Don’t be fooled: Tax Court judges are people too. They live and laugh and love, just like the rest of us. Their highfalutin position may require them to carry themselves with an excess of formality, but deep down, they all eagerly anticipate that rare moment when the court loosens the shackles and allows them to have a little fun.
And when it happens, as it did last week in Willson v. Commissioner, the results can be both entertaining and educational. Because when formality is sacrificed for simplicity — as Judge Holmes did in authoring his decision — the takeaway lessons of the case are often easier to absorb.
First, some background: the taxpayer (Willson) chose “S case” status, which allowed him to introduce evidence that would otherwise not be admissible, but more germane to this blog post, also permitted the Tax Court to conduct the trial as informally as possible. Which it most certainly did.
Willson was a bit of an entrepreneur, though not necessarily by choice. He built a bar in 1986 after a gunshot wound prematurely ended his career as an auto mechanic. Willson made considerable improvements to the bar and the surrounding parking lot, only to see the majority of the property burn down courtesy of some faulty hair-band pyrotechnics.
But perhaps we’re best served letting Judge Holmes explain the events leading up to the fire, as he does it quite eloquently; throwing in a brief history of the evolution of late 80’s rock for good measure. His words resemble those not of a reputable adjudicator, but rather those of a disillusioned codger ruminating on all that’s wrong with the world from the sanctity of his front porch, pausing just long enough to implore the neighborhood kids to get a haircut.
His words are, however, awesomely refreshing in their informality:
With these new stages, the bar became a local mecca for a type of “rock and roll” called “glam metal.” We also took judicial notice that “hairbands” had lost much of their popularity with the coming of something called “grunge rock” (another type of “rock and roll” music) in the early nineties. This was important to Willson’s business because “hair bands,” with such unlikely names as Head East, Great White, and Saturn Cats could still draw large crowds to a bar on the outskirts of Des Moines but had become affordable providers of live entertainment. Willson even invited one of these “hair bands” to be a sort of artist-in-residence. One night in 1994, a few band members did something to a smoke machine that sparked an enormous fire. This fire engulfed everything except the parking lots, the shed, and the property’s original house.
And with that I give you the first — and almost certainly the last– mention of Great White you’ll ever find in a Tax Court decision.
Undeterred by his bad fortune, Willson rebuilt the bar and rented out a portion of it to a new business; one that employed the type of women who was once a staple in the videos of the very 80’s music that caused the demise of the bar in the first place. Circle of life, I guess.
As Judge Holmes put it:
Willson rented out the old space to a tenant who installed minor improvements and opened an establishment felicitously–and paronomastically–called the “Landing Strip,” in which young lady ecdysiasts engaged in the deciduous calisthenics of perhaps unwitting First Amendment expression.
Now, we here at Double Taxation fancy ourselves as fairly bright individuals, but we’re not ashamed to admit that we only recognized about four words in that sentence. For those of you without a Word of The Day Calendar handy, here’s the best translation we could muster: Willson opened a strip bar with the clever name: The Landing Strip.
In 1999, the city of Des Moines began condemnation proceedings against Willson. Unfortunately for Willson, he wasn’t around to oversee the dealings with the city, as he was about to begin serving a federal prison term for, as Judge Holmes put it, “…something to do with money and drugs and possibly the bar.”
Willson eventually received $203,427 from the city in exchange for his property, leaving the Tax Court to determine the amount — if any — of the gain resulting from the condemnation.
Now typically, the Tax Court has a way of needlessly complicating even the most seemingly straight-forward of concepts through the required references to the statute, regulations, administrative procedures and a near-century of case law, all delivered in the standard legal mumbo jumbo.
And therein lies the beauty of an “S” case: Judge Holmes was permitted to explain the concepts of “amount realized” and “adjusted basis” for purposes of computing Willson’s gain or loss in layman’s terms, which can be a tremendous benefit to young CPAs struggling to grasp these intangible concepts.
Someone who sells property is taxed on the gain, not the sale price. This gain basically depends on two other numbers: the amount the seller receives and what is called “adjusted basis.”
The amount the seller receives is not just how much cash he pockets. It also includes, for example, money that goes to pay off other debts tied to the property. The amount that Willson received in this sense (called the“amount realized”) is $203,427.
That leaves us with the “adjusted basis.” To figure out Willson’s gain, we have to subtract the adjusted basis from the amount realized. Basis is pretty much what a property owner paid for the property plus what he later spent to improve it.
A taxpayer can’t generally deduct these payments right away because they provide a benefit that lasts longer than just one taxable year. But before calculating the capital gain the basis must be adjusted under section 1016. And depreciation is one of those adjustments we need to figure out in this case.
Most property doesn’t just fall apart one day, it suffers wear and tear over time. That’s why the Code allows a taxpayer yearly deductions for depreciation over the estimated useful life or recovery period of the property used in a trade or business.
When it was all said and done, the Tax Court held that Willson actually generated a loss on the condemnation, but not before also working through the implications of an involuntary conversion under § 1033 on Willson basis (upon recovering insurance proceeds after the hair-band fire.)