Case Summaries 03/2014

(petitioners, married couple, held interests in two entities that were treated as partnerships for tax purposes; one entity reported cash contribution to North Dakota Natural Resource Trust (NRT) of $170,000, $171,150, and $144,500 in the years at issue; the other entity reported bargain sales of conservation easements and charitable contributions in the amount of $349,000, $247,550, and $162,500 for the years at issue; the easements were in accordance with the 2002 Farm Bill program designed to protect topsoil; under state (ND) law, easements limited to 99 years; court determined that easements not perpetual and, therefore, not a qualified conservation easement; 99-year lease caselaw involving I.R.C. Sec. 1031 inapplicable because of a lack of perpetuity requirement in I.R.C. Sec. 1031).


(Tax Court order converting motion for summary judgment to motion for partial summary judgment and motion denied; petitioner's S corporation held real estate which was rented to petitioner's C corporation; petitioner materially participates in C corporation's business and self-rental rule of Treas. Reg. Sec. 1.469-2(f)(6) triggered and negates petitioner's passive losses; petitioner argued that self-rental rule inapplicable to S corporations; court noted that passive loss rules apply to petitioner as an individual and disallows petitioner's passive losses; court noted that petitioner's activities include those activities conducted through an S corporation citing Dirico v. Comr., 139 T.C. 396 (2012); court also noted that self-rental rule applies to S corporation's rental income passed through to petitioner from property rented to C corporation and used in C corporation's business because petitioner materially participated in C corporation's business, citing Veriha v. Comr., 139 T.C. 45 (2012)).


(petitioner worked for realty company and also personally owned and managed various rental properties; petitioner claimed that he worked less than 1,000 hours for realty company, but couldn't verify that number; petitioner's wife also worked for different realty company; a personally owned rental property was over 130 miles from petitioner's home; petitioner lived in CA, but had another rental property in FL; log of time spent on rental properties incomplete and second log completed after audit began; petitioner incurred loss on rental activities and attempted to deduct losses; IRS determined that losses were subject to passive loss limitations of I.R.C. Sec. 469; petitioner failed to satisfy test to be a rental real estate professional for failure to meet 750-hour test; 20 percent accuracy-related penalty imposed).


(while court acknowledges that a purpose of congressional Democrats in passing Obamacare with the mandate that all individuals buy government-approved health insurance was to redistribute wealth, court held that having a redistributive purpose does not cause an otherwise valid tax into an unconstitutional taking of private property; instead, to be an unconstitutional taking, tax must be "so arbitrary as to constrain to the conclusion that it was not the exertion of taxation, but a confiscation of property"; thus, individual mandate not an unconstitutional taking of private property under the Fifth Amendment; on Origination Clause claim, court held that claim to be dismissed on procedural grounds).


(case involves appropriate valuation of donated conservation easements with specific issue of whether “highest and best use” of land subject to easements was gravel mining or agricultural use as irrigated farmland; petitioners, corporation and two couples, owned land with another corporation in undivided one-fourth interests; tract was 1,560 acres with part used for gravel mining; with help of local accounting firm (Kennedy & Coe), petitioners conducted series of like-kind exchanges impacting approximately 163 acres not zoned for mining gravel; after transactions, each petitioner owned about 55 acres outright; appraiser hired and each taxpayer claimed charitable contribution donation under “before and after” approach due to easement restrictions; petitioner claimed highest and best use was for gravel mining; IRS denied deductions; Tax Court determined that highest and best use of land was for agricultural use resulting in lower value of property before imposition of easement restrictions, resulting in deduction of $100,000 rather than $2,000,000; Tax Court determined that highest and best use of any land is its current use unless taxpayer shows compelling reason for different use; petitioners had also overstated demand for gravel; accuracy-related penalty not imposed; court noted that for post-8/17/06 filed returns, “reasonable cause” exception to penalties repealed; on further review, appellate court affirmed and found no difference between conservation easement valuation and just compensation valuation in context of determining highest and best use of particular property; on issue of holding period of associated state (CO) tax credits, court upheld Tax Court determination that petitioner had no property rights in conservation easement contribution state tax credit until donation was complete and credits were granted, and credits never became part of petitioner's real property rights; thus, holding period of credits began at time credits granted and ended upon petitioner's sale of credits (which occurred in same month that they were granted) and capital gain on sale was short-term).


In this private letter ruling, the IRS has said that a cooperative can use email or a website to send notices to members about patronage dividends.  The cooperative had many members that bought personal and family items from the cooperative.  Patronage dividends were paid annually in nonqualified written notices of allocation.  Historically, the cooperative had used the U.S. mail to send the notices.  To cut down on costs, the cooperative proposed to send the notices via email or their website.  The IRS approved using the website or email to send the notices and that the cooperative could take an exclusion or deduction under I.R.C. Sec. 1382(b)(2) or tax benefit under I.R.C. Sec. 1383(a)(2) when the nonqualified written notice is paid or redeemed.  Priv. Ltr. Rul. 201413002 (Mar. 6, 2014). 


The petitioner, an elderly Iowa farmer, leases his land to his son and nephew for crop production.  Because the petitioner's land is rocky, rocks must be removed every year.  To facilitate rock removal, the petitioner purchased an ATV, paying $980 of sales tax on the purchase.  The petitioner claimed that the ATV purchase was exempt from sales tax as ag equipment/machinery.  Iowa Code Sec. 423.1(17) sets forth the exemption for farm machinery and equipment used in ag production and requires the machinery and equipment be used directly and primarily in the production of agricultural products.  The petitioner testified that he used the ATV approximately 80 percent of the time for removing rocks from the fields.  The balance of the time of ATV use was spent spraying trees and weeds, checking crops, tile blowouts and wet spots.  The Iowa Department of Revenue (IDOR) denied the exemption on the basis that the ATV was not used directly as an integral and essential part of production more than 50 percent of the time.  The IDOR viewed the removal of rocks as not related to planting, growing or harvesting of crops.  In re Lickteig, No. 13DORFC025, Iowa Dept. of Inspection and Appeals (Mar. 5, 2014).  


(ex-wife had taxable income via I.R.C. Sec. 66 from community property interest in partnership irrespective of whether ex-wife was a partner for tax purposes; couple was legally separated in 2002 after husband had formed an LLC which was general partner of LP; husband made capital contributions to LLC that were contributed to LP and which wife did not have knowledge of; on LLC and LP partnership returns wife not listed as partner; amended return showed wife as partner, but she didn't report income from LP; wife had right to stream of income from community property that funded the LP).


(petitioner conveyed conservation easement on 882 acres of undeveloped land to land conservancy; at time easement granted, land under long-term contract limiting use and development; petitioner claimed $4,691,500 charitable deduction as value of easement, but could only take $1,343,704 of deduction in tax year due to ceiling imposed by I.R.C. Sec. 170(b)(1)(B); unused portion carried over to 2006, 2007 and 2008; IRS challenged carryover amount; petitioner claimed highest and best use of property was as residential development and vineyard and IRS claimed there was no reduction in FMV of property due to easement; court agreed with IRS - petitioner failed to establish that FMV after easement was less that FMV of property before easement grant; petitioner also failed to establish that either residential development or vineyard use was property's highest and best use before easement imposed; petitioner failed to show that vineyard use a legally permissible use or economically feasible due to restricted access to property and lack of water; 40 percent gross valuation misstatement penalty imposed for underpayments for years at issue - no reasonable cause exception; in 2014, court denied reconsideration). 


(debtor appealed the bankruptcy court’s decision granting a customer’s motion to convert the debtor’s Chapter 12 to a Chapter 7 on the grounds of fraud; the bankruptcy court had found that the debtor committed fraud by entering into a contract for the sale of hay with the customer eight days after filing the Chapter 12 and without telling the creditor about the filing; in affirming the decision, the court ruled that the bankruptcy court properly applied 11 U.S.C. § 1208(d) in concluding that the debtor had committed fraud “in connection to the case”; the court also found that the bankruptcy court did not clearly err in making its factual findings; the record established that the debtor failed to inform the customer about material information).   


(petitioner engaged in over 500 trades annually, incurred losses and claimed ordinary loss status; court determined that $2.6 million of gross proceeds did not amount to substantial trading activity and that executing those trades on 154 days during year at issue (with 50 percent of trades occurring in three month period) not frequent activity; record failed to establish that petitioner held trades for short periods of time; petitioner actually traded on margin involving security sales, call and put options and short sales; 40 percent of trades were day trades; petitioner had substantial income from full-time day job in engineering field; court determined that petitioner not a trader and losses were capital in nature). 


(petitioners, married couple, sustained rental real estate losses; losses subject to passive activity loss limitations; time log was "ballpark guesstimate" constructed after-the-fact and couldn't establish material participation; petitioners' income at high enough level such that $25,000 deduction amount phased-out). 


(innocent spouse case involving equitable relief under I.R.C. Sec. 6015(f); couple married in 1992 and divorced in 2010; wife prepared couple's returns and couple failed to report over $9,000 in husband's non-employee compensation reported on 1099-Misc.; former wife filed request for innocent spouse relief via Form 8857 for 2007 tax year and IRS proposed to grant relief to former wife; court determined that former wife had actual knowledge of former husband's non-employee compensation and failed to qualify for relief, but court considered whether former wife eligible for equitable relief under I.R.C. Sec. 6015(f) based on facts and circumstances; court determined that three factors of Rev. Proc. 2013-34 neutral (economic hardship; legal obligation to pay liability; physical or mental health) three factors weighed in favor of former wife (marital status; lack of significant benefit; compliance with tax laws after divorce) and one factor weighed against granting relief (knowledge or reason to know)).


(operating costs (and investment advice fees) incurred by 90 percent owners of two partnerships were deductible by partners because partners controlled the partnerships and partnerships had profit motive (which is determined at the partnership level; court determined, based on partners' testimony, that sufficient profit motive attributed to partnership based on an investment strategy). 


(ESOP that corporation established where corporation later became an LLC taxed as partnership failed to qualify under I.R.C. Sec. 401(a); LLC cannot be sponsor of ESOP because definition of "qualifying employer securities" includes "stock" that employer issues and "partnership" defined under I.R.C. Sec. 7701 to exclude corporation). 


(issue was whether exempt organization (integrated health group operating hospitals and clinics) can conduct school activities along with exempt functions and still qualify as exempt organization under I.R.C. Sec. 170(b)(1)(A)(ii) and I.R.C. Sec. 514(c)(9)(c) such that debt-financed property rules inapplicable; IRS noted that to qualify as exempt under I.R.C. Sec. 170(b)(1)(A)(ii), organization's primary function must be school activities; primary function test not met where 13 percent of expenditures for instruction and 20 percent of employees involved with schooling and 6 percent of revenues derived from school activities). 


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