The United States Tax Court issued its opinion in Schneider v. Commissioner today. Although this case deals with the first-time homebuyer credit, which is no longer part of the tax code, the Schneider is still important as an object lesson for taxpayers who are in the midst of entering into tax-sensitive transactions (which are most transactions, by the way).
The facts in the case are relatively straightforward.
The taxpayer’s mother died, leaving a cooperative apartment in mid-town Manhattan to her children by the terms of her will. The taxpayer was one of seven siblings, so she inherited a 1/7 interest in the coop by the terms of her mother’s will.
The taxpayer and her siblings entered into an agreement pursuant to which the taxpayer purchased the remaining 6/7 interest in the coop from the estate, so that the taxpayer became the sole owner of the coop.
On her income tax return for 2008, the taxpayer claimed a $7,500 first-time homebuyer tax credit. Her return was audited, and the IRS took the position that she was not entitled to the claimed tax credit.
What was the IRS’s rationale for denying the taxpayer the right to claim the first-time homebuyer tax credit for her purchase of the Manhattan coop from her mother’s estate?
Was it because she was not a first-time homebuyer?
No. The taxpayer qualified as a first-time homebuyer because she had no present ownership interest in a principal residence during the 3-year period ending on the date of the purchase of the coop from the estate.
Was it because the coop itself did not qualify as a principal residence?
No. Treasury Regulation Section 1.121-1(b)(1) expressly includes within the definition of a “principal residence” an apartment occupied as a tenant-stockholder in a cooperative housing corporation.
Why, then, did the IRS deny the taxpayer the right to claim the first-time homebuyer tax credit?
In short, it was because the purchase was structured to be from the estate rather than from the taxpayer’s six other siblings.
The Tax Court noted that Section 36 of the Internal Revenue Code, the relevant section for the first-time homebuyer tax credit, required a “purchase” in order for the credit to be available, and the term “purchase” for purposes of this particular tax credit does not include a purchase by a beneficiary of an estate from the executor of an estate.
Even though the taxpayer’s siblings got the benefit of the taxpayer’s purchase of the coop through estate distributions to them as beneficiaries, it did not matter. The sale had been structured as being between the estate and the taxpayer.
Had the coop been distributed to the taxpayer and her siblings first and then sold by the taxpayer’s siblings to the taxpayer, the tax credit would have been available. However, as the Tax Court noted, “it is a well-accepted tax principle that a taxpayer is bound by the form given by the transaction.”
The first-time homebuyer tax credit is no longer available. So, why does this case matter to taxpayers now?
This case serves as a clear object lesson to taxpayers, now and in the future. Before you enter into a transaction, make sure that the form of the transaction is the best possible form for tax purposes.
There may be alternative ways to structure a transaction, with the substance being the same either way. However, if you choose a structure that has a different tax treatment from an alternative structure that you could have chosen, don’t think that you can claim the tax characteristics of the structure not chosen.
No. If you choose a particular form of transaction, you have chosen the tax characteristics that go with that form.
So, choose carefully. Uncle Sam is watching.