Keith v. Comm'r of Internal Revenue
| Decision Date | 28 December 2000 |
| Docket Number | No. 11426–98.,11426–98. |
| Citation | 115 T.C. No. 42,115 T.C. 605 |
| Parties | James W. and Laura L. KEITH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Taxpayers petitioned for redetermination of deficiencies arising from unreported income from sales of property by deed. The Tax Court, Nims, J., held that income attributable to each contract for deed was recognizable in year transfer was initiated.
Decision for IRS.
Prior to and during the years in issue, GIA, a proprietorship owned by P wife, sold residential real property by means of contracts for deed. Under these agreements, the buyers obtained possession; assumed responsibility for taxes, insurance, and maintenance; and became obligated to make monthly payments, with interest, of the purchase price. A warranty deed would be delivered to the buyers by GIA only upon full payment, and any default by the buyers prior thereto would render the contracts null and void, with GIA retaining all amounts paid as liquidated damages.
In accounting for these transactions, Ps reported the gain attributable to the contracts for deed in the year in which full payment was received and title transferred. Only interest payments were included in income for tax purposes until such time. GIA also depreciated the subject properties during the term of each contract.
Held: Each contract for deed effected a completed sale for tax purposes in the year of execution, and income attributable to such disposition must be recognized and reported for that taxable year.
Held, further, the net operating loss carryovers claimed by Ps must be adjusted to take into account income which should have been reported in years preceding those at issue, for contracts entered during such prior periods.
Held, further, Baertschi v. Commissioner, 49 T.C. 289, 1967 WL 1270 (1967), revd. 412 F.2d 494 (6th Cir.1969), will no longer be followed. William J. White, for petitioners.
Nancy E. Hooten and Mark S. Mesler, for respondent.
Respondent determined the following deficiencies and penalties with respect to petitioners' Federal income taxes for the taxable years 1993, 1994, and 1995:
+-------------------------------------------------------+
¦Taxable Year¦Income Tax Deficiency¦Penalty Sec. 6662(a)¦
+------------+---------------------+--------------------¦
¦ ¦ ¦ ¦
+------------+---------------------+--------------------¦
¦1993 ¦$74,925.00 ¦$14,985 ¦
+------------+---------------------+--------------------¦
¦1994 ¦127,304.00 ¦25,461 ¦
+------------+---------------------+--------------------¦
¦1995 ¦106,261.54 ¦21,252 ¦
+-------------------------------------------------------+
After concessions, the issues remaining for decision are:
(1) The proper method of accounting for, and timing of recognition of gain attributable to, sales of property by means of contracts for deed; and
(2) the reduction of net operating loss carryovers from years preceding the years in issue to reflect income attributable to contracts for deed executed in those prior years.
Additionally, the parties have agreed that a third issue, the availability of depreciation deductions for properties subject to such contracts for deed, is dependent upon and will be resolved by our decision regarding petitioners' accounting method. The parties have stipulated the amounts to be allowed as depreciation deductions in the event of a ruling either for petitioners or for respondent.
Unless otherwise indicated, all section references are to sections of the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
This case was submitted fully stipulated pursuant to Rule 122, and the facts are so found. The stipulations of the parties, with accompanying exhibits, are incorporated herein by this reference. Petitioners resided in Moultrie, Georgia, during each of the years in issue and at the time their petition was filed in this case.
Petitioner James W. Keith is a radiologist, and petitioner Laura L. Keith is a dentist. Mrs. Keith is also the owner of a proprietorship known as Greenville Insurance Agency (GIA). Mrs. Keith established the business in 1983 on the advice of her father, J.D. Latzak, as a vehicle to create potential tax savings. GIA was formed primarily to sell insurance, to purchase real estate for resale or rent, and to broker mortgages. Since its genesis, GIA has been run by Mr. Latzak who, because of large judgment creditors, could not conduct business or hold assets in his name. Although neither of the Keiths possesses an insurance license or has experience in real estate transactions, Mr. Latzak is a licensed insurance agent and an experienced broker. We previously addressed the treatment of insurance commissions and mortgage placement fees earned incident to GIA's operations for years 1984 through 1988 in Latzak v. Commissioner, T.C. Memo.1994–416. We now focus on the reporting of income attributable to the company's sales of real property.
During the years at issue, GIA was in the business of selling, financing, and renting residential real property. The sales were effected by means of contracts for deed. The record reflects 18 such contracts entered into between 1989 and 1995, 12 of which were executed in the 1993 to 1995 period presently before the Court. The following is representative of these agreements:
CONTRACT FOR DEED
This agreement entered into by the seller and the buyer(s). The seller hereby agrees to convey to the buyer(s) fee simple title to a certain property described on Exhibit “A” to this contract, at which time all of the conditions of the sale described below are met by the buyer.
BALANCE of $ __________ to be evidenced by a promissory note plus interest at ____% interest payable in ____ monthly installments of $ ______ per month, starting _________ and ending ________.
SPECIAL STIPULATIONS TO THE CONDITIONAL SALE:
(1) The buyer(s) shall pay the prorated [year of execution] property taxes, and all future property taxes promptly when due.
(2) The buyer(s) shall not permit the general condition of the property to deteriorate in value any futher [sic] than its delivered condition.
(3) The buyer(s) shall perform any and all required maintenance on the property.
(4) The buyer(s) shall assume all liabilities as if they had fee simple title.
(5) The property is to be used as a primary single family residence for the buyer(s), and for no other purpose.
(6) The buyer may not transfer or assign their [sic] rights or interest in this contract.
(6a) Fire Insurance in the amount of $ ___________ from a company approved by the Seller must be kept in force at all times, seller named as loss payee, until all terms are met by buyer.
(7) Payment of the monthly installments of $ _______ are required to be tendered to the seller at its offices stated above or other place so designated by the seller or its assigns, and payable in United States Currency, on or before the due date. Any payment accepted more than ten (10) days beyond the due date will require an additional charge of 10% of the amount payable, and the acceptance of same will not modify or novate any other terms and conditions and will not act as a waiver of the sellers [sic] right to declare the contract in default and null and void and of no effect.
The seller agrees to convey to the buyer(s), a Warranty Deed, free of any leins [sic] and encumbrances within ten (10) days after all of the terms and conditions of this agreement are met by the buyer(s).
Should the buyer(s) elect to acelerate [sic] this agreement, then the terms and conditions of the promissory note executed contemporaneously with this agreement by the buyer(s) would determine the amount to be tendered by the buyer(s) for the acceleration in order to prematurely obtain a warranty deed.
Should the buyer(s) default or breach or not meet any of the conditions of the terms herein specified, then this contract and the note attached evidenced by this contract will be immediately declared NULL & VOID, and no futher [sic] benefits or equities would be accrued to the buyer(s), except that the buyer(s) would be liable for any monies unpaid under the terms and conditions of the contract to the date that the contract was declared null and void.
It is understood and agreed by the Buyer(s) and the Seller that the $ ________ ernest [sic] money down payment, and the monthly installments and other charges tendered by the buyer(s) from inception, and any improvements to the property made by or on the behalf of the buyer(s) during the life of this contract, if forfeited by the buyer(s) as a result of default or breach of the contract, is a fair value for the liquidated damages incurred by the seller as a result of said breach or default.
No warranties as to the condition or usability of the property are either expressed or implied by the seller.
It is herein disclosed to the buyer(s) that the subject property may presently have existing debt being serviced by the seller, and that future debt (not to exceed the amount payable under this contract) may be incepted by the seller.1
The conditions of sale, as well as the provisions related to default, voidability, and liquidated damages, were substantially identical in all material respects in each of the...
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