Originally published on Forbes.com Aug 22nd, 2014
The fallout from sketchy tax shelters can stretch over a very long time. Michael and Ruth McElroy were in Tax Court recently trying to make that stretching work in their favor. They did not get a break. Not only were their deficiencies totaling over $150,000 for the years 1996 through 1999 ruled not to be time barred, they were also not allowed to write off their original investment of $37,500, since the transaction was purely tax motivated.
The Per Acre Value of Grave Plots
The shelter was kind of clever. The idea was that you would contribute to a partnership that bought land. After a year the partnership would donate the land to a not-for-profit cemetery at a much higher valuation.
There was a tad of plausibility in the whole thing. I’ve always wondered about how much per acre grave plots are. The numbers are truly astounding. According to some “highly reliable” sources I googled, you can fit 1,250 grave plots on an acre of land (That was about 3 times my own back of the envelope computation, but when I thought about it I realized I had the grave plots being much larger.) At $1,000 per plot that is well over a million per acre. According to this study prime agricultural land in Iowa goes for not much over $10,000 per acre. I doubt it is that much different in Virginia, where this deal was going on.
The three partnerships involved in the case were not all that greedy, really.
HMPA 1995-2, HMPA 1995-3, and HMPA 1995-4 each operated for one year (1996, 1997, and 1998, respectively). During or for the year of its operation, each partnership acquired cemetery sites at the total costs of $95,639, $169,167, and $252,373, respectively; contributed the sites to qualified charitable organizations; and reported that its partners (investors) could deduct charitable contributions aggregating $1,864,850, $2,936,700, and $5,282,050, respectively, representing the appraised values of the contributed sites.
That’s only a factor of 20 or so. Unfortunately, they forgot that you needed to hold the property for a year in order to take a charitable contribution based on fair market value.
The Elusive Tax Fairy
At any rate there have to be some basic economic factors that prevent developers from slapping some signs up on a grassy field that call it a cemetery and having its valuation go up by a couple of orders of magnitude. Joe Kristan in his coverage of this case, titled Tax Fairies in The Graveyard, gave a pretty good summation of its overall plausibility:
This thing should never have passed the “too good to be true” test. The deductions depended on incredible post-contribution appreciation in graves. Anybody thinking this sort of thing might actually work really needs to get out more. And there is no tax fairy.
(The “tax fairy” is the magical sprite that can make your taxes go away with fancy tax footwork. Joe simply does not believe in the tax fairy. Otherwise, he would have understood, that it was not appreciation of graves. It was the transformation into graves that created that stupendous appreciation, that those Grumpy Guses at the IRS did not believe in the fairy either.)
An Improper Tax Matters Partner
At any rate, the defense that the McElroys were putting up is pretty technical, but still rather interesting. It concerns the TEFRA rules for adjusting the income and deductions of partnerships. This was one of the adjustments that were part of the war against tax shelters. Oversimplifying, rather than duke it out with each partner, the IRS gets to argue with one partner, who is designated the Tax Matters Partner. (I’m enough of a partnership tax geek to call my other tax blog, which has a readership numbering in the scores – Your Tax Matters Partner.) While that is going on, the statute of limitations with respect to adjustments flowing from the partnership is suspended.
That is what happened with the three partnerships. The case concerning the partnership kind of dragged out.
Mr. Johnston (in his stated capacity as the partnerships’ TMP) petitioned the Court as to the FPAAs, on June 27, 2000, June 28, 2001, and June 25, 2002, respectively, and the resulting cases (partnership-level proceedings) were[*8] respectively placed on this Court’s docket at Nos. 7176-00, 8260-01, and 10715-02. Over the ensuing years, through September 24, 2008, respondent solicited and obtained Mr. Johnston’s consent to the filing in this Court of a series of joint motions to continue any trial in the partnership-level proceedings. The Court granted each motion.
The reason for the case dragging may have been related to Tax Matters Partner Johnston having other concerns.
On September 29, 2005, Mr. Johnston was indicted on (1) one count of conspiracy to defraud the United States by selling, claiming, and causing others to sell and claim millions of dollars in false and fraudulent tax deductions for charitable contributions and concealing from the IRS income from the sales of the fraudulent deductions and (2) multiple counts of aiding and assisting in the filing of false returns by investors in the partnerships so that the investors claimed charitable contribution deductions in amounts substantially greater than allowable.
So in 2008, the IRS asked that Mr. Johnston be removed as TMP, him being incarcerated and all. With this that and the other thing, the partnership case was finally resolved in 2013, quite appropriately on April Fools Day, which allowed the IRS to finally issue notices of deficiency to the partners. The McEroys argue that those notices which relate to returns from the mid-nineties are awful late. They understand that the litigation was going on, but given that Mr. Johnston was under criminal investigation, the proceedings were really invalid.
They add that, even if the petitions were valid, the partnership-level proceedings should be deemed to have ended years before the day they actually did end because respondent knew that Mr. Johnston could not be the TMP. On this point, petitioners state, respondent should not have joined with Mr. Johnston in repeatedly moving the Court to continue a trial of the partnership-level proceedings or at least should have informed the Court that Mr. Johnston was not a proper TMP.
“A Proper TMP” – that has a nice ring to it. Maybe a good title for a murder mystery with a tax twist.
The Decision
The Tax Court was not buying it:
The long and short of this issue is that the 1996 through 1998 Forms 1065 were timely filed, the FPAAs were timely mailed to the partnerships’ TMP within three years after the returns were filed, and petitions were timely filed in this Court as to the FPAAs. The assessment periods as to the partnership items therefore remained open at the commencement of and throughout the partnership-level proceedings, as stated in section 6229(d). Then, when petitioners filed their bankruptcy petition while the partnership-level proceedings were pending in this Court, petitioner’s partnership items were recharacterized as nonpartnership items by operation of law, and respondent had at least one year thereafter to mail the deficiency notice to petitioners.
The Court also made short work of their argument that they should be allowed to deduct the $37,500 that they actually were out-of-pocket,
Petitioners rely upon section 165(a) to support their claim to the loss deductions. That section lets a taxpayer deduct “any loss sustained during the taxable year and not compensated for by insurance or otherwise.” Sec. 165(a). The applicability of section 165(a) here hinges on whether petitioner incurred the claimed losses in a transaction entered into for profit. See sec. 165(c)(2). Petitioners’ meeting of that standard, in turn, requires that we find that petitioner’s primary reason for investing in the partnerships was to make an economic profit, or in other words, a profit without consideration to any tax benefit flowing from the partnerships.
Afternotes
I have a bit of sympathy for the McElroys, when I compare their situation to the Son-of-Boss shelter participants who managed to get away with their even more ridiculous losses thanks to the Supreme Court’s Home Concrete decision which denied the IRS attempt to apply a six-year statute to phony basis. It will be interesting to see how far into the future we will still be dealing with the fallout from the turn of the millennium “tax fairies”.
Lew Taishoff also covered this case with an article titled “Elegy In A Graveyard”. Despite how it can sometimes appear, I don’t just copy Lew Taishoff and Joe Kristan. I read the cases and pick the ones that I think are interesting. Those guys are just a lot quicker than I am.
Another little side note. Apparently, the land involved in this whole mess was sold at auction a couple of years ago for $700,000 and may actually become a cemetery. Most aptly the story on fredericksburg.com indicates:
The property, which has been known as Sunrise Lake Memorial Garden and the George Washington National Memorial Cemetery and Garden, is mostly an open field, and it’s not clear how many, if any, bodies are buried there.
Maybe the “Cemetery Tax Fairy” is one of them.