Selling taxpayers often ignore or fail to appreciate the full picture of their sale transaction. This article examines two recent Tax Court cases in which taxpayers incorrectly accounted for the consideration received as sellers of property.
Often to their peril, selling taxpayers ignore or fail to appreciate the full picture of their sale transaction, as effectively demonstrated by Braen v. Commissioner, TCM 2023-85, and Parker v. Commissioner, TCM 2023-104. More specifically, the taxpayers in each case incorrectly accounted for the consideration received as sellers of property.
It is noteworthy that these recent Tax Court cases, although unrelated and quite disparate (and potentially appealable to different circuits) reinforce the notion that sellers of property must account for all consideration received in the sales transaction, including items that on first blush may appear divisible from or otherwise unconnected to the deal. Braen is appealable to the U.S. Court of Appeals for the Third Circuit, and Parker is appealable to the U.S. Court of Appeals for the Ninth Circuit.
In Braen, the taxpayer did not treat as consideration received in the sale the value of a favorable zoning change to other property owned by the taxpayer, even though the zoning change was a condition of the deal. In Parker, although debt cancellation was a condition of the deal, instead of treating the cancelled amount as part of the sale consideration, the taxpayer treated it separately as cancellation of indebtedness income subject to the insolvency exclusion under IRC section 108.
What Went Wrong
‘Braen’
Braen involved a purported bargain sale to the Town of Ramapo, a governmental body, with the selling taxpayer’s expectation of a charitable deduction to the extent the consideration received was less than the full value of the property sold. Unfortunately, the taxpayer was unable to show that although documented as a bargain sale that there actually was one. The problem was that in determining its amount realized on the sale, the taxpayer ignored the value of the favorable zoning change regarding taxpayer’s retained property, where the zoning change was a condition of the sale.
Taxpayer, an S corporation, and its owners, desired to expand their quarrying business, i.e., owning and operating a quarry by exploiting land it owned and additional land that it was acquiring, for such purposes in and around Ramapo, New York. Governmental approvals were required to own and operate a quarry. Taxpayer eventually threw in the towel and decided to sell the property it had hoped to use for quarrying purposes.
After expending substantial time and effort trying to gain permission to operate a quarry, including dealing with community opposition to the plan, and engaging in litigation with the Town of Ramapo, taxpayer and Ramapo agreed to settle the litigation, and Ramapo agreed to purchase the property initially intended for quarrying. Early on, taxpayer had owned other property in Ramapo, which had a favorable zoning designation. Ramapo removed the favorable zoning designation.
As a condition of the sale and settlement, Ramapo restored the favorable zoning designation. The value of the restored zoning designation was additional consideration received by the taxpayer. However, the taxpayer did not account for it as part of its amount realized on the sale. IRC Section 1001.
An alternative ground for denying the charitable deduction was taxpayer’s failure to provide the contemporaneous acknowledgment from the Town of Ramapo, as required by IRC section 170(f)(8)(A). The Internal Revenue Code requires that the taxpayer obtain from Ramapo written acknowledgement of the zoning benefit as part of the consideration for the acquired property, as well as a good-faith valuation of such benefit.
Adding insult to injury, the substantial valuation misstatement penalty, as provided by IRC section 6662(a) and 6662(b)(3), was imposed on the taxpayer due to taxpayer’s overvaluing the property sold to Ramapo, apparently based upon an overzealous appraisal. The overvaluation, of course, led to the resulting overstated charitable deduction in the purported bargain sale.
‘Parker’
Parker involved the mischaracterization of the consideration received by the taxpayer, unlike in Braen where the issue concerned whether certain consideration was received, and, if so, its value. In Parker, an unrelated buyer acquired various properties owned by the taxpayer. The terms of the deal required the termination of certain nonrecourse loans encumbering the properties.
The taxpayer, an S corporation, owned various properties through a number of disregarded entities. Encumbering the properties were various nonrecourse loans that had been advanced by an unrelated lender. The taxpayer entered into sale agreements for the properties with an unrelated buyer, and as a condition of the sales, the nonrecourse indebtedness had to be cancelled.
The taxpayer maintained that since it was insolvent, the cancelled debt was excluded from its gross income as provided in IRC Section 108 (a)(1)(B). The taxpayer ignored the connection between the cancelled debt and the deal, i.e., a condition of the deal required the cancellation of the debt. The taxpayer reported the cancellation of the debt as a separate transaction, unrelated to the sale.
The issue, succinctly framed by the court:
In deciding whether debt relief results in gain or COD income, we focus on the facts and circumstances surrounding how the taxpayer-debtor satisfied or extinguished the underlying debt. (citations omitted.) If nonrecourse debt relief is conditioned upon a sale or exchange of property or is otherwise a part of that underlying sale or exchange, the amount of debt relief is properly included in the amount realized and is not COD income. (citations omitted.)
Parsing through the facts, the court determined that the debt cancellation occurred in connection with the sale of the properties to the buyer and, therefore, was part of the consideration received for the properties and not cancellation of indebtedness income subject to IRC Section 108.
The court concluded:
The COD was part and parcel of the global agreement to convey the Livermore property, with [third party lender] accepting new personal guaranties, a partial payment by the Buyers, and the escrowed deed to the Iowa property in consideration of that cancellation. We conclude that [third party lender’s] cancellation of [the nonrecourse loans] was dependent on [taxpayer’s] sale of the Livermore property to the Buyers and it was a part of the same sale transaction.
Lesson Learned
It is generally not a mystery when a taxpayer sells property to another. For tax and perhaps other purposes, it is very important to appreciate the economics of the deal and the related rights and obligations of the parties. Regardless of how extraneous it may appear, examination of anything of value passing between the parties is necessary to see where it fits.
Reprinted with permission from the New York Law Journal, An ALM Publication