Not Enough Activity to Be a Developer

If you suffer a loss on the disposition of real property, you want to be treated as a developer for income tax purposes - that is, to be treated as engaged in a trade or business. That way, you can get ordinary loss treatment and not a long termor short term capital  - the ordinary loss will typically be available to offset more types of income than a capital loss.

So how many properties must one be dealing with and how much activity is needed to cross into developer territory? This question comes up a lot - it is a question of facts and circumstances. In a recent Tax Court case, ownership of 3 properties coupled with sporadic development activities was not enough for ordinary loss treatment.

More particularly, the taxpayer had a plan to purchase properties, tear them down, build single or multi-unit residences, and then sell them - alternatively he might rent them out. From 2003 through 2007, he bought one rental property and two tear-down properties. He developed one tear-down into a two-condominium building and sold it. Regarding the subject property he incurred costs to prepare the property for development, paying for architectural, electrical, and mechanical plans, permits, property taxes, and interest. He borrowed money to develop the property - ultimately he defaulted and lost the property in foreclosure.

The court did not find him to be a developer. Some of the court’s observations included:

1. The intent to develop is not enough.

2. Sales activity should be frequent and continuous - not sporadic.

3. Not enough properties involved here.

4. That the property was sold in foreclosure instead of to a regular buyer is a neutral fact.

5. The taxpayer’s primary source of income was elsewhere - the development activities would account only for an insubstantial portion of his income.

6. The taxpayer was lackadaisacal about keeping business records.

Reading the facts, I would have said that the taxpayer was in the trade or business of real estate development - too bad for the taxpayer I wasn’t the judge on his case.

Evans, TC Memo 2016-7

Disclosure of Cash Real Estate Purchases

The purchase of real estate without bank financing presents an opportunity for those with unclean funds to launder those funds and make them appear legitimate, at least in the opinion of the Financial Crimes Enforcement Network (FinCEN). This is especially so if the buyer is an entity such that the ultimate individual owner is hidden from public view.

To combat this, earlier this month FinCEN issued Georgraphic Targeting Orders that will require some U.S. title insurance coompanies to identify the natural persons behind companies that make all cash purchases of residential real estate in Manhattan and Miami-Dade County.

Obviously, this is not a comprehensive disclosure dragnet, and it is only temporary. So it would appear that this is either a fact finding exercise and/or an in terrorem warning to potential money launderers that FinCEN is on their case.

Elective Share Rulings

Under Florida law, a surviving spouse can elect to receive 30% of the elective share estate of his or her deceased spouse, in lieu of receiving what was left to the surviving spouse under the decedent’s estate planning documents. This prevents a spouse from entirely cutting a surviving spouse out of his or her Last Will and other dispositive documents.

In determing what makes up the total value of the elective estate (against which the 30% is multiplied), Florida Statutes provide a listing of what to include. They also provide a listing, in Fla.Stats. §732.2055, of what is allowed to reduce the size of that estate for purposes of the 30% computation.

The 4th DCA recently addressed whether the total elective share estate should be reduced for charges of lawyers hired by the personal representative to litigate estate claims. The court looked at former Fla.Stats. § 732.207 (1998), the predecessor statute to Fla.Stats. §732.2055, which predecessor statute applies to the subject estate. That statute read:

732.207 Amount of the elective share. -- The elective share shall consist of an amount equal to 30 percent of the fair market value, on the date of death, of all assets referred to in s. 732.206, computed after deducting from the total value of the assets:

    (1) All valid claims against the estate paid or payable from the estate; and

    (2) All mortgages, liens, or security interests on the assets.

One can see in this statute that valid claims against the estate are deductible - does this mean that expenses of the estate to litigate those claims are likewise deductible?

No, said the appellate court. Since “the statute clearly and unambiguously sets forth only four types of expenses or costs which the probate court is to deduct from the value of the assets in the surviving spouse's elective share,” and attorney fees are not one of them, it found no basis for deducting attorneys fees. While Fla.Stats. §732.2055 is different from the prior Fla.Stats. §732.207, as to this issue the language is fairly similar, so this ruling should be strong precedent as to how the newer statute also applies.

The court also acknowledged that a delay in paying the elective share entitles the spouse to interest on the amount due for the delay period after the entry of the elective share payment order. It noted “it would be inequitable for Spouse to be denied the opportunity for a reasonable return on her court-determined minimum elective share.” Here, the probate court only allowed for interest on 40% of the elective amount due the spouse, since the court noted that she would not be able to retain the remaining portion due to taxes. The appellate court affirmed the probate court on this, stating that “it would ... have been inequitable for Spouse to enjoy a windfall of interest on a portion of the value of her minimum elective share which, due to taxes, she would not be entitled to retain.”

The opinion did not provide much background on this tax payment issue. However, it seems to me that the court should have taken into account that the spouse was either charged interest by the government on late payment of taxes while waiting for her distribution, or alternatively paid the taxes relating to the elective share assets on time out of her own other assets (or borrowings) and thus loss the economic benefit of those tax payments for the period after payment until she received the elective share assets. To me, then, I would think the estate gets the windfall here and the spouse is injured. Again, since I don’t know the underlying facts, perhaps there are some other facts or justifications that entered into the calculus of who benefitted or suffered economically from the delay in payment.

For more on this case, see also Blackburn v. Boulis in Rubin on Probate Litigation.

ACE J. BLACKBURN, JR., CHRIS A. ECONOMOU, GUS MORFIDIS and JOAN S. WAGNER, as Personal Representatives of the Estate of Konstantinos Boulis, a/k/a, Gus Boulis, Appellants, v. EFROSINI BOULIS a/k/a FRANCES BOULIS, Appellee. 4th District. Case Nos. 4D14-1579 and 4D14-2048. January 20, 2016.

Applicable Federal Rates - February 2016

Lodestar Methodology for Determining Reasonable Attorney Fees is Rejected

Fla.Stats. §736.0708(1) tells us that unless the trust agreement says different, "a trustee is entitled to compensation that is reasonable under the circumstances." The statutes do not tell us how to compute what is “reasonable.”

Back in 1958, the Florida Supreme Court, in West Coast Hospital Ass’n v. Florida National Bank of Jacksonville, 100 So.2d 807 (Fla. 1958),  listed out the factors that should determine what is reasonable for this purpose. These factors are:

• The amount of capital and income received and disbursed by the trustee. • The wages or salary customarily granted to agents for performing like work in the community. • The success or failure of the trustee’s administration. • Any unusual skill or experience the trustee brought to the trust administration. • The loyalty or disloyalty of the trustee to the beneficiaries. • The amount of risk and responsibility assumed by the trustee. • The time involved in administering the trust. • The custom in the community as to compensation of trustees by settlors or courts and as to compensation paid trust companies and banks serving as trustees. • The character of the work performed by the trustee, whether routine or involving skill and judgment. • Any estimate the trustee has given of the value of his or her own services.• Payments made or allowed by the beneficiaries to the trustee and intended to be applied toward the trustee’s compensation.

Subsequent to that case, there have been several cases that many argue require a “Lodestar” approach to computation of trustee fees. The Lodestar approach generally is an hourly fee approach - calculate how many hours the trustee works and multiply it by a reasonable hourly rate and you reach a reasonable fee. This approach differs greatly from the above factor approach, and will typically result in significantly lower trustee fees when dealing with trusts with significant assets. The Lodestar approach is usually raised by trust beneficiaries unhappy with the fees being charged by a trustee. To my knowledge, most trustees do not apply the Lodestar approach.

There are several weaknesses to the Lodestar argument. First, the case law cited applies to payment of attorneys fees in trust matters, and personal representative fees. Attorneys provide a different service, have different duties, are officers of the court, and have different exposure to liability, than trustees, so an automatic extension of the Lodestar approach to trustees just because attorneys are subject to them is a stretch. Likewise, personal representatives are now paid in large part on a reasonable fee schedule promulgated by statute - hourly fees were thus rejected by the legislature. Lastly, when Florida adopted a new trustee fee statute in 2007, the Senate Staff Anlysis of the statute specifically provided that regarding the statute, the West Coast Hospital factors should be considered in determining what trustee fee is reasonable.

Now, the 2nd District Court of Appeal has ruled that trustee fees should not be calculated under a Lodestar formula. The court seemed particularly influenced by the above Senate Staff Analysis that included a reference to the West Coast Hospital factors. Hopefully, this decision will put the issue to bed, but I guess that a few more District Courts of Appeal may need to similarly rule before trust beneficiaries cease raising Lodestar as the mechanism for computing trustee fees.

See Rubin on Probate Litigation for a further discussion of this case.

Robert Rauschenberg Foundation v. Bennet Grutman, Bill Goldston, and Darryl Pottorf, as trustees of the Robert Rauschenberg Revocable Trust, Case No. 2D1403794, 2nd DCA, January 6, 2016

Fraudulent Conveyance Litigation Expenses are Not Deductible

Expenses of business litigation, and litigation involving the production or collection of income or of property held for the production of income, are typically deductible under Code Sections 162 or 212. It is often forgotten, however, that if the subject of litigation is the defense of, or to perfect title to, real or personal property, such expenses must be capitalized into the asset and not deducted. See Treas. Regs. §1.263(a)-2(e).

Fraudulent conveyance litigation involves a party asserting, or defending against, a claim that property was transferred from one person or entity to another to avoid the transferred property from being reached by creditors of a transferor. In a recent Chief Counsel Advice, the IRS concluded that the defense of a fraudulent conveyance claim by the transferee of property was in the nature of the “defense of real or personal property.” The litigation expenses of the defender had to be capitalized and could not be immediately deducted under Section 162.

Chief Counsel Advice 201552028

Did You Get An Erroneous IP-PIN Number from the IRS?

Taxpayers who are the victim of identity theft in regard to tax filings are eligible to receive an IP-PIN number from the IRS. This is a special number issued to the taxpayer that the taxpayer uses when filing the income tax return. A new one is issued each year. If a taxpayer in the program files the return without it or with the wrong number, the return will not be processed, or its processing will be delayed while the IRS confirms the return was not filed by an imposter. This procedure protects the taxpayer from an imposter filing a false return to obtain a fraudulent refund of taxes paid by the taxpayer.

So late in December, the IRS mailed out millions of letters assigning new IP-PIN numbers for people to use on their 2015 tax return filings. The problem is that the letter said to use the number for 2014 returns, not 2015.

The IRS is now advising recipients that the letter was meant for the 2015 tax year, and the number should be used for 2015 tax year filings even though the letter says 2014. Hopefully, if you got one, you did not throw it away thinking that you didn't need such a number for the 2014 tax year since you had previously filed for 2014.

Understanding Your CP01A Notice

Tax Burden of Highest Earning Taxpayers Back on the Rise

This graphic from The Wall Street Journal shows that the share of taxes paid by the top 400 taxpayers is back on the rise (using 2013 tax data), as higher U.S. tax rates take effect.