KOCH, SHERRY S. (F) (2014)
Topic Code: C012 Capital Gains Deduction Document Reference: 14201029
Scott D. Rhodes, CPA
Rhodes, Wieder & Ellis PC
2900 Westown Parkway, Suite 130
West Des Moines, Iowa 50266-1315
Re: Sherry S. Koch
Docket No. 2010-200-1-0066
Individual Income Tax Protest
Dear Mr. Rhodes:
I represent the Iowa Department of Revenue in tax matters. This case was referred to me for further review. After reviewing all the facts and circumstances, I concur with the Department’s recommendation to deny this protest. This letter sets forth the facts and reasons for this decision.
The issue in this protest is the Department’s denial of the capital gain deduction on the Protester’s 2006 Iowa individual income tax return. The Protester sold 400 acres of farm land. The applicable statute is section 422.7(21) and the administrative rule that implements that statute is Iowa Administrative Code rule 701-40.38. The two major requirements for the deduction are that the property must have been held ten years and that the taxpayer must meet the test for material participation.
The relevant facts are as follows:
· Jack Koch is the Protester’s late husband and Randolph Koch was Jack Koch’s father.
· The land had been in the Koch family since the 1800s.
· 1956 – Jack turned 22. There is no mention of Jack doing any actual farm work after this.
· 1966 – Randolph Koch began cash renting the land to Mr. Goshorn.
· 1972 – 180 acres were transferred from the Estate of Esther Koch to Randolph Koch and Jack Koch subject to a life estate in Randolph Koch.
· 1990 – Randolph Koch died and Jack and Sherry Koch acquired title to the full 400 acres.
· 2005 – Jack Koch died and Sherry Koch owned all 400 acres.
· 2006 – Sherry Koch sold all 400 acres.
· Mr. Goshorn farmed the land the entire time from 1966 to when Sherry sold it.
The Protester meets the 10-year holding requirement for the property. However, the evidence does not support that the Protester or her late husband materially participated in the farming operation. The farmland was cash rented from 1966 until it was sold. Rule 40.38(1) presumes that a person that cash rents farm land does not materially participate, thereby placing the burden on the taxpayer to overcome that presumption. My review finds that you clearly have not presented facts and explanations to support your claim of material participation. Please note that the determination for material participation is based on the 10 calendar years immediately prior to the sale. Again, see rule 40.38(1).
In my view, the information provided to the Department is vague and ambiguous in addition to not being credible. For instance:
· This is a cash rent situation, however the four tests referenced in the protest were for crop-share arrangements.
· In the protest you also stated, “the activities of the farmer (tenant) could not have continued were it not for the involvement of the taxpayer.” No evidence was provided to support this statement. At the beginning of the period ten years prior to the sale, the tenant had been farming nearly 30 years. It does not seem reasonable that he would need the landlord to tell him how to farm. Not only did Jack Koch not live in the area, he himself had not farmed for well over 30 years.
· The taxpayer’s daughter stated, “My parents livelihood depended on the success or failure of the farms.” One of her parents was a biology teacher and the other an x-ray technician. The farm was not necessary for their livelihood. Additionally, her parents had guaranteed income by cash renting the land. The tenant bears the risks of weather, grain prices, etc.
· In your letter dated June 29, 2012, you stated that “The situation involved risk due to the inexperience of the tenant.” No explanation was provided as to how or why Mr. Goshorn was inexperienced after thirty or forty years of farming. Also, your letter dated May 9, 2013 exaggerates the risk of the landlord. There is always a chance of default by the tenant, but it is negligible. The landlord has legal recourse against that tenant and could find a new tenant the next year.
I find no evidence that this cash rent situation is different than others, as you claim. The rental agreement you provided for the period September 1, 2004 to February 1, 2009 is typical; it is brief and not complicated. The sentimentality of the old farm and discussions about farming with a life-long friend do not equate to any regular, continuous, and substantial farming activity. Additionally, the “Material Contributions” you described in the June 29, 2012 letter are evidence of investor-type activities, not day-to-day activities indicative of material participation.
The Department was correct in not accepting the estimated number of hours you provided with the June 29, 2012 letter. The Courts have acknowledged that the temporary regulations do not explicitly state what records a taxpayer needs to maintain, but they have consistently held that they do not allow a postevent “ballpark guesstimate.” Fowler v. Commissioner, T.C. Memo 2002-223; Goshorn v. Commissioner, T.C. Memo 1003-578. They have held that “while the regulations are somewhat * * * [ambiguous] concerning the records to be maintained by taxpayers, they by no means allow a postevent ‘ballpark guesstimate.’” Carlstedt v. Commissioner, T.C. Memo 1997-331 (citing Speer v. Commissioner, T. C. Memo 1996-323). “The Court is not bound to accept the unverified, undocumented testimony of taxpayers, and we decline to do so in this instant case.” Carlstedt v. Commissioner, supra (citing Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam 540 F.2d 821 (5th Cir.1976)); Bogus v. C.I.R. 2009 WL 3353055, 4 (U.S. Tax Ct.). “It has often been stated that an income tax deduction is a matter of legislative grace and that a taxpayer has the burden of proving his right to a claimed deduction.” Woodward v. U.S., 106 F. Supp. 14, 27 (N.D. Iowa 1952).
In summary, the Department was correct in denying this protest. If you agree or choose not to pursue the protest, please inform me in writing within 30 days of the date of this letter. That letter along with payment of the amount due will allow me to inform the Director that the protest has been resolved, no issues remain, and the case may be closed. You and the Protester will receive a formal Closing Order in a separate mailing. The Department’s research shows that the payment of $89,490.94 was postmarked in February 2010 but the amount paid only included interest through January 2010. The current balance due through the end of this month is $332.00. Therefore, the remaining balance due represents one month’s interest, plus interest on that amount since that time.
If you do not agree with the Department’s position and wish to pursue this matter further, please inform me in writing within 30 days of the date of this letter. I will then file an Answer, thereby initiating contested case proceedings. An Administrative Law Judge will then notify both parties of a time and date for an evidentiary hearing.
If I do not receive a response within 30 days of the date of this letter, the Department will construe this as failure to pursue the protest and it will file a Motion to Dismiss the protest pursuant to Iowa Administrative Code rule 701-7.11.
Sincerely,
VALENCIA VOYD McCOWN
Assistant Attorney General
VVM:cml
cc: Iowa Department of Revenue,
Audit Services Section