Originally published on Forbes.com Aug 26th, 2014
Does a taxpayer face tax trouble from not maximizing the rent?. That seems to be the holding in a recent Tax Court decision in the case of Harrison Hunter. I’m not sure that Mr. Hunter should have actually won, but the Tax Court’s reasoning in the case is a little disturbing when I think through the possible implications. Here is the story.
Mr. Hunter was a merchant sailor working for the Military Sealift Command. He was required to be at sea for very long periods of time. In 1992 he purchased a three-bedroom house. The rental losses on the house for the years 2009, 2010 and 2011 were what was at issue in the Tax Court decision. The total tab was about $30,000 including penalties. I have to say that, much as I like to root for the taxpayer, I can understand why Mr. Harrison lost.
Here are some key facts, according to the decision. He kept his own furniture in the house. Also, it was a little unclear as to exactly where he was staying when he was not at sea or exactly how much he was at sea during the period. He was renting the house to a lady named Minerva Corfman. His brother, whose address he used for his mail, managed things for him. The brother was supposed to collect the rent and utilities from Ms. Corfman – $450 and $210 per month respectively – but apparently did not do that great a job, collecting only one month in either 2008 or 2009.
All that added up to Mr. Harrison losing.
Petitioner has failed to establish that he did not use the Lemoore property as a personal residence while he was in California during the years at issue. At trial petitioner admitted that his furniture was left in the Lemoore property from 2009 to 2011. Petitioner did not provide any information regarding how much time he was not at sea (if any) and where he stayed during those times. Petitioner has failed to establish that he did not reside at the Lemoore property for the greater of 14 days or 10% of the number of days the dwelling was rented at fair rental value during the years at issue.
If that were the end of it, I would have felt a little bad for Mr. Harrison, who was representing himself, but I probably would not have even bothered with bothering you with this case. It was the next part of the decision that disturbed me.
Even if petitioner did not reside at the Lemoore property, we still find that he used the property for personal purposes because he rented the dwelling for less than fair rental value. Petitioner stated that he based the amount of rent on what Ms. Corfman could pay rather than on the fair rental value rates for comparable properties in the Lemoore, California, area.
That pronouncement is a little disturbing. Imagine a fact pattern that is somewhat less egregious. Imagine if we had a taxpayer who is taking a long term view and wants to minimize management concerns. So he or she finds tenants of good character, who will maintain the value of the property and charges them significantly below market. Alternatively, imagine someone renting to a family, whose breadwinner falls on misfortune. The amateur landlord just can’t find it in his heart to evict and allows the tenants to stay on longer than business prudence might dictate.
Of course, those situations appear quite a bit different from Mr. Harrison’s. Nonetheless, I wish the Tax Court had stopped with his bad facts and not moved on to a general sense that losses can be denied if you are a little too easygoing.
As usual in cases like this, penalties were asserted and upheld. Mr. Harrison indicated that he had consulted a tax preparer but did not provide name, credentials or contact information. I have to say, I would have started getting nervous on the first return and been really nervous on the second one. I think I might have told him to find another preparer in year three, if not sooner.
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