Just Not a First-Time Homebuyer Home

One more of the 2008 First Time Homebuyer Tax Credit “not for nuthin’”s, David Merritt Funk, T. C. Sum. Op. 2012-82, filed 8/22/12.

Dave and Amber J. Reeves enter into an Iowa land contract in 2007 to buy a home, move in and start paying taxes, but don’t get a deed until 2008.

I don’t see land contracts here in the East, but they’re common, I am told, out in the Great Wide-Open. Seller agrees to deed real estate to purchaser if purchaser makes all installment payments of purchase price and interest, pays all taxes and insurance when due, and makes all repairs. If you read the land contract, most of which is printed in Judge Chiechi’s decision, it looks like a purchase money mortgage, bar the warranty of title.

Dave argues he didn’t own the home until he got the deed, in 2008, when he got a conventional mortgage, paid off the seller, and got the deed. Dave alone claimed the FTHBC-1.

Of course, the FTHBC-1 fails, as the purchase took place too soon, in 2007, rather than in 2008. While the seller had legal title until 2008, Dave had equitable title under Iowa law in 2007, was in possession and treated the home as his principal residence, and had the benefits and burdens of ownership. And Dave deducted his mortgage interest and real estate taxes on the home for calendar 2007. So Dave was a first time homebuyer before the magic date for the credit.

I’m glad that both iterations of the FTHBC are gone. They did little or nothing to alleviate the housing crisis, and were invitations to game the system.

And Cut to the Chase

It’s the dog days of summer, and Tax Court is somnolent; nothing but unsubstantiated deductions and loss carryforwards, with the odd protester thrown in.

So I’m reduced to reading Undesignated Orders. Those mostly tell litigants to serve and file responses, sign their petitions, or report the status of their cases.

However, today, 8/21/12, we have two orders that go a little farther.

First is Charnae Mattrice Hester, Docket No. 10495-12. Charnae’s petition is bounced for late filing, even though she claims she did file timely under Section 7502. The bad news for Charnae is that she didn’t put enough postage on the envelope.

Chief Judge Thornton has a certain quantum of pity for hapless Charnae, but that won’t get her into Court: “Petitioner appears to rely on the ‘timely mailing is timely filing’ rule of I.R.C. section 7502, however, the benefits of that rule are unavailing here because when the petition was initially mailed, it did not bear proper postage. Accordingly, the date the petition was re-mailed with sufficient postage applied controls.

“The record establishes that the petition was not filed within the applicable statutory 90- day period. This Court has no authority to extend that period provided by law for filing a petition “whatever the equities of a particular case may be and regardless of the cause for its not being filed within the required period.” Axe v. Commissioner, 58 T.C. 256, 259 (1972). Accordingly, this Court lacks jurisdiction to redetermine the deficiency determined in the notice of deficiency for 2010.” Order, at p. 2. (Citations omitted.)

But of course Charnae can petition IRS for an audit redetermination (good luck with that, Charnae), or pay the tax and sue in District Court or Court of Federal Claims (supra).

Charnae, next time pay the postman; it’s cheaper than the filing fee in USDC.

Next up is Jane E. Zdunek, Docket No.27966-10S. Jane wants to introduce evidence on the trial that “… the correspondence examination did not properly handle the audit prior to the notice of deficiency and that the case could have been resolved at the examiner’s level with no adjustment to the interest expense and therefore no need to take the matter to Tax Court.” Order, at p. 1.

IRS files a Motion in Limine to forbid the introduction “of evidence relating to the communications between petitioner and respondent prior to the issuance of the notice of deficiency on the grounds that such evidence is neither relevant nor material and is an attempt by petitioner to go behind the notice of deficiency.” Order, at p. 1.

STJ Armen sets the motion down for hearing next week, rather than going on the papers, because Jane hadn’t stated what evidence she means to submit. But he reminds the parties to stick to the facts of the deficiency: “…unless the parties settle this case, the issue at trial for decision by the Court will be whether the amount claimed was interest expenses and, if so, whether it was paid. The issue will be decided based on the relevant facts as adduced at trial and the applicable law, i.e., Internal Revenue Code, applicable Treasury regulations, and prior judicial cases. Events that occurred during the administrative stage of this case are generally irrelevant, as such events have nothing to do whether petitioner is entitled to the deduction claimed. Further, the Court will decide the disputed issue de novo, i.e., without regard to a prior administrative proceeding, if any. [Emphasis added.]”. Order, at pp. 1-2 (Emphasis by the Court).

So, Jane, the past isn’t even prologue. Prove you paid a deductible expense, and you’re good to go.

Unless you can prove hardship, the schedules of national and local allowances govern housing expenses for figuring out collectibility. That’s the lesson Judge Goeke has for Wayne Clark, in T. C. Memo. 2012-238, filed 8/16/12.

Even though Wayne had only paid about $5K of the nearly $750K he owed in taxes for three years, he went and bought a house for $950K.  Judge Goeke describes this palazzo as having “at least 4,000 square feet of interior finished living space, is on a lot of approximately two acres in a gated ‘golf course community’, and has four bedrooms and five bathrooms.” T. C. Memo. 2012-238, at p. 4.

Wayne’s explanation is that he was a part-time consultant for Prince George’s County, MD, trying to entice business to locate there, using his wholly-owned LLC, Clarke & Company, LLC.

Wayne claims “that he ‘purchased his primary residence to help promote confidence among businesses that Prince George’s County is still a booming community’ and that he used his home ‘office to meet prospective clients and the location of his office allowed him to produce income. Petitioner further claims that without the home office ‘he would be forced to rent outside space which would not be a viable option considering the unpredictable nature of his income’.” T. C. Memo. 2012-238, at p. 13.

Wayne says that the SO assigned to his CDP abused his discretion by not allowing Wayne’s special circumstances to trump the national and local allowances.

Judge Goeke isn’t going there. “While respondent was generally aware of petitioner’s business, there was no evidence presented that petitioner made the Appeals Office aware of the fact that one of the rooms in his home was used as an office for Clarke & Associates. Indeed, each Form 433-A petitioner submitted listed an address for Clarke & Associates that was different from his personal address listed. There was no evidence presented that petitioner informed respondent’s Appeals Office or the SO that his housing expenses may have helped him (through Clarke & Associates) to produce income. Because petitioner failed to prove this information was provided to the SO, we find that he failed to prove the SO abused his discretion in using the local standard housing and utilities allowances instead of petitioner’s stated housing and utilities expenses.

“Even if petitioner had informed the SO of the facts regarding his business and home office, we would still rule that the SO did not abuse his discretion, as we find that petitioner’s home was not a necessary expense for production of his income and that no special circumstance exists which would allow him to deduct his stated housing and utilities expenses. Apart from vague testimony, petitioner offered no evidence that owning the home helped Clarke & Associates generate business. We also compare the size of the house as a whole (4,000 square feet on two acres of land with four bedrooms and five bathrooms) with the size of the areas used for business. Petitioner testified he used one room as an office but that he also “spread things out in the–off the kitchen. Sometimes we bring folks in, and they sit in the living room and downstairs”. Considering the cost of the house (nearly four times the local standard housing and utilities allowance) and the vague and unproven benefits to his business, we find that petitioner was not entitled to his claimed housing and utilities expenses of . . .and that the SO did not abuse his discretion in not allowing him this claimed monthly expense.” T. C. Memo. 2012-238, at pp. 15-16. (Footnotes omitted.)

A home is a house only if it fits the schedules, or you can show true hardship. Sorry, Wayne.

Isn’t Worth the Paper It’s Not Written On

Another uninteresting Tax Court case August 14 (unopposed summary judgment in a collection alternative where taxpayer wasn’t current with estimateds and current liabilities), so on to the Designated Hitters.

And who shows up (twice) but our old friend the Flying Dream Teamer F. Lee Bailey? See my blogposts “Service Trumps Sickness”, 4/2/12, and “A Victim of His Own Success”, 4/4/12.

You’ll remember F. Lee got rudely handled over the money he earned while safeguarding his client’s ill-gotten gains for the benefit of a U. S. civil forfeiture, based on a handshake. F. Lee again asserts a handshake over a pension distribution from his late wife Patricia, which IRS claims F. Lee got, but F. Lee claims he held in trust for Patricia’s mom, Mrs. McGovern, pursuant to an oral trust.

Judge Gustafson gets this gem on a motion for reconsideration, and issues a Designated Order, filed 8/14/12. Bottom line: F. Lee, you have to be more specific. F. Lee claims that Mrs. McG wanted a mortgage paid off on a condo if her daughter predeceased her, which in fact happened. But the mortgage never made it into the trial record, and Judge Gustafson can’t tell if F. Lee would have benefited from the payoff.

Now oral trusts can be enforced, but they need “strong proof”, and F. Lee hasn’t got it. Judge Gustafson: “Mr. Bailey’s position, if it succeeded, would therefore excuse the payee (himself) from tax on apparent income and would shift the liability to someone unknowable by the tax collector–i.e., the beneficiary of an oral trust. The law abhors such asymmetry or ‘whipsaw’. In the United States Court of Appeals for the First Circuit (to which an appeal in this case would be taken), that abhorrence reflects itself in a heavy evidentiary burden that is put on a party to a contract who seeks a tax treatment at odds with the terms of a contract. See Muskat v. United States, 554 F.3d 183, 188-189 (1st Cir. 2009) (to alter an allocation in a written agreement for tax purposes, ‘the proponent must adduce “strong proof” that, at the time of execution of the instrument, the contracting parties actually intended the payments to compensate for something different’). Here Mr. Bailey asks us to uphold a tax treatment at odds with the apparent terms of the pension contract, which named Mr. Bailey in his individual capacity (not as a trustee) as the death benefit beneficiary. If we treat this situation as analogous to Muskat and therefore look for ‘strong proof’ of an oral trust, that strong proof is certainly lacking.” Order, at p. 3.

So an oral trust had better be strong, or it’s not worth the paper it’s not written on.

Oh yes, the citation is F. Lee Bailey et al., Docket No. 3080-08, 3081-08.

That’s the advice I would give Big Jim Dempsey, the V.P. of Atlantic Coast Masonry, Inc., which corporation gets short shrift in T. C. Memo. 2012-233, filed 8/13/12, with Judge Jacobs cementing IRS’ position that the masons Big Jim hired were employees, not independent contractors, so FICA, FUTA and ITW (income tax withholding), plus penalties and interest, fall on Big Jim like a ton of metaphoricals.

Of course, Big Jim and Blanche (Mrs. Big Jim, President) kept no records except a cash ledger book, did everything in cash, and made deals on a handshake. Big Jim bought the materials and supplies, which by the terms of the subcontracts under which Atlantic was employed belonged to the general contractors (a standard provision in subcontracts); the masons furnished their own tape measures, trowels, levels and hand tools. And being skilled workers, the masons didn’t need much supervising: apparently you point them at a pile of bricks and a tub of mortar, and they’ll build you a wall where you want, as high as you want. McNally, apparently a friend of Big Jim’s, ran the shape-ups of the masons and did whatever minimal supervision was required.

Oh, of course Big Jim and Blanche never filed 940s, 941’s, 1065s for their Sub S Atlantic, 1040s for themselves, or 1099-MISCs for the supposedly independent contractor-masons.

Now why hire  a lawyer, when it looks like Big Jim, Blanche and Atlantic are toast? Here’s why. Atlantic appears by Big Jim, who is an officer, with nobody else. The issue is whether Big Jim controlled the masons’ work. Judge Jacobs:  “The examining revenue agent testified without objection by petitioner that in interviews some of the masons and laborers stated they would receive instructions relating to the masonry jobs from Mr. Dempsey. None of the masons, laborers, or supervisors other than Mr. McNally testified at trial.” T. C. Memo. 2012-233, at p.15, footnote 6.

How do you spell “hearsay”? And how, Judge Jacobs, do you expect a bricklayer like Big Jim to know to object when the examining agent proffers objectionable evidence? Or who to call as a witness?

Granted, even without the objectionable hearsay, Big Jim’s walls were about to come tumblin’ down.

But it’s just another example of how the unrepresented taxpayer in Tax Court is in the position of certain predecessors of Big Jim’s, who were on a job in the Middle East making bricks without straw.

See my blogpost “You’ve Got to Be More Specific”, 4/19/11.

Nothing new in Tax Court on Friday, 8/10/12, except a Designated Order from Judge Lewis (right way to spell “Lewis”, Judge) Carluzzo.

The Tax Court website instructs us that “(D)esignated orders may exclude routine, nonsubstantive orders such as scheduling orders or rulings on motions for extension of time. Designated orders are not a complete inventory of all orders of the Court nor are these versions official documents of record. Designation practices of Judges vary; some select more of their orders for posting here than others.” In short, Designated Orders are snapshots of a Judge’s life in Court. And the Judges select the snapshots.

This one is interesting because IRS could have saved time and money by being specific. The order here dismisses the petition for redetermination of deficiencies for lack of prosecution. Petitioner asked for a continuance on the day of trial, and IRS moved to dismiss.

Judge Carluzzo holds off on both, sends the parties off, and asks for a status report. Petitioner gives none, but IRS states “on June 12, 2012, the parties conferred and ‘resolved five out of eleven of the issues asserted in the notice of deficiency.’”

Judge Carluzzo, a patient jurist, goes on to state: “Nevertheless, as of the date of respondent’s status report, certain substantiating documents long promised by petitioner had yet to be provided to respondent. The reductions, if any, in the deficiencies here in dispute as a result of the resolution of the five issues referenced in respondent’s status report are not apparent from anything submitted.”

So we don’t know what the final number is, IRS not having told us exactly to what IRS and petitioner agreed. But Judge Carluzzo has had it with petitioner, and dismisses the petition.

Now Section 7459(d) tells us what the Tax Court has to do when a petition is dismissed in a redetermination: “If a petition for a redetermination of a deficiency has been filed by the taxpayer, a decision of the Tax Court dismissing the proceeding shall be considered as its decision that the deficiency is the amount determined by the Secretary. An order specifying such amount shall be entered in the records of the Tax Court unless the Tax Court cannot determine such amount from the record in the proceeding * * *”

So there’s a judgment for IRS in whatever amounts IRS and petitioner agreed to. Plus Section 6662(a) penalties, of course.

But wouldn’t it have made Judge Carluzzo’s life a lot simpler if IRS had specified in the status report exactly what IRS’ deal was with petitioner? And what was IRS’ bottom line?

Oh, by the way, the Order is Ogungbayi v. Commissioner, Docket No. 17493-11 S, filed 8/10/12.

Yes, you have to be more specific.

Unabated, On an Erroneous Refund

The tale of Luther Herbert Alcorn, III, 139 T. C. 4, filed 8/9/12, is a comedy of errors, ending in unabated interest. Judge Wells traces the errors, from Lute’s misplaced 1040-ES payment through IRS’ ignoring his note and double-crediting his ES payment, to Lute’s not noticing that his refund was $4 grand too much.

Lute filed timely and included his $4 grand 1040-ES payment, but he put it on the wrong line, line 62, “withholding”, lumped in with his other withholding, and not line 63, “previous overpayment applied plus 1040-ES”. I can feel Lute’s pain; I made a similar mistake myself one year, withholding from an IRA distribution didn’t get properly credited, so my refund was too small, and I spent the best part of a year trying to get that omelet unscrambled, fortunately without interest or a subsequent year’s deficiency resulting.

But Lute wasn’t so lucky. Lute attached a note to his 1040, stating his $4G estimated was included in the withholding amount. IRS argued they had no time to read billets doux from taxpayers, but their own Manual says “‘Examine all attachments to the return’ and ‘all taxpayer-initiated correspondence must be responded to within 30 days.’ Internal Revenue Manual pt. 3.11.3.3.7 (Jan. 1, 2008).” 139 T. C. 4, at p. 16. (Footnote omitted.)

Lute’s note wasn’t a model of clarity, but Judge Wells said it could have tipped IRS off that Lute’s 1040-ES payment was already included in the computations in his return.

IRS double-credits the $4K, sends Lute a big refund, but then IRS wakes up, discovers the erroneous refund, asks for and gets its money back. Lute asks for and gets abatement of the late payment penalty IRS imposed, because Lute didn’t file or pay late, but when Lute asks for abatement of interest, IRS says “Since the tax information shown on your original return was incorrect or incomplete, this is considered a contributing factor in the issuance of the refund, and therefore does not qualify for the removal of the interest charge under the Tax Reform Act of 1986.” 139 T. C. 4, at p. 5.

Now for the law; since nobody disputes the facts, this is a pure question of law (summary judgment). Sections 6404(e)(1) and 6404(e)(2) are the basic rules. Section 6404(e)(1) is the famous IRS managerial or ministerial delay; Section 6404(e)(2) is the mandatory interest abatement for erroneous refunds less than $50K unless taxpayer error caused the error. And each abatement period commences to run at different times, although they may overlap.

Naturally, Lute and IRS each claim the other made the mistake and they themselves were blameless, but Judge Wells says no: “Although neither party is willing to admit to making an error, it is clear to us that both parties made errors. Accordingly, we examine the statute to decide whether, on the basis of the facts and the errors committed by both parties, respondent abused his discretion in denying petitioner’s request for abatement of interest.” 139 T. C. 4, at p. 9.

IRS claims this is not an erroneous refund, but overstated withholding. That doesn’t fly, because the plain language of Section 6602 and Section 7405 relegates IRS to a civil action for recoupment of the erroneous refund, and not deficiency, followed by lien and levy, because there was no underpayment of tax.

So the question for Judge Wells is whether IRS abused its discretion by denying Lute the refund under Section 6404(e)(2), where the magic language is “the taxpayer in any way caused the erroneous refund.” Judge Wells notes that Northern District of Ohio once ordered a refund where the taxpayer contributed to the erroneous refund, and later the Court of Federal Claims, relying on the N.D. Ohio case, found IRS had made a serious error in addition to that taxpayer’s erroneous claims; but Tax Court refuses to follow those cases, because both fail to explain how the words “in any way” don’t mean in any way.

Judge Wells finds in Section 6404(e)(1) that IRS has discretion to abate interest, so that Section 6404(e)(2) likewise gives IRS discretion to abate, even though the statute doesn’t say so.

“For instance, some erroneous refunds will also result in deficiencies, and, for those deficiencies, the Commissioner is authorized by section 6404(e)(1) to abate interest on a deficiency caused by an error or delay ‘if no significant aspect of such error or delay can be attributed to the taxpayer’. That limitation authorizes abatement even if the taxpayer is somewhat at fault for the error or delay, as long as the taxpayer’s fault is not a significant aspect of the error or delay. Consequently, the section 6404(e)(1) limitation is not as restrictive as the limitation under section 6404(e)(2), which reserves mandatory abatement for those situations where the taxpayer has not ‘in any way caused’ the error. If a taxpayer committed some minor fault that contributed to the Commissioner’s issuance of an erroneous refund but that was nonetheless overwhelmingly the Commissioner’s error, and, if that refund resulted in a deficiency, the Commissioner clearly would be authorized to abate interest pursuant to section 6404(e)(1) for the period after the Commissioner contacted the taxpayer in writing. However, if section 6404(e)(2) is read to restrict abatements on erroneous refunds to only those situations where the taxpayer did not cause the erroneous refund ‘in any way’, then the taxpayer would be ineligible for abatement pursuant to section 6404(e)(2). Because that result seems incongruous, we conclude that the ‘in any way caused’ limitation under section 6404(e)(2) applies only to the mandatory nature of section 6404(e)(2) and does not restrict the Commissioner’s authority to abate interest with respect to erroneous refunds.” 139 T. C. 4, at pp. 19-20. And IRM pt. 20.2.7.5 (Mar. 9, 2010) states that IRS has discretion to abate interest under Section 6404(e)(2) even for refunds greater than $50K.

So did IRS abuse its discretion? No. Lute did make the mistake that set the train of events in motion, and when he got the refund check he should have noticed something was wrong.

“In respondent’s (IRS’) January 28, 2011, letter denying petitioner’s request to abate the interest on petitioner’s excess refund, respondent explained that, because an error on petitioner’s return contributed to the issuance of the refund, petitioner did not qualify for interest abatement. We cannot conclude that it was an abuse of discretion for respondent to decline to abate interest because of petitioner’s mistake on his Form 1040. That determination is consistent with the limitations regarding taxpayer fault in both section 6404(e)(1) and (2). Additionally, we note that petitioner should have been aware that respondent had issued an erroneous refund when he received a much larger refund than he expected because the May 11, 2009, letter and tax statement explained that respondent had changed the amount of estimated tax reported on petitioner’s return. That explanation should have alerted petitioner to respondent’s error and prompted petitioner to contact respondent to inquire about the refund, as petitioner did when he received respondent’s August 30, 2010, letter telling petitioner that he owed money. On the basis of the foregoing, we conclude that respondent did not abuse his discretion when he denied petitioner’s request for abatement of interest with respect to the erroneous refund.” 139 T. C. 4, at pp. 23-24.

Sorry, Lute, but thanks for the lesson.

Joe Veriha claimed his truck leasing operation was passive, but the IRS said his position was too aggressive, so Joe’s operation gets recharacterized as active, in Joseph Veriha and Christina F. Veriha, 139 T.C. 3, filed 8/8/12, with Judge Wells at the wheel.

Joe ran a trucking business C Corp, but leased his trucks and trailers from a Sub S he owned 99% of, or else from an LLC he owned 100% of. Joe also ran the C Corp, which employed both him and Chris; he materially participated in the C Corp.

Among the other little quips and jingles introduced by the celebrated Internal Revenue Code of 1986, as elaborated by Treasury, is Reg. 1.469-2(f)(6), Income Tax Regs. (sometimes referred to as the “self-rental rule or the recharacterization rule”).

This goodie says that, while all rental activity is generally (don’t you just love the word “generally”?) passive, rental of equipment from an entity controlled by taxpayer, which equipment is used in a trade or business in which taxpayer materially participates, is active, not passive. Thus passive losses cannot be used to offset income generated by such rental activity.

Now Joe’s Sub S rentals made money, but Joe’s LLC rentals lost, so Joe of course wanted to net the two and pay tax only on the overall net. IRS said Joe could net within the Sub S, and net within the LLC, but could not net the LLC’s losses against the Sub S’s gains. See my blogpost “Winning the Paper Chase”, 6/6/12.

Joe had separate leases for each truck and each trailer, either from his Sub S or his LLC.

Judge Wells: “Each tractor was leased (to Joe’s C Corp) as one unit, and each trailer was leased (to Joe’s C Corp) as one unit. The monthly rate for leasing each tractor was determined by the tractor’s age, and the monthly rate for leasing each trailer was determined by the type of trailer. During 2005, the tractors and trailers owned by (Joe’s Sub S) and (Joe’s LLC) were all parked in the same lot and were intermingled. All the tractors were painted the same yellow color, and all received the same scheduled maintenance. (Joe’s C Corp) paid the expenses for all of the tractors and trailers and insured all the tractors and trailers under the same blanket insurance policy. In determining which tractor or trailer to use on a route, (Joe’s C Corp) made no distinction between those (Joe’s Sub S) owned and those (Joe’s LLC) owned. Similarly, when it assigned drivers, (Joe’s C Corp) did not make any distinction on the basis of the ownership of the tractor or trailer.” 139 T. C. 3, at p. 4.

“Section 1.469-2(f)(6), Income Tax Regs., explicitly recharacterizes as nonpassive net rental activity income from an ‘item of property’ rather than net income from the entire rental ‘activity’. Section 469 and the regulations thereunder distinguish between net income from an ‘item of property’ and net income from the entire ‘activity’, which might include rental income from multiple items of property. Even when items of property are grouped together in one activity, section 1.469-2(f)(6), Income Tax Regs., still applies to recharacterize rental income from an item of property as nonpassive income.” 139 T. C. 3, at pp. 7-8 (Citation omitted.)

Now here’s where the trail becomes tangled. “The parties disagree about the definition of the phrase ‘item of property’. In the notice of deficiency, respondent (IRS) determined that the income from (Joe’s Sub S) should be recharacterized as nonpassive income. The notice of deficiency does not explain the rationale for that recharacterization, and petitioners contend that the notice of deficiency determined that each fleet of tractors and trailers (Joe’s Sub S) and (Joe’s LLC) owned was a separate ‘item of property’ and that the income from (Joe’s Sub S) should be recharacterized pursuant to section 1.469-2(f)(6), Income Tax Regs. However, on brief respondent contends that the notice of deficiency determined that each individual tractor or trailer is an ‘item of property’ but that respondent elected not to challenge the offsetting of income and losses with respect to each tractor or trailer within (Joe’s Sub S) or (Joe’s LLC). In contrast, petitioners contend that the entire collection of tractors and trailers, i.e., all the tractors and trailers whether owned by (Joe’s Sub S) or (Joe’s LLC), constitutes a single ‘item of property’.” 139 T.C. 3, at p.8.

Of course, neither the Code nor the Regs define the term “item of property”, so Judge Wells hits the books and finds: “…‘item’ is defined as a separate thing that is part of a larger collection. Those definitions support respondent’s contention that each separate tractor or trailer is an ‘item of property’. Indeed, the articulation of petitioners’ argument requires the use of a term such as ‘collection’, ‘group’, or ‘whole’, all of which serve to distinguish the collection of tractors and trailers from any single tractor or trailer, i.e., any single ‘item of property’. Accordingly, we conclude that each individual tractor or trailer is an ‘item of property’ within the meaning of section 1.469-2(f)(6), Income Tax Regs.” 139 T. C. 3, at pp. 9-10.

Joe argues that IRS did, at least in one reported case, treat bunch of over-the-road trailers as a single item of property, but Judge Wells won’t drive that road. “We are not persuaded by petitioners’ contention. We have repeatedly held that, even with respect to the same taxpayer, the Commissioner is not bound in any given year to allow the same treatment as in prior years.” 139 T. C. 3, at p. 11.

“Accordingly, we conclude that respondent is not bound to treat petitioners’ tractors and trailers as one item of property even though the Commissioner may have treated the over the road trailers … as one item of property. Moreover, it is not even clear that… the  Commissioner actually treated all of the over the road trailers as one item of property. Indeed, the Commissioner’s treatment of the trailers … is consistent with respondent’s position in his brief that, although respondent considers each individual tractor or trailer a separate item of property, respondent is electing not to challenge petitioners’ offset of the income and losses from each item of property within (Joe’s Sub S) and (Joe’s LLC).” 139 T. C. 3, at p. 12. (Citation omitted)

And if Joe claims that the entire fleet of tractors and trailers were all one “item of property”, why did he have two entities to run the rentals? Joe could have put them all under one entity, but under good old Commissioner v. Nat’l Alfalfa Dehydrating & Milling Co., 417 U.S. 134 (1974), you can pick the business form, but once you do, you’re stuck with it.

So no go, Joe. But your winning Sub S can net its aggregate losses against its aggregate winnings to get the amount of active income on which you must pay tax.

That’s the claim of Gregory Raifman and Susan Raifman in T. C. Memo. 2012-228, filed 8/7/12, and Judge Wells is prepared to listen, even though IRS wants Greg and Sue tossed on summary judgment.

See my blogpost “It Might Be a Rip-Off But It Isn’t a Theft”, 6/16/11. There, Oscar Hawaii couldn’t show that anyone made away with his stock or that his stock was worthless, so no theft loss. But here, it’s a different story.

Greg’s and Sue’s financial whiz Joltin’ Joe Ramos hooked them up with the improbably-named but larcenously-inclined Yuri Debevc Derivium. Derivium, through his eponymous financial corporation, claimed to convert big capital gains on appreciated stock into non-taxable loan proceeds.

In a manner reminiscent of Mid-Coast Financial (see my blogpost “Game Ends In No Score”, 5/30/12), Derivium lends Greg and Sue 90% of millions’ worth of the stock they pledge to Derivium, which gets the stock registered in the name of Derivium; loan terms are  principal to be repaid in three years with interest accruing. Derivium supposedly is going engage in hedging transactions via its overseas siblings and subsidiaries, so they can return the stock untouched by human hands when Greg and Sue repay the loan with interest.

Of course, it’s the classic ring-a-ring-rosie. Derivium hedges nothing, sells the stock, sends the 90% to Greg and Sue, keeps the 10% for itself, using part thereof to play Ponzi with other suckers. Finally, Greg and Sue demand back their stock, which has increased in value, at loan maturity, but by that time Derivium is over the hill and far away.

Greg and Sue sue all and sundry, but get only “a paltry sum” from Joltin’ Joe, and a soldier’s farewell from Wachovia Securities, that cleared the stock sale.

When Greg and Sue get a deficiency from IRS for a year subsequent to the Derivium swindle,  they claim they’d have a loss carryforward to offset the deficiency, if the Derivium deal was in fact theft.

Now we remember from poor ol’ Oscar Hawaii that State law decides whether there’s been a theft loss. Greg and Sue are Californians, and the Bear Republic has a unitary theft statute, combining all the good old law school criminal law 101, everything from classic robbery to embezzlement to larceny by trick or device.

The case comes up on a CDP, and even though IRS concedes that the AO should have considered the carryforward but didn’t, IRS doesn’t want to send the case back to Appeals, and asks for Rule 121 summary judgment.

IRS doesn’t get it.

First, de novo review of liability, as Greg and Sue never got the chance to dispute their tax liability with respect to one of their deals with Derivium.

Second, the question of loan vs. sale. Judge Wells finds a basketful of cases holding that the Derivium deals were sales, not loans. Title to the stock passed to Derivium under the documents; Derivium could do what it wanted with the stock, ostensibly in aid of its hedging operations (nudge-nudge, wink-wink) and it did; it dumped the stock, took its cut, sent the suckers some money, and jumped the hedge, leaving the suckers to whistle for their stock.

Every other Derivium customer who tried to claim “loan” got told that they had sold their shares, with a call option to cause Derivium to sell the shares back to them for the “principal and interest”. If they could find Derivium.

But Greg and Sue take a different tack. “Petitioners contend that the. . . Loan was neither a loan nor a sale but rather a theft. Section 165(a) allows a taxpayer to deduct any loss sustained during the taxable year that is not compensated for by insurance or otherwise. Section 165(c) limits the deduction for individuals to losses incurred in a trade or business, losses incurred in a transaction engaged in for profit, and casualty and theft losses. Under section 165(e), ‘any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers such loss.’ A taxpayer is not entitled to deduct a loss if he has a claim for reimbursement and there is a reasonable prospect of recovery. Sec. 1.165-1(d)(2)(i), (3), Income Tax Regs. A reasonable prospect of recovery exists when the taxpayer has a bona fide claim for recoupment from third parties or otherwise and there is a substantial possibility that such claims will be decided in the taxpayer’s favor. The amount of a casualty or theft loss is generally limited to the lesser of the property’s reduction in fair market value or the property’s adjusted tax basis. Secs. 1.165-7(b)(1), 1.165-8(c), Income Tax Regs. Taxpayers bear the burden of proving both the occurrence of a theft within the meaning of section 165 and the amount of the loss.” T. C. Memo. 2012-228, at pp. 16-17.

Bringing California law into play, Judge Wells finds that, because Greg and Sue tried to get their stock back at the stated maturity of the “loan”, rather than just walking away, or rolling the “loan” over, or trying to get their stock back before maturity, Greg and Sue have spelled out a case of theft. Now all they have to do is prove it.

“From the beginning, according to Mr. Raifman’s affidavit, Derivium misrepresented the nature of the transaction into which petitioners entered. As far as we can tell, Derivium never engaged in a plausible hedging strategy. Instead, its alleged actions appear to be tantamount to a massive bet that the price of all of its clients’ stocks would fall, ‘hedged’ only by a Ponzi scheme. Mr. Raifman also states in his affidavit that petitioners relied on Derivium’s misrepresentations when they chose to enter into the . . . Loan program and that they were defrauded. Indeed, it appears that the failure of Derivium to honor petitioners’ options to repurchase their ValueClick stock cost petitioners millions of dollars. On the basis of the statements in Mr. Raifman’s affidavit, we conclude that the instant case is distinguishable from . . . the other prior Derivium cases. Accordingly, we conclude that there remains a dispute over genuine issues of material fact concerning the existence of a theft loss under California law.” T.C. Memo. 2012-228, at pp. 22-23. (Footnote and citation omitted.)

Now this case was decided on summary judgment, that is, on the papers and not after a trial with witnesses. A party can only get summary judgment if there are no material questions of fact for a trial; and the party opposing summary judgment gets the benefit of the doubt if they can show a disputed fact other than just a denial.

So Greg and Sue will get a trial, where they can try to prove the exact extent of their loss, and that, when they claimed the loss on their 1040, they had no reasonable prospect of recovery from Derivium, Joltin’ Joe or Wachovia.

And Judge Wells delivers a semi-rebuke to IRS, by way of a farewell footnote: “We are puzzled by respondent’s choice not to seek remand of petitioners’ case to the Appeals Office, despite respondent’s concession that the Appeals Office erred by failing to consider whether petitioners’ carryback with respect to their claimed theft loss during 2006 was within the scope of the Appeals hearing. Accordingly, we will order respondent to wait until he has concluded the examination of petitioners’ amended 2006 return before proceeding with the instant case in this Court. In that regard, we will also order the parties to submit a status report advising the Court when the examination of petitioners’ 2006 return has been concluded.” T. C. Memo. 2012-228, footnote 10, at p.24.

That’s Fortunato Gonzalez and Maria C. Gonzalez, petitioners in T. C. Sum. Op. 2012-78, filed 8/6/12, a “not-for-nuthin’”, with Chief  Special Trial Judge Panuthos rolling the dice.

Fortunato wasn’t, and Maria didn’t do better. They were gamblers; amateurs, not pros, and at the close of play they were down big time, they claimed. IRS didn’t think so, brandishing W-2Gs showing $20K in winnings from a casino, that never made it onto Fortunato’s and Maria’s 1040.

Fortunato and Maria showed on the trial they cashed checks near the weekends, when they played, and didn’t make much money from anything else. They didn’t have losing betting slips or players’ club cards, or anything but their bank statements and the canceled checks they cashed.

CSTJ Panuthos: “Petitioners attempted to substantiate gambling losses, relying on (1) their general testimony that they lost more money than they won, (2) checks that were cashed regularly so that funds would be available at the casino, and (3) the theory that all gamblers lose money.” T.C. Sum. Op. 2012-78, at p. 5.

See my blogpost “I’m a Rambler, I’m a Gambler”, 7/18/11:  “Moore said that he called the IRS in 2004 to ask how to keep track of his gambling losses and that the IRS told him he could use bank statements. Moore claimed to have kept bank statements as records of his gambling transactions, but he did not present any bank statements as evidence.” 2011 T.C. Mem. 173, footnote 3, at pp. 3-4.”

But Faustino and Maria got it right. They had the bank statements and their canceled checks, and played show-and-tell at trial. So CSTJ Panuthos gives them a Cohan approximation, and sends them off for a Rule 155.

Chief STJ Panuthos: “Petitioners wrote checks to cash at least once a month for most of the year in issue, and most of the checks were negotiated near weekends and holidays. We are satisfied that at least some of these funds and some of the winnings were used to engage in gambling activities. Taking into account the credible testimony of petitioners, the fact that gambling winnings were used to engage in additional gambling activity, the cashing of checks on the weekends, and the fact that petitioners’ disposable income from other sources was otherwise limited, and using our best judgment to reasonably estimate the amount of gambling losses, we allow petitioners a gambling loss of $15,000. Accordingly, petitioners may deduct $15,000 of gambling losses against the $20,700 of gambling winnings.” T.C. Sum. Op. 2012-78, at pp. 6-7.

Better than nothing, but keep good records, gamblers. They might help you win even when you don’t win.