Florida Supreme Court Gives Expansive Protection to Husband’s Separate Property under a Prenuptial Agreement

A divorcing wife asserted that because a 20 year old prenuptial agreement made no specific reference to enhancement in value of nonmarital property attributable to marital labor or funds, the enhancement in value to the husband’s assets during the marriage is subject to equitable distribution. Similarly, the agreement did not specifically provide that the husband’s earnings will be his separate property, so the wife sought a finding that these were not protected under the prenuptial agreement.

The agreement did provide that the property “owned or hereby acquired by each of them respectively” would be free of claims of the other spouse. It also provided that “each party agrees that neither will ever claim any interest in the other’s property,” and if one party “purchases, [a]cquires, or otherwise obtains, property in [his/her] own name, then [that party] shall be the sole owner of same.”

Both the District Court of Appeals and the Supreme Court found that the above general waiver language was broad enough to protect enhancement in value of property and the husband’s separate earnings as separate property of the husband, thus denying the wife an interest in those assets upon divorce. While the ruling is fact specific based on the specific language of the agreement, it does call into question other lower court decisions that found earnings and appreciation to be marital property subject to division when they were not specifically described as separate property in the agreement.

Of course, these issues can be entirely avoided by providing specific waivers as to these items in the prenuptial agreement.

As an aside, the fairness of a marital agreement can be an issue in the enforceability of that agreement in Florida. In Casto v. Casto,  508 So.2d 330 (Fla. 1987), the Florida Supreme Court found that unfairness or unreasonableness can negate enforceability, although full and complete financial disclosures will still allow for enforceability even if the agreement is unfair or unreasonable. Casto continues to apply to postnuptial agreements in Florida. Prenuptial agreements are now governed by Fla.Stats. Section 61.079 – that statute similarly voids prenuptial agreements if unconscionable, with a savings if there is full and complete financial disclosure (measured at the time of the agreement and not at divorce) even though there were disproportionate wealth between the spouses, due to the $1.9 million the spouse would obtain under the agreement.

Hahamovitch v. Hahamvitch, Florida Supreme Court Case No. Sc14-277 (September 10, 2015)

Taxpayers Must Correctly Write-Off Balances for Partial Bad Debt Deduction

Code Section 166(a)(2) allows for a deduction for partially worthless debts for business debts. One of the requirements to be able to deduct is that the amount deducted “was charged off” on the books during the tax year.

In a recent Legal Advice issued by Field Service Attorneys, the taxpayer put a contra-asset account on its balance sheet to reflect a partial loss. The issue was whether that was sufficient to be a charge off on the books for this purpose.

The government attorneys noted  the case of International Proprietaries, Inc. v. Comm., 18 TC 133 (1952) that the creation of a reserve account, without an actual reduction in the accounts receivable account, was not enough to constitute a charge off – even though it did reduce net income. In the current analysis, the attorneys equated the creation of a contra-asset account as nothing more than a reserve.

The taxpayer sought to rely on Brandtjen & Kluge, Inc., 34 T.C. 416 (1960). In that case, the taxpayer increased its account entitled “Reserve for Doubtful Notes and Accounts” and debited bad debts, reducing its income. So far, pretty similar facts to our taxpayer. However, there, the taxpayer also made an adjusting journal entry in a new ledger account entitled “Reserve for Loss” with an explanation being “To charge bad debts with loss fro Canadian operation.” The court found that such account and explanation indicated a “sustained loss and not an anticipated future loss” and allowed the deduction.

The Legal Advice concludes that the current facts were closer to International Proprietaries than to Brandtjen, and thus disallowed the current loss.  

Thus, what the IRS and courts are trying to determine is whether the book entry shows a provision for losses anticipated in the future, or whether it shows a current loss and write-off. To avoid the issue entirely, taxpayers would be best served by actually reducing the balance of the receivable account to obtain partial worthlessness loss treatment.

As an aside, a taxpayer can defer the charge-off and deduction to a later year when partial worthlessness is greater, or wait to deduct the entire debt amount in the year of total worthlessness. For the taxpayer at issue here, the loss of the deduction for partial worthless should not result in a total loss – it should be able to deduct it in a later year (not beyond the year of total worthlessness) by doing the correct charge off on its books.

Legal Advice Issued by Field Attorneys 20153501F

No Section 121 Gain Exclusion When Seller of Residence Obtains it Back in Foreclosure

Marvin sold his principal residence for $1.4 million on an installment basis. He reported current gain of $657,796, and excluded $500,000 of that gain from income under Code Section 121 as a sale of a principal residence. The remaining $157,796 of gain was reported on the installment basis. After the sale, Marvin reported $56,920 of gain from cash installment payments received.

The buyer defaulted on his debt and Marvin foreclosed and took the property back. He recognized the remaining $97,153 in long-term capital gains, per the reacquisition of real property rules of Section 1038. Marvin did not resell the residence within a year of his reacquisition.

The IRS asserted that the original $500,000 Section 121 exclusion could not be used to offset gain on the sale and reaquisition, and thus applying the rules of Section 1038 Marvin had gain of $448,080 at the time of the foreclosure and reacquisition. Marvin argued that just because he foreclosed on the property does not mean that the initial $500,000 gain exclusion should not be available to him for purposes of the Section 1038 gain computation.

The Tax Court agreed with the IRS. It noted that Congress did put a special rule in Section 1038(e) that provides if a principal residence is reaquired, and then is resold within 1 year thereafter, the original Section 121 exclusion will continue to apply. Since Marvin did not resell within a year, he could not use this provision. The Tax Court reasoned that if the original Section 121 exclusion applied in a Section 1038 computation of gain for persons that did not resell within 1 year, then there would be no need for Section 1038(e) and it would be a meaningless Code provision. Thus, to give effect to Congress putting Section 1038(e) in the Code, Congress must have recognized that for situations when there is no resale within a year, that Section 121 would not apply.

DeBough, 106 AFTR 2d ¶2015-5192 (CA8 8/28/2015)