Tax News
In Evans v Comm’r, the Tax Court disallows an ordinary loss from a foreclosure sale
January 13, 2016
The Tax Court released a few days ago Evans v Comm’r,  T.C. Memo. 2016-7.  This case offers a continued illustration of the perils of “facts and circumstances” Tax Court litigation. “Facts and circumstances” is a term of art in tax law that pops its head in almost every other page of the Internal Revenue Code. One of the few most topical for the investment industry instances of “facts and circumstances” include the “trader v. investor” issue, the “trade or business” issue, and last but not least the “dealer v. investor” (or “developer v investor”) issue. This case involves the last of these examples.

Evans was a successful executive of a California real estate development company. He was in the business for over 30 years and was responsible for managing architects, designs and contractors. As a side business he acquired for himself various real-estate projects. Evans’s plan when purchasing properties for development and sale was to tear down the existing structures, construct single or multiunit residences, then sell those residences for gain. His alternative objective was to generate income by renting these residences to tenants. The types of tasks that Evans performed with respect to his personal real-estate projects included looking for properties to purchase, hiring architects, hiring contractors, and obtaining permits.

Well, regrettably for Evans, one of these projects turned for the worse and was sold in a non-judicial foreclosure sale at a loss. Evans felt that he was a developer for tax purposes and proceeded to report the tax loss on Schedule C of his Form 1040. The IRS took the contrary position and claimed that the loss was capital in nature. Now, this is a far too familiar story. If there is one recurring highly litigated tax issue, this is the developer v. investor issue. It is safe to say that there are probably over 100 cases dealing with this particular problem. What is interesting about this case? Aside from the fact that it is the latest case coming out of the Tax Court, the interesting part is that the taxpayer lost not because he couldn’t prove that he held the property for resale but because he was not engaged in a trade or business. Despite his development activities and other commercial efforts, the Tax Court was not inclined favorably. In convincing the Tax Court to hold against the taxpayer, the IRS’ crafty logic was as follows. For you taxpayer, proving that you held the property primary for resale means nothing unless you can prove that you held it for resale to customers in a trade or business.  That’s where the taxpayer failed. Proving that he acquired property with the intention of developing it did not mean that he was in the business of property development and sale! The taxpayer just did not have enough activity to convince the Court he was conducting a business. 

The case would be most topical to real estate investment funds and can be found here
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Tags: dealer v. investor, developer, real estate fund and installment sale