SCOTUS Reports

Tag: Basis of Property

  • Timanus v. Commissioner, 32 T.C. 631 (1959): Basis of Inherited Property and Installment Sales

    32 T.C. 631 (1959)

    The basis of inherited property is its value at the date of death of the previous owner, and initial payments in an installment sale exceeding 30% of the selling price preclude installment reporting.

    Summary

    In Timanus v. Commissioner, the Tax Court addressed two main issues. First, it determined the proper basis for calculating depreciation on real estate inherited by the taxpayer, differentiating between property directly inherited and property that passed through joint tenancy. Second, it examined whether the taxpayer could use the installment method to report income from a real estate sale. The court held that the basis for depreciation depended on how the property was acquired, specifically differentiating between property inherited directly and property that passed through joint tenancy. It also ruled that the initial payments received by the taxpayer exceeded 30% of the selling price, thus preventing the use of installment sale reporting.

    Facts

    The taxpayer, G. Loutrell Timanus, inherited several properties. One property, 1307 Maryland Avenue, was inherited directly from his mother, who received it after Timanus’s father died. The other properties, 1309 and 1311 Maryland Avenue, were held in joint tenancy with his mother, and Timanus received them upon her death. Timanus claimed depreciation deductions on these properties. Additionally, Timanus sold a tract of land, receiving initial payments in the year of sale. The Commissioner of Internal Revenue disputed both Timanus’s depreciation calculations and his use of the installment method for reporting the gain from the land sale.

    Procedural History

    The Commissioner determined deficiencies in Timanus’s income tax for the years 1950 and 1951. Timanus challenged the Commissioner’s determinations in the United States Tax Court. The Tax Court considered the issues of proper basis for depreciation and the eligibility for installment sale reporting. The Tax Court issued a decision on these issues in 1959.

    Issue(s)

    1. Whether the taxpayer’s basis of three pieces of improved real estate was fully recovered through annual depreciation allowances prior to 1950 so that no depreciation deductions are allowable for 1950 and 1951.

    2. Whether the initial payments received by petitioners in 1951 upon the sale in 1951 of a tract of unimproved real estate exceeded 30 per cent of the selling price so as to preclude making return of the gain realized on an installment basis under section 44(a) and (b) of the 1939 Code.

    Holding

    1. No, because the properties were fully depreciated before 1950.

    2. Yes, because the initial payments received by the petitioners in 1951 exceeded 30% of the selling price.

    Court’s Reasoning

    The court determined the basis of the real properties by referencing the time of their acquisition. For the properties acquired through his father’s death, then held in joint tenancy with Timanus’s mother, the court stated that the basis was their fair market value at the time of the father’s death. For property inherited from the mother’s will, the basis was the fair market value at the time of the mother’s death. The court found that the taxpayer had not provided sufficient evidence to support his claimed basis. The court referred to Section 113(a)(5) of the 1939 Code to determine the adjusted basis for depreciation. The Court concluded the properties were fully depreciated prior to 1950 based on these calculations, thus disallowing any depreciation deduction in 1950 and 1951.

    Regarding the installment sale, the court analyzed the agreement for the sale of the Florida real estate. Because the sale agreement specified that $560,000 would be paid to the petitioners, that amount was determined to be the selling price. The court found that the initial payments, which included the cash down payment and the assumption of a mortgage, exceeded 30% of this $560,000 selling price. The court cited Regulation 111, Section 29.44-2, stating that a mortgage assumed by a buyer is not part of initial payments.

    The court distinguished this case from Walter E. Kramer, because the contract specifically listed the amount paid to each owner, as opposed to a lump sum.

    Practical Implications

    This case highlights the importance of properly determining the basis of inherited property, especially when multiple methods of acquisition are involved. It emphasizes the significance of the date of acquisition for determining basis and allowable depreciation. It also reinforces the criteria for installment sales, particularly the definition of “initial payments” and the 30% threshold. Attorneys advising clients with inherited property must carefully document the acquisition method to establish the correct basis for depreciation. When structuring real estate sales, it is essential to understand the definition of “selling price” and “initial payments” to determine if installment sale treatment is permissible. This case is a reminder that the specific terms of the sale agreement control the determination of selling price when applying the installment method, and the allocation of payments matters.

  • Beckman Trust v. Commissioner, 26 T.C. 1172 (1956): Basis of Property in Revocable Trusts at Grantor’s Death

    Beckman Trust v. Commissioner, 26 T.C. 1172 (1956)

    When a grantor establishes a revocable trust and reserves the income for life and the power to revoke the trust with the consent of a non-adverse party, the basis of the property in the hands of the trust after the grantor’s death is the fair market value at the date of the grantor’s death, as if the trust instrument had been a will.

    Summary

    The United States Tax Court addressed whether the basis of stock sold by the Beckman Trust after the death of the grantor should be determined under Internal Revenue Code section 113(a)(2) or 113(a)(5). The grantor had created a trust, retaining the income for life and the right to revoke the trust with the consent of two named trustees. The court held that the trust fell under section 113(a)(5), meaning the basis of the stock should be the fair market value at the date of the grantor’s death. The court reasoned that the grantor’s retained control over the trust assets, including the power to revoke, meant the property should be treated as if it had been transferred by will, aligning with the purpose of section 113(a)(5) to treat such transfers as incomplete gifts until death.

    Facts

    In 1932, Hazel B. Beckman created a trust, transferring stock to the trust. The trust was to last for the lives of her daughters. Beckman reserved the income of the trust for her life. The trust instrument allowed Beckman to revoke the trust with the consent of her father during his lifetime, and after his death, with the consent of designated trustees. The trust was amended in 1943 to specify the trustees whose consent was required for revocation. Beckman died in 1947. In 1950, the trust sold a portion of the Wenonah stock and reported a capital gain, using the stock’s value at the time of Beckman’s death as the basis. The Commissioner determined the basis of the stock should be the same as in the grantor’s hands, resulting in a larger taxable gain.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in the trust’s income tax for 1950, based on the Commissioner’s calculation of the capital gain from the sale of stock. The Beckman Trust contested the deficiency in the U.S. Tax Court.

    Issue(s)

    1. Whether the basis of the stock sold by the Beckman Trust should be determined under Section 113(a)(5) of the Internal Revenue Code, based on the fair market value at the date of the grantor’s death.

    2. Whether the grantor’s power to revoke the trust with the consent of trustees who did not have adverse interests satisfied the requirements of Section 113(a)(5).

    Holding

    1. Yes, because the trust met the requirements of Section 113(a)(5), as the grantor reserved the income for life and the right to revoke the trust with the consent of trustees.

    2. Yes, because the grantor retained sufficient control over the trust property through the power to revoke with the consent of non-adverse trustees, which is considered equivalent to a power to revoke reserved solely by the grantor for purposes of the section.

    Court’s Reasoning

    The court focused on interpreting Section 113(a)(5) of the Internal Revenue Code, which provides a special rule for determining the basis of property transferred in trust. The court examined whether the trust satisfied the conditions for the special rule, particularly the requirement that the grantor reserved the right to revoke the trust. The court found that the trust met the requirements of the statute. The court found the trust instrument reserved to the grantor at all times prior to her death the right to revoke the trust with the consent of two nonadverse trustees, or one nonadverse trustee. The court cited the legislative history of the 1928 Revenue Act which indicated the intent to treat such transfers as if the trust had been a will. The court stated, “In view of the complete right of revocation in such cases on the part of the grantor at all times between the date of creation of the trust and his death, it is proper to view the property for all practical purposes as belonging to the grantor rather than the beneficiaries.” The court looked to principles of gift taxation and the concept that a gift is not complete until put beyond recall. Since Beckman retained control over the property through her right to revoke, the court concluded that for tax purposes, the stock did not vest in the beneficiaries until her death.

    Practical Implications

    This case is significant because it clarifies how Section 113(a)(5) applies to trusts where the grantor’s power to revoke is subject to the consent of a non-adverse party. Attorneys and tax professionals must consider this when advising clients on estate planning. The case establishes that when drafting revocable trusts, a reserved right to revoke, even if requiring the consent of a trustee without an adverse interest, can trigger the application of Section 113(a)(5). This will result in the basis of the trust property being determined by its value at the time of the grantor’s death. This can have significant tax implications, as the stepped-up basis at death can reduce capital gains taxes. Later cases have followed this principle, reinforcing the importance of understanding the implications of retained powers in trust instruments on the basis of assets. This ruling emphasizes the importance of carefully structuring trusts to achieve the desired tax outcomes and the necessity of considering gift tax principles when analyzing the effect of such trusts.

  • James E. Caldwell & Company v. Commissioner of Internal Revenue, 24 T.C. 597 (1955): Deductibility of Business Expenses Related to Fraudulent Activities

    24 T.C. 597 (1955)

    Business expenses, to be deductible, must be related to legitimate business operations, and are not deductible if incurred as a result of fraudulent activities unrelated to the taxpayer’s core business.

    Summary

    The United States Tax Court addressed several issues related to the deductibility of business expenses for James E. Caldwell & Company. The primary issue concerned whether payments made by the company, one to settle a suit alleging fraudulent conveyance and another related to a judgment against the company for fraudulent activities, could be deducted as business expenses. The court held that the payment to settle the suit related to real estate was not deductible as it was considered a capital expenditure to remove a cloud on title, and that the payment made toward the judgment arising from the fraudulent scheme was not deductible because the activities did not relate to the normal and legitimate operations of the business. The court also addressed the proper basis for determining the gain on the sale of stock received as a gift where the donor’s basis was unknown, ruling that a zero basis was appropriate in such circumstances.

    Facts

    James E. Caldwell & Company (petitioner) was a Tennessee corporation. The company was incorporated in 1931. The company’s principal officer conveyed real estate to the company in exchange for stock. Later, a judgment creditor of the officer sued to rescind the conveyances, and the petitioner settled the suit. Subsequently, the petitioner was found liable, along with its officers, in a suit filed by a receiver of another corporation for engaging in a fraudulent conspiracy. Petitioner paid a sum toward satisfaction of the judgment and related attorney’s fees. The petitioner also sold shares of stock of another corporation, which it had acquired by gift. The petitioner did not have records from which to determine the basis of the shares in the hands of its donor.

    Procedural History

    The Commissioner of Internal Revenue determined deficiencies in the petitioner’s income tax. The petitioner contested the deficiencies in the United States Tax Court. The Tax Court reviewed the Commissioner’s determinations and rendered a decision.

    Issue(s)

    1. Whether the petitioner was entitled to use as its basis for computing gain on the sale of certain real estate the amount paid to a judgment creditor of the officer in compromise of a suit to rescind the conveyance, and the amount paid for a title guaranty policy used in borrowing cash for the settlement?

    2. Whether the petitioner was entitled to deduct from its gross income, either as a loss or as an ordinary and necessary expense of its business, the amount which it paid toward satisfaction of a judgment entered against it for engaging in a fraudulent conspiracy, and related attorney’s fees?

    3. Whether the Commissioner erred in using a zero basis to compute the petitioner’s gain from the sale of shares of stock of another corporation, where the petitioner acquired the shares as a gift and the basis of the donor was unknown?

    Holding

    1. No, because the additional amounts paid did not increase the company’s basis in the property.

    2. No, because the expenditures were not related to the normal, legitimate business operations.

    3. No, because the petitioner was unable to establish a basis for the stock.

    Court’s Reasoning

    The court reasoned that the payment made to settle the creditor’s suit was not an additional cost basis for the real estate. It was determined that since the creditor’s claim was against the original conveyance, the petitioner could not derive a greater interest than the seller’s entire title. The court cited the principle that the income tax consequences of settlements of litigation must be determined with regard to the nature of the claim involved and the relationship of the parties to the proceeding.

    Regarding the second issue, the court emphasized that for an expense to be deductible under Section 23 of the Internal Revenue Code, it must be incurred in connection with the taxpayer’s business. The court held that the payment of the judgment stemmed from a fraudulent conspiracy wholly unrelated to the petitioner’s normal business. The court cited Kornhauser v. United States, 276 U.S. 145 (1928), stating that expenses must be directly connected with, or proximately resulted from, the business to be deductible.

    Regarding the third issue, the court found that the Commissioner was correct in using a zero basis because the petitioner had no records or evidence of the basis. The court cited Burnet v. Houston, 283 U.S. 223 (1931) to support its conclusion.

    Practical Implications

    The case illustrates that the deductibility of business expenses is closely tied to the nature and legitimacy of the activities giving rise to those expenses. It serves as a precedent for the principle that a payment to settle a lawsuit, or pay a judgment resulting from an activity completely separate and apart from the conduct of the taxpayer’s business, is not a deductible business expense. It also underscores that taxpayers must maintain adequate records to establish a basis for assets, failing which they may be deemed to have a zero basis for tax purposes. Businesses and their advisors should carefully consider: whether expenses are directly connected to the business; the specific nature of the expenses; and the potential impact of fraudulent or illegal activities.

  • Levy v. Commissioner, 17 T.C. 728 (1951): Basis of Gifted Stock & Subsequent Estate Tax Payments

    17 T.C. 728 (1951)

    The basis of stock acquired as a gift is not increased by the amount of federal estate tax paid by the donee in a subsequent year, even if the gift was made in contemplation of death and included in the donor’s estate.

    Summary

    Hetty B. Levy received stock as a gift from her husband, Leon Levy, who later died. After Leon’s death, the IRS determined that the stock gifts were made in contemplation of death, including the stock’s value in Leon’s estate, which increased the estate tax liability. Hetty sold the stock in 1945 and paid a portion of Leon’s estate tax in 1946. She then sought to increase her basis in the stock sold in 1945 by the amount of estate tax she paid in 1946. The Tax Court held that the basis could not be adjusted retroactively for estate tax payments made after the sale, as this would contradict annual accounting principles.

    Facts

    • Hetty B. Levy received 128,650 shares of Stern & Company stock as gifts from her husband, Leon Levy, in 1939 and 1941.
    • Leon Levy died in 1942. His will directed that all estate taxes be paid out of the residuary estate.
    • In 1945, Hetty sold 96,487 shares of the Stern & Company stock for $136,151.24. The stock had a cost basis to Leon of $30,909.79.
    • In 1946, the IRS determined a deficiency in Leon’s estate tax, including the stock gifted to Hetty, determining that the gifts were made in contemplation of death.
    • Hetty paid $54,311.50, representing her share of the estate tax attributable to the gifted stock, to the IRS.
    • Hetty sought to increase the basis of the stock she sold in 1945 by the amount of estate tax she paid in 1946.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in Hetty Levy’s 1945 income tax, disallowing the increase in the basis of the stock. Levy petitioned the Tax Court, contesting the Commissioner’s decision. A refund claim was previously filed and denied.

    Issue(s)

    1. Whether the basis of stock acquired by gift can be increased by the amount of federal estate tax paid by the donee in a year subsequent to the sale of the stock, when the stock was included in the donor’s estate as a gift in contemplation of death.

    Holding

    1. No, because adjusting the basis for events occurring after the sale of the property would violate the principle of determining income taxes on the net results of annual accounting periods.

    Court’s Reasoning

    The court reasoned that under Section 113(b)(1)(A) of the Internal Revenue Code, adjustments to the basis of property are allowed for expenditures properly chargeable to the capital account. However, it held that the estate tax payment in 1946 was not an expenditure of this nature. The court emphasized that because Hetty sold the stock in 1945, no lien attached to the stock in 1946 when she paid the estate tax. Further, the court stated that allowing adjustments to the basis of property for events occurring after the year of a completed transaction would keep the transaction open indefinitely, which is contrary to annual accounting principles. Citing Burnet v. Sanford & Brooks Co., 282 U.S. 359 and Security Flour Mills Co. v. Commissioner, 321 U.S. 281, the court held that income taxes are determined on the net results of annual accounting periods and that the gain realized on a sale is determined by the transactions in that year and cannot be affected by events in a subsequent year.

    Practical Implications

    This case establishes that taxpayers cannot retroactively adjust the basis of property sold to account for subsequent payments of estate tax. This ruling reinforces the importance of determining tax liabilities on a yearly basis. The decision prevents taxpayers from attempting to keep a gain or loss transaction open indefinitely. It aligns with the principle that tax consequences are generally determined at the time of the sale or disposition of property, not by subsequent events. Later cases would cite this case to disallow similar post-sale adjustments.