Continuing Life Cmtys. Thousand Oaks v. Comm'r of Internal Revenue

• Decision Date: 06 April 2022
• Docket Number: 4806-15
• Parties: CONTINUING LIFE COMMUNITIES THOUSAND OAKS LLC, SPIEKER CLC, LLC, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

T.C. Memo. 2022-31

CONTINUING LIFE COMMUNITIES THOUSAND OAKS LLC, SPIEKER CLC, LLC, TAX MATTERS PARTNER, Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 4806-15

United States Tax Court

April 6, 2022

Fred B. Weil, Christopher A. Karachale, Lawrence M. Cirelli, and Wendy Abkin, for petitioner.

Melanie E. Senick and Gregory Michael Hahn, for respondent.

MEMORANDUM OPINION

HOLMES, JUDGE:

Continuing-care communities are a new business for old Americans. They promise to provide housing and health-care assistance and they promise to do so for as long as their residents live. The residents pay very large sums both upfront and over time to the communities to provide for services of uncertain duration and cost. The communities must make sure they earn returns on their investments despite these uncertainties. And state governments recognize that elderly people who have given up very large amounts of money in exchange for a promise need to have someone make sure the promise is kept.

This case is about how a company that owns one such community had to account for a portion of the upfront payments from its residents when it calculated its taxable income for 2008-10. The company followed generally accepted accounting principles in recognizing when

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and how much of these payments it reported on its returns. The Commissioner says that's not good enough.

The appropriate accounting for these payments is important to companies across the nation that provide continuing care. It is not one we've addressed thoroughly before.

Background

The taxpayer here was named Continuing Life Communities Thousand Oaks, LLC during the years at issue.^[1] It is a Delaware LLC with its principal place of business in Thousand Oaks, California.

I. The Continuing Care Industry

Continuing Life's business is to provide housing and care to seniors even as their needs change. A new resident might need only housing and food, but as time batters away he may need more. And although Continuing Life is not a hospital, it does promise to provide for its residents' needs all the way through skilled nursing care. The range of services that it promises costs a lot. And this is reflected in the entry fee-the initial payment that Continuing Life charges to move into the community-and in large monthly payments too. Continuing Life is no outlier-industry surveys show that the entry fees in similar communities average $402, 000, with some at over $2 million, and that monthly service fees run between $2, 000 and $4, 000.^[2] See infra pp. 8-9.

California lawmakers recognized the potential for abuse here- there is a lot of money at risk, and seniors are, or may eventually become, susceptible to undue influence-so they have put the industry under strict regulation. California's legislature noted that "tragic consequences can result if a continuing care provider becomes insolvent or unable to provide responsible care." Cal. Health & Safety Code § 1770(b) (West 2001). California law thus requires them to provide lifetime care. It calls this a "continuing care promise," and the contracts are called "life care contracts." Id. § 1771. The continuing-care promise

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is defined as "a promise, expressed or implied, by a provider to provide one or more elements of care to an elderly resident for the duration of his or her life." Id. If a continuing-care community fails to fulfill a continuing-care promise, then it is subject to criminal and civil punishment and will not receive any payment for its services. Id. § 1793.5(d).^[3] California isn't alone; other states have also enacted strict regulations on continuing-care communities. See, e.g., N.J. Stat. Ann. § 52:27d-330 (West 2021) (New Jersey); 2021 N.M. Laws Ch. 56 (S.B. 152) (New Mexico); N.Y. Pub. Health Law § 4650 (McKinney 2021) (New York).

Entry into the industry in California is controlled by the state's Department of Social Services, which issues a certificate of authority for continuing-care communities to operate. Cal. Health & Safety Code § 1771.5. But continuing-care-community regulation doesn't stop with living conditions and management; California also places minimum standards on continuing-care communities' contractual obligations, id. § 1770(f), and requires that they provide financial statements to the residents, id. § 1771.8(f). It also requires that owners of continuing-care communities follow generally accepted accounting principles (GAAP) when they prepare those statements. See id. § 1771(a)(7).

II. Continuing Life Communities

Continuing Life owns and operates the continuing-care community in Thousand Oaks, California. Next door is Oakview at University Village, an assisted-living facility and skilled-nursing facility. A resident can move to Oakview if his health deteriorates and he needs additional support. Continuing Life built the community in the early 2000s and began accepting residents in 2007. It is open to individuals who are at least 62, but the average age of residents who moved in during the years at issue was approximately 82. Prospective residents choose from among 12 different floor plans that vary by their size, number of rooms, and availability of parking. Continuing Life provides one daily meal to its residents, along with other basic amenities, such as linen service and cleaning. It describes these services in a detailed form document that is central to this case-the Residence and Care Agreement, which makes what California law considered a

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"continuing care promise" and is a life-care contract. New residents sign this Residence Agreement.^[4] The Residence Agreement lays out all the rights and obligations between the residents and Continuing Life. California's Department of Social Services must approve life-care contracts, and the parties stipulated that for all years at issue, the Department has done so. The parties also stipulated that if Continuing Life violated the Residence Agreement by failing to satisfy the obligation to provide life-time care, it would not have been able to collect any fees or payments and would have been subject to criminal fines; those individuals responsible would face imprisonment.

A specific part of the Residence Agreement is called the Joinder in Master Trust Agreement University Village Thousand Oaks Master Trust (Joinder Agreement). This Joinder Agreement is important because it's how Continuing Life funds its operations and makes its money. To put its importance into perspective requires some description of the three fees Continuing Life charges: the Contribution Amount, the Deferred Fee, and monthly fees. These three charges are not just how Continuing Life earns income but they also give an insight into the economics of its industry. The Contribution Amount ranged during the years before us from $245, 000 to $570, 000 and was determined entirely by a resident's choice of floor plan-his age, health, and life expectancy played no role in determining how Continuing Life set this amount. Another interesting feature of the Contribution Amount is that residents do not pay it to Continuing Life-they instead pay it, under the Joinder Agreement, to Kenneth Cummins as trustee of the Master Trust. When a resident makes this payment, he becomes a grantor of the Master Trust. Cummins and the Master Trust acted as a third-party intermediary between the residents and Continuing Life to ensure that Continuing Life's finances were in check and the residents' payments were properly accounted for.

Continuing Life had this roundabout set up for a couple reasons. The legal reason is that California law requires it. Cal. Health & Safety Code § 1792.6(a) ("Any provider offering a refundable contract, or other entity assuming responsibility for refundable contracts, shall maintain a refund reserve in trust for the residents."). But the Contribution Amount also had a business purpose: It provides "permanent financing for the UVTO campus and improvement" and "protect[ing] and

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conserv[ing] the Master Trust property for the benefit of the residents." The benefit to Continuing Life's financing comes from a provision in the Master Trust itself that authorizes Cummins to use Contribution Amounts to make interest-free loans to Continuing Life. Securing these loans is a deed of trust to all of Continuing Life's real property and improvements, current and after-acquired equity in all of the improvements, fixtures, personal property, present and future leases and rents from the property, and intangible property associated and used in connection with Continuing Life's real property. Continuing Life used these loans to make improvements to the campus, and Cummins annually tours the property to ensure that the collateral remains sufficient to secure the loans. He reports the status of the loans and collateral to the residents' council and the council's budget-and-finance subcommittee, and he also holds annual town hall meetings with the residents to provide information on the administration of the Master Trust. Cummins owes fiduciary duties only to the residents and not to Continuing Life: He earns his fees and pays the Trust's expenses out of the pooled Contribution Amounts.

Apart from these relatively small expenses of managing the Trust, this arrangement meant that a resident (and his heirs) would, others things being equal, be quite secure that the nominal value of the corpus of his Contribution Amount would be preserved. The Joinder Agreement and Master Trust provide that Cummins has to repay this amount whenever a Residence Agreement was terminated. Termination comes in three ways: death, voluntary departure, and expulsion. And here we come to the key bit of Continuing Life's income that is the subject of these motions-the Deferred Fee. Section 12 of the Residence Agreement defines the Deferred Fee and calculates it as a percentage of the Contribution Amount. Section 12.5 states: "If this...