U.S. Tax Court judges could look at clients' moves to sell or keep annuities when evaluating the clients' overall financial status.
Judge Albert Lauber took the treatment of a couple's annuity into account in a recent opinion about a case involving a charitable contribution deduction for a conservation easement related to the 2016 donation of 110 acres of rural farmland in Shelby County, Alabama, to the Heritage Preservation Trust.
Ranch Springs LLC, a limited liability company controlled by Jason Carpenter and his wife, claimed a $25.8 million value for the easement on its 2017 return. Lauber determined that the actual value of the easement was just $335,500. The judge held that the limited liability company should pay a 40% penalty for a valuation misstatement.
For an annuity advisor, the most interesting section of the opinion may be the judge's analysis of whether the Carpenters were facing distress when they sold nearby property in a related transaction.
What it means: Clients who are deciding whether to liquidate annuities or tap other sources of cash first may be giving the courts messages about whether they are facing severe financial distress or are simply taking sensible steps to get cash.
The underlying case: The Carpenters first sold land next to Ranch Springs in 2016, then donated the rest of the land to the Heritage Preservation Trust.
The Internal Revenue Service argued that Ranch Springs should base the valuation of the conservation easement on the price of the land sold in 2016.
Ranch Springs LLC, the petitioner, said the Ranch Springs land is worth much more because it could be used to start a limestone quarry.
Lauber's ruling hinged on the value of limestone, whether the couple's 2016 property sale reflected the true value of the land sold, and how to interpret efforts to value the land subject to the easement using the discounted cash-flow method.
Ranch Springs LLC is filing an appeal and has asked for a motion to stay the Tax Court ruling on the case, Ranch Springs LLC, Ranch Springs Investors LLC, Tax Matters Partner v. Commissioner of Internal Revenue.
"Petitioner is disappointed in the Tax Court's opinion," according to a statement from a Ranch Springs representative. "We are hopeful the appellate court gives the taxpayers guidance on two points that petitioner put forth at trial."
Ranch Springs LLC wants the courts to recognize that, to identify a truly comparable sale, both the buyer and the seller had to understand the highest and best use of the property.
The limited liability company also wants the courts to understand that using the discounted cash-flow income method to value land is not the same as creating a business valuation, according to the statement.
Representatives for the IRS declined to comment.
The financial distress analysis: The Carpenters told the courts they sold the land next to the Ranch Mirage property for a low price because they needed cash for legal bills. They described the sale as a distress sale.
Lauber gave a number of reasons for determining that the sale was not a distress sale.
One was a review of the Carpenters' other resources.
"The couple had other assets they could have accessed for this purpose," the judge wrote in the opinion. "Mr. Carpenter had an IRA, and his wife had a sizable annuity investment."
Lauber suggested that selling the land rather than using the other assets was a rational strategy.
"An IRA distribution would have been taxed in full as ordinary income, whereas a sale of real estate would generate tax only on the gain," Lauber said. "And Mr. Carpenter was reluctant to suggest liquidation of his wife's annuity to satisfy an obligation arising from his personal business activities."
Simply selling assets to raise cash does not show that the sellers face a "compulsion to sell," Lauber wrote.
"People often sell assets to raise cash to satisfy their desires or meet their obligations," Lauber added. "They may liquidate assets — stocks, bonds, mutual funds or real estate — to pay for their children's education, to buy a new home, to pay medical bills, or to treat their family to an extended vacation. Selling an asset for such a purpose provides no evidence that the seller is under a 'compulsion to sell.'"
Credit: Shutterstock
© Touchpoint Markets, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to TMSalesOperations@arc-network.com. For more information visit Asset & Logo Licensing.