Tax Court In Brief | Patacsil v. Comm'r | Insolvency To Avoid Recognition Of Cancellation-of-Indebtedness Income; Net Operating Loss; Reliance On Tax Professional

• Published date: 06 February 2023
• Subject Matter: Tax, Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy, Tax Authorities
• Law Firm: Freeman Law
• Author: Freeman Law

The Tax Court in Brief - January 16th - January 20th, 2023

Freeman Law's "The Tax Court in Brief" covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

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Tax Litigation: The Week of January 16th, 2022, through January 20th, 2023

• Lucas v. Comm'r, T.C. Memo. 2023-9| January 17, 2023 | Urda, J. | Dkt. No. 2808-20

Patacsil v. Comm'r, T.C. Memo. 2023-8| January 17, 2023 |Holmes, J. | Dkt. No. 21902-19

Summary: Ernesto Patacsil and Marilyn Patacsil ("Taxpayers") owned a business that ran group homes for consumers with intellectual or physical maladies in California, being an expensive yet statutorily encouraged social-service endeavor. See Disability and Aging Community Living Advisory Committee, Cal. Health & Hum. Servs. Agency. Their business was always in danger of toppling financially, and Mrs. Patacsil did not help the situation by her gambling proclivities. Taxpayers used a system of envelopes for maintaining records of expenses and receipts. Taxpayers used accountants to prepare their returns for the years in issue, being 2015, 2016, and 2017. For 2015, Taxpayers claimed near $500,000 of "other expenses." For the 2016 and 2017 returns, Taxpayers provided their preparer near 6,000 files from the envelopes.

The preparer completed Forms 4797, Sales of Business Property, for both 2016 and 2017 relating to the sale of group homes known as Knickerbocker and Hildreth. They bought Hildreth in 2005 for $622,263; claimed a basis built up to $921,450; a gross sale price of $416,000; and a canceled loan of $391,080. They also claimed to have no allowable depreciation even though the property was used in their business. These numbers led them to claim a loss of $505,450. For Knickerbocker, they reported that in 2017 they sold the property for nothing but that they did receive $365,000 of loan forgiveness upon the sale. Taxpayers reported having a total accumulated basis of $125,587 in the property from which they had taken $101,361 of depreciation deductions. This left them with a basis of $24,226 in the property at the time of the sale. Ignoring the cancellation of debt, Taxpayers reported the $24,226 claimed basis as a loss on their return. Testimony at trial in the Tax Court indicated this reporting was in error.

Their preparer advised them to exclude any cancellation-of-indebtedness income on the ground that they were insolvent for tax year 2016, based on personal property valuations, loans and liabilities, and real property value estimates and resulting in about $3 million in assets against $3.9 in liabilities. But, they did not update the figures for 2017. On their 2017 return, they carried forward about $450,000 as a net operating loss from the 2016 return, calculated by adding Taxpayers' business income on Line 12 with the other gains or...