Monday, May 30, 2022
The courts are constantly deciding tax issues. Two recurring themes in numerous cases involve timing of asset sales and recordkeeping/substantiation. Those two issues are on display in court opinions that I summarize. On the real estate side of the ledger fence issues loom large (and always have) as do partition actions (don’t leave property at death to your children in co-equal undivided interests – just don’t) and warrantless searches of farmland.
Recent court opinions involving taxes and real estate – it’s the topic of today’s post.
Recent Tax Cases of Interest
Questions Remain on “Unforeseen Circumstances” Exception Under I.R.C. §121
Webert v. Comm’r, T.C. Memo. 2022-32
The petitioners, a married couple, bought a home in 2005. The wife was diagnosed with cancer later that year and underwent costly treatments. They resided in the home until 2009 and then rented out the home and resided in another home the husband owned. The sold the first home in 2015. They filed joint returns for tax years 2010 through 2015. During those years, they reported income from the lease of the first home on Schedule E. They reported that they used the home for personal purposes for 14 days in 2010 and zero days in 2011 through 2015. Their depreciation schedules mirrored the number of fair rental days reported for the property on their Schedule E. On their 2015 return, they reported the sale of the first home but excluded the gain from gross income. The IRS audited and asserted that the income from the sale of the home should have been reported and moved for summary judgment. The Tax Court granted summary judgment to the IRS on the issue of whether the petitioners used the home as their principal residence for at least two of the last five years immediately preceding the sale as I.R.C. §121 requires. They did not. However, the Tax Court determined that issues of material fact remained on whether the wife’s health problems were the primary reason for the sale such that the gain might be excludible because the sale was on account of health or other unforeseen circumstance in accordance with I.R.C. §121(c)(2)((B).
Jewelry Gift Not Properly Substantiated – Charitable Deduction Denied
Albrecht v. Commissioner, T.C. Memo. 2022-53
In 2014, the petitioner donated approximately 120 pieces of Native American jewelry to a museum, a qualified charity. The museum executed a “Deed of Gift” which specified, in part, that “all rights, titles, and interests” in the jewelry were transferred from the donor to the donee upon donation unless otherwise stated in the Gift Agreement. The petitioner claimed a charitable deduction for the donation on her 2014 return and supported the claimed deduction by submitting the “Deed of Gift” documentation. The IRS denied the deduction on the basis that the “Deed of Gift” documentation did not meet the substantiation requirements of I.R.C. §170(f)(8)(B) that require a description of the donated item(s), whether the donee provided any form of consideration in exchange for the donation, and a good faith estimate of the value of the donation. The IRS pointed out that the “Deed of Gift” documentation from the museum did not state whether the museum provided any goods or services in return for the donation. In addition, the terms of the “Deed of Gift” documentation with the museum referred to a superseding agreement, “the Gift Agreement,” which left open the question of whether the donor retained some title or rights to the donation, and also indicated that the petitioner’s documentation did not include the entire agreement with the done. The Tax Court agreed with the IRS and held that the petitioner did not comply with the substantiation requirements of I.R.C. §170(f)(8)(B) and denied the charitable deduction.
Legal Issues Related to Real Estate
Court Construes State Fence Law
Yin v. Aguiar, 146 Haw. 254, 463 P.3d 911 (2020)
The plaintiff leased property from a third party for growing sweet potatoes. Under the lease, the plaintiff was responsible for keeping cattle from damaging his crop. The plaintiff filed a complaint against a neighboring cattle owner claiming that the cattle damaged over 13 acres of the plaintiff’s sweet potato crop and the landowner’s fence in the amount of $190,000. The cattle owner claimed he was not liable because the fence between the properties was not a legal fence. The fence was less than 4 and ½ feet tall and was made from hog wire, which did not meet the state law requirements for a legal fence. The cattle owner further pointed to the plaintiff’s lease, which stated the plaintiff was responsible for keeping cattle off the leased property. The state Supreme Court determined that that it was inappropriate to interpret state fence law to hold cattle owners solely responsible for properly fenced or entirely unfenced property (including property enclosed with improper fencing) because that did not comport with the legislative intent of the fence laws. But, the Supreme Court also concluded that to hold the plaintiff liable for the damage due to a clause in his lease agreement would be against public policy because upholding the clause would be contrary to state fence law that holds livestock owners responsible for escaped livestock in certain situations. The state Supreme Court remanded the case to the circuit court for further proceedings consistent with its opinion.
“Improvements” Valued in Partition Action
Claeys v. Claeys, No. 124,032, 2022 Kan. App. LEXIS 16 (Kan. Ct. App. May 6, 2022)
Two brothers each inherited an undivided one-third interest in farmland, and the wife of a deceased brother owned the other one-third interest via a trust created for her benefit. She filed a partition action seeking to sever the co-ownership. The brothers counterclaimed, asserting they improved the value of the land and that her share should be offset to account for the improvements. The brothers obtained a water permit, installed an $83,000 ten-tower irrigation system to convert the dry land to irrigation crop farming, and spent over $10,000 on piping and a water meter. The irrigation system was one brother’s personal property. The sister in-law did not contribute to the cost of these improvements. Three commissioners were appointed to appraise the land and they valued the dryland at $390,000 and the irrigated land at $2,065,000. She elected to take the smaller tract that was not worth as much. The commissioners determined that because her tract was less valuable, the brothers owed her $428,333 to account for her one-third interest. The trial court ultimately ordered the brothers to pay her the $428,333 for her one-third interest in the higher-valued land based on a finding that improvements were limited to physical structures and equipment. $50,000 of the $428,333 was placed in escrow and the brothers filed a counterclaim that the $50,000 represented her one-third interest in the increased value from irrigation and should be credited against what they owed her. The trial court ruled for the sister-in-law on the counterclaim, finding that the increase in value was attributable solely to the pivot irrigation system. As personal property of one of the brothers, the irrigation system was not an “improvement.” The trial court awarded the $50,000 to the sister-in-law. On appeal, the appellate court held the trial court erred when it found the brothers did not improve the land. The appellate court determined that Kansas law requires a broader inquiry into possible improvements to the land other than just physical structures and equipment. The appellate court held that the improvements enhanced the property’s condition by increasing productivity and were not mere repairs or replacements. Changing the land’s status from dry to irrigated and obtaining a water right improved the value of the land. Accordingly, the appellate court held that such “improvements” should be considered to offset the sister-in-law’s share in the property and remanded the case to the trial court.
State Law Allowing Warrantless Searches Unconstitutional
Rainwaters, et al. v. Tennessee Wildlife Resources Agency, No. 20-CV-6 (Benton Co. Ten. Dist. Ct. Mar. 22, 2022)
The plaintiffs owned farmland on which they hunted or fished. They marked fenced portions of their respective tracts where they hunted and posted the tracts as “No Trespassing.” Tennessee Wildlife Resources Agency (TWRA) officers entered onto both tracts on several occasions and took photos of the plaintiffs and their guests without permission or a warrant. Tennessee law (Tenn. Code Ann. §70-1-305(1) and (7)) allows TWRA officers to enter onto private property, except buildings, without a warrant “to perform executive duties.” The TWRA officers installed U.S. Fish & Wildlife Service surveillance cameras on the plaintiffs’ property without first obtaining a warrant to gather information regarding potential violations of state hunting laws. The plaintiffs challenged the constitutionality of the Tennessee law and sought injunctive and declaratory relief as well as nominal damages. The defendants moved for summary judgment arguing that the plaintiffs lacked standing and that there was no controversy to be adjudicated. The trial court found the Tennessee law to be facially unconstitutional. The trial court noted that the statute at issue reached to “any property, outside of buildings” which unconstitutionally allowed for warrantless searches of a home’s curtilage. The trial court also determined that the officers’ information gathering intrusions were unconstitutional searches rather than reasonable regulations and restrictions, and that the statute was comparable to a constitutionally prohibited general warrant. It was unreasonable for the TWRA officers to enter onto occupied, fenced, private property without first obtaining consent or a search warrant. The trial court also held the plaintiffs had standing to sue because they experienced multiple unauthorized entries onto their private property, and that declaratory relief was an adequate remedy. The trial court awarded nominal damages of one dollar. The defendant has appealed, and the case is ongoing.
The cases summarized in this post point out several important things: 1) for purposes of the gain exclusion rule of I.R.C. §121, usage of the principal residence as a “principal residence” is critical, as is the timing of the sale; 2) the substantiation rules for charitable deductions must be closely followed; 3) fence law statutes tend to be old and can be complex and somewhat difficult and confusing to apply; 4) leaving land at death to children in co-equal undivided interests often creates issues, including partition actions and difficulties in equating each separate tract; and 5) the warrantless search of farmland is a continuing issue in agriculture.