Taxing Definitions

Definition — Standing Alone

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Image Source: Solitary Seagull © Charles Shapiro Dreamstime Stock Photos
Image Source: Solitary Seagull © Charles Shapiro Dreamstime Stock Photos

The annual accounting concept is a familiar part of tax law. Under internal revenue code section 441, you compute your taxable income on the basis of your taxable year. When completing your return, you look at events on an annual basis, using the facts as they exist at the end of the year covered by the return. Each taxable year is a separate unit, and the future is left to take care of itself.

Here are two examples.

1.

In February, a calendar year taxpayer sold land and received cash for the entire purchase price. The contract of sale obligated the taxpayer to take the land back if at any time within nine months of the sale the land could not be rezoned for business purposes.

In October, the buyer determined it was not possible to have the land rezoned. The taxpayer took the land back during October. The buyer received a refund of all amounts expended in connection with the transaction.

What do you think?

or

Source: Revenue Ruling 80-58

2.

In February, a calendar year taxpayer sold land and received cash for the entire purchase price. The contract of sale obligated the taxpayer to take the land back if at any time within one year of the sale the land could not be rezoned for business purposes.

The following January, the buyer determined it was not possible to have the land rezoned. The land was returned to the taxpayer in February (one year after the sale) and the buyer received back all amounts expended in connection with the transaction.

What do you think?

or

Source: Revenue Ruling 80-58

Another aspect of “each year standing on its own” is the fact that the IRS can be inconsistent in allowing (or disallowing) similar deductions on a year to year basis. For instance, in Summary Opinion 2014-109 (Campbell), the IRS determined the taxpayer’s Coast Guard retirement pay was not excludable from income on the basis of disability, even though his returns had taken that position and been accepted as filed for multiple previous years.

There’s also the question of what happens when unforeseen events taking place in the current year affect deductions you took in the past.

In Summary Opinion 2011-117 (Rose), the taxpayer entered into a contract to buy beachfront property in 2006. At the time he entered into the contract there was an existing house on the property. The taxpayer purchased the property in order to build a new house on the lot and not because he intended to make use of the existing house. The purchase contract provided that the existing house would be torn down and completely removed from the property before the closing date.

The taxpayer borrowed $1,260,000 from a bank to buy the property. The loan was secured by a mortgage on the property. At the time of closing, the demolition of the existing house had been completed and the property consisted of a vacant lot.

The taxpayer deducted the interest on the initial loan on his tax returns for 2006 and 2007. In 2008, after a permitting process involving the Department of Environmental Protection, the taxpayer received a construction permit. However, due to a severe decline in the real estate market, he was unable to secure an additional bank loan to cover construction costs. In 2009 he sold the property and suffered a loss.

The IRS said that because the taxpayer sold the property before completion of a residence that was ready for occupancy, the interest was not deductible.

The taxpayer said subsequent events prevented completion of a qualified residence, and he did not know in 2006 and 2007 that events beyond his control would prevent him from completing the home.

At issue: Do subsequent year events that prevented the completion of construction of a qualified residence disqualify the interest deduction for the years at issue?

What do you think?

or

The case: TC Summary Opinion 2011-117 (Rose)

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Sorry, wrong answer :(
Right answer!

The rescission of the sale during the year placed both taxpayers at the end of the taxable year in the same positions as they were prior to the sale. Thus, the original sale is to be disregarded for federal income tax purposes because the rescission extinguished any taxable income for that year with regard to that transaction. No gain is recognized by the taxpayer.

Right answer!

There was a completed sale in year one. However, because only the sale and not the rescission occurred in year one, at the end of year one neither taxpayer was in the same positions as they were prior to the sale.

The rescission in year two is disregarded with respect to the taxable events occurring in year one. The taxpayer must report the sale for year one. In year two, when the property was reconveyed to the taxpayer, she acquired a new basis in the property, which was the price paid to the buyer for the reconveyance.

Sorry, wrong answer :(
Sorry, wrong answer :(
Right answer!

It is a well-known principle that each taxable year stands alone and is evaluated separately. In evaluating each year on its own, it would be impossible for the taxpayer or the Internal Revenue Service to have known that the proposed residence would never become ready for occupancy.

The appropriateness of the deductions claimed should be evaluated on the basis of the facts and circumstances as they existed in 2006 and 2007. Events beyond the taxpayer’s control occurred in subsequent years and prevented him from completing a residence.

We hold that the planned residence was under construction during 2006 and 2007. Therefore, the taxpayer is entitled to the claimed mortgage interest deductions for the taxable years 2006 and 2007.