Capital Gain or Loss: Why It s Not Always Simple 61 st MNCPA Tax Conference Edward K. Zollars, CPA www.cperesources.com ed@tzlcpas.com Capital Gain Basics Capital Gain or Loss: Why It s Not Always Simple 2
3 Is it an Asset? Capital Gain or Loss: Why It s Not Always Simple 4
Asset vs. Not Asset First question is was an asset sold? Have to both Have an asset and Must own it (that is, have the right to prevent others from using it) Identifying an intangible asset is often where questions crop up 5 Make Sure You Identify What Was Sold Muskat v. Commissioner, CA1, No. 08-1513, 2009 TNT 19-55, 1/28/08 Sometimes the buyer and seller end up settling the issue Payment of nearly $4 million labeled agreement not to compete (payment for non- services) Claimed it was really for goodwill on amended return First Circuit agreed that he could not recharacterize it 6
Payment for Services, Not Patent Farris v. Commissioner, TC Memo 2010-222, 10/12/10 Sold rights to his idea for $1 Also entered into representative sales agreement with entity Claimed latter was truly for patent and represented capital gain Substance over form doesn t work when taxpayer is one challenging the form 7 Contract Was Not a True Option Advice Memorandum AM2010-005, 11/12/10 Had a contract designed to look like an option contract However given retained rights and various links to value IRS concluded really owned the basket of securities Not capital gain/loss on when closing out option, but rather simply held leveraged securities 8
State Tax Credits Were Assets Tempel v. Commissioner, 136 TC No. 15, 4/5/11 Received transferrable credits from Colorado of $240,000 Tax Court found credit was an asset and its sale generated capital gain Rejected substitute for ordinary income argument as well However did not agree with taxpayer that they had basis in the credit for costs of establishing easement 9 No Asset Sold in Whistleblower Award Duffy v. United States, US Court of Federal Claims, 115 AFTR 2d 2015-438, 2/13/15 Saw activity in violation of Sarbanes- Oxley Did not result in sale of business goodwill rather paid for termination True even though signed on as a consultant and claimed had damaged reputation Was also not excludable under 104 10
Partnership Existed, Thus Was Asset United States v. Stewart, et al, 116 AFTR 2d 2015-5159, 8/20/15 Formed partnership to manage oil operations, with payout if interest sold IRS claimed not really partnership, just management services and agreement disclaimed a partnership Court found it was truly a partnership and, as such proceeds of sale represented capital gain 11 Nothing Sold in Exchange for False Claims Act Reward Patrick v. Commissioner, 142 TC No. 5, 2/24/14, affirmed CA7, Docket No. 14-2190, 8/26/15 Taxpayer received award under False Claims Act for starting lawsuit on behalf of federal government Court did not find any asset he sold Lawsuit wasn t a right to sell Didn t own the documents he had 12
Assets Held for Sale in Ordinary Course of Business Capital Gain or Loss: Why It s Not Always Simple 13 Inventory Issue Excluded from capital assets Gain on sale is ordinary (normally not good) Loss on sale is ordinary (generally much better tha capital) Taxpayers tend to be opportunists on this one Key is whether the asset was truly held for sale in the course of business 14
Lots Subdivided and Sold Found Not to Be Held for Sale in Situation Rice v. Commissioner, TC Memo 2009-142, 6/19/09 Bought land to build dream home Eventually subdivided and sold off excess land as lots Even though had sales over number of years, activity did not rise to that of a trade or business Court bought that principal purpose of purchase was to build dream home, and sales were just a side- effect 15 Taxpayer Not a Trader Kay, Jr. v. Commissioner, TC Memo 2011-159, 7/6/11 Not quite inventory, but similar idea To be a trader must have numerous and frequent trades Also need election under Section 475(f) But Kay s trades didn t make the cut Many positions held more than 30 days Trades per year of 313, 72, and 84 and only on a few days 16
Partially Completed Home Not Inventory, Loss Capital Bennett v. Commissioner, TC Memo 2012-193, 7/12/12 Decided to build home for sale during boom First claimed plan to occupy as residence on original loan application Refinancing did not indicate this Sold before complete for loss of over $1.3 million Tax Court allowed not a personal asset But also not inventory 17 Real Estate from Tax Lien Business Inventory SI Boo v. Commissioner, TC Memo 2015-19, 2/4/15 Bought tax liens, from time to time ended up with property Treated sales of real estate as capital gains (not inventory) Court disagreed was a fundamental part of its tax lien business 18
Substitute for Ordinary Income Capital Gain or Loss: Why It s Not Always Simple 19 Court Developed Test Should not obtain capital gain treatment if substitute for ordinary income True even if otherwise would seem to meet test of capital asset Example sale of lottery winnings 20
Lawsuit Allocation Did Not Reflect Economics of Situation Healthpoint, Ltd. v. Commissioner, TC Memo 2011-241, 10/3/11 Court struck down allocation of award Settlement put all of the award to goodwill even though jury awarded punitive damages Found parties not really adversarial when it came to punitive damages Settlement was substitute for punitive damages 21 Position in Lawsuit Capital Asset, Not Substitute for Ordinary Income Long v. Commissioner, 114 AFTR 2d 2014-5446, CA 11, 11/20/14 reversing TC Memo 2013-233, 10/21/13 Taxpayer had millions of income- but what type Had right to acquire land on which he would develop condominiums Tax Court said was substitute for ordinary income CA11 disagreed- found lawsuit was property and he was paid for selling the right to finish lawsuit 22
Stock Incentive Rights Not Capital Asset Stout v. Commissioner, TC Memo 2015-133, 7/21/15 Employer acquired, paid for stock incentive units held Despite being similar to stock they are linked to, not capital asset Rather since compensation, payment for them is a substitute for ordinary income 23 Statutory Rules Capital Gain or Loss: Why It s Not Always Simple 24
Sometimes Statute Overrides Worthless securities capital loss despite lack of sale Abandonment of certain rights under 1234A treated as capital loss (though again no sale) Trader electing under 475(f) treated as ordinary despite selling capital asset Need to identify certain hedging transactions to get capital treatment 25 Ignorance is Not Bliss Chief Counsel Email 201034018, 8/27/10 Taxpayer unaware of need to identify certain transactions as hedging transactions Would have done so had they known Found did not meet inadvertent error test of Reg. 1.1221-2(g)(2)(ii) 26
Capital Gain Denied for Patent Cooper v. Commissioner, 143 TC No. 10, 9/23/14 IRC 1235(a) denies capital gain on sale of patent if transferred to related party (25% ownership) Transferred to entity where he held 24%, with other interests held by sister and close friend Held effective control, so had not transferred substantially all rights to patent income ordinary 27 1234A and Abandonment Pilgrim s Pride Corporation v. Commissioner, 141 TC No. 17, 12/11/13, reversed, CA5, 115 AFTR 2d 2015-477, 2/25/15 Tax Court found 1234A rights extended to rights inherent in equity interests Also effectively voided Rev Rul 93-80 (partnerships) Fifth Circuit disagreed But what about other circuits???? 28
Capital Gain or Loss: Why It s Not Always Simple 61 st MNCPA Tax Conference Edward K. Zollars, CPA www.cperesources.com ed@tzlcpas.com