Volume 12 Issue 6 -- November/December 2000
The following hypothetical situation is based upon actual cases sent to us by Steve Staley, CPA, of Augusta, GA, in 1990, and Mike O’Malley, CPA, of Bedford, MA, in 2000. The common thread is the sale of a principal residence – with the possibility of moving the house!
While the tax law governing sales of residences has changed considerably in that 10-year period (in 1990 taxpayers under age 55 could only rollover but not exclude gain on residences; in 2000 there is a broad exclusion of such gain), the legal principles involved in both cases are similar. We picked these two cases because they illustrate the type of analysis you should be seeking for your clients.
A developer, Mr. G. Reedy, says to Mr. Lucky, “I want your land for development, but I really don’t want your house that is on the land.” Lucky thinks quickly, “I own the adjacent lot, so I will have my principal residence moved there.”
Next, Lucky comes to you, his advisor, and asks, “Can I exclude the gain from the sale to the developer if I move my principal residence?” At this point, you scratch your head and wonder, “Hmm..., if all that is sold is a vacant lot with the house removed, is this really the sale of a principal residence?”
You check some tax authorities and find that one case, Poague v. United States, 90-2 USTC ¶50,448 (E.D. Va.1990), affd without opinion, 947 F.2d 942 (4th Cir. 1991), suggests that if the seller (Lucky) is required, pursuant to the sales contract, to remove all buildings and improvements from the property sold, then the sale of the lot qualifies as “a residence” for purposes of § 121. Other rulings suggest that a transfer of land that does not include the house is not a residence.
The facts in Poague were unusual and the case was in a different Federal Circuit from Lucky’s situation. Could, or should, the Poague case be relied upon? What if the Lucky-G. Reedy sales contract stated that Lucky had the contractual right and obligation to remove the house?
The Tax and Business Professionals’ advice was to have the sales contract state that the Seller was selling all of his rights to the house and the land. Why word the contract in such a manner that the developer is not legally bound to let Lucky remove his residence?
By wording the sales agreement as a complete sale of all of Lucky’s interest, the IRS probably would be precluded from arguing that the “residence” had not been sold. Would such wording make it possible for the developer to change his mind and give Lucky’s former residence to someone else? The answer is yes, but it would be economically impractical. If Lucky did not remove the house, then the developer would have to incur the needless expense of moving or demolishing the house
While there was perhaps some authority for Lucky receiving the benefits of § 121’s $500,000 exclusion if Lucky had the contractual right to remove the house, a sale of all of Lucky’s interest seemed to be the best route to follow. It seemed to us that despite the Poague case, the IRS could raise the practical argument, “What has been sold except vacant land?”
The IRS could argue, with some force, that all that has been sold was vacant land because Lucky still had his principal residence, albeit on a different parcel of land. By taking a relatively small chance that the developer might change his mind and give the house to someone other than Lucky (or demolish it), Lucky is in a much stronger position to withstand an IRS audit.
In Lucky’s situation there were gray areas, which commonly occur in tax and business laws. Much of what we do could be classified as “risk analysis,” because in unusual situations like Lucky’s, either the law or the authorities interpreting it, or both, are unclear.
Services like ours are designed to assist you in
addressing these types of problems. If you have a matter, simple or complex in nature, and need
help, keep us in mind.
By Tax and Business Professionals, Inc.
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