tcmemo_2017_122 united_states tax_court greenteam materials recovery facility pn greenwaste recovery inc tax_matters_partner et al petitioners v commissioner of internal revenue respondent docket nos filed date kevin p courtney and william j mitchell for petitioners thomas r mackinson and chong s hong for respondent we consolidated with this case greenteam of san jose pn greenwaste recovery inc tax_matters_partner docket no and greenwaste of tehama pn zanker road resource management ltd a california limited_partnership tax_matters_partner docket no we allowed the parties to file separate briefs memorandum findings_of_fact and opinion holmes judge in a california partnership called greenwaste of tehama sold its waste-collection business in tehama county and the city of red bluff to waste connections inc for dollar_figure million that same year two related partnerships called greenteam of san jose and greenteam materials recovery facility greenteam facility also sold the assets of their businesses in the city of san jose to waste connections for dollar_figure million the sales included both tangible and intangible assets the parties settled the tax treatment of the sales of these assets except for one--the contractual rights to provide waste-collection services to these local governments the greenteam partnerships say that these contracts were franchises and that the code has a special rule that taxes the sale of franchises at the favored capital-gains rates the commissioner doesn’t believe that section applies he wants us to sift through decades of caselaw where we ourselves separated sales of contracts that produced capital income from sales of contracts that produced ordinary_income findings_of_fact a greenwaste of tehama greenwaste of tehama was formed in to bid on what the waste and recycling business calls a request for proposal rfp from tehama county and the city of red bluff to take care of their waste and recycling needs neither red bluff nor tehama county kept good records for this sort of thing so greenwaste of tehama employees dug through what records there were and talked to the city and county regulators--a chore that took months greenwaste of tehama engineers also had to figure out what permits were required and what it was going to take to put the whole waste and recycling business together this was hard work and greenwaste of tehama spent about dollar_figure to put together its bid in california the winner of an rfp typically gets the exclusive right to manage a city’s waste and recycling for a fixed term--usually seven to ten years it’s not unusual for contracts to be renewed though and businesses like greenwaste of tehama will often assume their contract will be renewed when they put together their rfp calculating how much it will cost to manage a city’s waste and recycling demands can also be tricky a business must consider a variety of costs--including the need for buildings and trucks--before it submits a final number greenwaste of tehama’s heavy lifting paid off and it beat out a number of other bidders what it won was a package of five contracts two contracts gave greenwaste of tehama the exclusive right to collect and dispose_of all of tehama county’s recyclables and its residential and commercial waste two contracts gave greenwaste of tehama the same right to red bluff’s recyclables and its residential and commercial waste and the company agreed to provide any equipment like carts and bins the fifth contract wasn’t to collect garbage but to dump it greenwaste of tehama got the exclusive right to use the tehama county-red bluff landfill to get rid of what it picked up as part of this contract greenwaste of tehama also agreed to pay for any needed improvements at the landfill even though title to these improvements would revert to tehama county and red bluff when the contract ended the tehama collection contracts started running in the summer of and the red bluff collection contracts started later that year all four contracts ran through date but could be extended by mutual agreement the parties agree that in the four collection contracts were collectively worth dollar_figure and the landfill contract was worth dollar_figure b the san jose partnerships the greenteam of san jose deal was similar back in san jose also issued an rfp for waste disposal and recycling services for single-family homes a few months later it issued a similar rfp for multifamily residences greenteam of san jose was formed to bid on these rfps like greenwaste of tehama greenteam of san jose spent a good deal of time and money to put together its bids and even hired outside consultants san jose is the unofficial capital of silicon valley so it is no surprise that greenteam of san jose incorporated some innovative tech in its bid for this ancient work it attached an rfid radio frequency identification tag to every trash bin so greenteam of san jose could track when and where trash was collected it also was the first waste collection company to put computers in its garbage trucks to monitor collection and greenteam developed the necessary software itself greenteam of san jose even experimented with different types of vehicles before it found one that was both productive and efficient enough to meet its obligations to san jose this all went very well and greenteam of san jose won the contracts in the summer of these contracts ran through but could be extended for up to three years much as with greenwaste of tehama’s greenteam of san jose’s contracts required it to collect and dispose_of residential waste and recyclables in one section of san jose but it also had to build a processing facility to sort and store recyclables and keep san jose’s recyclables separate from those of others to meet this requirement greenteam of san jose formed greenteam facility greenteam of san jose did a good job and when san jose issued another rfp in it won the bid again c waste connections in a company called chaparral group llc a consulting group for the waste industry asked the greenteam partnerships if they would be willing to sell they were that summer the greenteam partnerships signed a consulting agreement with chaparral and chaparral quickly put together a package that estimated potential sale prices things moved quickly and by that fall the greenteam partnerships had signed a letter of intent to negotiate with the highest bidder--waste connections in the fall of the greenteam partnerships officially sold their assets to waste connections greenwaste of tehama’s was an all-cash deal for dollar_figure million with a very minor exception greenwaste of tehama didn’t keep any interest in the tehama county and red bluff contracts the asset-purchase agreement allocated the only asset not included was a single truck dollar_figure to a covenant_not_to_compete dollar_figure to tangible assets dollar_figure to buildings and dollar_figure to land waste connections’ deal with greenteam of san jose and greenteam facility was very similar it too was all cash and a sale of substantially_all its assets--including the san jose contracts--for a lump sum of dollar_figure million later reduced to dollar_figure million there were no contingent payments greenteam of san jose didn’t keep any interest in the san jose contracts either the asset-purchase agreement allocated dollar_figure to a covenant_not_to_compete and dollar_figure to land buildings and equipment d tax reporting of the deals on its tax_return greenwaste of tehama reported the values of the covenant_not_to_compete and the tangible assets the same way the parties allocated them in the tehama asset-purchase agreement that left dollar_figure which greenwaste of tehama reported as goodwill to be taxed at capital-gains rates greenteam of san jose and greenteam facility had to divide up the amounts allocated in their asset-purchase agreement to their respective returns greenteam of san jose reported dollar_figure for a covenant_not_to_compete dollar_figure for land buildings and equipment and dollar_figure--its remainder--for goodwill and going-concern value likewise greenteam facility reported dollar_figure for a covenant_not_to_compete dollar_figure for land buildings and equipment and dollar_figure--its remainder--for goodwill and going-concern value to summarize as a technical matter this means that greenteam of san jose reported dollar_figure from the transfer of a class v asset and dollar_figure from the transfer of class vi and vii assets on its form_8594 asset acquisition statement under sec_1060 greenteam facility reported its values similarly on its return the irs instructions for form_8594 tell us what these classes mean class_v_assets are all assets that are not class i through iv assets cash actively_traded personal_property assets the taxpayer markets-to-market and stock or class vi and vii assets class_vi_assets are sec_197 intangibles except for goodwill and going- concern value which are separately classified as class_vii_assets item covenant_not_to_compete tangible assets goodwill going concern greenwaste of tehama dollar_figure big_number big_number greenteam of san jose dollar_figure big_number big_number greenteam facility dollar_figure big_number big_number 1we note the sum of greenwaste of tehama’s covenant_not_to_compete the tangible assets and the goodwill going concern--dollar_figure dollar_figure dollar_figure--is dollar_figure which was the purchase_price in its asset-purchase agreement similarly the sum of greenteam of san jose and greenteam facility’s tangible assets and goodwill going concern--dollar_figure dollar_figure dollar_figure dollar_figure--is dollar_figure which was the purchase_price in their asset-purchase agreement everything seemed fine until the commissioner showed up in audited the returns under tefra and issued notices of final_partnership_administrative_adjustment fpaa recharacterizing the gains from the contracts as ordinary_income for the tax_year he sent greenwaste of tehama an fpaa tefra is the tax equity and fiscal responsibility act of pub_l_no 96_stat_324 one part of which governs the tax treatment and audit procedures for most partnerships see tefra secs stat pincite tefra partnerships are subject_to special tax and audit rules see secs each tefra partnership for example is supposed to designate a tax_matters_partner to handle the partnership’s administrative issues with the irs and any resulting litigation tefra requires the uniform treatment of all partnership items --a term defined by sec_6231 and --and its general goal is to have a single point of adjustment for the irs rather than having it make separate partnership_item adjustments on each partner’s individual return see h_r conf rept no pincite 1982_2_cb_600 if the irs decides to adjust any partnership items on a partnership return it must notify the continued recharacterizing dollar_figure as ordinary_income greenteam of san jose an fpaa recharacterizing dollar_figure as ordinary_income and greenteam facility an fpaa recharacterizing dollar_figure as ordinary_income the partnerships all filed timely petitions disputing the commissioner’s recharacterizations most continued individual partners of the adjustment by issuing an fpaa sec_6223 an fpaa generally includes a notice of final_partnership_administrative_adjustment form 870-pt agreement for partnership items and partnership level determinations as to penalties additions to tax and additional_amounts including a schedule of adjustments and an explanation of adjustments listing the commissioner’s other adjustments or determinations all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure unless otherwise indicated of this amount dollar_figure was related to the sale to waste connections and the remaining dollar_figure was related to other expenses greenteam of san jose’s fpaa recharacterized the entire amount reported on its form_4797 sales of business property the dollar_figure is the amount of tangible assets and goodwill going concern allocated to greenteam facility dollar_figure minus the amount for its covenant_not_to_compete dollar_figure minus its adjusted_basis in the assets dollar_figure and an adjustment for depreciation dollar_figure greenteam facility’s fpaa likewise recharacterized the entire amount reported on its form_4797 the dollar_figure is the amount of tangible assets and goodwill going concern allocated to greenteam facility dollar_figure minus the amount for its covenant_not_to_compete dollar_figure minus its adjusted_basis in the assets dollar_figure and an adjustment for depreciation dollar_figure because the partnerships’ principal places of business were in california continued issues were resolved through stipulation and settlement but there’s one issue left--whether the greenteam partnerships recognized capital_gains or ordinary_income when they sold the contracts to waste connections the parties fought at first about the values of these contract rights but before trial stipulated that the total value of waste connections’ agreement with greenwaste of tehama was dollar_figure the value of its agreement with greenteam of san jose was dollar_figure and the value of its agreement with greenteam facility was dollar_figure opinion the greenteam partnerships’ argument is simple the sales of the contracts fall under sec_1253 which says that a taxpayer gets capital-gains treatment when it sells a franchise unless it has a continuing interest in the franchise after the transfer the commissioner disagrees he thinks sec_1253 doesn’t apply precisely because the greenteam partnerships didn’t keep any interests in the contracts and didn’t receive any contingent payments the commissioner says that since sec_1253 doesn’t apply we have to decide whether the contracts were capital assets by looking at sec_1221 the six-part multiprong test of foy continued when they filed their petitions these cases are presumptively appealable to the ninth circuit see sec_7482 v commissioner 84_tc_50 and the substitute-for-ordinary-income doctrine the greenteam partnerships think they still win under foy i whether the contracts were franchises the first question we must answer is whether the contracts the greenteam partnerships sold were franchises under sec_1253 sec_1253 says that a transfer of a franchise trademark or trade_name may not be treated as a sale_or_exchange of a capital_asset if the transferor retains any significant_power_right_or_continuing_interest in the franchise trademark or trade_name sec_1253 sec_1253 defines franchise for the purposes of that section franchise --the term franchise includes an agreement which gives one of the parties to the agreement the right to distribute sell or provide goods services or facilities within a specified area the definition is unambiguous so we need only look at the plain language of the statute 12_f3d_1005 10th cir aff’g 95_tc_495 995_f2d_530 4th cir aff’g 98_tc_435 sec_1253 tells us that there’s a franchise for the purposes of sec_1253 if there is an agreement in which one party receives the right to provide services within a defined area see tele-commc’ns t c pincite if a transaction satisfies these three requirements then it falls under sec_1253 id we directly addressed this issue in tele-communications in that case we found that prospective cable operators had to sign an agreement with a local_government to construct and operate a cable franchise id pincite such agreements typically lasted between ten and fifteen years and required the operators to pay the local_government a percentage of their revenue and promise to maintain certain construction standards air certain programming and open local offices with regular business hours id pincite but if they did so the operators got a de_facto territorial monopoly id pincite tele-communications was a major cable operator that had bought three such cable systems from another cable operator id pincite the issue in tele-communications was whether those franchises were franchises under sec_1253 id pincite the commissioner argued that they weren’t because they were granted by the local_government and that the legislative_history of sec_1253 showed that congress intended the section to apply only to private franchises id pincite we disagreed and held that the definition of franchise was broad unambiguous and applied to the franchises tele-communications bought we focused on the nonexclusive term includes in sec_1253 and reasoned that congress would not have used that term if it had meant for sec_1253 to be applied narrowly id pincite the tenth circuit affirmed our decision see 12_f3d_1005 the fourth circuit also followed our reasoning see 995_f2d_530 holding that franchise included a fcc license under sec_1253 we won’t disrupt this consensus and find that the greenteam contracts meet the definition in sec_1253 the contracts were agreements to provide services--specifically landfill waste-disposal and recycling services these services had to be performed within specific areas the greenwaste of tehama contracts had to be performed in tehama county and red bluff and the greenteam of san jose contracts had to be performed in san jose the commissioner however has a new argument he argues that franchise in the california waste and recycling industry means only a contract even the commissioner seems to concede in portions of his briefs that the contracts meet the definition of franchise under sec_1253 he wrote t he gwt contracts appear to meet the sec_1253 definition of ‘franchise ’ but that is irrelevant that continues to renew until it’s terminated the industry contends the commissioner calls only these evergreen contracts franchises when a contract between a company and a local_government is to provide specific services for a limited time usually between and years it is instead a municipal contract the commissioner says that the california waste and recycling industry would classify these contracts as municipal contracts so they can’t be franchises under sec_1253 the commissioner’s problem is that the industry definition in california doesn’t matter for federal income-tax purposes see tele-commc’ns t c pincite the important consideration is the substance of the taxpayer’s activity and whether it falls within the definition of the code not the form or labels placed upon the activity sec_1253 specifically defines franchise and that’s the definition we have to use holding that sec_1253 includes the contracts here as franchises isn’t the end of the matter we also need to figure out whether the greenteam partnerships kept any significant_power_right_or_continuing_interest in the franchises if they did their income from the sales is ordinary see sec_1253 b see also revrul_88_24 1988_1_cb_306 but that’s an easy question here--none of the greenteam partnerships kept any interest in the franchises and they didn’t receive contingent payments--they got lump-sum payments even the commissioner concedes in his briefs that the partnerships didn’t hold onto any significant interests in the franchises or receive contingent payments since we are dealing with franchises under sec_1253 and the partnerships didn’t keep any interests in the franchises or receive contingent payments we know the transactions aren’t ineligible for capital-gains treatment see sec_1253 ii capital_gains treatment now we must decide how to read the rest of sec_1253 the greenteam partnerships argue that not getting kicked out of sec_1253 automatically entitles them to capital-gains treatment but sec_1253 says what doesn’t get capital_gains treatment not specifically what does the commissioner says this means sec_1253 is inapplicable by its own terms so the transactions are taxed as ordinary_income a closer look at the whole section resolves this issue though sec_1253 talks about capital accounts paragraph says any amount_paid or incurred on account of a transfer sale_or_other_disposition of a franchise trademark or trade_name to which paragraph does not apply shall be treated as an amount chargeable to capital_account emphasis added this implies that the sale of a franchise leads to capital_gains unless the transaction is specifically knocked out of sec_1253 by sec_1253 our court has already addressed this issue too in 86_tc_492 aff’d 864_f2d_1521 10th cir we held that sec_1253 gives a transferor of a franchise capital-gains treatment so long as it doesn’t retain any significant interest in the franchise and the franchise was a capital_asset the fifth circuit agrees it also explained that sec_1253 says a taxpayer doesn’t get capital-gains treatment when it transfers a franchise if it retains a significant interest in the franchise 936_f2d_833 5th cir aff’g tcmemo_1990_340 mcingvale also said that sec_1253 assumes the inverse too--when a taxpayer transfers a franchise and doesn’t retain a significant interest the transaction is taxed as the sale_or_exchange of a capital_asset iddollar_figure the legislative_history of sec_1253 confirms the courts’ interpretation congress originally passed sec_1253 to deal with conflicting caselaw surrounding the question of whether payments from a franchisee to a franchisor qualified for capital-gains treatment see s rept no u s c c a n see also eg 365_f2d_337 5th cir aff’g 35_tc_773 and tcmemo_1963_288 354_f2d_757 8th cir 307_f2d_816 4th cir rev’g tcmemo_1961_112 250_f2d_503 10th cir rev’g 26_tc_61 we won’t disrupt this consensus either sec_1253 applies to the transactions because the taxpayers here kept no significant interest in the contracts they sold caselaw then tells us that this entitles them to capital-gains treatment on their profits from the sales this means that we need not discuss the commissioner’s arguments that the franchises weren’t capital assets under sec_1221 and the foy test or under the substitute-for-ordinary-income doctrine decisions will be entered under rule


internal_revenue_service number release date index number ------------------------- -------------------------- ---------- -------------------------------------------------------- department of the treasury washington dc third party communication date of communication month dd yyyy person to contact ---------------------- id no ----------------- telephone number -------------------- refer reply to cc ita b03 plr-128438-12 date date ty ------- ty ------- legend taxpayer a ------------------------- taxpayer b ---------------------------- taxpayers taxpayer a and taxpayer b minority owner c ---------------------------- minority owner d --------------- insurance_company ---------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- practice entity g -------------------------------------------------------- practice entity h -------------------------------------------------------------------------- ------------------------------------------------------------- dollar_figurej ----------------- dollar_figurek ------------ dollar_figurer ------------ dollar_figures ----------- dollar_figuret ----------- plr-128438-12 aa ------ bb ------ cc -------- dd ----------- ee ------ ff ----------- gg ----------- year ------- year ------- year ------- year ------- date -------------------------- date -------------------- date ------------------ date -------------------------- date ---------------------- date -------------------------- date -------------------------- date ----------------------- dear ------------------ this is in response to the letter sent by your attorneys dated date in the letter your attorneys requested that the irs rule that the dollar_figurej taxpayer a paid to insurance_company in year is deductible as a loss incurred_in_a_trade_or_business under sec_165 of the internal_revenue_code code in the year paid and that the dollar_figurek plr-128438-12 taxpayer a paid to the insurance_company in year will be deductible as a loss incurred_in_a_trade_or_business under sec_165 in the year paid facts the taxpayers are physicians who practiced medicine under several professional entities including practice entity g and practice entity h when practice entity g a limited_liability_company was formed on date taxpayer a owned aa and minority owner c owned bb of practice entity g at some point later not specified in the taxpayers’ submission taxpayer b became a member of practice entity g with a cc ownership_interest taxpayer a’s ownership fell to cc and minority owner c continued to own bb taxpayers currently practice under practice entity h when practice entity h also a limited_liability_company was formed on date taxpayer a owned dd of practice entity h taxpayer b owned ee and minority owner d owned ff minority owner d subsequently left the practice after minority owner d’s departure until date taxpayer a owned ff and taxpayer b owned gg of practice entity h on date taxpayer b became an employee of practice entity h and thus taxpayer a came into ownership of of practice entity h in year the insurance_company sued the taxpayers minority owner c and practice entities a and b for insurance fraud demanding both compensatory and punitive_damages on date the parties entered into a settlement agreement in which the defendants agreed to pay dollar_figurej by date and dollar_figurer in monthly installments of dollar_figures beginning on date included in the dollar_figurej was dollar_figuret of unpaid legitimate bills for patient services due to practice entity g at that point entirely owned by taxpayer a that the insurance_company was refusing to pay until the parties settled the litigation in exchange for the payment the insurance_company agreed to release its claim for restitution in a then pending criminal action the agreement stated that each defendant shall be individually responsible for any and all payments due under this agreement taxpayer a paid the balance of the dollar_figurej less the dollar_figuret to the insurance_company in year in year taxpayer a and taxpayer b each paid dollar_figurek to the insurance_company equal to the dollar_figurer due under the settlement agreement minority owners c and d paid no amounts due under the settlement agreement taxpayer a has represented a that he previously included in his gross_income in prior tax years the amounts he now seeks to deduct and b that he and all other defendants in both lawsuits are jointly and severally liable for the amounts due under the settlement agreement because the language of the settlement agreement imposes joint liability upon the defendants and new jersey law imposes joint_and_several_liability upon members of a limited_liability_company law and analysis plr-128438-12 deductions are a matter of legislative grace and a taxpayer must satisfy the specific statutory requirements of the deductions claimed 503_us_79 308_us_488 292_us_435 taxpayers bear the burden of proving entitlement to the deductions they claim 290_us_111 sec_162 of the code and sec_1_162-1 of the income_tax regulations regulations allow a deduction for all the ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business sec_165 states that taxpayers may deduct any loss sustained during the taxable_year and not_compensated_for_by_insurance_or_otherwise in the case of an individual the deduction under sec_165 is limited to losses_incurred in a trade_or_business losses_incurred in any transaction entered into for profit though not connected with a trade_or_business and losses of property not connected with a trade_or_business or a transaction entered into for profit if such losses arise from casualty or theft the repayment of fraudulently obtained funds is not deductible under sec_165 991_f2d_292 6th cir 69_tc_990 35_tc_279 accordingly the taxpayers are not entitled to a deduction under sec_165 for the restitution they paid to the insurance_company however taxpayers that repay embezzled funds are ordinarily entitled to a deduction under sec_165 in the year in which the funds are repaid 905_f2d_667 2nd cir revrul_65_254 1965_2_cb_50 holds that a deduction is allowable under sec_165 with respect to the repayment of embezzled funds by the embezzler for the taxable_year in which the repayment is made a similar result was reached in revrul_82_74 1982_1_cb_110 which holds that a convicted arsonist is entitled to a loss deduction under sec_165 for repayment to an insurance_company for restitution in the taxable_year of repayment to the extent the proceeds were previously included in gross_income in short payments in the nature of restitution are deductible under sec_165 courts will typically give effect to the express tax characterization of a settlement payment by the parties to a settlement agreement thus the parties’ characterization of the payment rather than the character of the original claims to which the settlement payment relates determines the deductibility of such payments 72_tc_1136 acq 1980_1_cb_1 48_tc_15 revrul_80_334 1980_2_cb_61 taxpayer a has represented that under new jersey law members of a limited_liability_company are jointly and severally liable for the payment of damages awarded in civil suits the insurance_company released its claim for restitution in the criminal suit in exchange for the taxpayers’ settlement payment thus the settlement payment was restitution as stated above payments for restitution are deductible under sec_165 therefore taxpayer a may deduct the portions of the damage award he plr-128438-12 actually paid to the insurance_company as losses under sec_165 provided he received no contribution from any other party and included the amounts in his gross_income in prior tax years see revrul_82_74 1982_1_cb_110 conclusion we conclude that taxpayer a may deduct the payments he made to the insurance_company in the years the payments were made provided that he received or will receive no contribution from any other party and included the amounts he paid in his gross_income in prior tax years except as expressly provided herein no opinion is expressed or implied concerning the federal_income_tax consequences of any aspect of any transaction or item discussed or referenced in this ruling this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative a copy of this letter must be attached to any income_tax return to which it is relevant alternatively taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter_ruling the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely christopher f kane chief branch income_tax accounting cc


office_of_chief_counsel internal_revenue_service memorandum number release date cc ita b05 preno-109073-07 uilc date date to associate area_counsel sbse attn susan s canavello managing counsel occ new orleans la from william a jackson chief branch income_tax accounting subject destruction of principal_residence for purposes of sec_121 this chief_counsel_advice responds to your request for assistance this advice may not be used or cited as precedent legend taxpayer ----------------- issue absent an actual sale_or_exchange of the property has the damage to taxpayer’s principal_residence under the facts described below resulted in its destruction within the meaning of sec_121 of the code which is treated as a sale of the property for purposes of sec_121 conclusion for purposes of sec_121 of the code whether the destruction of a taxpayer’s principal_residence has occurred is a question of fact based on the facts of this case the level of damage to taxpayer’s principal_residence results in its destruction for purposes of preno-109073-07 sec_121 and thus the property may be treated as sold for purposes of sec_121 facts taxpayer’s property was substantially damaged as a result of a natural disaster the property was damaged to such an extent that it must practicably be rebuilt although components of the residential structure remain standing subsequently enacted land use regulations essentially require deconstruction followed by elevation total first floor and roof and near total second floor reconstruction at an expense exceeding the fair_market_value of the entire property prior to the disaster the fair_market_value of the property prior to the damage in question is estimated at dollar_figure the fair_market_value after the disaster is estimated at dollar_figure taxpayer’s adjusted tax basis in the property is dollar_figure and the costs of repair are estimated at dollar_figure taxpayer received dollar_figure in insurance and other proceeds and will receive dollar_figure in excludible sec_139 hazard mitigation payments taxpayer meets the ownership and use requirements of sec_121 of the code and is aware that the recognition of gain may be deferred under the provisions of sec_1033 and sec_1033 however taxpayer has inquired whether he may treat the involuntary_conversion as itself a ‘sale’ under sec_121 law and analysis sec_61 of the internal_revenue_code provides generally that except as otherwise provided by law gross_income includes all income from whatever source derived including gain derived from dealings in property see sec_61 the concept of gross_income encompasses accessions to wealth clearly realized over which taxpayers have complete dominion 348_us_426 1955_1_cb_207 gross_income does not however include receipts of all kinds for example recoveries of capital or basis or amounts representing compensation_for damages of property are not accessions to wealth unless they exceed basis sec_1016 of the code provides that proper adjustment shall be made to the basis_of_property for expenditures receipts losses or other items properly chargeable to capital_account sec_1001 provides that the gain from the sale_or_other_disposition of property is the excess of the amount_realized over the adjusted_basis provided in sec_1011 for determining gain sec_1011 provides generally that the adjusted_basis for determining gain from the sale_or_other_disposition of property is the basis determined under sec_1012 cost adjusted as provided in sec_1016 under sec_1016 basis is adjusted by expenditures receipts losses and other items properly chargeable to capital_account under sec_1001 the entire amount of gain must be recognized except as otherwise provided preno-109073-07 sec_1033 of the code provides in part that if property as a result of its destruction in whole or in part emphasis added theft seizure or requisition or condemnation or threat or imminence thereof is compulsorily or involuntarily converted into money and during the period specified in sec_1033 the taxpayer purchases property similar_or_related_in_service_or_use to the converted property at the election of the taxpayer gain will be recognized only to the extent that the amount_realized upon the conversion exceeds the cost of the replacement_property sec_121 provides that a taxpayer may exclude gain from the sale_or_exchange of property if during the 5-year period ending on the date of the sale_or_exchange the taxpayer has owned and used the property as the taxpayer’s principal_residence for periods aggregating years or more under sec_121 of the code the amount of gain excludable under sec_121 is limited to dollar_figure for single taxpayers and dollar_figure for married taxpayers filing a joint_return sec_121 permits pro-ratable exclusions in the case of certain_sales or exchanges occurring by reason of unforeseen circumstances eg involuntary_conversions under sec_121 involuntary_conversions the destruction emphasis added seizure or condemnation of property is treated as a sale of the property for purposes of sec_121 sec_121 provides that in applying sec_1033 the amount_realized from the sale_or_exchange of property shall be treated as being the amount determined without regard to sec_121 reduced by the amount of gain not included in gross_income pursuant to sec_121 under sec_121 the destruction of property is treated as the sale of the property for purposes of sec_121 the statute and legislative_history are silent regarding the legislative intent behind the term destruction as used in sec_121 further we have found no case law defining the term for purposes of sec_121 moreover the term destruction is not specifically defined for other purposes in the code absent subtitle e alcohol tobacco and certain other excise_taxes the word destruction is only used in the code where a section may expressly apply to either partial or total destruction for example many sections of the code use the phrase destruction in whole or in part such as sec_143 mortgage revenue bonds a d unrelated_business_taxable_income for exempt_organizations involuntary_conversions long-term_capital_gain includes involuntary_conversions of property used in a trade_or_business this suggests that the term destruction may encompass both partial and complete destruction when specified however the lack of this common phrase in sec_121 may indicate that congress specifically intended the deemed sale rule_of sec_121 to apply only to a complete destruction emphasis added other code sections use the phrase destruction or damage such as sec_451 destruction of crops and 1400l tax_credit for new_york_liberty_zone this suggests that the term destruction is distinguishable from damage and does not encompass partial destruction preno-109073-07 because sec_121 does not expressly apply to a partial destruction we read sec_121 to apply solely to a complete destruction eg in whole of the residence there is no definition of complete destruction in the internal_revenue_code therefore other sources must be referred to in determining the meaning of this term in construing a statute courts generally seek the plain and literal meaning of its language 471_us_84 more specifically words in a revenue act generally are interpreted in their 'ordinary everyday senses ' 506_us_168 quoting 383_us_569 quoting 331_us_1 see also 311_us_112 common understanding and experience are the touchstones for the interpretation of revenue laws the meaning of the term destruction is to ruin the structure or to put out of existence merrian-webster online dictionary http www m- w com dictionary destruction last visited date see james a ballentine ballentine’s law dictionary 3rd edition defining destruction as a wrecking tearing down breaking up or burning up cf c g willis inc v 41_tc_468 stating that involuntary_conversion within the meaning of sec_1033 means that the taxpayer’s property through some outside force or agency beyond his control is no longer useful or available to him for his purposes revrul_80_175 1980_2_cb_230 118_tc_126 the use of the term destruction in the above sources suggests that in the case of a residence complete destruction occurs when the residence is damaged to the extent that the remaining structure cannot be utilized to advantage in restoring the property to its prior condition thus one factor to consider in determining if a complete destruction of a taxpayer’s principal_residence has occurred is whether based on this plain and literal meaning of the term destruction the residence is damaged to the extent that the remaining structure cannot be utilized to advantage in restoring the property to its prior condition another factor to consider in determining complete destruction of property is whether the cost of repair substantially exceeds the fair_market_value of the property prior to its damage in such a case it may not be economically feasible to repair property that has already sustained partial destruction the lack of economic feasibility of repairing damaged property is a factor suggesting complete destruction of the property although we have found no legal authorities under sec_121 that consider the economic feasibility of repair in determining the destruction of property it is helpful to consider authorities regarding involuntary_conversions under sec_1033 in revrul_80_175 1980_2_cb_230 taxpayers sold timber that had been damaged as a result of a hurricane the ruling holds that gain from the sale of the damaged timber was eligible for nonrecognition under sec_1033 the rationale in the ruling for including the downed timber as property that was involuntarily converted was that the sale of the downed timber was dictated by the damage caused by the hurricane the downed timber was not preno-109073-07 repairable and was generally no longer useful to the taxpayer in the context of its original objective the ruling distinguished this situation from the case in c g willis inc v 41_tc_468 where the court considered application of sec_1033 of the code to the proceeds of the sale of a partially damaged ship which along with insurance proceeds was reinvested by the taxpayer in property similar_or_related_in_service_or_use the court in that case denied the claim for nonrecognition treatment because since the ship was repairable i t cannot be said that the sale of the unrepaired ship was a result of its partial destruction t c pincite thus in the context of sec_1033 the lack of economic feasibility of repair can result in the sale of partially damaged property being treated as part of the involuntary_conversion of the property similarly it would seem reasonable to consider economic feasibility of repair of a damaged principal_residence in determining whether the damage amounts to a complete destruction for purposes of sec_121 whether damage to a taxpayer’s principal_residence is sufficient to result in its destruction for purposes of sec_121 is a factual determination in this particular case there are sufficient facts and circumstances to conclude that taxpayer’s property was destroyed in whole as a result of the disaster it is not required under the above rationale that the taxpayer’s principal_residence be completely destroyed by or at the time of the catastrophic event only that its complete destruction be caused by such event a residential structure that must be essentially deconstructed prior to reconstruction has been destroyed for purposes of sec_121 from the information presented it appears that taxpayer’s principal_residence was damaged to such an extent that the remaining structure cannot be utilized to meaningful advantage in restoring the property to its prior condition the fact that taxpayer will nonetheless choose to reconstruct his principal_residence at the same location does not vitiate this conclusion further the cost of repairing the taxpayer’s residence in this case substantially exceeds the fair_market_value of the residence prior to the catastrophic event thus making repair economically unfeasible the law does not require taxpayers to make uneconomic choices assuming no additional basis adjustments or casualty_loss considerations taxpayer’s gain on the transaction deemed sale is dollar_figure dollar_figure - dollar_figure dollar_figure since this amount is less than dollar_figure all gain may be excluded from such deemed ‘sale’ under sec_121 sec_121 provides that in applying sec_1033 the amount_realized from the sale_or_exchange of property shall be treated as being the amount determined without regard to sec_121 dollar_figure reduced by the amount of gain not included in gross_income pursuant to sec_121 dollar_figure or dollar_figure which is taxpayer’s basis in the property accordingly for purposes of sec_1033 were it to be applicable_taxpayer has no gain to defer this writing may contain privileged information any unauthorized disclosure of this writing may undermine our ability to protect the privileged information if disclosure is determined to be necessary please contact this office for our views preno-109073-07 thank you for soliciting our views in this matter if you have any questions concerning this memorandum please contact us at --------------------------- ------------------------------------ --------------------------------------------------------- --------------------------------------