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Sales of Real Property are Sporadic, Therefore Loss on Foreclosure Is Capital.

(Parker Tax Publishing January 25, 2016)

A taxpayer's real estate activities did not amount to a trade or business because his property sales were sporadic, and not frequent and continuous. Thus, a loss on the foreclosure of one of his real estate properties was a capital, not ordinary, loss. Evans v. Comm'r, T.C. Memo. 2016-7.


Jeffrey Evans has worked in the field of real-estate construction and development since he graduated from college in 1973. Since 2002, he has been a full-time employee of Athens Group, a real-estate development firm. Apart from his full-time job at Athens Group, Evans purchased for himself residential real-estate properties that he hoped to either develop for sale or rent to tenants. From 2002 to 2007, Evans bought one rental property in Corona del Mar, California and two tear-down properties: one in Corona del Mar and one in Newport Beach. Over the course of three years, Evans developed the tear-down property in Corona del Mar into a two-condominium building, then sold it. The Newport Beach property, which was purchased on June 26, 2006, for $1.4 million in cash, was a plot of land which included a shack and a garage.

While he owned the Newport Beach property, Evans incurred costs to prepare the property for development. He paid an architect for drawings of the two-unit house that he intended to build there. Evans paid other individuals for electrical and mechanical plans. He incurred additional costs for permits, property taxes, and interest.

In 2007, Evans borrowed $250,000 from a trust, which acquired a lien on the Newport Beach property. He subsequently defaulted on the loan and, in October of 2008, the Newport Beach property was sold in a foreclosure sale for $556,000. As of the end of 2008, Evans knew that the foreclosure sale had occurred, but he did not know whether he was entitled to receive any proceeds from the sale. In 2009, Evans learned that there were proceeds distributable to him and he received $280,325 from the sale of the Newport Beach property.

Evans and his wife filed their 2008 tax return in 2012and reported a $1,041,000 inventory loss from the foreclosure sale of the Newport Beach property. The $1,041,000 loss was equal to the $1,597,000 they reported as their basis in the Newport Beach property minus the $556,000 that they reported as sale proceeds. The Evanses did not report that they had any business income or losses, other than the loss from the foreclosure sale. The couple reported a net operating loss for 2008 of $942,000. The couple filed their 2009 tax return also in 2012 and reported an NOL carryover of $942,000.

The IRS issued the couple a notice of deficiency, which included penalties, in which it determined that the couple owed $370,000 in tax. The notice did not mention or incorporate the loss on the Newport Beach property. The case went before the Tax Court where Evans's position with respect to the loss from the foreclosure sale of the Newport Beach property was: (1) the foreclosure sale resulted in an ordinary loss for 2008, (2) assuming an ordinary loss from the foreclosure sale in 2008, he had an NOL of $942,000 for 2008, (3) he was permitted to carry over this NOL of $942,000 and apply it as a deduction against his 2009 income. Alternatively, Evans asserted that the loss from the foreclosure sale was sustained in 2009, giving rise to an ordinary loss for 2009. The IRS argued that (1) the character of the loss from the foreclosure sale of the Newport Beach property was capital and (2) the loss was sustained in 2008.


The Tax Court agreed with the IRS that the loss from the sale of the Newport Beach property was deductible as a capital loss in 2008. The court noted that, under Reg. Sec. 1.165-1(d)(1), a loss is treated as sustained during the tax year in which the loss occurs as evidenced by closed and completed transactions and as fixed by identifiable events occurring in that tax year. A loss resulting from a foreclosure sale, the court observed, is typically sustained in the year in which the property is disposed of and the debt is discharged (the debt being the debt secured by the property and satisfied - in full or in part - from the proceeds of the foreclosure sale).

The Newport Beach property was sold in a nonjudicial foreclosure sale in 2008, the court observed, and, under California law, a nonjudicial foreclosure sale generally constitutes a final adjudication of the rights of the debtor and the lender, and a debtor whose property is sold in a nonjudicial foreclosure sale has no right to redeem the foreclosed property. Thus, the court concluded, the loss occurred in 2008 because, under operation of California law, the foreclosure of the Newport Beach property in that year extinguished (1) Evans's legal obligation to the trust from which he borrowed money, and (2) Evans's legal rights in the Newport Beach property.

The court rejected Evans's argument that, because he was a cash-method taxpayer and did not receive (or have notice of) the proceeds from the sale until 2009, the loss did not become deductible until 2009. The court said there was no authority to support the proposition that a loss from a sale is not deductible until proceeds from the sale are received by the taxpayer or the taxpayer is notified that proceeds are distributable to him or her.

The court's determination that the loss was a capital loss was the result of it analysis of several factors which led to the conclusion that Evans's personal real-estate-development activities did not constitute a trade or business for purposes of Code Sec. 1221(a)(1). First, the court said that even if Evans acquired the Newport Beach property with the intention of developing it, this does not mean that he was in the business of property development and sales. Second, the court said, if a taxpayer engages in regular (rather than isolated or sporadic) sales of property, such activity would support a finding that he or she is engaged in a trade or business. Apart from the Newport Beach property, the court noted, Evans specifically identified only two properties he had previously acquired. Thus, the court concluded, Evans's property sales were sporadic, and not frequent and continuous. Third, the court noted that Evans supplied very few records related to his personal real-estate transactions, and his testimony concerning his properties was notably vague. According to the court, one generally expects that a person who considers himself or herself in business will maintain books and records for that business. In conclusion, the court surmised that Evans's primary source of income was his full-time job and that any income he may have earned from developing properties accounted for an insubstantial portion of his income.

For a discussion of whether a taxpayer's activities constitute a trade or business, see Parker Tax ¶90,105. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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