Page 625 - TaxAdviser_2022

TAX CLINIC

Sec. 469(j)(6) provides that the basis of client and trusted advisers will ensure hand” (Malat v. Riddell, 383 U.S. 569,
the passive activity will be increased by a fair and equitable asset division for 572 (1966)).
any suspended passive losses, and losses both parties.
will not be realized until the activity is For more on this topic, see Facts of the case
sold. If representing the transferee, the “Dividing Up Assets When a Marriage Because the case involves whether the
tax adviser should request all relevant Ends: Tax Implications,” on p. 54. taxpayer was a real estate dealer or
data related to the passive investments From Amy I. Kinkaid, CPA, J.D., MT, merely an investor, it is necessary to
transferred, including the date of the and Charles E. Federanich, CPA, MT, discuss some details about his activities.
original purchase and the adjusted basis AEP, Pease Bell CPAs, Cleveland Since 1981, the taxpayer, William
at the time of the transfer. Musselwhite, had been a practicing
personal injury attorney at his family’s
Charitable contribution Real Estate law firm in North Carolina. In 1986,
carryforward the taxpayer joined his father, uncle,
Regs. Sec. 1.170A-10(d)(4)(i)(b) Real estate dealer or investor? and brother in his first real estate
provides that a charitable contribu- A recent Tax Court case venture — a 100-acre residential land
tion carryforward is allocated between It is the age-old struggle of taxpayers in development and eventual sale of 90
spouses based on how the contribu- the business of developing and owning lots over 13 years. Also during this
tion would have been allocated if real estate — how to turn a profit from time, the taxpayer and his brother
the taxpayers had originally filed as the sale of real estate into a capital gain were involved in a similar 100-acre
married filing separately. Rev. Rul. but, if there is a loss, how to deduct phased development, likewise in
76-267 provides that the taxpayers it as an ordinary loss. Musselwhite, North Carolina.
must follow rules set out in Regs. Sec. T.C. Memo. 2022-57, is not the first In 2005, Musselwhite met a future
1.170A-10 to determine the allocation Tax Court case in which the taxpayer business partner who was a real estate
of the charitable contributions and are argued with the IRS over whether developer. Together they formed a
not permitted to make their own alloca- the real estate was an investment two-member limited liability company
tion agreement. versus held in the ordinary course (LLC). On the first and subsequent
of a trade or business. However, two North Carolina LLC annual reports,
S corporation losses things stand out about this case — the the LLC indicated the nature of its
Transfers of S corporation stock incident first is that it was an ordinary loss business was real estate investment. The
to a divorce are tax-free under Sec. recast into a capital loss. The second LLC initially purchased for investment
1041(a). S corporation suspended basis is that the history of tax returns and purposes five condominiums and
losses are carried over to the transferee. reporting seemed to be as crucial in immediately sold two. In addition, it
Sec. 1366(d)(2)(B) provides that the the court’s analysis and fact-finding purchased two undeveloped lots and a
transferee will treat disallowed S as the taxpayer’s lack of real estate house in Wilmington, N.C. In 2006,
corporation losses as incurred by the S development activity. a third-party developer approached
corporation in the succeeding tax year. Ultimately, the sole dispute in this the LLC and its members, including
case was whether the land was a capital Musselwhite, with a deal to purchase
Ensuring an equitable division asset or inventory. Capital assets are their Wilmington house for $1 million,
of assets property held by the taxpayer, except and the LLC would, in turn, purchase
Tax advisers play an important role for certain items such as stock in four wooded lots from the third party’s
assisting clients in determining the trade of the taxpayer held primarily development. This third party also
tax consequences of asset transfers for sale to customers, or depreciable offered a one-year personal guaranty
prior to the finalization of a divorce property used in a trade or business that the lots would sell within one year
settlement and in making tax filing (Sec. 1221(a)). Further, the Supreme and net $1 million or he would buy
decisions for post-divorce tax years. Court has held that the purpose of Sec. back the remaining unsold lots.
Tax advisers have historical knowledge 1221(a) is to “differentiate between A year later, as the real estate market
that is crucial to identifying tax the ‘profits and losses arising from the started to take an ugly turn, the lots had
issues that need to be addressed to everyday operation of a business’ on not sold, and, in 2008, the LLC sued
provide for an equitable division of the one hand … and the ‘realization the third party to enforce his promise
the couple’s assets. Coordinating early of appreciation in value accrued over a to repurchase the lots. Instead, the third
and frequent communication with the substantial period of time’ on the other party agreed to complete any remaining

16 December 2022 The Tax Adviser