

But I have some sympathy for Big Al’s position. See my blogposts “Don’t Ambush the Indians”, 4/7/11, and “Don’t Ambush the Accountants, Either”, 8/17/11.

Cesare Giaquinto confronts the famous line from the 1977 Mel Brooks classic “High Anxiety” when his attempt to claim he’s not responsible for a bunch of TFRPs from his employer founders on his failure to claim the certified letter from IRS containing the Letter 1153, the key to appealing from the determination to assess the TFRPs of his employer against him as a responsible person.

Judge Marvel has the story in 2013 T. C. Memo. 150, filed 6/12/13.

Cesare worked for Salvadeo, and filled out a Form 4180, Report of Interview with Individual Relative to Trust Fund Recovery Penalty or Personal Liability for Excise Taxes, when a Revenue Officer called to find out why Salvadeo hadn’t paid $95K worth of withholdings.

But Cesare never sent in a Form 433-A, because Salvadeo told him not to. Cesare also didn’t pick up his certified mail on three occasions, and only got the Letter 3172 telling him about the tax lien IRS was filing against him.

IRS gets a USPS employee to testify that they left USPS Forms 3849s, attempted delivery notices, for Cesare. “Where the Commissioner has shown that he properly sent the appropriate notice to a taxpayer by certified mail and that the mail carrier left USPS Forms 3849, we have sometimes found that the taxpayer’s failure to claim delivery of the certified mail was deliberate.” 2013 T. C. Memo. 150, at p. 12 (Citations omitted).

“Petitioner contends that he had no reason to avoid or refuse any mailing from the IRS that would have given him the opportunity to contest the sec. 6672 trust fund recovery penalties. Our cases, however, are replete with instances where taxpayers thought that ignoring or refusing mail from the IRS would make their tax problems disappear.” 2013 T. C. Memo. 150, at p. 14, footnote 9 (Citations omitted).

Needless to say, Cesare lost his chance to contest his responsible personhood. His tale of nonreceipt doesn’t convince Judge Marvel, who finds deliberate refusal to receive the Letter 1153.

Compare and contrast with Antonio Lepore’s story, as told in my blogpost “You Didn’t Get It – Part Deux”, 5/31/13.