CONVERSION OF PERSONAL RESIDENTIAL
PROPERTY-APPLICABLE DEDUCTIONS
ToM LocKHART
CONVERSION OF PERSONAL RESIDENTIAL PROPERTY - APPLICABLE DEDUCTIONS
BY TOM LOCKHART
When a taxpaye r abandons his personal res1dence, there are several al te rnative
methods of disposition available to him.
His choice of disposition may result in
the applicability of certain income tax deductions.
Specifically t hese deduct i ons
include 165 (c)(2) losses, 167(a)(2) depreciation, and 212(2) maintenance expenditm .& sl and their .applicability depends upon the characterization. of the property
concerned.
The Service and the courts have employed the term "conversion\' in describing
the recharacterization of personal residential property into property capable of
qenerating th . . se deductions.
The courts have had no trouble in granting or
denying deductions once the proper characterization of the abandoned residential
property has been determined, but the problem lies in delineating the necessary
elements constituting conversion.
Not onl y have the courts approached the problem differently according to the
post-abandonment .activity of the taxpayer, but also according to the deduction
cl aimed .
Therefore, in searc hing for the combination of elements which constitutes
conversion, the most illuminating approach is to separate the distinct dispositive
acti vities of the taxpayer and examine each in light of the deduc t ion claimed.
The three dispositive activities concerned are - rentinq and holding for
sale -
ho lG .~ Q
for rent or sale -and holdinq for sale.
There are conceivable
variations of eac h classi.ficat iv n, but to formulate a structured approach to the
:
ascertainment of
conve~sion
"":•
specific categorization should be utilized.
When
a variance from the three specific classifications substantially affects the
determination of conversion, it will be noted.
Co nfusion about conversion has been magnified by distinctions among the
deductions clai med .
The three deductions
~nder
consideration are allowable by
2
reason of the property being converted to an income-oriented classification.
l 67(a)(2) and 212(2) deductions are applicable upon determination that t he property i s "held f or the production of income."
The phrase has been held to the
same purpose and construction in both sections. 2 Therefore, theoretically, the
same el ements of conversion are required for both and the courts have so held. 3
The problem develops in the allowance of the 165(c)(2) deduction which is
applicable to "losses incurred in any transaction entered into for profit."
The
Serv ice has submi tted and the courts have accepted the proposition that there is
a subs t antive distinction bet ween what constitutes property" held for t he production of income" and a "transaction entered i nto for profit. ,A
(Historical
development of t he distinction discussed in detail subsequently under Holdinq for
ren t or sal e- 165) Consequently, conversion entails different prerequ i si t es
depending on t he deduction claimed. (167(a)(2) and 212(2) versus l65(c)(2)).
Whether this distinction is justified or not, t he tax advisor must be aware
of its presence and continued precedential effect upon the courts.
In Cowles v.
Commiss ioner the Tax Court ques t ioned the validity of this distinction, but nevert heless felt bound by previous decisions.
Perhaps ; we were writing on a clean slate, we would be
i ncli ned to r e-examine this di stinction . . ·. but in light
of the foregoing deGisions, we are unwilling to chart a
new course.5
As this article proceeds, a more detailed examination will be undertaken concerning the spec ific deductions , the
reports of t he legislature,
various situations.
corr~sponding
regulations, explanatory
and the co urts' application of these deductions to
However, for the reader to be able to follow a structured
approach to the conversion problem, he needs to remain conscious of the previously
discussed distinction between "property held for the production of income" and a
"t ransacti.on entered into for profit."
3
Re ntinq . and Holding for Sale
If t he taxpayer actually rents his former residence all three of the deductions may be applicable.
Conversion occurs sufficient to warrant recognition
of the existence of .,property held for the production of income., and a 11 transaction entered into for profit .. when the taxpayer actu.a lly rents. 6 Determination
of actual rental depends upon evaluation of the economic substance of the transaction.
Rental includes both the taxpayer's income-producing motive and the
economi c reality of a rental situation.
The profit-inspired motive requirement is determined through evaluation of
the rental price in relation to the taxpayer's anticipated rental expenses.
The
bona fide intent to profit has been recognized though actual profits were negligible.
In Rechnitzer v. Commissioner the Service argued that if the renting taxpayer had
allowed for depreciation, he wou l d have recognized an extremely small profit;
therefore, the
p~ofit
motive is negated.
The court, in disposing of this argument
said:
The rental . . . was intended to be a lucrat i ve transaction.
The fact that the {taxpayer] failed t o take into account a
sum for depreciation in determining their profit is irrelevant. We cannot penalize a taxpayer for his bad judgment.B
Conversely, recognition of a profit motive has been denied the taxpayer who
accurately anticipated all of the property expenses but di d not set a price sufficient l y in excess of these expenses.
The Tax Court stated that the purported
rental agreement should not be accorded an independent, profit-inspired .signi9
.
f 1cance.
The economic transaction must actually be a rental or lease situation.
This
requirement connotes an independent, legal significance of the transaction.
This concept is most prevalent in determination of a deductible loss incurred in
11
a transaction entered into for profit. 11
The independent legal significance of a rental agreement may be questioned
4
i f the tenar
.ubsequently becomes the purchaser of the residence.
In Dawson v.
Commissioner 10 the agreement in question was part of a conditional sales contract
which provided for the proposed purchaser's rental of the property in the interim.
The Tax Court, in disallowing the loss deduction on the subsequent sale, stated:
It thus appears that the purported rental agreement was
executed simultaneously with the sale aqreemlot and was
only incidental to the sale of the property. l
Conversely, in Rechnitzer v. Commissioner 12 the court. was satisfied that the
rental agreement was bona fide and not a subterfuge when the taxpayer executed a
"Residential Lease'' with an option in the tenant to purchase which was subsequently
exercised.
In addition, the agreement must be binding on the parties.
This requirement
has evolved from the elevated status given by the courts and the Service to the
term ''transactions" under 165.
The case law created the concept of the taxpayer's
preclusio·n from reoccupancy of the premises. This concept was applied by the Tax
Court in Grohse v. Commissioner13 in disallowance of a claimed loss deduction.
The agreement under consideration was the product of negotiations between the taxpayer and . the proposed tenant.
This tenant had made a small security deposit which
was forfeited upon his breach of the agreement.
In refusing to
r~cognize
conver-
sion the court reasoned that there was not sufficient proof of what the agreement
entailed to conclude that the taxpayer executed a valid lease of the property.
"To qualify as a transaction the (taxpayer) must have bound himself so that he may
not reacquire his original occupancy of the premises merely by changing his mind." 14
An extension of the concept which necessitates the taxpayer's preclusion from
reoccupancy is the additional requirement
extended period of time.
th~t
the actual rental must be for an
(This reinforces the reality ·of a rental situation
and the taxpayer's intent to make a profit.)
The Tax Court, in the disallowance
of a 165 loss deduction, stated that the rental income received front the property
for a period of two to three months "is too trivial to show a real intention on
the part of [the taxpayer] to convert the property to income-producinq property." 15
5
On~e
conversion has been ascertained (whether under rental and subsequent
sale or any other method of disposition discussed in this article), for allowance
of 165 and 167 deductions there is the nece~sity of the taxpayer's proof of the
fair market value at the date of conversion.
The Service and the courts have
adhered to the rule that upon converion the basis to which 165 and 167 deductions
apply is
~he
lesser of the adjusted iost basis or fair market value at date of
conversion. 16 Therefore, for allowance of these deductions, the fair market
value at the date of conversion must be established to determine the depreciable
base and show that in fact a loss was suffered. 17
Holding f or rent or for sale
167 & 212
As previously noted, the phrase "property held for the production of income"
in both 167 and 212 has been held to the same construction.
Consequently, the
same elements constituting conyersion are applicable in regard to hoth deductions.
Therefore, the starting point for determination of the applicability of these
deductions to a former residence abandoned
~nd
held for rent or sale can be found
in the Regulations under 1.212-1:
(b) Ordinary and necessary expenses paid or incurred in the
management, conservation, or maintenance of a building devoted
to rental purposes are deductible notwithstanding that there is·
actually no income therefrom in the taxable year and regardless
oy the manner in which the property in question was acquired.
(h) [These expensesl are deductible even though such property
was formerly held by the taxpayer for use as a home.18
This proposition of the Service has . been
co~firmed
in the case law.
In
determining whether the standard prescribed by the applicable sections of the Code
have been satisfied, the courts look to the use made of the property and the taxpayer's intent in respect to the future use or disposition of the property.
When
"sufficient efforts" are made to rent, the property is then beinq held for the
pr~duction
of income, and this holds true despite the fact that no income is
actually received.~ 9
6
~s~ ffi cient
but th e courts,
efforts'' to rent is obviously not a precisely definable standard,
i~
determining if the property is held for rental purposes, evaluate
the taxpayer's intention and activities in light of the existing circumstances.
The taxpayer's bona fide intent has been recognized upon proof of a reasonable
r ental offering price and that the taxpayer was amenable to reasonable offers. 20
Thi s bona f ide intent, as evidenced by the taxpayer's appropriate actions, will
.
warr ~ ~t
.
classification of the property as devoted to rental purposes, provided that
the adverse state of the market for rental property does not rob such an offer to
ren t of
" L
1~s
"
21
s1gn1"f 1cance.
•
Moreover, if this offer is bona fide in light of the
existing circumstance s , there is no requirement that the taxpayer show an appropriation of his former residence to income producing purposes by an irrevocable
act.
(The significance of this will become more apparent under the subsequent
review of 165 applicability.)
The discussion under this section of the article has to this point been
limited to the rental context of the taxpayer's intent and activities: the act of
holding for sale has not been considered.
This is because the bona fide offer to
ren t is su ffi cient to warrant the allowance of 167 and 212 deductions.
The devotion
to rental purposes is not controverted by a corresponding h~lding for sale. 22
Furthermore, an offer to sell does not affect the extent of the depreciation deduction allowed.
In disposing of the Service's argument for disallowance or reduction
of a cla imed depreciation deduction (see Service's argument under Holding for Sale
section applicable to 167), the Tax Court in Sherlock v. Commissioner noted that
the taxpayer was concerned with selling, but
[l]t is not improbable to assume that if sales market persisted
to be unfavorable and a decent rental opportunity arose, [the
taxpayer] would have continued to he a landlord for entire
useful li f e of house . . . . [Therefore the taxpayer] may
depreciate to a basis of less than actual sale price.23
Therefore, if an actual bona fide offer to rent is in existence up until the
sal e of the house, all allocable depreci ation and maintenance expenses are
deductible regardless of the accompanying offer to sell.
7
165
Gen eral Proposition:
Abandonment of personal residence and holding for rent
or sale does not constitute a conversion of the property into a "transaction
entered into for profit. "24 This should not, hov1ever, prevent the tax advisor
. f rom examination of the underlying reasons for the qeneral rule denying 165 d·eduction allowance.
Understanding the concepts and principles from which the
approach taken by the courts and the Service has evolved
may facilitate the tax
ad visor's abi l i t y to formulate alternative courses of action which may succeed
in recogn it ion as a 165 transaction.
The qeneral rule of disallowance has its genesis in the elevated status
given to the term "transaction."
This status necessarily implies the requirement
of somet hing more of t he taxpayer for applicability of 165 than 167 and 212.
In Cowl es v. Comm issioner 25 the Service exhibited this position by conceding
t hat of fers to rent as well as to sell are sufficient to entitle the taxpayer to
certain deductions
wi ~ h
respect to "property held for production of income", but
con t endi nq tha t me re offers to rent or sell are insufficient to meet the statutory
0
req uirements of a "transaction entered into for profit." The court felt bound by
prior decj3ions 26 _upholding the Service's position and this distinction continues
--·--:----- .
t o be recog nized.
The grea t er burden on the taxpayer in establishing a 165 transaction can be
t raced from t he Supreme Court's opinion in Heiner v. Tindle.
(The taxpayer had
aba ndoned, leased for an extended length of time, and was successful in claiming
a l O\J deduction upon subsequent sale of the property) The Court, in applicati9n
of § 214(a) (5) of 1918 Revenue Act, 27 held that § 214 was intended "to permit deduct i on of capital losses wherever the capital investment was used to produce
t axable income." 28 The Servic_e reflected that decision in the promulgation of
.
29
regulations under the 1928 Revenue Act. (Art. 171 of Regs 7~):
If property purchased or constructed by the taxpayer for use
as his personal residence is, prior to its sale, rented or
8
otherwise appropriated to income producing purposes and is
used for such purposes up to the time of sale.
The application of this reasoning was specifically applied in the situation of
the taxpayer holdin9 for rent or sale by the Second Court of Appeals in denial of
a loss deduction:
Ce rtai nly it strains the language of Art. 161, Re9. 74, to find
that the property is "appropriated to•• and •'used for" income
producing purposes by merely listing it with a broker for sale
or rental .30
The interpretative evolution of what constitutes a "transaction entered into
for profit•' has led to the formulation of the concept of irrevocable action taken
by the taxpayer.
This irrevocable action enables the Service or the court to
identify the event which warrants characterization as a new transaction mutually
exclusive of
t ~e
taxpayer•s prior transaction -- that of acquiring and utilizing
the premises as a residence.
This necessity of precise objective occurrences is
expounded by the Service under Regs § 1 .165-l (b): ·
"a loss must be evidenced by
closed and completed transactions, fixed by identifiable events."
The courts have employed various explanations in denying recognition of a 165
transaction, but . the general · reasoning proceeds as follows:
act irrevocably.
The taxpayer did not
Therefore, the property's characterization remains subject to
his unfettered will because his actions did not place it out of his power at any
time to resume occupancy of the premises or sell it.
As a result, there has not
been such an appropriation to income producin9 purposes as entitles him to a deduction for the loss on the subsequent .sale of the property.
The determination that the taxpayer has not entered into a new transaction
__w hich- war-rants a- Hi5 deduction allO\'Jance
abandons and offers to rent.
T~e
has been made continually when he
consideration of the tax advisor should be
whether the taxpayer may qualify or enhance the nature of his activity of holding
f or rent and thus warrant recognition of a transaction entered into for profit.
9
The Tax Court has held that the taxpayer has -s9 structured his activities
relating ·to his offer to rent as to constitute a 165 transaction.
Commissioner
In Heine v.
the court awarded transactional status, upon ascertainment that the
taxpayer listed the abandoned residential property for rent or sale and made
\
"strenuous efforts to dispose of it," including an attempt to have the property
rezoned. 31 In Burns v. Commissioner 31 the court found that the taxpayer's action
of having his house, furnishings, and land appraised was sufficient to warrant
recognition of a "transaction entered into for profit.''
The preceding cases, favoring recognition of a 165 transaction upon ascertainment of certain qualified activities relating to an offer to rent, do not reflect
the existing state 'of the law.
At the present time an offer to rent, no matter how
it is structured, will not warrant recognition of a tr-ansaction separate from
the personal oriented transaction originally involved.
This can be inferred from
the courts' deference to the phrase "rented or otherwise appropriated." 33 Rental
denotes actual income, and ·"appropriated"
"otherwise."
~s
given similar status by the connector
Therefore, in the context of rental, appropriation and the court-
34
bl e ac t.1on appear t o requ1re
. ac t ua 1 rece1p
. t of 1ncome.
.
.
deve 1ope d concep t of 1rrevoca
Holding for Sale
167 & 212
The phrase ''held for the production of income" was introduced into the tax
law by the Revenue Act of 1942.
1939 Code.
35
This Act amended section 23(a) and (b) of the
The P.ouse and Senate Finance Committee Reports. concerning the
amending statute, stated, "Income ·. . · . is not confined to recurring income but
applies as \A•e11 to gain from disposition of property." 36
For purposes of this article the questions become -- Will these deductions
be allowed as expenses incurred in the holding of property for gain upon disposition when the taxpayer abandons and subsequently holds the premises for sale?
If so, what considerations do the courts consider relevant in allowing or disallowing $UCh deductions?
10
A general understanding of the nature of the problem raised by these questions
and the
courts~
approach to a solution can be a valuable
~sset
to the tax advisor
fjrst, because of the frequency with which this situation occurs (abandonment and
holding .for sale) and the fact that the case law has set forth no concrete rules.
More significantly, the taxpayer who claims 167 and 212 deductions in this situation can anticipate opposition from the Service.
Prime Issues (released July 16,
197~
The Service's current List of
under the Freedom of Information Act)
includes:
Residence listed for sale: whether a taxpayer who ceases to
use property as residential property and immediately offers
it for sale only without attempting to rent the property is
entitled to a deduction for depreciation o~ maintenance
expenses during the period prior to the time the property
is sold.37
.
(Prime
issue~
are those that the Service will ordinarily insist on litigating and
that wi11 not ordinarily be conceded or .compromised.)
"Imme~iately
held for sale" is th,e key concept upon which the courts have
focused in the development of the requirement that the property must be "held for
post conversion appreciation."
The test applied in determining whether such
requirement has been satisfied
is "the purpose or intention of the taxpayer in
light of all the facts and circumstances."38
As in all instances of conversion the Service and the courts are tryin9 to
distinguish between nondeductible personal expenses and deductible income
oriented expenses.
Expenses referable .to the property after abandonment, when the
property is immediately held for sale, are regarde·d as incidental to the previous
personal use and the current disposition of the property and without which the
expenses would not have occurreQ.-3 9 Therefore, evidence of immediate holding for
sale upon abandonment creates a heavy presumption against the taxpayer.
40
The
Tax Court in Riss, in disallowance of depreci·ation and maintenance expense deductions,stated:
11
Listing for sale . . . soon after it was vacated . . . and
the ·loss which was P.Xorrienced strongly militate against
the suggestion that [the property \'/as] held with a view
toward realizing any kind of profit attributable to post
abandonment activity of the real estate market.41
The "loss which was experienced" referred to ·in Riss relates to another
factor considered in determining the taxpayer's intent to realize post conversion
appreciation.
This concerns the applicable basis of the· property, which is
instrumental in the determination of the nature of the taxpayer's offer to sell.
It is beyond doubt that the basis applicable for determining loss and depreciation
deductions is the lesser of the adjusted cost basis or fair market value at date
of
con~ersion
42
but this principle does not apply in determination of the
existence of the taxpayer's profit-seeking intent.
The majority opinion in Newcombe stated that the proper basis for determination of the taxpayer's intent is the original cost basis:
If the taxpayer is merely seeking to recov~r his investment
or a part thereof, it will be difficult to find that the
property was "held for the production of income•• [qain from
disposition] . . . . Consequently, it would appear that the
property is being held simply for the production of a loss
and the expenses would not be . deductible.43
This approach seems extremely harsh and unfair to the taxpayer.
connotes a
n~w
use rif the property.
To
d~ny
Conversion
conversion because of an element
referable to a past utilization of the property is not only unjust but appears to
be totally devoid of reason.
The taxpayer's intent is· evaluated at the time of
the claimed conversion and should be ascertained from the circumstances and facts
then existing.
The concurring opinion in Newcombe expo·unded this position:
The only sensible answer is appreciation over the fair market
value of the property at the time of conversion, for otherwise
the owner of a residence which had declined in value durinq
occupancy woul~ be precluded from any tax benefits in attempting
to minimize his loss even though it was quite apparent that the
property would appreciate in value after he had abandoned it as
a residence unless he could also prove that he · reasonably expected the appreciation . to ca;ry through his original tax base.44
12
The holding in Newcombe that post-conversion appreciation was not intended
was based upon other 9rounds and the majority•s proposition relatinq to the
applicable basis was dicta.
This basis; controversy continues but ultimately it
should be resolved in favor of the fair market value at. the date of the claimed
conversion.
Intention to seek post-conversion appreciation and confirmatory taxpayer
action are what warrant the allowance of the 167 and 212 dedtJctions, but fixing
and asking a price above the fair market value at date of conversion or cost
basis does not necessarily satisfy the~e requirements (especially when the property is immediately held for sale).
(taxpaye~
The Tax Court in Butler v. Commissioner
had listed for sale before abandonment) stated:
The fact that the property was eventually sold for a gross
sale price . . . [which produced a] loss on the transaction,
also suggests that the initial asking price . . . was in the
nature of .a starting point for bargaining rather than the anticipated final sale price. . · . . In any event, the gross sales
price was subject to a 6 percent real estate commission and
perhaps also to other selling costs whic~ further reduced the
likelihood that the eventual ·sale price would produce a orofit.45
Another consideration is the absence of rental offers.
The Service has con-
sistentfy focused upon this and contended that absence of offers to rent conclusively precludes recognition of an intent to seek post-conversion appreciation.
The Tax Court in Newcombe, however, purportedly refused to give the existence or
non-existence of offers to rent such determinative status. The court cited Snith
v. Commissioner, 46 where the taxpayer succeeded in his 167 and 212 claim, subsequent
to his abandonment and immediate listinq .of the premises for sale.
In Smith
substantial weight was given to the factsthat retention of the prooerty for investment purposes was not justified by any rental
~Jhich
could be obtained and
rent~
would have obstructed the taxpayer•s wish to get his .money out of it.
A similar factual situation (including an
adv~rse
rental market) led to an
opposite result in Riss:
The fact that the . . . property was too large to nut on
rental market merely explai~s why the rental of that
13
property was not a feasible post-conversion pursuit. It
does not, ipso facto, establish the existence of some
other i ncome-producing motive adequate enough to support
(167 & 212)47 .
the deduct1ons b~ing sought.
Notwithstanding the Newcombe court•s purported refusal to give the absence
'
of offers to rent determinative status ·in the ascertainment of conversion, when
jb~_. p r-oper-ty
is -inmediately held for sale upon abandonment the absence of rental
offers will preclude re-characterizatio~ of th~ personal residence (Service•s
position).
Smith was decided contrary to the weight of authority and has subse-
quently been limited to its facts ·and is of little precedential value to the taxpayer. 48
"..j he absence of rental offers should only be relegated to minimal significance
when the taxpayer evidences the intent to retain the property in anticipation of
post-conversion appreciation.
This intent to realize post-conversion appreciation
is supported by the taxpayer •s activities of having the ·property appraised upon
abandonment and delaying attempts to sell at a price greater than appraised
49
value.
The preceding considerations were based on the assumption that the approach
to and effect of conversion are the same for the applicability of both 167 and 212
deductions.
There is, however, a conceptual difficulty inherent in seeking gains
from the disposition of property which distinguish the two deductions.
This dis-
tinction has not been clarified in the case law since the issue does not present
itself until conversion is determined; ;and in this area, \'lith the exception of
Smith, the taxpayer has put together an extended losing streak.
Assuminq, however, that the taxpayer establishes· conversion by the approach
.
.
' he .takes in regard to the abandonment and subsequent holding for sale, what are
his 167 depreciation claims? The Service has argued that since the property is
held only for the production of income by way of sale, no deduction for depre'
ciation is allowable because the propet:'tY has no reasonably ascertainable useful
life and has a salvage value at least. equal to its fair market value as of date
14
of conversion. 50 This argument was not utilized by the Service in Smith.and the
courts subsequently have not been directly faced with the issue in this context.
Notwithstanding the lack of case ·law. in point, the Service's arqument is valid and
the cnurts
by way
\.:;
o~
dicta appear to favor it.
. 165
There are few cases which have dealt with the situatiDn where the taxpayer
has abandoned his residence, subsequently holdinq for sale, and ultimately claiming
a loss deduction.
This, in all probabil~ty, is a result of the taxpayer's
limited success in being allowed 167 and 212 deductions in this area, combined with
I
the
~ore
qualified standard of activity !necessary to constitute a "transaction
entered into for profit. 11
The courts' approach to this issue 'was effectively stated in Leslie, where
the taxpayer abandoned his residence and listed it for sale with his agent:
Merely permitting the property to be offered for sale after
deciding not to occupy it further is not sufficient to
terminate the loss from residential use and initiate a new
transaction for profit . • . ~ 51
The same concept of "held for post ~ conversion appreciation" is applicable
.to 165 deductions, but the elevated sta~us given to the standard of a "transaction
entered into for profit 11 will ·preclude allowance of loss deduction when the taxpayer's only post-abandonment activit,Y ;is holding the property for sale.
Conclusions
Althourh this article is intended to provide a foundation for the tax counsel's
'
attack upon the Service's disallowance lof applicable deductions claimed by the
taxpayer, its main purpose is prospective in nature.
·- -
. . ..
That is -- what may the tax
~·
advisel' suggest as to subsequent
dispo~ition
of. a residence which the taxpayer
intends· to abandon?
Formulation of the most effective iand economically beneficial method of disposition depends upon the specific taxpayer's position . and the state of the
15
relevant-market.
Evaluation of the taxpayer's status necessarily differs in
each situation.
There are basically two market conditions, however, in which the taxpayer who
inten~j
to dispose of his abandoned residence might seek converted status of his
property.
Both of these market conditiors are such that in relation to the tax-
payer's objectives he should anticipate a substantial
interi~
period between
abandonment and sale.
The first of these situations results when the taxpayer realizes that because
of the static state of the market he may encounter an extended waiting period
before a fair price will be obtained.
The other situation occurs when, because
of the progressive tendencies of the market, the taxpayer anticipates appreciation
of the abandoned residence.
Assuming that the taxpayer is financially capable of avoiding unfavorable
immediate disposition, conversion of the property may be economically beneficial
to him . .The taxpayer's immediate concern \'lill be conversion of the premises
into "property held for the production of income" for the applicability of 167
and 212 deductions.
These deductions w111 create r.urrent annual tax
I
henefit~
and
· moreover~ the taxpayer in either of the; previously mentioned market situations is
not anticipatinq a post-conversion
There is, of course. a
los~.
substan~ial
difference between not anticipating a
loss and not in fact suffering a reduction in value.
is delaying sale under either of the two market
Therefore, if the taxpayer
si~uations,
conversion sufficient
to warrant a 165 deduction might be beneficial in case of an unanticipated loss
upon sale.
Once a taxpayer has inhabited a residence, however, he must achieve
I
more- than attempted rental (subsequent ' to abandonment) to establish a 165 trans'
action. In this context, unless the taxpayer is in a position to rent and is
wi_lling to do so, conversion for purposes of "165 will have to be foregone.
Holding for sale or rent is sufficient to establish conversion into ''property
held
fa~
the production of income."
Holdinq for rent must be bona fide, however,
!
and this entails reasonable efforts
and~
Therefore, when the taxpayer holds for
reasonable market rental offering price.
.
'
~ent,
he must be prepared for the possibility
I
h~s
of actual rerital and he must evaluate
.
position and capabilities accordingly.
i
Renting or holding for rent, in addition to holding for sale, should be
the approaches taken to disposition by the taxpayer if, faced with a static market,
~nd
he wants the advantage of 167
period.
d~ductions
212
during his anticipated waiting
The necessity of rental or att~mpte~ rental is based upon two grounds.
First, since the taxpayer is
no~
seeking post-conversion
a~preciation
but rather
a favorable position for ultimate realization of a fair market price, the avail!
~
ability of 167 and 212 deductions is dependent upon the property being held for
recurring·- type income.
As an extension of the concept of recurring income, established by rental or
attempted rental, the abandoning taxpayer is allowed to immediately hold his
I
property for sale without loss of the applicable deductions.
Immediate holdinq
for sale is of substantial significance ;due to the taxpayer's goal in relation
to the nature of the market.
The stati~ state of the ma~ket does not necessarily
'
preclude prompt realization of a fair price.
- for
5ale~ ~he
By immediately placing his property
taxpayer is in a position:' to realize his objective if the
o~portunity
arises sooner than expected.
The taxpayer who anticipates post-conversion appreciation because of a progressive market has the additional option of holding the abandoned oremises for
sale.
This method of disposition can b:e conducive to recoqnition of
I
11
property
I
taxpayer acts affirmatively, evidencinq
held for the production of income" if the
i
his intent to seek post-conversion
may be established when, upon
app~1eciation. 52
I
'
~
:
I
abandonm~nt,
This profit-seeking intent
the taxpayer has his property appraised
and then delays holding for sale at a P,rice in excess of the appraised value_.
.
.i
Neither the 1engt.h of delay in. hal di ~g !for sa 1e nor the amount of excess of the
17
asking price over the appraised value are subject to delineation.
It is evident
that the longer the ·delay and the greater the excess, the greater will be the
support given to the taxpayer's intention of realizing post abandonment appreciation.
Consideration of the taxpayer's method of disposition
~
.'
~nder
either of the
i
anticipated market situations should
al~ays
be premised on the following inquiry:
Will the economic advantages of realizing 167 and 212 deductions and the possibility
of a 165 deduction outweigh the converse possibility of realizing a gain or a
larger giin due to a new applicable basjs of the property?
The answer will be
affected by uncertainities which have not been resolved in the case law.
Query, can the taxpayer establish conversion for purposes of 167 depreciation
~onversion
-(assuming fair market value at date of
is less than cost) and then
i
claim his original cost basis as applicable in the § 1001 formula determination
. ?53
of ga1n.
At first ~lance, if the taxpaye~ i~ denied the applicability of variable
bases depending upon the tax significant event involved, it would appear that
'
.
the Service and the courts would be
~oncept
actin~
arbitrarily
in view of their dual
of conversion.
A closer examination of the Service's and courts' approach to the availability
of deductions in this area, however, leads to an opposite conclusion.
Although
the requirements for conversion differ ·depending on whether a 165 or 1 f7 deduction
is claimed, once conversion for purposes of either deduction has been ascertained,
the same standard is employed for determination of the applicable
h~sis.
Assuming
that the taxpayer's adjusted cost basis is greater, the fair market value at date
of conversion becomes the tax basis.
ca ll_y__ p~y_j nq. for the prel)1i ses.
market if he sold.
His
When the taxpayer converts he is theoretico~t
is the amount he could receive on the
I
The fair market va~ue _of the premises thus becomes the cost
basis of his tax-significant venture.
'
.
18
When the taxpayer establishes conversion for purposes of 167, the property
will acquire a tax basis.
Once the taxpayer realizes tax benefits in accordance
with this tax basis, he should be estopped from denying the
of
applic~bility
this basis in later tax-significant events concerning the same property. 54
•
l
The residence-abandoning taxpayer can structure his dispositive activities
to establish conversion, but conversion for whatever deductible purposes
necessarily assure the taxpayer of an
ov~rall
tax advantage.
do~s
not
1.
· 2.
Tnt . Rev. Code of 1ql)l~, §~ 1n5-(c )(2), 167 (a )(2), 212(?).
E.g. , Newcomt:e v. Comni s.Gioner, 5!1
<r. C •
12<)8 ( 197 ()) .
3.
E.r:., Robi.n::;0n v. C:nmnissioner, ? , 7.C.
305 (19li3).
I
4.
E. r;. , r~crr::m v. Corrm1.ssioner, 7() F .:2d 3qo (5th Cir. 1 :1~ r;), cert. denied,
296 U.S. {-;QJ. (1935), nff'p.: a Memora;ndum Opinion of' the Fd. of 'I'Rx Appeals;
Stutz v. CC'rrrr.is::::loner,
CCH Tax Ct. r.1cm. 888 (19f•S); P.or'T'Tllarm v.
Comm18s.i on<:·r, 17 T.C. n(l3 (1951).
2a
5.
29 CCH Tax Ct. r~em. 8Flll, 88~ (1970),.
6.
See,
7.
?6 ·ccH 'T'nx ct.
8.
Id. at 302.
9.
Dawson v. Comnissioner, 31 CCII Tax Ct. r~em. 5 (197?.).
~rP.?.5 . r.~v. . ~§ 1.165-9(b)(1) (19F.4), 1.212~l(h) (197?).
r~lem.
?98 (1967).
'10.
Jd.
11.
Id. at 10.
1?.
?.6 CCH '!'ax Ct .
r~em.
298 ( 1967) .
13.
27 CCH 'l'ax Ct.
r~Terr..
220 (196P.).
14 . . Id. at 22l.
15.
1(.
Foeh1 v. Corrrnis.s:l.oner, 20 .CCH Tax Ct.
r~ern.
l1J.8, 420 (J.Qf:l).
Trean. Rer:. ~ 1.165-9(b)(2) (196t); e.~., Howard v. tlr.ited Stat€'-:>, 69-2 USTC
Trea~;. ~g . . l.167(e)-J (1064); £.:.f.=_, f.1ei:>irw:ero v.
Corrrniss loner, 27 C'CH Tax ·Ct. !'!em. · 2·5 (19fR).
.
'..C ,I Y534 "{'iif.'b. _Ill. 1969).
17 . Cottrell v. Corrn:issioner, 29 CCH '{ax
r:t. t·1m..
9S6 _(1 Q70).
18.
Treas. Rev,. ~ 1.212-1(b), (h) (197?).
19.
See, e.p:,., SI:Prlocl< v. C'0rrrnissioncr, 31 CCP. Tax Ct. f·1t'rr.. )Fl~ (1g7?; Herrmann v.
Cor:rmissior.cr, 17 T.C. 903 (1951); 1FobinGon v. Corrrn1esjr.rPr, ;: ':'.C. 305 (1q43).
20.
Sherlock v. Conmissioner, 31 CCH 1'ax Ct.
21.
Newcomhe v. Corrmissioner,
22.
Herrmann, 17 T.C. 903 (1951).
23.
31 CCH Tax Ct. r~em. 383, 3R6-87 ( }-97~).
24.
F:.p;., C:ottrell v. Corrrnissioncr) 2£} CCH Tax rt. lt.err;,
ccrm:1s3joner, ?l.i CCH Tax Ct. ~1('_m. j P88 (lq65).
91
rr.em. 383 (1072).
'1'. C. 1?.98 (197()) .
nc:.(.
(lY70); Stutz v.
r~em.
25.
29 CCH Tax Ct.
26 .
Cases
27.
No~tT
Int. Rev. Code of 1954, § 165(c()(2).
28.
276
u.s.
20.
Now
TrP-~5. r.e~.
30.
Rwnsey v. rcrrmissioner, ~2 F.2d 158!, 1~0 (2d C:ir. 1<)36), cert. denied,
299 U.S. S52 (1Q36)
31.
10 CCH ~ax Ct. Mem. 7~R, 741 (1951), hut distinction in that taxpayer acquired
the property as personal resider.ce for daughter instead of 11erself.
32.
21 T.C. 8S7 (1954).
33.
Treas.
34.
See, e.g;. , Rumsey v. Commissioner, f82 F. ?d ·158 ( 2d Cir. 1936); Grohse v.
Commissioner, 27 CCP. 1ax Ct. Mem. 220 (19fP).
35.
Now Int. Rev. Code of 1951;, §§ ?12 (2), 1(,7(a)(2).
36.
H.R. Rep. Uo. 2333, 77th Gong., 2d
r.ong., 2d Sess. A7 (1942).
37.
1 CCH I nt • nev. tl.anual , General Manar.ern=mt tilT 1277 (191 3 ) •
'38.
Newcombe, 54 T.C. 1298, 1303 (1970).
39.
Leslie v. Ccmnissioner, 6
40.
Beckjord v. Corrmissioner, 32 CCH Tax Ct . . r·1P.m. 541 (1973).
~ 1ted
note
1~
884 (1970).
supra .
582, 585 (1928).
Re~.
§ 1.165-9(h)(l) (1964).
§ 1.165-9(b)(l)
(1964).
'!'.c.
~ess.
75 (1942); S. Rep. No. 1631, 77th
l
48e (19116).
41 . . Riss v. Comm1ssioner, 56 T.C. 388, 417 (1971).
42.
Note lfi supra.
41.
Newcombe at 13()1-02.
(197?).
Accord, Opper v. Commissioner, 317 CCH Tax Ct. Tllem. lt85
44. "'<Newcombe at 1304.
I
45.
?9 CCH Tax Ct. Merr.. 880, 881 (1970).
I
•
26 CCH Tax Ct. Mem. 149 (1967), aff'd
per curiar., 397 F.2d 804 (9th Cir. 1968).
I
47. Rjss, 56 T.C. 3R8, 417 (1971).
46.
48.
See, TR.wis v. Ur.i ted State::;, 73-1 ,US'J'C ~ 9254 (S.D. Ohio 197:·:); Ne>whre v.
· Corrmissioner, 30 CCH Tax Ct. 11':em. ;705 (1971) •
I
See
_,
Newcorn~e . at· 1~0?-03.
~0.
E•.p;-., Sherlock, 31 CCH Tax Ct. f~em. 383 (197?).
51.
Lesli.e v. Corrrni:::aj.or.er, 6 '!'.C. 488, 4Q3 (1C)46)
52.
But remer.1b~r the valici arp.;urnent against tJ:1e applicability c·f 1117 depreciation
deductions \\'hen seeking gnin from appreciaticn -- Holding for Sale - 167 and
212.
53.
Int. Rev.
54.
Cf.,
Cod~
of 195t, § 1001.
Trea~ . Rc~. ~ 1.101~-l(b).