Helvering v. Brunn & the Issue of Taxable Gain

Taxable Gain Income Tax Amendment

Taxable Gain

After a great deal of suspense, drama and record-breaking levels of nail-biting on the part of our readers, Huddleston Tax Weekly is proud to announce that we will be picking up our XVI Amendment series. We will contribute a few more articles to this series before we move on to other things. The purpose of our XVI Amendment series is twofold: firstly, our aim is to show how important this political act was to American society; and secondly, by examining some of the issues which were sparked by this amendment, our other goal is to provide our readers with a sense of the complexity of tax law as a field. This latter goal, if realized, should confer significant benefits to our readers: if you’re familiar with some of the essential issues in the field of tax law, the likelihood is strong that you’ll be more effective in how you handle your own tax situation.

One of the things which makes tax law such a fascinating field is that it forces you to formally analyze many terms which are casually – and often carelessly – used in everyday conversation. In common parlance, terms such as “income,” “gain” and “property” are understood intuitively and require little or no clarification. But tax law does not operate in this same way. In tax law, these terms, along with many others, have much more narrow and occasionally shifting meanings which must be carefully examined in whatever context they originally appeared in order to produce a sustainable legal result. Though they may appear simple, these terms can create all sorts of complexity in tax litigation.

The case of Helvering v. Brunn (1940) is a good example of a case which involved formal analysis of a term which is typically grasped very rapidly. The judicial officers had to determine whether the events which occurred in the case could be construed as “taxable gain.” The XVI Amendment only removed the restrictions on the taxing power of Congress, it did not contribute to the issue of what constitutes taxable gain. The case of Helvering v. Brunn explored this issue, and it added an important layer to our understanding of taxable gain. In a sense, it helped to clarify the full scope of the amendment by showing what can – and what cannot – be taxed.

Let’s look at this case more closely to get a sense of its full significance.

Facts

The respondent (a landowner) executed a lease with a tenant which provided, among other things, that any improvements or buildings added to the land during the time of the lease would be surrendered back to the respondent when the lease expired. The tenant destroyed an existing building on the land and then developed a new building in its place. The difference in value between the old building and the new one was approximately $51,434.25. The tenant forfeited the lease when he was unable to keep up with rent and taxes. Subsequently, the IRS claimed that the respondent realized a gain of $51,434.25 as a consequence of the new building which had been added to the land. The respondent disputed this claim and contended that any value conferred by the new building did not qualify as taxable gain under the prevailing construction of this term.

Law

The prevailing definition of “gross income” derived from the Revenue Act of 1932. The central question of the case was whether the value conferred by the new building should be treated as a taxable gain under the bounds established by this act.

Ruling

The court (the Supreme Court of the U.S.) ruled that the respondent had in fact realized a taxable gain when the tenant added the new building to the land. The respondent highlighted the importance of transferability (or exchangeability) to the definition of taxable gain in certain contexts. The new building was not “removable” or “separable” from the land in the sense that it could not be taken off the land and still maintain its current market value. The respondent argued that this lack of transferability made the value bestowed by the new building nontaxable. In support of this of position, the respondent cited a number of cases which apparently held that transferability was a key component of taxable gain in stock dividend transactions. The court stated that the logic underlying the importance of transferability was limited to those types of transactions and did not apply to the present situation.

The key point to gather from Helvering v. Brunn is that gain can be taxable even outside of a traditional business transaction. And the gain needn’t be transferable, at least not in most contexts. Taxable gain can be triggered whenever value has been added or an event places someone in a financially superior position. Forgiveness of a liability or exchange of property, for instance, can trigger taxable gain even though cash isn’t involved and no sale has occurred.

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Owning real estate often brings up tax issues. If you’re a current or future real estate owner and you’d like to learn about the tax perks of real estate ownership, check out our presentation on this topic by our CPA, Jessica Chisholm

Trump’s New Tax Proposal Could Have Substantial Impact on Seattle Homeowners

Trump Real Estate Deduction Seattle Tax Property Mortgage Interest

Trump’s Plan & the Seattle Market

President Donald Trump has developed a proposal to rewrite the tax code in such a way that it may render the mortgage interest deduction meaningless for all but a small minority of wealthy homeowners. Opponents argue that this provision would take away an important incentive of homeownership; supporters contend that the change benefits the majority of Americans and would expand homeownership opportunities for middle income earners.

Let’s examine Trump’s proposal in greater detail and highlight how the changes could impact the Seattle real estate market.

Proposed Revisions

The proposal contains a number of changes; perhaps the most important one is the raising of the standard deduction from its current level of $12,700 (for married couples filing jointly) to $24,000. On its face, Trump’s proposal does not eliminate the mortgage interest deduction, but its goal of substantially raising the standard deduction would mean that millions would cease to itemize their write-offs and consequently fail to deduct the interest from their home loan.

Trump’s plan also modifies existing deductions for state and local taxes, including property taxes. Opponents contend that the property tax deduction is another important perk of homeownership which should not be removed.

The Trump administration states that the changes will actually stimulate home purchases for low to middle income Americans because the higher standard deduction will enable greater savings. The proposal is also likely to trigger a measurable decline in average home pricings across the country which will increase access to homeownership.

Possible Impact

Currently, the Seattle real estate market has a median home price of approximately $722,250. This figure undoubtedly places Seattle among the most expensive real estate market in the country. Assuming the Seattle buyer puts down twenty percent, this median price means that the typical Seattle homeowner will pay roughly $2,735 per month in mortgage costs over a 30-year loan. Given its status, there’s no question that the Seattle real estate market will be impacted by the Trump proposal very heavily. A large number of our homeowners will suddenly be in a situation in which itemizing will no longer make financial sense. Trulia – the well-known property data provider – determined that the number of households eligible for the mortgage interest deduction in Seattle would drop from 56 percent down to 26 percent.

Whether Trump’s changes increase or decrease homeownership across the country obviously remains to be seen; what is certain is that the real estate industry as a whole is lined up in opposition to Trump’s proposal. Supporters and opponents both appear to have facts and figures which bolster their respective positions. Perhaps only a fair trial will determine whether Mr. Trump’s plan will be beneficial to the nation.

Source

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To learn more about the mortgage interest deduction and other tax benefits of homeownership, see this presentation by our CPA Jessica Chisholm

Investment Property & the Personal Residence Exclusion

Vacation Home House Property Investment

Investment Property

Contrary to what many may suppose, the initial purpose underlying the acquisition of a property does not necessarily bar future invocation of the principal residence exclusion (under IRS section 121). As we’ve discussed earlier, Section 121 of the Internal Revenue Code allows homeowners to exclude up to $250,000 ($500,000 for married couples filing jointly) of gain from the sale of a “principal residence” (as defined by the code). What we haven’t mentioned yet, however, is that property may be converted from its original purpose — say, for investment — into a primary dwelling specifically to take advantage of the principal residence exclusion. This is an extremely useful piece of information for many real estate owners. In many cases, a person will acquire real property as an investment — a vacation rental house, for example — and then later decide to use that same property as a personal residence. As long as the property is used as a “principal residence” — meaning that the owner has used the property as a residence for at least two years out of the most recent five-year period — the owner may utilize the exclusion provided by section 121.

Converting Your Investment (Rental) Property into a Principal Residence

Perhaps the most common instance of “converting” a property initially used for investment purposes into a property eligible for the exclusion provided by section 121 is the conversion of rental property. If they have access to the requisite funds, many real estate owners choose to invest in rental property in order to generate regular supplemental income. They may decide to acquire a vacation house and then rent this property out to tenants. It may become financially beneficial (or financially necessary) for the real estate owner to eventually convert this investment rental property into a primary dwelling at some point in the future; once the owner satisfies the time requirements of the provisions of section 121, they can then sell the property and exclude as much of the gain as the section allows.

Converting investment property into a primary dwelling for the purpose of invoking section 121 of the IRC is just one piece of expertise that the team at HTC is familiar with. As promised, we will return to the sixteenth amendment very soon, but before we do we thought it helpful to draw attention to this little gem of tax knowledge. Stay tuned for more gems in the future!

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If this article grabbed your attention, you should view our presentation on real estate tax advantages by our resident CPA Jessica Chisholm

The Basics of Tenancy-in-Common Ownership Arrangements

Real Estate Tenancy Common Ownership

Tenancy-in-Common Arrangements

Many of our clients are real estate owners and so in this installment of HTW we thought it beneficial to introduce the concept of tenancy-in-common ownership arrangements. A tenancy-in-common (TIC) is a form of joint ownership which involves multiple owners who share an undivided fractional interest in a single piece of real estate. This means that each owner possesses rights which are essentially identical to those of single owners rather than co-owners of typical partnerships. Being a co-owner in a tenancy-in-common arrangement confers numerous benefits; let’s discuss some of the basic characteristics of TICs and highlight a few of the distinguishing features of this type of arrangement.

Distinguishing Features

As mentioned, co-owners to a TIC possess undivided fractional interests in the underlying property. In practice, this means that they are not barred from freely transferring or alienating their interest in the TIC. At any time, a TIC co-owner can distribute their interest to another person without having to receive prior consent from the other co-owners. This distinguishes a TIC from other joint ownership arrangements, such as a tenancy-by-the-entirety.

Another distinguishing feature of TICs is the ability to have interests divided unequally among co-owners. Theoretically, in a TIC, one co-owner may possess a larger interest than other co-owners. In a scenario involving three co-owners, for instance, one co-owner may possess a fifty percent ownership and the two remaining co-owners may each possess an interest of twenty-five percent. This type of unequal division of ownership is either disallowed or typically not seen in alternative arrangements.

In a TIC, co-owners all share in the profits of the real estate and are all affected by changes in property value. Each co-owner receives a separate deed and insurance title to his or her interest in the real estate.

Another important feature of TICs is the ability of TIC co-owners to use their interest as part of a section 1031 exchange. As we’ve discussed several times, section 1031 allows capital gains tax to be deferred in the event that the proceeds from the sale of real property are reinvested in other real property of like-kind. Typically, section 1031 may not be invoked by traditional partnerships, but TICs are an important example of a jointly owned piece of real estate which may partake in a 1031 transaction.

In the near future, following a few more articles on the sixteenth amendment, we will discuss TICs in greater detail by exploring some legal cases involving TICs and section 1031 of the IRC.

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Huddleston Tax CPAs of Seattle & Bellevue
Certified Public Accountants Focused on Small Business

(800) 376-1785
40 Lake Bellevue Suite 100, Bellevue, WA 98005

Huddleston Tax CPAs & accountants provide tax preparation, tax planning, business coaching, Quickbooks consulting, bookkeeping, payroll and business valuation services for small business. We serve Seattle, Bellevue, Redmond, Tacoma, Everett, Kent, Kirkland, Bothell, Lynnwood, Mill Creek, Shoreline, Kenmore, Lake Forest Park, Mountlake Terrace, Renton, Tukwila, Federal Way, Burien, Seatac, Mercer Island, West Seattle, Auburn, Snohomish and Mukilteo. We have a few meeting locations. Call to meet John Huddleston, J.D., LL.M., CPA, Tawni Berg, CPA, Jennifer Zhou, CPA, Jessica Chisholm, CPA or Chuck McClure, CPA. Member WSCPA.