U.S. Tax Court – Excess Land Around Home is not Investment Property that Qualifies for an Investment Interest Deduction – Los Angeles Income Tax Planning Income Tax Litigation Attorney Bruce Givner

by Bruce Givner on April 4, 2013

The arguments taxpayers use to justify items on their tax returns range from the silly to the colorful. Sometimes they can also be clever. But as one taxpayer recently discovered, even clever arguments are not always successful with the Internal Revenue Service (IRS).
In 2005, Mr. and Mrs. Norman wanted to buy a single family home on 9.875 acres for $1.8 million. Though the couple had planned to spend no more than $1 million, they justified the additional $800 thousand after the seller told Mr. Norman there were plans to convert at least 7 of the acres into a development project. So the Normans secured a loan for $2.310 to cover the cost of the property plus $550 thousand for home renovations.
On the Normans’ 2005 federal income tax return, the couple claimed a home mortgage interest deduction of $88 thousand. They reported no net investment income and claimed no investment interest deduction. On their 2006 joint return, petitioners claimed a home mortgage interest deduction of $85 thousand. They also claimed an $18 thousand investment interest deduction on the grounds that the debt attributable to the 7 acres ($800 thousand) was an investment interest expense. After an audit the IRS limited the home mortgage interest deductions to $43 thousand and $87 thousand for 2005 and 2006 respectively. The investment interest deduction was disallowed.
The Tax Court agreed with the IRS holding that:
1) the purchase agreement for the residence did not contain an allocation of the purchase price between the residence and the extra 7 acres,
2) there was no meeting of the minds between the sellers and the Normans on what portion of the purchase price, if any, should be allocated to the extra 7 acres, and
3) the Normans had no appraisal to support their allocation.
This case is a lesson to taxpayers that any home purchase agreement which potentially includes land for future development should clearly state an allocation between the residential and investment property.
Givner & Kaye focuses on sophisticated income tax planning and compliance, tax litigation and procedure, estate planning, and asset protection plans for individuals and businesses in Beverly Hills, Calabasas, West Los Angeles, Hollywood, and other areas of Los Angeles, Orange, Ventura, San Bernardino, Riverside and Santa Barbara Counties. Call Los Angeles Estate Planning and Asset Protection Plan Attorneys Givner & Kaye at (310) 207-8008 today.

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