Sometimes You Lose when You Win!

Published on: 08:57AM Apr 30, 2012

The Tax Court recently ruled in favor of a taxpayer regarding a Section 1031 exchange. In the Reesink case (TC Memo 2012-118), the court indicated that the taxpayers were entitled to nonrecognition treatment on the purchase of a house that they ultimately moved into as their personal residence. 

Normally, you cannot sell investment property (such as farmland) and then purchase a house to live in. This is considered to be non-like-kind property. In the current case, the intent of the taxpayers was to purchase the house and then rent it out. However, they were unable to get the rent they wanted and ultimately decided to sell their current home and move into the house they had just purchased as their replacement property.

The primary reason that the taxpayers won was their intent to rent the house out; however, taking this case to Tax Court and winning the victory probably cost them in excess of $50,000 and many hours of effort and heartburn.

If the taxpayers had been diligent in providing the correct information to their tax preparer, most likely this would have never gone to Tax Court and/or never been picked for an audit. They never told the preparer that they were moving into the home and also underreported their rental income by more than $16,000 for the year.

The bottom line is that whenever you have a complicated tax situation, such as a 1031 exchange, you must review it with your tax adviser and, even more importantly, provide all of the information to him so he can prepare a proper tax return.