A Florida couple got a painful tax lesson following an even more painful lesson in how not to be a landlord. The sad story is in Tax Court Summary Opinion 2017-79. Although they have made themselves public, they don’t need me to make them more famous, so I will refer to them as Robin and Terry, my all-purpose generic couple. The case is about a theft loss on Robin and Terry’s 2012 return.
The theft loss was the result of their foray into landlording. In August 2011, Robin and Terry entered into an agreement to rent a fully furnished 3,800 square foot house to another couple. We’ll call them the Tenants From Hell (TFH). There was a further agreement to sell some of the furniture and accouterments. A few days before move-in TFH provided a check for initial rent and security deposit. The check bounced. Robin and Terry approached them about it and were promised another check. Early in November, Robin and Terry lost their patience and commenced an eviction action. When they got access to the house on November 15 they found that all the furnishings had been removed – furniture, window coverings, draperies, and accouterments. There was also damage to the house and the need for a paint job.
Robin and Terry managed to track down TFH along with a sheriff’s deputy and recovered some items. It was difficult sorting out what belonged to Robin and Terry and TFH, so the deputy said they should come back the next day. You might be shocked, shocked to learn that TFH were nowhere to be found the next day.
Deduction Pushed Into Next Year
Robin and Terry did not give up right away and tried various ways and means to recover their property.
During 2012 petitioners were in touch with attorneys and law enforcement officers in an attempt to determine whether they would be able to recover their furnishings or seek monetary damages. Petitioners discovered that the tenant and her husband had been involved in this type of activity before and had routinely made offers to purchase furniture and then disappeared without making payment. During 2012, after petitioners were able to assess the tenant’s financial situation, they determined that it would be a “waste of time” to pursue the tenant and her husband, either civilly or criminally. It was at this point in 2012 that petitioners became aware that theythey would not recover their furniture and other household items. (Emphasis added)
That sentence in bold is the business lesson in this sad tale. With a better reference check before renting to TFH, Robin and Terry might have found out about TFH’s penchant for skipping out with recliners and armchairs and the like.
The pain of the tenant from hell might have been mitigated somewhat by the tax deductions. Robin and Terry were conservative in that they did not take a theft loss in 2011 when the theft occurred, but waited until 2012, when it was finally determined that there was no more point in chasing TFH. When it came to valuation, though they may have caught the Agent From Hell. AFH was willing to allow some loss, but nothing near the $29,979 that they claimed. Also, AFH argued that the loss should have been taken in 2011.
Documentation
Robin and Terry did a better job of documenting their loss, than most people would have.
Petitioners were able to find and offered at trial photographs of the household furnishings taken shortly before the tenant and her husband moved in during September 2011. On the basis of the photographs and coupled with their recollection, petitioners made a schedule of the items that were the basis of their $29,979 theft loss deduction. In order to show fair market values of the items, petitioners found examples of the items for sale on websites such as eBay. They also researched the cost of fabrication of items such as drapery to arrive at values. They used the prices from their research and applied some discounts to arrive at their estimates of fair market values.
There was enough there for the court to refer to the famous Cohan rule. At Joseph B Cohan and Associates the young staff accountants thought the rule was named after our managing partner Herb Cohan or his eponymous father, who still came in some days despite being over eighty. Actually it is named for George M. Cohan of Broadway fame, who was not big on documenting his expenses but was still allowed something. The scope of the Cohan rule has been narrowed by legislation requiring specific documentation in some areas, but it still remains.
So Robin and Terry got somewhere with the Tax Court, but not that far. The Tax Court allowed $9,194. They were dismissive of an additional $5,467 in documented repairs since that was not part of the theft loss. Seems like it should otherwise have been deductible. On the other hand that would probably be a 2011 item. The Court also allowed the accuracy penalty, which I think is pretty harsh.
It was their failure to prepare and maintain adequate records and documentation in support of their claimed $29,979 theft loss deduction that resulted in our reaching a $9,194 total value of the items lost. …..
Although petitioners sought advice about how to report a theft loss, they have not shown the specific source of the advice and whether it was reasonable for them to rely on the advice received. We accordingly hold that petitioners, on account of their negligence or disregard of rules or regulations, are liable for a section 6662(a) accuracy-related penalty with respect to the underpayment.
You really can’t tell from the decision whether Robin and Terry inflated their loss at all. If they did not they got a really raw deal with the accuracy penalty rubbing salt in the wound.
This is not exactly an instance of Reilly’s Sixteenth Law of Tax Planning – Being right without substantiation can be as bad as being wrong. Robin and Terry probably had as much substantiation as you would expect assuming they rented out a house furnished with stuff that had been accumulated over time and originally intended for personal use.
Other Coverage
Bryan Camp has a pretty extensive analysis on the TaxProf Blog – Lesson From The Tax Court: Substantiation And The Cohan Rule. He thinks Judge Gerber got it wrong:
I don’t think the Tax Court correctly followed Cohan in ______. For example, the Court accepted as true that the taxpayers really did lose a cocktail table to the scammers. But the Court refused to allow them any deduction because, it said, the taxpayers did not give “sufficient detail for the Court to objectively estimate a value.” I am not sure Cohan says the Court must be able to “objectively” estimate a value. (Taxpayer name omitted)
Ken Berry in accountingWEB focused on the deduction timing.
And, of course, Lew Taishoff had something. Mr. Taishoff covers the Tax Court with an astounding thoroughness. He has a great summary of the lessons:
A cautionary tale for lessors, this. Official bank cashier’s checks for first rent and security if your tenant is less than WalMart; and receipts and depreciation schedules for everything.