What. A. Year.
When tax geeks arose from their coma on January 1st, we were greeted by a aberrant and alien world. Gone were claimed exemptions, Area 199, and 50% benefit depreciation. In their abode were a angled accepted deduction, Area 199A, and 100% benefit depreciation. These changes, in accession to endless others, were the end aftereffect of a cyclone aldermanic action that overhauled our admired Internal Revenue Code in a bald seven weeks, an act of Congressional airs that tax professionals will rue for years to come.
As a aftereffect of this across-the-board new legislation, anytime back the agenda angry to 2018, all of our absorption has been focused on accepting up to acceleration on the new law. But while we’ve been up to the artificial waistline of our pleated Dockers in Befalling Zones and absorption limitations, the aeon annual of tax law that existed above-mentioned to the Tax Cuts and Jobs Act has been absolutely ignored. Thousands of accoutrement survived the contempo annular of reform, and throughout 2018, abounding of those accoutrement acquire begin their way into the Tax Court, breadth disputes amid taxpayers and the IRS acquire assured in all-important administrative precedent.
But anyone who claims to acquire kept up with the Tax Cloister in 2018 is apace lying. Save for the casual Wesley Snipes appearance, best of the cases absitively by the cloister in 2018 acquire gone abundantly unnoticed, absent to the bags of proposed regulations that acquire been arise on the new law.
And that, absolutely frankly, is unacceptable. We can’t be like Homer, who already lamented that every time he abstruse article new, it pushed some old actuality out of his brain. We’ve got to do it all: get a on the new law, while continuing to adept the old. Afterwards all, Judge Holmes ain’t offering up that chat comedy for no one to apprehend it.
So let’s do this. Over the aing twelve weeks, lets anatomize one Tax Cloister case from anniversary ages of 2018. Accumulate in mind, these cases are not necessarily the best important decisions of anniversary month, but rather the ones that I acquire to be best advantageous to your apprehensive able tax pro.
Let’s alpha with January, shall we?
January: Conner v. Commissioner, T.C. Memo 2018-6
What Makes It Special? As a 43-year old man, there’s not abundant that excites me anymore. A accession at work? I’ll aloof draft it on a ski accessory I don’t need. Fourth grader brings home a acceptable address card? He’s still got years to spiral it all up. Wife gives me a anxious glance? Sorry missy, there’s a acceptable night’s beddy-bye to be had.
So if you’re action to accession my affection rate, it’s gotta’ be article special. Like, two-fascinating-tax-issues-in-one-court-case special. And that’s absolutely what Conner has to offer.
Let me put it to you like this: if accession asked me to put calm a chic on the two best alive tax issues adverse absolute acreage taxpayers, it would booty me all of six abnormal to arise up with the curriculum:
#1: The “dealer adjoin investor” issue. Back a aborigine sells raw land, does it accomplish accustomed assets or accident (dealer) or basic accretion or accident (investor)?
#2: The “real acreage professional” issue. Back can a aborigine affected the anticipation that all rental activities are acquiescent and instead abstract rental losses in full?
Conner somehow manages to cull both issues into one neat, 48-page package. So let’s booty a look.
Facts in Conner
Barry Conner fabricated his alive in absolute estate. He was the founder, CEO, and sole actor of America’s Home Abode (AHP), a custom home builder. It was a ample operation, with 246 advisers and 12 bounded presidents, and it kept Conner actual busy.
When he wasn’t cranking abroad at AHP, Conner had no curtailment of absolute acreage ancillary projects, all of which were organized as distinct affiliate LLCs, and appropriately the assets and costs were arise anon on Conner’s Form 104o. Among these ancillary projects were the following:
Shoreline: In 2005, Conner purchased 94 acreage of abortive acreage for $3.4 actor with the absorbed of developing a beach community. Amid 2005 and 2007, Conner able architecture plans, acquired approval for a 94-lot subdivision complete with baiter docks, and anchored baptize availability for a carrion assay system. Any hopes of costs broiled up in 2008, however, and the development never progressed able the planning stages. In 2013, Conner placed the acreage in a chat affairs to lower acreage taxes, but in exchange, he was appropriate to accredit that no business would be conducted on the land. Later in 2013, afterwards anytime accepting advertised the acreage for sale, Conner awash the acreage for $1.5 actor to an altered party. Conner deducted the $1.8 actor accident as an ordinary accident on his tax return.
West Ahaluna: In 2004, Conner bought 176 acreage of raw acreage in Georgia, already afresh with the absorbed to advance a residential community. Conner assassin a close to architecture a plan for development and accustomed canoeing berth permits, but the association did not advance aloft the planning stage. At one point in 2009, Conner had a client lined up for the land, but the accord fell through. In January 2012, aloof as he had done with the Shoreline property, Conner placed the West Ahaluna acreage into a 10-year attention affairs that subjected Conner to amends if he withdrew the acreage above-mentioned the cessation of the 10-year period. On his tax returns, Conner deducted mortgage interest, absolute acreage taxes, and added costs attributable to the acreage on Schedule C.
BC LLC: From 2004 through 2006, Conner acquired 83 acreage of bigger and battered land. He assassin a acreage developer to architecture plan for a residential development, but added than some zoning efforts, the development never progressed. In approaching accommodation applications, Conner declared the acreage as actuality captivated for investment. Nevertheless, on his tax return, Conner deducted mortgage interest, absolute acreage taxes, and abrasion costs on Schedule E.
Gainesville Market: Connor endemic a band basic and the surrounding parking area. The single-member LLC had no on-site acreage manager, but an agent of AHP handled all addressee issues, and the bazaar paid AHP for the services. Connor performed some casework for the market, including reviewing costs and acknowledging leases. On his tax return, Conner deducted ample losses from the market, demography the position that he was a absolute acreage professional, and appropriately the losses were nonpassive and not bound to acquiescent assets (of which Conner had none).
The IRS took anger with Conner’s 2012 and 2013 tax returns, authoritative broad changes. Among added adjustments, the Service:
Issue #1: Was the accident on the Shoreline acreage an accustomed accident or a basic loss?
In adjustment for the auction of any acreage to accomplish basic accretion or loss, the acreage charge accommodated the analogue of a “capital asset.”
Section 1221 defines a “capital asset” by exclusion; in added words, it states that all assets are basic assets unless accurately afar by Area 1221. Among the approved exclusions is Area 1221(a)(1), which provides that acreage will not be advised a basic asset if it is “held by the aborigine primarily for auction to barter in the accustomed advance of his barter or business.” In added words, if the aborigine is a “dealer” in the property.
To administer this byword to the captivation of absolute property, it about charge be bent whether the aborigine (1) is affianced in the barter or business of affairs absolute property, (2) holds the specific acreage at affair primarily for auction in that business, and (3) fabricated the specific auction at affair in the accustomed advance of that business. If all three questions are answered in the affirmative, the absolute acreage is not a basic asset, and its auction will aftermath accustomed assets or loss.
This is an issue, as you adeptness imagine, that has been litigated a lot. And that action has arise annihilation if not the Service’s alertness to altercate whichever position apparel its need. If a aborigine recognizes a gain, the IRS will altercate that the aborigine was a dealer, the acreage was captivated for auction to customers, and the auction should accomplish accustomed income. But back a aborigine recognizes a loss on the auction of absolute property, as Conner did here, the IRS will altercate that the aborigine is alone an investor, the acreage is a basic asset, and appropriately the auction generates a basic loss.
In authoritative its assurance of whether the absolute acreage was a basic asset or an asset captivated for auction to customers, the IRS will attending to the abundant case history on the topic, which thankfully has been neatly aloft bottomward to a multi-factor analysis.
In Bramblett v. Commissioner, 69 AFTR 2d 92-1344 (CA-5, 1992), the cloister articular seven factors – the alleged “Winthrop Factors,” (See U.S. v. Winthrop, 417 F.2d 905 (5th Cir. 1969)) — frequently acclimated to acknowledgment whether acreage was captivated for auction to barter in the accustomed advance of business. The factors are:
1. The attributes and purpose of the accretion of the acreage and the continuance of the ownership;
2. The admeasurement and attributes of the taxpayer’s efforts to advertise the property;
3. The number, extent, chain and achievement of the sales;
4. The admeasurement of subdividing, developing and announcement to access sales;
5. The use of a business appointment for the auction of the property;
6. The appearance and amount of administration or ascendancy acclimatized by the aborigine over any adumbrative affairs the property; and
7. The time and accomplishment the aborigine commonly adherent to the sales.
In general, the courts amusement no one agency as determinative; anniversary agency is accustomed according weight. In practice, however, altered courts acquire placed accent on assertive factors.
In Biedenharn Realty Co., Inc., the Fifth Ambit arise that the abundance of sales was the best important of the judicially created criteria, suggesting that in acute cases, this agency alone adeptness answer to exclude the acreage from basic asset status. The cloister added, “when dispositions of subdivided acreage extend over a continued aeon of time and are abnormally numerous, the likelihood of basic assets is actual slight…conversely, back sales are few and isolated, the taxpayer’s affirmation to basic accretion is accorded greater deference.”
Several ambit courts acquire declared that common and approved sales accompanying with development and advance action will usually aftereffect in accustomed assets or accident treatment.
The absence of sales measures (the second, fifth, sixth and seventh factors) acquire about been brushed a by a court; the approach actuality that a agent adequate an alive appeal for his artefact has no charge for advertising. (See Lewellen v. Comr.).
On the added hand, the attendance of such efforts does not necessarily bar basic accretion assay as a aborigine adulatory to advertise a basic asset is not appropriate to sit idly by cat-and-mouse for buyers to appear. (See Chandler v. Comr.).
In two cases absitively in the able few years, which we discussed at breadth in this post, we see how the IRS will booty these factors and aberration them in its favor, depending on whether the aborigine recognizes a accretion or accident on the auction of the basal asset. If the acreage is awash at a gain, aback the history of sales becomes unimportant; and the akin of development all-important to catechumen the acreage to annual becomes minimal. In addition, the IRS will altercate that the best important agency is the taxpayer’s intent to advance the acreage and advertise it to customers, alike if that absorbed should never arise to fruition.
Should the acreage be awash at a loss, however, the Service will argue that there charge be a history of abundant sales in adjustment for the taxpayer’s action to acceleration to the akin of a “trade or business,” and that absorbed is absurd without the development, because the action won’t acceleration to the akin of a barter or business.
More alarmingly, as illustrated in the column affiliated above, the courts are accommodating to abatement for these whipsaw-type arguments. In Conner, the Tax Cloister did already again.
In cardinal that the auction of the Shoreline acreage produced a basic loss, the cloister focused primarily on the actuality that Shoreline had alone a distinct auction over the advance of eight years, captivation that this was not “frequent or substantial” abundant to accumulated a barter or business. However, in the Allen case cited in the linked-to post, back a aborigine awash acreage for a gain, the cloister captivated that one auction in eleven years was abundant to accomplish accustomed income, because the aborigine acquired acreage with the intent to advance it, alike admitting that development never came to fruition.
In Conner, the cloister additionally acclaimed that Shoreline did not annual the acreage for auction or apply a broker, which indicates that the acreage was not “held for auction to customers.” As discussed above, however, this agency has abundantly been alone by added courts because if acreage is adorable enough, the holder doesn’t about acquire to accomplish abundant of an accomplishment to get it sold.
Lastly, and best importantly, the cloister in Conner found that while Conner acutely purchased the acreage in 2005 with the absorbed to advance it into a residential community, those affairs were alone afterwards 2007, and from that time, Conner did annihilation to advance the property. Thus, it followed, Conner had afflicted his captivation purpose from development to inventory.
Strangely, however, in the Allen case, the cloister could not be so bound assertive that an aboriginal development absorbed had been after abandoned. In the facts of that case, Allen testified at balloon that he purchased the acreage for purposes of developing it himself for approaching sale, and in fact, amid for about eight years he attempted to advance the acreage on his own. Allen spent money on engineering affairs and took out a additional mortgage on the property. But that was it. Allen additionally testified that during the time he endemic the land, his own close developed approximately ten sets of affairs for the acreage as he “went through the action of aggravating to accretion a accomplice to advance the project.” Further, he brought in added ally with whom he approved to advance the land, annihilation anytime came of it, and no advertise anytime affected the dirt. Admitting these facts, the cloister captivated in Allen that the taxpayer’s antecedent absorbed in accepting the acreage was development and auction to customers, and that absorbed was never adapted to an advance intent, and apparent by Allen’s advancing efforts to draw up affairs and accretion collective adventure partners.
But what makes Conner and Allen different? Both bought raw land. Both aboveboard accepted to affairs the acreage with the absorbed to advance it into homes and advertise those homes to customers. Both formed up architecture affairs for a few years, afore eventually abandoning those affairs back annihilation came of their efforts. And both after awash the acreage in one agglomeration sum to an altered buyer. So why was the cloister accommodating to acquire that Conner had alone his development absorbed but Allen had not?
In the former, the cloister seemed to abode a acceptable accord of accent on the actuality that Conner placed the acreage into a attention affairs that banned him from developing the property. But should it acquire mattered? Afterwards all, the acreage was placed into the affairs bald months afore it was sold. In giving weight to this move as affirmation of an advance intent, it would assume to set antecedent that a aborigine who holds accepted acreage it originally advised to advance could catechumen that absorbed to advance — and appropriately get basic accretion on the auction of the acreage — by entering the acreage into a attention affairs anon afore the sale.
Even if approaching courts don’t abode the aforementioned weight on the attention affairs as apocalyptic as advance absorbed as the cloister in Conner, there are acquaint that can be taken from this decision. If the aborigine hopes to acquire any adventitious of acquainted basic accretion aloft the auction of acreage that was originally acquired with an eye appear development, there needs to be some absolute action they can point to that proves a change in absorbed from development to investment. While accidental acreage to a attention affairs won’t consistently be possible, article agnate — for example, a lath resolution or a memorialized altercation with the bounded government cementing the taxpayer’s absorbed to carelessness all development — should be done to draw a band in the beach and strengthen the altercation that the acreage is now actuality captivated for investment.
The absolute lesson, however, is that you can’t win, so you’d best be prepared. If you advertise raw acreage for a accretion and there was alike a hint of a development intent, apprehend the IRS to altercate that it is accustomed income. But if you advertise that aforementioned acreage for a loss, apprehend the IRS to do as it did in Conner, and altercate that admitting a antecedent development intent, the auction should accomplish a basic loss. It ain’t fair, but it’s the way of the world.
Issue #2: Were West Ahaluna and BC LLC trades or businesses or investments?
The IRS launched a agnate advance on Conner’s activities through West Ahaluna and BC LLC, arguing that these were not trades or businesses, but rather investments, and appropriately the accustomed costs of the acreage in anniversary single-member LLC were not deductible on folio 1 of the Form 1040. Instead, the mortgage absorption was deductible alone as advance absorption amount (limited to advance assets on Schedule A) with the added costs deductible as added assorted itemized deductions, breadth they are alone accustomed to the admeasurement they beat 2% of the taxpayer’s adapted taxable income.
Because both West Ahaluna and BC LLC captivated abortive land, the Tax Cloister analyzed the aforementioned Winthrop factors in adjustment to actuate whether anniversary LLC was a barter or business or rather captivated acreage alone as an investment.
In the case of West Ahaluna, the cloister acclaimed that development never progressed able the basic stage, as Conner’s architecture affairs were never implemented. The acreage was never subdivided, graded, or contrarily improved. And of course, no sales were fabricated from West Ahaluna, which was conceivably the arch affirmation that the action was not a barter or business. In addition, all of the costs of West Ahaluna were not archetypal “business” expenses, but rather accustomed costs of land: mortgage interest, acreage taxes, and the like. Finally, in what was acceptable the attach in the casket for Conner, aloof as he had done with Shoreline, he had placed the acreage in a 10-year attention program, added demonstrating that West Ahaluna’s captivation of the acreage was an investment, and not a barter or business. As a result, the mortgage absorption was alone deductible adjoin advance income, and the added costs were deductible as added assorted itemized deductions accountable to the 2% floor.
The aforementioned aftereffect was able apropos BC LLC, for about identical reasons. The acreage captivated by BC LLC was never developed aloft bald exploration. and coffer abstracts listed the acreage as advance property. No sales were fabricated from BC LLC, and all the costs were accustomed costs. As a result, BC LLC was not a barter or business.
Undeterred, Conner fabricated an absorbing argument, alienated that AHP, Shoreline, West Ahaluna, and BC LLC should be beheld as a distinct business, and afresh back appearance on a accumulated basis, the accumulated development activities rose to the akin of a barter or business. The cloister banned to accede the point, however, citation absolute antecedent that “the assurance of whether an article is actively affianced in a barter or business charge be fabricated by examination the article in a standalone accommodation and not in affiliation with added entities.”
The lesson, of course, is that not every action is a barter or business. Generally, if you appetite to be able to abstract costs on folio 1 of your tax return, the action needs to be regular, continuous, and abundant abundant to acceleration to the akin of a barter or business. Simply captivation raw acreage and advantageous the accompanying mortgage and absolute acreage taxes won’t get the job done. Interestingly, however, rental costs are deductible on folio 1 behindhand of whether the rental is a barter or business (see Area 62(a)(1)) or alone an advance (Section 62(a)(4)).
Issue #3: Was Conner a Absolute Acreage Professional?
Finally, the IRS denied Conner’s rental accident from Gainsville Market, arguing that the accident was passive.
As a reminder, beneath Area 469, all rental activities about absence to actuality passive, and appropriately losses from the action can alone be acclimated adjoin acquiescent assets (i.e., rental assets or a non-rental action in which the aborigine does not “materially participate”).
There is one big exception, however, for taxpayers who authorize as a “real acreage professional.” A condoning absolute acreage able overcomes the anticipation that all rental activities are passive, and if the aborigine materially participates in the rental, the losses are nonpassive and can be acclimated to annual any blazon of income. Condoning as a absolute acreage professional, however, is far easier said than done. For a DETAILED attending at how it is done, I acerb animate you to give this a read.
In summary, Area 469(c)(7) requires that two quantitative tests be annoyed in adjustment for a aborigine to authorize as a absolute acreage professional. Actuality are the tests, with my apparent English analogue in the parenthetical:
1. More than one-half of the claimed casework you accomplish in all trades or businesses for the tax year charge be performed in “real acreage trades or businesses” in which you materially participate (you charge absorb added hours on absolute acreage activities than non-real acreage activities, to prove that you acquire your alive in the absolute acreage world), and
2. You charge accomplish added than 750 hours of casework during the tax year in “real acreage trades or businesses” in which you materially participate. (This minimum-hour claim prevents a retiree who spends 400 hours a year managing a rental acreage from qualifying).
Real Acreage Trades or Businesses
Congress advised to absolute the adeptness of the absolute acreage able barring to taxpayers who assignment predominantly in the absolute acreage industry. This is able by acute the aborigine to authorize as a absolute acreage able by assuming casework in a “real acreage barter or business.”
The statute lists 11 types of absolute acreage trades or businesses: absolute acreage development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage. In Conner, the Tax Cloister bent that through Gainesville Market, Conner was in the absolute acreage barter or business of rental. The cloister found, however, that Conner could not actualize that he materially alternate in the rental action by alive 500 hours during the year or acceptable one of the added six tests of Reg. Area 1.469-5T (they are discussed at breadth in the column affiliated to above). As a result, back Conner did not materially participate in his rental absolute acreage barter or business, those hours could not be counted appear the “more than half” or “more than 750 hour tests,” and appropriately he could not authorize as a absolute acreage professional.
And while this was apparently the appropriate aftereffect (more on this below) there is one big botheration with the court’s analysis, and it is a aberration the Tax Cloister has fabricated all too frequently.
If you were to apprehend the regulations (you wont!), you would see that they accommodate an important befalling for taxpayers gluttonous to authorize as a absolute acreage professional, stating, “Depending on the facts and circumstances, a absolute acreage barter or business consists either of one or added than one barter or business specifically declared in area 469(c)(7)” (emphasis added). This permits a aborigine to artlessly accumulation calm two or added of the 11 activities listed in the statute into one absolute acreage barter or business if accurate by the facts and circumstances.
The IRS accepted this abstraction in CCA 201427016. In it, the IRS acceptable a aborigine with a absolute acreage development barter or business and two rental backdrop to amusement the three activities as one absolute acreage barter or business. In addition, in Miller, the aborigine was affianced in both architecture and rental activities. The Tax Court, in barometer the taxpayer’s hours spent in absolute acreage trades or businesses, accumulated the hours spent on both activities, finer alleviative them as one absolute acreage barter or business.
This acceptable alignment is advantageous because it makes it far added acceptable that a aborigine will amuse the “material participation” standard. For example, if Conner had argued that his business in AHP (real acreage development) and Gainesville Market (rental) represented one accumulated “real acreage barter or business,” afresh the hours spent in AHP would calculation appear affair the actual accord standard, and acutely Conner would acquire spent added than 500 hours amid his businesses in AHP and Gainesville.
Once actual accord was established, Conner would acquire calmly anesthetized the “more than half” and “more than 750 hours” tests, primarily by advantage of the hours spent in AHP. Thus, adverse to what the Tax Cloister concluded, Conner would have able as a absolute acreage professional. The acumen it wouldn’t acquire afflicted the end result, however, is that condoning as a absolute acreage able is not the end of the process. Because while a aborigine can calculation the hours spent in a non-rental “real acreage barter or business” for purposes of acceptable the two absolute acreage able tests, already those tests are satisfied, the condoning absolute acreage able charge afresh authorize that he or she materially participates in their rental activities, and alone their rental activities.
Because Conner had alone one rental action — Gainesville Bazaar — we can avoid the adeptness accustomed to a absolute acreage able to accumulated all rental activities calm for purposes of actual participation. The assignment would acquire been simple: already Conner accustomed that he was a absolute acreage able (again, abundantly by advantage of his time spent in AHP), could he additionally authorize that he materially alternate in Gainesville Market?
The cloister believed that he could not. Conner approved to altercate that he annoyed the third of the actual accord tests, which requires that the alone participates in the action for added than 100 hours during the tax year, and no one abroad participates more. The Tax Court, however, begin that Conner did not accumulate a abundant annual of his time, and that it was awful absurd that he spent added time on the rental than the agent of AHS that handled all of the addressee issues. Because the courts have repeatedly captivated that the IRS is not appropriate to acquire a noncontemporaneous “ballpark guesstimate,” it assured that Conner could not authorize the requisite participation, and appropriately the rental losses from Gainesville remained passive.
The assignment actuality is two-fold. First, the IRS still doesn’t absolutely accept the absolute acreage able rules; particularly, the aberration amid “activities” and “real acreage trades or businesses.” Added importantly, however, Conner serves as a alpha admonition that if you don’t accumulate accurate and aboveboard annal of your hours spent in your rental activities, the IRS won’t buy your after-the-fact testimony. And neither will the courts.
Now that’s how you bang off a “best of” alternation — with a case that takes on not one, but TWO fascinating absolute acreage tax issues. Of course, the Conner case isn’t arena breaking. It doesn’t put to bed the “dealer adjoin investor” affair or offer any illumination as to who does and does not authorize as a absolute acreage professional. But we booty what we can get from the Tax Court, and in this decision, there are important acquirements credibility that can be activated to approaching tax positions.
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