Tim L. Gerhardt & Pamela J. Holck Gerhardt ( 2023 )

United States Tax Court
160 T.C. No. 9GLADYS L. GERHARDT, ET AL., 1
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket Nos. 11127-20, 11128-20, Filed April 20, 2023.
11129-20, 11146-20.
—————
Ps contributed high-value, low-basis real estate and
other property to charitable remainder annuity trusts
(CRATs). The CRATs sold the contributed property and
purchased five-year single premium immediate annuities
(SPIAs) with most of the proceeds, naming Ps as recipients
of the annuity payments. On their 2016 and 2017 tax
returns, Ps took the position that the payments they
received from the CRAT-funded SPIAs were not subject to
tax, with the exception of small amounts Ps reported as
interest. R examined Ps’ tax returns and determined
deficiencies, taking the position that, under I.R.C. §§ 664
and 1245, the annuity payments Ps received were
distributions from the CRATs and taxable to them as
ordinary income.
Two Ps, J and S, separately relinquished rental
property and cash in exchange for other rental property in
2017. On their tax return for 2017, J and S took the
position that gain from the disposition of the relinquished
1 Cases of the following petitioners are consolidated herewith: Alan A.
Gerhardt and Audrey M. Gerhardt, Docket No. 11128-20; Jack R. Gerhardt and
Shelley R. Gerhardt, Docket No. 11129-20; and Tim L. Gerhardt and Pamela J. Holck
Gerhardt, Docket No. 11146-20.
Served 04/20/23
2
property should be deferred because the transaction
qualified as a like-kind exchange under I.R.C. § 1031. R did
not dispute that the transaction met the requirements of
I.R.C. § 1031, but determined that I.R.C. § 1245 precluded
deferral of the gain.
J and S also sold certain property (MS) in 2017.
They reported the net gain from the sale as ordinary
income. R recomputed the amount of the gain and
characterized it as long-term capital gain.
For T and P, two other Ps, R determined an
accuracy-related penalty under I.R.C. § 6662(a) for 2016.
T and P claim the penalty should not apply because they
acted with reasonable cause and in good faith reliance on
their advisers.
Held: The annuity payments Ps received from the
CRAT-funded SPIAs in 2016 and 2017 were distributions
from the CRATs and taxable to them as ordinary income
under I.R.C. § 664.
Held, further, Ps have not met their burden of
showing that R erred in characterizing the payments as
ordinary income on the basis of I.R.C. §§ 664(b) and 1245.
Held, further, Ps’ contrary arguments find no
support in the Code, regulations, or caselaw.
Held, further, J and S have not met their burden of
showing that R erred in determining that I.R.C. § 1245
precluded deferral of the gain realized from the disposition
of the relinquished property.
Held, further, J and S offer no argument as to R’s
determinations concerning the sale of MS and have
forfeited any objections on this point, so R’s determinations
with respect to the sale of MS stand.
Held, further, T and P have not met their burden of
showing that they acted with reasonable cause and in good
faith reliance on their advisers.
—————
3
Anita L. Steburg, for petitioners.
Stephen A. Haller, for respondent.
OPINION
TORO, Judge: In these consolidated cases, petitioners
(collectively, Gerhardts) contributed high-value, low-basis properties to
charitable remainder annuity trusts (CRATs). The CRATs promptly
sold the properties, purchased immediate annuities with most of the
proceeds, and designated the Gerhardts as the recipients of the
payments under the annuity contracts. In 2016 and 2017, the Gerhardts
received payments from the CRAT-funded annuity contracts. The
principal issue before us (which affects all petitioners) is whether those
annuity payments are taxable to the Gerhardts. We conclude they are.
The Gerhardts maintain, essentially, that selling the high-value,
low-basis properties through the CRATs and having the CRATs buy
immediate annuities for their benefit allowed them to have most of the
sale proceeds returned to them tax free over time. That view finds no
support in the law governing CRATs or elsewhere. Rejecting the
Gerhardts’ “too good to be true” arguments and consistent with our
holding in Furrer v. Commissioner, T.C. Memo. 2022-100, we conclude
that the annuity payments they received in 2016 and 2017 are
distributions from the CRATs and taxable to them as ordinary income
under section 664. 2
Also before us are three additional issues each affecting only some
petitioners: (1) whether Jack and Shelley Gerhardt should have
recognized ordinary income under section 1245 when they disposed of
depreciated property as part of a section 1031 like-kind exchange,
(2) whether Jack and Shelley Gerhardt’s gain from the sale of
depreciated property is long-term capital gain, and (3) whether Tim and
2 Unless otherwise indicated, all statutory references are to the Internal
Revenue Code, Title 26 U.S.C. (Code), in effect at all relevant times, all regulation
references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all
relevant times, and all Rule references are to the Tax Court Rules of Practice and
Procedure. We round all monetary amounts to the nearest dollar.
4
Pamela Gerhardt are liable for an accuracy-related penalty under
section 6662(a). We find for the Commissioner on each issue. 3
I. Docket Nos. 11127-20, 11128-20, 11129-20, 11146-20 (CRAT
Issue) 4
Background
A. The Gerhardts’ CRATs
The Gerhardts apparently learned about using CRATs as a
wealth-preservation strategy from John Eickhoff of Hoffman Associates,
LLC, in 2015. Mr. Eickoff referred the Gerhardts to Aric Schreiner of
Columbia CPA Group, LLC, for tax advice. In 2015, Mr. Schreiner
presented the Gerhardts with a “CRAT strategy.” The record does not
disclose the substance of Mr. Schreiner’s presentation, but soon after
that presentation, the Gerhardts formed CRATs with Mr. Schreiner’s
involvement. 5
Although they are broadly similar, we describe the facts for each
petitioner below. For clarity, we refer to individual petitioners by their
first names.
3The parties have filed Stipulations of Settled Issues in each case making
concessions with respect to other issues, which we do not discuss further in this
Opinion.
4 For ease of analysis and readability, our Opinion proceeds in four parts.
Part I addresses the issue common to each of the consolidated cases. Part II addresses
two issues related to Docket No. 11129-20. Part III addresses an issue related to
Docket No. 11146-20. Part IV sets out our conclusion. Within each Part (other than
Part IV), we first provide the relevant factual background and then discuss the
applicable legal rules.
The parties submitted these cases fully stipulated under Rule 122. The facts
set out in the background sections below are based on the pleadings and the parties’
Stipulations of Facts as amended once, including the Exhibits attached thereto. The
Stipulations of Facts (as amended) with accompanying Exhibits are incorporated
herein by this reference.
Gladys, Alan, Audrey, Jack, and Shelley Gerhardt were residents of Minnesota
when they timely filed their Petitions in these cases. Tim and Pamela Gerhardt were
residents of Illinois.
5 We note only for context that both Mr. Eickoff and Mr. Schreiner also were
involved in the formation of the CRATs in Furrer. See Stipulation of Facts ¶¶ 9(a),
10(a), 13(a), 14(a), 15(a), 16(a), 17(a), 18(a), 19(a), 22–25, Furrer v. Commissioner, T.C.
Memo. 2022-100 (No. 7633-19).
5
B. Gladys Gerhardt 6
The Albert and Gladys CRAT was created on November 2, 2015.
Albert and Gladys were the CRAT’s grantors and noncharitable
beneficiaries. The CRAT instrument listed five organizations as
charitable remaindermen. Gray, Lawrence & Jenkins, LLC, was the
CRAT’s trustee.
Relevant here, the CRAT instrument required the trustee to pay
to the beneficiaries for a five-year period an “Annuity Amount” “equal to
the greater of: (1) ten percent of the initial net fair market value of all
property transferred to [the CRAT] . . . or (2) the payments received . . .
from one . . . or more Single Premium Immediate Annuities [(SPIAs)]
purchased by the Trustee.” Stipulation of Facts Ex. 13–J, at 23.
The CRAT instrument listed Albert and Gladys Gerhardt as the
beneficiaries of the Annuity Amount. But the CRAT instrument also
provided that “[n]either the Recipients nor the Recipients’ Children
shall have any right title, interest, or incident of ownership in or to any
[SPIA] transferred to or purchased by the Trustee.” Id. at 22. The CRAT
instrument defined the term “Recipients” as those “entitled to receive
the current annuity payment” and identified Albert and Gladys as the
Recipients. Id. at 15.
Albert and Gladys contributed real estate to the Albert and
Gladys CRAT on November 10, 2015. The Albert and Gladys CRAT filed
Form 5227, Split-Interest Trust Information Return, for the 2015 tax
year reporting the total fair market value of the contributed properties
as $1,808,000. With Mr. Schreiner’s assistance, Gladys filed Form 709,
United States Gift (and Generation-Skipping Transfer) Tax Return,
with her and Albert’s 2015 income tax return, reporting total adjusted
basis of $97,517 in the contributed properties. In December 2015 and
March 2016, the trustee of the Albert and Gladys CRAT sold the
properties for at least $1,658,000. 7
6Gladys engaged in the transactions described here and filed joint federal
income tax returns with her husband, Albert, who is now deceased.
7 The parties’ stipulations regarding the total sales price are inconsistent. One
stipulation reflects total proceeds of $1,808,000, First Am. First Stipulation of Facts
¶ 32(e); another lists total proceeds of $1,658,000, id. ¶ 41. The discrepancy of
$150,000 appears to be attributable to the fact that the Albert and Gladys CRAT owned
only 50% of one of the properties it sold and thus received only 50% of the proceeds for
that property. The discrepancy does not affect the result for the years before us.
6
Using the proceeds from the sales, the Albert and Gladys CRAT
purchased a SPIA from Symetra Life Insurance Co. (Symetra) for
$1,537,822 on March 7, 2016. The SPIA contract identified the Albert
and Gladys CRAT as the “Owner” of the SPIA, but listed Albert as the
annuitant and Gladys as the joint annuitant. 8 Under the SPIA contract,
Symetra was required to pay an annuity of $311,708 to Albert and
Gladys beginning on April 6, 2016, and on each April 6 thereafter until
five total payments were made.
Albert and Gladys received an annuity payment of $311,708
($155,854 each) in each of 2016 and 2017. For 2016 and 2017, the Albert
and Gladys CRAT reported these annuity payments as CRAT
distributions to Albert and Gladys on Form 5227:
Recipient Distributions 2016 2017
Ordinary Income $2,026 $2,026
Albert Gerhardt
Corpus 153,828 153,828
Ordinary Income 2,026 2,026
Gladys Gerhardt
Corpus 153,828 153,828
The Albert and Gladys CRAT issued Schedules K–1 (Form 1041),
Beneficiary’s Share of Income, Deductions, Credits, etc., to both Albert
and Gladys for 2016 and 2017. For each year, the Schedules K–1
reported interest income of $2,026 paid to each of Albert and Gladys.
The Schedules K–1 reported no other income.
Albert and Gladys jointly filed their federal income tax returns
for the 2016 and 2017 tax years. Damon T. Eisma of Eisma & Eisma
Attorneys at Law prepared the returns. On these returns, Albert and
Gladys reported the interest income reported to them by the Albert and
Gladys CRAT. They did not report the remaining payments from the
CRAT-funded annuity on either the 2016 or the 2017 tax return.
On Forms 5227, the Albert and Gladys CRAT reported its assets
at the end of 2015 to 2017 as follows:
8 The SPIA contract defined the term “Annuitant” in relevant part as “the
natural person intended to receive payments under this Contract.” The SPIA contract
also provided that “[t]here may be a joint Annuitant.” Stipulation of Facts Ex. 38–J,
at 3.
7
2015 2016 2017
Trust Principal or
$1,774,271 $1,410,953 $1,103,298
Corpus
Undistributed
– – –
Income
Undistributed
– – –
Capital Gains
Undistributed
Nontaxable – – –
Income
The Commissioner examined Albert and Gladys’s 2016 and 2017
tax returns as well as the Albert and Gladys CRAT trust accounting and
reporting for those years. During the examination, the Commissioner
determined that the Albert and Gladys CRAT trust accounting was
inaccurate and adjusted it in relevant part as follows:
8
CRAT Trust Accounting According to IRS Examination
2015 2016 2017
Prior Year Accumulated Ordinary
-0- -0- $1,159,807
Income
Ordinary Income: Interest Income -0- $4,052 4,052
Capital Gain or Loss: Form 4797 -0- 9 1,467,462 10 -0-
Current Net Ordinary Income Before
-0- 1,471,514 11 4,052
Distributions
Total Distributable Income
-0- 1,471,514 1,163,859
(Cumulative)
Distributions to Noncharitable
-0- 311,707 311,707
Beneficiaries
Undistributed Ordinary Income -0- 1,159,807 852,152
The Commissioner also determined that the income the Albert
and Gladys CRAT realized on sales of the contributed properties was
ordinary income under section 1245. Thus, according to the
Commissioner, all the payments Albert and Gladys received in 2016 and
2017 from the CRAT-funded annuity were ordinary income to them
under section 664(b).
The Commissioner issued Albert and Gladys a notice of deficiency
for 2016 and 2017. Among other items not relevant here, the
Commissioner increased Albert and Gladys’s gross income by $307,656
for each of 2016 and 2017 to reflect the adjustments to their ordinary
income from the CRAT-funded annuity payments.
9 The record reflects that the Albert and Gladys CRAT sold some of the
contributed property in 2015 rather than 2016. So, it would appear that some of the
gain and income included in the chart for 2016 should have been included for 2015
instead. But, because the CRAT made no distributions in 2015, this possible error does
not affect its total distributable income (cumulative) for 2016 and 2017.
10 The parties stipulate that the Commissioner determined that the Albert and
Gladys CRAT sold the real estate contributed by Albert and Gladys for $1,658,000 and
that it had a cumulative adjusted basis in the properties of $190,538. See supra note 7.
In view of these amounts, the Albert and Gladys CRAT realized gain of $1,467,462
from the sale of the real estate. Relying on section 1245, the Commissioner further
determined that the gain should be treated as ordinary income.
11 The “Current Net Ordinary Income Before Distributions” amount consists of
interest income of $4,052 and capital gain treated as ordinary income under
section 1245 of $1,467,462.
9
C. Alan and Audrey Gerhardt
The Alan and Audrey CRAT was created on November 10, 2015.
Alan and Audrey were the CRAT’s grantors and noncharitable
beneficiaries. The CRAT instrument listed one organization as a
charitable remainderman. Gray, Lawrence & Jenkins, LLC, was the
CRAT’s trustee.
The terms of the Alan and Audrey CRAT instrument are similar
to those discussed in the previous section, see Part I.B above, so we will
not repeat them here. 12 The CRAT instrument identified Alan and
Audrey as the beneficiaries and recipients of the Annuity Amount
required to be paid out by the trustee.
Alan and Audrey contributed real estate to the Alan and Audrey
CRAT on November 10, 2015. The Alan and Audrey CRAT filed
Form 5227 for the 2015 tax year reporting the total fair market value of
the contributed properties as $1,222,000. With Mr. Schreiner’s
assistance, Alan and Audrey filed Forms 709 with their 2015 income tax
return, each reporting total adjusted basis of $42,079 in the contributed
properties. In March 2016, the CRAT’s trustee sold the properties for
$1,222,000.
Using the proceeds from the sale of the properties, the Alan and
Audrey CRAT purchased a SPIA from Symetra for $1,022,618 on
March 22, 2016. The SPIA contract identified the Alan and Audrey
CRAT as the “Owner” of the SPIA, but listed Alan as the annuitant and
Audrey as the joint annuitant. 13 Under the SPIA contract, Symetra was
required to pay an annuity of $207,232 to Alan and Audrey beginning
on April 6, 2016, and on each April 6 thereafter until five total payments
were made.
Alan and Audrey received an annuity payment of $207,232
($103,616 each) in each of 2016 and 2017. For 2016 and 2017, the Alan
and Audrey CRAT reported these annuity payments as CRAT
distributions to Alan and Audrey on Form 5227:
12 The same applies to the CRAT instruments for the remaining CRATs.
13 The SPIA contract defined the term “annuitant” in the same way as the
Albert and Gladys CRAT SPIA contract and also provided for the possibility of a joint
annuitant. See supra note 8.
10
Recipient Distributions 2016 2017
Ordinary Income $1,347 $1,347
Alan Gerhardt
Corpus 102,269 102,269
Ordinary Income 1,347 1,347
Audrey Gerhardt
Corpus 102,269 102,269
The Alan and Audrey CRAT issued Schedules K–1 to both Alan
and Audrey for 2016 and 2017. For each year, the Schedules K–1
reported interest income of $1,347 paid to each of Alan and Audrey. The
Schedules K–1 reported no other income.
Alan and Audrey jointly filed their federal income tax returns for
the 2016 and 2017 tax years. Damon T. Eisma of Eisma & Eisma
Attorneys at Law prepared the returns. On these returns, Alan and
Audrey reported the interest income reported to them by the Alan and
Audrey CRAT. They did not report the remaining payments from the
CRAT-funded annuity on either the 2016 or the 2017 tax return.
On Forms 5227, the Alan and Audrey CRAT reported its assets
at the end of 2015 to 2017 as follows:
2015 2016 2017
Trust Principal or
$1,200,685 $818,080 $613,542
Corpus
Undistributed
– – –
Income
Undistributed
– – –
Capital Gains
Undistributed
– – –
Nontaxable Income
The Commissioner examined Alan and Audrey’s 2016 and 2017
tax returns as well as the Alan and Audrey CRAT trust accounting and
reporting for those years. During the examination, the Commissioner
determined that the Alan and Audrey CRAT trust accounting was
inaccurate and adjusted it in relevant part as follows:
11
CRAT Trust Accounting According to IRS Examination
2015 2016 2017
Prior Year Accumulated Ordinary -0- -0- $904,201
Income
Ordinary Income: Interest Income -0- $2,694 2,694
Capital Gain or Loss: Form 4797 -0- 1,108,739 14 -0-
Current Net Ordinary Income Before -0- 1,111,433 15 2,694
Distributions
Total Distributable Income -0- 1,111,433 906,895
(Cumulative)
Distributions to Noncharitable -0- 207,232 207,232
Beneficiaries
Undistributed Ordinary Income -0- 904,201 699,663
The Commissioner also determined that the income the Alan and
Audrey CRAT realized on sale of the contributed properties was
ordinary income under section 1245. Thus, according to the
Commissioner, all the payments Alan and Audrey received in 2016 and
2017 from the CRAT-funded annuity were ordinary income to them.
The Commissioner issued Alan and Audrey a notice of deficiency
for 2016 and 2017. Among other items not relevant here, the
Commissioner increased Alan and Audrey’s gross income by $204,538
for each of 2016 and 2017 to reflect the adjustments to their ordinary
income from the CRAT-funded annuity payments.
D. Jack and Shelley Gerhardt
Jack and Shelley created two CRATs, Jack and Shelley CRAT I
and Jack and Shelley CRAT II, on November 10, 2015, and February 17,
2016, respectively. Jack and Shelley were the grantors and
noncharitable beneficiaries of the CRATs. The CRAT instruments also
14 The parties stipulate that the Commissioner determined that the Alan and
Audrey CRAT sold the properties contributed by Alan and Audrey for $1,222,000 and
that it had a cumulative basis in the properties of $113,261. In view of these amounts,
the Alan and Audrey CRAT realized income of $1,108,739 from the sale of the
properties.
15 The “Current Net Ordinary Income Before Distributions” amount consists of
interest income of $2,694 and capital gain treated as ordinary income under
section 1245 of $1,108,739.
12
listed Jack and Shelley as the beneficiaries and recipients of the Annuity
Amount required to be paid by trustee. The Jack and Shelley CRAT I
instrument listed two organizations as charitable remaindermen, and
the Jack and Shelley CRAT II instrument listed four organizations as
charitable remaindermen. Gray, Lawrence & Jenkins, LLC, was the
trustee of both CRATs.
Jack and Shelley contributed real estate to Jack and Shelley
CRAT I in November 2015 and to Jack and Shelley CRAT II in May
2016. Each CRAT filed Form 5227 in the year of its creation, reporting
the fair market values of the contributed properties at the time of
contribution. Jack and Shelley CRAT I reported the total fair market
value of the contributed properties it held as $1,530,000. Jack and
Shelley CRAT II reported the fair market value of the contributed
property it held as $440,550. With Mr. Schreiner’s assistance, Jack and
Shelley each filed Forms 709 with their 2015 and 2016 income tax
returns reporting their contributions to Jack and Shelly CRAT I and
Jack and Shelley CRAT II. Jack and Shelley each reported total
adjusted basis of $62,548 in the properties contributed to Jack and
Shelly CRAT I and adjusted basis of $72,359 in the property contributed
to Jack and Shelley CRAT II.
In March 2016, Jack and Shelley CRAT I sold the contributed
properties it held for $1,455,000. Later in 2016, Jack and Shelley
CRAT II sold the contributed property it held for $440,550.
Both CRATs used proceeds from the sales of the contributed
properties to purchase SPIAs from Symetra. Jack and Shelly CRAT I
purchased a SPIA for $1,287,283. The SPIA contract identified the
CRAT as “Owner” of the SPIA, but listed Jack as the annuitant and
Shelley as the joint annuitant. See supra note 13. Under the SPIA
contract, Symetra was required to pay an annuity to Jack and Shelley
of $260,902, beginning on April 6, 2016, and each April 6 thereafter until
five payments were made.
Jack and Shelley CRAT II purchased a SPIA for $367,302. The
complete SPIA contract is not in the record, but the parties stipulated
that Jack was listed as the annuitant of the SPIA, and Shelley was the
joint annuitant. Under the SPIA contract, Symetra was required to pay
13
an annuity to Jack and Shelley of $73,678, beginning in July 2016 and
each July 16 thereafter until five payments were made.
Jack and Shelley received an annuity payment of $260,902
($130,451 each) from the SPIA purchased by Jack and Shelley CRAT I
and an annuity payment of $73,678 ($36,839 each) from the SPIA
purchased by Jack and Shelley CRAT II in 2016 and 2017. For each
year, Jack and Shelley CRAT I reported the annuity payments as CRAT
distributions to Jack and Shelley on Form 5227:
Recipient Distributions 2016 2017
Ordinary Income $1,696 $1,696
Jack Gerhardt
Corpus 128,755 128,755
Ordinary Income 1,696 1,696
Shelley Gerhardt
Corpus 128,755 128,755
Similarly, Jack and Shelley CRAT II filed Forms 5227 with the
Commissioner reporting the annuity payments as CRAT distributions
to Jack and Shelley as follows:
Recipient Distributions 2016 2017
Ordinary Income $111 $111
Jack Gerhardt
Corpus 36,729 36,729
Ordinary Income 110 110
Shelley Gerhardt
Corpus 36,728 36,728
In addition to filing the Forms 5227, each CRAT issued to Jack
and Shelley Schedules K–1 for 2016 and 2017. The Schedules K–1
reported total interest income paid to Jack and Shelley equal to the total
interest income listed on the Forms 5227. The Schedules K–1 reported
no other income to Jack and Shelley.
16 The parties have stipulated that the annuity payments were to begin in June
2016 and continue in June of each following year until five payments were made. Our
review of the record shows that the SPIA contract for Jack and Shelley CRAT II
required Symetra to make the payments beginning in July 2016 and in July of each
following year until five payments were made, and we so find. See Cal-Maine Foods,
Inc. v. Commissioner, 93 T.C. 181, 195 (1989) (holding that we are not obliged to accept
a stipulation between the parties when it is clearly contrary to facts disclosed by the
record).
14
Jack and Shelley jointly filed federal income tax returns for the
2016 and 2017 tax years. Damon T. Eisma of Eisma & Eisma Attorneys
at Law prepared the returns. On these returns, Jack and Shelley
reported the interest income reported to them by the CRATs on the
Schedules K–1. They did not report the remaining payments from the
CRAT-funded annuities on the 2016 or the 2017 return.
On Forms 5227, Jack and Shelley CRAT I reported its assets at
the end of 2015 to 2017 as follows:
2015 2016 2017
Trust Principal or
$1,530,000 $1,182,759 $925,248
Corpus
Undistributed
– – –
Income
Undistributed
– – –
Capital Gains
Undistributed
– – –
Nontaxable Income
On Forms 5227, Jack and Shelley CRAT II reported its assets at
the end of 2016 and 2017 as follows:
2016 2017
Trust Principal or Corpus $298,938 $220,388
Undistributed Income – –
Undistributed Capital – –
Gains
Undistributed Nontaxable – –
Income
The Commissioner examined Jack and Shelley’s 2016 and 2017
tax returns as well as the CRATs’ trust accounting and reporting for
those years. During the examination, the Commissioner determined
that the Jack and Shelley CRAT I trust accounting was inaccurate and
adjusted it as follows:
15
CRAT Trust Accounting According to IRS Examination
2015 2016 2017
Prior Year Accumulated Ordinary
-0- -0- $1,052,385
Income
Ordinary Income: Interest Income -0- $3,392 3,392
Capital Gain or Loss: Form 4797 -0- 1,309,085 17 -0-
Current Net Ordinary Income Before
-0- 1,312,477 18 3,392
Distributions
Total Distributable Income
-0- 1,312,477 1,055,777
(Cumulative)
Distributions to Noncharitable
-0- 260,902 260,092
Beneficiaries
Undistributed Ordinary Income -0- 1,052,385 795,685
The Commissioner also adjusted the Jack and Shelley CRAT II
accounting as follows:
17 The parties stipulate that the Commissioner determined that Jack and
Shelley CRAT I sold the properties contributed by Jack and Shelley for $1,455,000 and
that it had a cumulative basis in the properties of $145,915. In view of these amounts,
Jack and Shelley CRAT I realized income of $1,309,085 from the sale of the properties.
18 The “Current Net Ordinary Income Before Distributions” amount consists of
interest income of $3,392 and capital gain treated as ordinary income under
section 1245 of $1,309,085.
16
CRAT Trust Accounting According to IRS Examination
2016 2017
Prior Year Accumulated Ordinary Income -0- $366,872
Ordinary Income: Interest Income -0- 19 -0-
Capital Gain or Loss: Form 4797 $440,550 20 -0-
Current Net Ordinary Income Before
440,550 21 -0-
Distributions
Total Distributable Income (Cumulative) 440,550 366,872
Distributions to Noncharitable
73,678 73,678
Beneficiaries
Undistributed Ordinary Income 366,872 293,194
The Commissioner also determined that the income Jack and
Shelley CRAT I and Jack and Shelley CRAT II realized on sales of the
contributed properties was ordinary income under section 1245. Thus,
according to the Commissioner, all the payments Jack and Shelley
received in 2016 and 2017 from the CRAT-funded annuities were
ordinary income to them.
The Commissioner issued Jack and Shelley a notice of deficiency
for 2016 and 2017. Among other items, the Commissioner increased
Jack and Shelley’s gross income by $330,967 for each of 2016 and 2017
to reflect the adjustments to their ordinary income from the CRAT-
funded annuity payments.
E. Tim and Pamela Gerhardt
Tim and Pamela Gerhardt created two CRATs, Tim and Pamela
CRAT I and Tim and Pamela CRAT II, on November 10, 2015, and
19 We do not readily see why the Commissioner’s trust accounting omits
interest income of $221 reported by Jack and Shelley CRAT II on its Forms 5227 for
2016 and 2017. But this omission does not affect our analysis for the years before us.
20 The parties stipulate that the Commissioner determined that Jack and
Shelley CRAT II sold the property contributed by Jack and Shelley for $440,550 and
that it did not have any basis in the property. In view of these amounts, Jack and
Shelley CRAT II realized income of $440,550 from the sale of the property.
21 The “Current Net Ordinary Income Before Distributions” consists solely of
capital gain treated as ordinary income under section 1245 of $440,550.
17
January 21, 2016, respectively. Tim and Pamela were the grantors and
noncharitable beneficiaries of the CRATs. The CRAT instruments also
listed Tim and Pamela as the beneficiaries and recipients of Annuity
Amount required to be paid by the trustee. The Tim and Pamela CRAT I
instrument and the Tim and Pamela CRAT II instrument listed six
organizations each as charitable remaindermen. Gray, Lawrence &
Jenkins, LLC, was the trustee of both CRATs.
Tim and Pamela contributed real estate to Tim and Pamela
CRAT I in November 2015 and to Tim and Pamela CRAT II in February
2016. Each CRAT filed Form 5227 in the year of its creation, reporting
the fair market values of the contributed properties at the time of the
respective contributions. Tim and Pamela CRAT I reported the fair
market value of the contributed property it held as $310,000. Tim and
Pamela CRAT II reported the fair market value of the contributed
property it held as $549,450. With Mr. Schreiner’s assistance, Tim and
Pamela filed Forms 709 with the Commissioner reporting the
contributions to Tim and Pamela CRAT I and Tim and Pamela CRAT II.
Tim and Pamela reported no adjusted basis in the property contributed
to Tim and Pamela CRAT I. They reported an adjusted basis of $90,245
in the property contributed to Tim and Pamela CRAT II.
In December 2015, Tim and Pamela CRAT I sold the contributed
property it held for $310,000. In May 2016, Tim and Pamela CRAT II
sold the contributed property it held for $549,450.
Both CRATs used proceeds from the sales of the contributed
properties to purchase a SPIA from Symetra. Tim and Pamela CRAT I
purchased a SPIA for $252,158. The SPIA contract identified the “Tim
Leroy and Pamela Holck Gerhardt [CRAT]” as the SPIA’s “Owner.” Tim
was listed as the annuitant and Pamela as the joint annuitant. See
supra note 13. Under the SPIA contract, Symetra was required to pay
an annuity to Tim and Pamela of $50,967, beginning on March 1, 2016,
and on March 1 of each year thereafter until five payments were made.
Tim and Pamela CRAT II purchased a SPIA for $456,410. The
record does not include a copy of the SPIA contract for Tim and Pamela
CRAT II, but the parties stipulated that Tim was the annuitant and
Pamela was the joint annuitant. Under the SPIA contract, Symetra was
required to pay an annuity to Tim and Pamela of $92,204, beginning on
June 1, 2016, and on June 1 of each year thereafter until five payments
were made.
18
Tim and Pamela received an annuity payment of $50,967 from
Tim and Pamela CRAT I and an annuity payment of $92,205 22 from Tim
and Pamela CRAT II in 2016 and 2017. For each year, Tim and Pamela
CRAT I reported the annuity payments as CRAT distributions to Jack
and Shelley on Form 5227:
Recipient Distributions 2016 2017
Ordinary Income $255 $255
Tim Gerhardt
Corpus 25,229 25,229
Ordinary Income 255 255
Pamela Gerhardt
Corpus 25,228 25,228
Similarly, Tim and Pamela CRAT II reported the annuity payments as
CRAT distributions to Tim and Pamela on Form 5227:
Recipient Distributions 2016 2017
Ordinary Income $139 $139
Tim Gerhardt
Corpus 45,964 45,964
Ordinary Income 138 138
Pamela Gerhardt
Corpus 23 45,964 45,964
In addition to filing the Forms 5227, each CRAT issued to Tim
and Pamela Schedules K–1 for 2016 and 2017. The Schedules K–1
reported total interest income paid to Tim and Pamela equal to the total
interest income listed on the Forms 5227. The Schedules K–1 reported
no other income to Tim and Pamela.
Tim and Pamela jointly filed federal income tax returns for the
2016 and 2017 tax years. Anthony J. Baldassano prepared the returns.
Tim and Pamela reported the interest income reported to them by the
22The Stipulation of Facts filed by the parties is inconsistent as to the annual
amounts paid to Tim and Pamela by the Tim and Pamela CRAT I-funded annuity and
the Tim and Pamela CRAT II-funded annuity. Based on our review of the record, we
find that the correct number for the Tim and Pamela CRAT I-funded annuity is
$50,967 and the correct number for the Tim and Pamela CRAT II-funded annuity is
$92,205.
23 The parties stipulated that the corpus distributions to Pamela were reported
on Forms 5227 as $46,964 for both 2016 and 2017, due perhaps to what appears to be
a scrivener’s error in the 2016 Form 5227. Based on our review of the record, we find
the correct amount is $45,964.
19
CRATs on the Schedules K–1. They did not report the remaining
payments from the CRAT-funded annuities on the 2016 or the 2017
return.
On Forms 5227, Tim and Pamela CRAT I reported its assets at
the end of 2015 to 2017 as follows:
2015 2016 2017
Trust Principal or
$288,685 $201,728 $151,271
Corpus
Undistributed
– – –
Income
Undistributed
– – –
Capital Gains
Undistributed
– – –
Nontaxable Income
On Forms 5227, Tim and Pamela CRAT II reported its assets at
the end of 2016 and 2017 as follows:
2016 2017
Trust Principal or Corpus $372,652 $275,631
Undistributed Income – –
Undistributed Capital
– –
Gains
Undistributed Nontaxable
– –
Income
The Commissioner examined Tim and Pamela’s 2016 and 2017
tax year returns as well as the CRATs’ trust accounting and reporting
for those years. During the examination, the Commissioner determined
that the Tim and Pamela CRAT I trust accounting was inaccurate and
adjusted it as follows:
20
CRAT Trust Accounting According to IRS Examination
2015 2016 2017
Prior Year Accumulated
-0- -0- $238,228
Ordinary Income
Ordinary Income: Interest
-0- $510 510
Income
Capital Gain or Loss: Form
-0- 288,685 24 -0-
4797
Current Net Ordinary Income
-0- 289,195 25 510
Before Distributions
Total Distributable Income
-0- 289,195 238,738
(Cumulative)
Distributions to Noncharitable
-0- 50,967 50,967
Beneficiaries
Undistributed Ordinary
-0- 238,228 187,771
Income
The Commissioner also adjusted the Tim and Pamela CRAT II
accounting as follows:
24 The parties stipulate that the Commissioner determined that Tim and
Pamela CRAT I sold the property contributed by Tim and Pamela for $310,000 and
that it had a cumulative basis in the property of $21,315. In view of these amounts,
Tim and Pamela CRAT I realized income of $288,685 from the sale of the property.
25 The “Current Net Ordinary Income Before Distributions” amount consists of
interest income of $510 and capital gain treated as ordinary income under section 1245
of $288,685.
21
CRAT Trust Accounting According to IRS Examination
2016 2017
Prior Year Accumulated Ordinary
-0- $457,246
Income
Ordinary Income: Interest Income -0- -0-
Capital Gain or Loss: Form 4797 $549,450 26 -0-
Current Net Ordinary Income Before
549,450 27 -0-
Distributions
Total Distributable Income (Cumulative) 549,450 457,246
Distributions to Noncharitable
92,204 92,204
Beneficiaries 28
Undistributed Ordinary Income 457,246 365,042
The Commissioner also determined that the income Tim and
Pamela CRAT I and Tim and Pamela CRAT II realized on sales of the
contributed properties was ordinary income under section 1245. Thus,
according to the Commissioner, all the payments Tim and Pamela
received in 2016 and 2017 from the CRAT-funded annuities were
ordinary income to them.
The Commissioner issued Tim and Pamela a notice of deficiency
for 2016 and 2017. Among other items, the Commissioner increased Tim
and Pamela’s gross income by $142,385 for each of 2016 and 2017 to
reflect the adjustments to their ordinary income from the CRAT-funded
annuity payments.
26 The parties stipulate that the Commissioner determined that Tim and
Pamela CRAT II sold the property contributed by Tim and Pamela for $549,450 and
that it did not have any basis in the property. In view of these amounts, Tim and
Pamela CRAT II realized income of $549,450 from the sale of the property.
27 The “Current Net Ordinary Income Before Distributions” consists solely of
capital gain treated as ordinary income under section 1245 of $549,450.
28 As described above, we find that the amount of the annuity distributions was
actually $92,205 for each year.
22
Discussion
F. General Background
A CRAT is a type of a charitable remainder trust. I.R.C. § 664.
“[A] staple among estate planners,” a charitable remainder trust is often
a vehicle used by “individuals with substantial appreciated capital gain
property, a charitable intent, and a need for a stream of income during
their lifetimes.” Richard Fox, Charitable Giving: Taxation, Planning,
and Strategies ¶ 25.01 (2023), Westlaw WGL-CHARGIV (footnotes
omitted). “The basic concept of a [CRAT] involves a [grantor’s] transfer
of property to an irrevocable trust, the terms of which provide for the
payment of a specified amount, at least annually, to the grantor or other
designated noncharitable beneficiaries for life or another predetermined
period of time up to twenty years.” Id. (footnotes omitted); see also I.R.C.
§ 664(d). What remains in the trust after the expiration of that period
(which cannot be less than “10 percent of the initial net fair market
value of all property placed in the trust,” I.R.C. § 664(d)(1)(D)) “must be
transferred to one or more qualified charitable organizations or continue
to be held in the trust for the benefit of such organizations.” Fox, supra,
¶ 25.01. In short, unlike an immediate gift to charity, a contribution to
a CRAT “blends the philanthropic intentions of a donor with his or her
financial needs or the financial needs of others.” Id.
As a rule, the grantor recognizes no gain when transferring
appreciated property to a CRAT. See Buehner v. Commissioner, 65 T.C.
723, 740 (1976) (“A gift of appreciated property [to a CRAT] does not
result in income to the donor . . . .” (quoting Humacid Co. v.
Commissioner, 42 T.C. 894, 913 (1964))); see also Furrer, T.C. Memo.
2022-100, at *8–9 (discussing treatment of CRATs). 29 Moreover,
because CRATs are exempt from income tax, a CRAT can sell
appreciated property without itself paying tax on the sale. See I.R.C.
§ 664(c)(1); Treas. Reg. § 1.664-1(a)(1)(i); Fox, supra, ¶ 25.01.
But that does not mean that the grantor or other noncharitable
CRAT beneficiaries do not have to pay tax with respect to distributions
from the CRAT. “Although a [CRAT] is itself exempt from income tax
and, therefore, pays no tax on any of its taxable income, the annuity . . .
payments made to the noncharitable beneficiaries carry out taxable
29 In addition, the grantor may be entitled to a charitable contribution
deduction equal to the present value of the remainder interest at the time of the
transfer to the CRAT. See I.R.C. § 170(f)(2)(A); Treas. Reg. § 1.170A-6(b).
23
income that is subject to tax at the beneficiary level.” Fox, supra,
¶ 25.50 (footnote omitted); see also Alpha I, L.P. v. United States, 682
F.3d 1009, 1015 (Fed. Cir. 2012) (stating the rule and citing
section 664(b) and (c)(1)). This is so because when property is
transferred to a CRAT, the basis of the property in the CRAT’s hands
generally is the same as it would be in the hands of the grantor. See
I.R.C. § 1015(a) and (b); Treas. Reg. §§ 1.1015-1(a)(1), 1.1015-2(a)(1).
And when the CRAT sells the property, it realizes gain to the extent the
amount realized from the sale exceeds its adjusted basis. I.R.C. § 1001;
see also Treas. Reg. § 1.664-1(d)(1)(i) (discussing the assignment of
income to categories at the CRAT level). Although not taxable to the
CRAT, that gain must be tracked and affects the treatment of
distributions from the CRAT. 30 See, e.g., Treas. Reg. § 1.664-1(d)(1)(viii)
(providing examples illustrating the rules).
Congress has established specific ordering rules that govern the
characterization and reporting of annuity amounts distributed by a
CRAT to its income beneficiaries. See I.R.C. § 664(b). Under this
regime, distributions from a CRAT to income beneficiaries are deemed
to have the following character and to be distributed in the following
order:
(1) as ordinary income, to the extent of the CRAT’s current and
previously undistributed ordinary income;
(2) as capital gain, to the extent of the CRAT’s current and
previously undistributed capital gain;
(3) as other income, to the extent of the CRAT’s current and
previously undistributed other income; and
(4) as a nontaxable distribution of trust corpus.
30 The tax treatment set out in the text sometimes leads commentators
describing the benefits of a CRAT to say that “[a]ppreciated assets held by an
individual can be disposed of on a tax-free basis.” Fox, supra, ¶ 25.02. But, as we have
explained, and as the same commentators recognize, that is not quite right: “Although
assets may be sold on a tax-free basis by a [CRAT], because distributions from the trust
to noncharitable beneficiaries are subject to tax, a more accurate statement might be
that a [CRAT] defers the payment of income tax [until noncharitable beneficiaries
receive distributions from the CRAT].” Id. n.24.
24
I.R.C. § 664(b)(1)‒(4); Fox, supra, ¶ 25.50. 31
CRATs are subject to strict reporting requirements to ensure
compliance with the statutory ordering rules. See I.R.C. § 4947(a);
Treas. Reg. § 1.664-1(a)(1)(ii). A CRAT must file an annual information
return on Form 5227 reflecting its income, deductions, accumulations,
and distributions for the year. See I.R.C. § 6011(a); Treas. Reg.
§ 53.6011-1(d). And it must issue to each income beneficiary a Schedule
K–1 properly describing the tax character of all distributions. See I.R.C.
§ 6034A(a); Treas. Reg. § 1.6034-1(a).
G. Burden of Proof
The Commissioner’s determinations in a notice of deficiency are
generally presumed correct, and the taxpayer bears the burden of
proving those determinations erroneous. See Rule 142(a)(1); Welch v.
Helvering, 290 U.S. 111, 115 (1933). The parties have stipulated that
the Gerhardts received the payments from the CRAT-funded annuities
at issue, and the Gerhardts do not otherwise argue that the burden is
on the Commissioner to connect the Gerhardts with the income. See
Pittman v. Commissioner, 100 F.3d 1308, 1313 (7th Cir. 1996), aff’g T.C.
Memo. 1995-243; Page v. Commissioner, 58 F.3d 1342, 1347 (8th Cir.
1995), aff’g T.C. Memo. 1993-398; Day v. Commissioner, 975 F.2d 534,
537 (8th Cir. 1992), aff’g in part, rev’g in part on other grounds, and
remanding T.C. Memo. 1991-140. Instead, the issue before us is
whether those payments are taxable to the Gerhardts. As to the annuity
payments, the Gerhardts have not alleged, and the evidence does not
establish, that the burden of proof as to any factual issues before us has
shifted to the Commissioner under section 7491(a). Accordingly, the
burden remains with the Gerhardts to prove the Commissioner’s
determinations are erroneous.
H. Application to the Gerhardts
As we have already discussed, distributions from a CRAT
typically are taxable in the hands of noncharitable beneficiaries to the
extent of the CRAT’s income. See I.R.C. § 664(b). Each of the CRATs
here received appreciated property from the Gerhardts. The Gerhardts
did not recognize gain on the transfers to the CRATs, and the CRATs
have the same bases in the properties as the Gerhardts did before the
31 See also Miller v. Commissioner, T.C. Memo. 2009-182, 2009 WL 2432375.
25
contributions. 32 See I.R.C. § 1015(a) and (b); Veterans Found. v.
Commissioner, 38 T.C. 66, 72 (1962), aff’d, 317 F.2d 456 (10th Cir. 1963);
Treas. Reg. §§ 1.1015-1(a)(1), 1.1015-2(a)(1). 33 After receiving the
properties, the CRATs sold them and used the proceeds to purchase
SPIAs. The Gerhardts then received annual distributions from the
CRATs in the form of annuities paid by the CRAT-funded SPIAs.
The CRATs realized gains on the sales of the contributed
properties. See I.R.C. § 1001(a). Although the CRATs did not have to
pay tax on those gains because of section 664(c), under section 664(b),
the income they earned was relevant for determining the character of
the distributions the Gerhardts received. See Treas. Reg. § 1.664-
1(d)(1)(ii)(a); see also Alpha I, L.P., 682 F.3d at 1015 (“[T]he income of a
CRUT is taxable to its income beneficiaries upon distribution.”); Fox,
supra, ¶ 25.50. 34
As we have already discussed, the character of CRAT
distributions to noncharitable beneficiaries follows the character of the
income to the CRAT. See I.R.C. § 664(b). The distributions are
characterized in the following order: (1) ordinary income, (2) capital
gains, (3) other income, and (4) trust corpus. Id. Here, the
Commissioner determined that the income the CRATs earned was
ordinary income because the properties the CRATs sold were subject to
the rules of section 1245—a point not disputed by the Gerhardts. 35 On
32 The Gerhardts have made no argument that the adjusted bases in the
properties increased by reason of section 1015(d)(1) (adjustment to basis for gift tax
paid). They have therefore forfeited any argument on that front. We note further that
the record does not show that they actually paid gift tax on the contributions to the
CRATs.
The Gerhardts also concede on brief that, if they had sold the properties
instead of contributing them to the CRATs, they would have taxable gains in the
amounts determined by the Commissioner. See Pet’rs’ Reply to Resp’t’s Opening
Br. 3–9.
33 See also Magness v. Commissioner, T.C. Memo. 1965-260, 1965 Tax Ct.
Memo LEXIS 70, *8–9, *9 n.3 (stating the rule and providing background on its
adoption).
34 See also Miller v. Commissioner, 2009 WL 2432375, at *2.
35 The Gerhardts state in their answering brief that the Commissioner’s
characterization of the gains from the CRATs’ sales of the contributed properties was
“of little or no consequence.” Pet’rs’ Reply to Resp’t’s Opening Br. 20. They are
mistaken. This characterization is indeed consequential. But the Gerhardts do not
argue that the gains should be characterized in any other way (for example, as capital
26
the basis of this determination and well-established law, see I.R.C. §§ 64,
1245(a), the Gerhardts had ordinary income from the CRATs as follows:
Ordinary Income from CRATs, Including Interest Income Already Reported by the
Gerhardts
Petitioner CRAT 2016 2017
Gladys Albert and Gladys CRAT $311,708 $311,708
Alan and Audrey Alan and Audrey CRAT 207,232 207,232
Jack and Shelley Jack and Shelley CRAT I 260,902 260,902
Jack and Shelley CRAT II 73,678 73,678
Tim and Pamela Tim and Pamela CRAT I 50,967 50,967
Tim and Pamela CRAT II 92,205 92,205
The Gerhardts resist the straightforward analysis set out above.
In their telling, the Code does a lot more than exempt the CRATs from
paying tax on built-in gains realized when contributed property is sold.
According to the Gerhardts, the Code also relieves them from paying tax
on the distributions that were made possible by the CRATs’ realization
of the built-in gains. As they put it, “all taxable gains (on the sale of the
asset[s contributed to the CRATs]) disappear and the full amount of the
proceeds [is] converted to principal to be invested by the CRAT.” Pet’rs’
Opening Br. 6–7 (emphasis added). In the Gerhardts’ view, “[i]t becomes
obvious that Congress intended [this treatment] to promote charitable
giving while offering large tax benefits as incentives.” Id. at 7. The gain
disappearing act the Gerhardts attribute to the CRATs is worthy of a
Penn and Teller magic show. But it finds no support in the Code,
regulations, or caselaw.
In Furrer, we considered facts and arguments nearly identical to
those before us now and reached the same conclusion. We invited the
Gerhardts to distinguish Furrer and even extended the briefing schedule
to allow them to do so. But, tellingly, their briefs fail to mention the case
gains). Therefore, they have forfeited the argument. See, e.g., Smith v. Commissioner,
No. 5191-20, 159 T.C., slip op. at 41 (Aug. 25, 2022); see also Hackett v. City of S. Bend,
956 F.3d 504, 509 (7th Cir. 2020); Jenkins v. Winter, 540 F.3d 742, 751 (8th Cir. 2008)
(“Claims not raised in an opening brief are deemed waived.”).
27
at all. 36 Their silence confirms our view that the reasoning in Furrer
applies with equal force here.
As best we can tell, the Gerhardts maintain that the bases of
assets donated to a CRAT are equal to their fair market values. See
Pet’rs’ Reply to Resp’t’s Opening Br. 10–11 (“Utilizing CRATs, the assets
are donated to a CRAT and book at the fair market value of the asset at
that time. The donor’s basis is a moot point as the controlling fair
market value is the price at the time the asset is donated to the CRAT.”);
id. at 13 (“The trustee of the CRAT has no way to know the cost basis of
any asset donated to it, nor is it required to obtain such information
since that is not required by the Internal Revenue Code.”). Section 1015
flatly contradicts their position. Section 1015(a) governs transfers by
gift, and section 1015(b) governs transfers in trust (other than transfers
in trust by gift). Under either provision, the basis in the property “shall
be the same as it would be in the hands of the donor” under
section 1015(a) or “in the hands of the grantor” under section 1015(b). 37
And the Gerhardts’ claim that section 1015 does not govern transfers to
CRATs because it does not specifically mention them is meritless.
Nothing in the text of the provision excludes CRATs from its scope.
The Gerhardts also seek shelter in the rules governing the
taxation of annuities in section 72. But, if one respects the form of the
transactions the Gerhardts chose, the Gerhardts did not buy any
annuities from Symetra. The CRATs did so and directed how payments
under the annuities were to be made. 38 Thus, any amounts paid by
36 This is particularly notable given that the Gerhardts’ counsel in these cases
also represented the Furrers. Moreover, neither the Gerhardts’ Opening Brief nor
their Reply to Respondent’s Opening Brief cites a single case in support of their
position. As we have already explained, no such support exists.
37 The position the Gerhardts advance has not been the law for more than a
century. As Treasury Regulation § 1.1015-3(a) provides: “In the case of property
acquired by gift or transfer in trust before January 1, 1921, the basis of such property
is the fair market value thereof at the time of the gift or at the time of the transfer in
trust.” (Emphasis added.) For property transferred after December 31, 1920, “the
basis of the property for the purpose of determining gain is the same as it would be in
the hands of the donor.” Treas. Reg. § 1.1015-1(a)(1) (governing “property acquired by
gift . . . (whether by transfer in trust or otherwise)”); see also Treas. Reg. § 1.1015-
2(a)(1) (setting out the same rule for “property acquired . . . by transfer in trust (other
than by a transfer in trust by gift, bequest, or device)”).
38 As we have already noted, under the SPIA contracts, the Gerhardts did not
have “any right title, interest, or incident of ownership in or to any [SPIA] transferred
to or purchased by the Trustee.” Stipulation of Facts Ex. 13–J, at 22. Symetra appears
28
Symetra as directed by the CRATs constitute amounts distributed by
the CRATs for purposes of section 664(b). Contrary to the Gerhardts’
view, nothing in section 72 overrides their obligation to comply with the
rules of section 664(b) with respect to those amounts.
In light of the foregoing, it is plain that the Gerhardts have not
shown that the determinations in the notices of deficiency on this issue
were incorrect. Therefore, they must be upheld.
II. Docket No. 11129-20 (Additional Issues Relating to Jack and
Shelley Gerhardt’s Returns)
(1) Section 1031 Like-Kind Exchange Issue
Next we consider whether, for the 2017 tax year, Jack and Shelley
Gerhardt properly excluded gain from the disposition of other property
(Armstrong Site) from gross income under section 1031 or whether that
gain must be recognized under section 1245. The Commissioner does
not dispute that the transaction at issue met the requirements of
section 1031. Instead, the Commissioner argues that, despite
section 1031, the gain must be recognized as ordinary income because
the property was depreciated “section 1245 property.” See I.R.C. § 1245.
After finding the facts that follow, for the reasons set out below, we
decide this issue in the Commissioner’s favor.
Background
Located in Armstrong, Iowa, the Armstrong Site was held by Jack
and Shelley as rental property for the production of income. It
comprised hog buildings and equipment as well as raw land. On
January 19, 2017, Jack and Shelley relinquished the Armstrong Site to
Andrew Gerhardt intending that it be exchanged for like-kind property.
On February 28, 2017, a new property, the Cape Coral property, was
identified as the exchange property. On March 17, 2019, Jack and
Shelley received the Cape Coral property from Andrew Gerhardt.
Jack and Shelley treated this exchange as a section 1031 like-kind
exchange on their 2017 tax return. They reported a fair market value
to have followed this contractual provision by issuing Forms 1099–R, Distributions
From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance
Contracts, etc., reflecting each year’s annuity payments to the CRATs, not the
Gerhardts. And the Gerhardts have stipulated that the CRATs reflected the annuity
payments as distributions on their Forms 5227, Schedule A, Part II-A, Current
Distributions Schedule, for each relevant year.
29
of $390,000 for the Cape Coral property. They also reported $104,338
as “[a]djusted basis of like-kind property [they] gave up, net amounts
paid to other party, plus any exchange expenses” not used elsewhere on
their return. 39 Stipulation of Facts Ex. 10–J, at 17. Consistent with
these amounts, Jack and Shelley reported deferred gain of $285,662 on
the exchange of the Armstrong Site.
As already noted, the Commissioner examined Jack and Shelley’s
2017 return. The revenue agent conducting the audit accepted the fair
market value of the Cape Coral property and agreed that Jack and
Shelley paid for the property with the Armstrong Site (valued at
$300,000) and $90,000 in cash. But the agent made adjustments to Jack
and Shelley’s reported exchange expenses, as well as their reported
basis in the Armstrong Site. And he determined that the gain from the
Armstrong Site was subject to the rules of section 1245 and that the gain
should not be deferred but should be treated as ordinary income.
Consistent with these determinations, the Commissioner increased Jack
and Shelley’s income for 2017 by $284,746. 40
Discussion
A. Recognition Under Section 1245
Typically, under section 1031, no gain or loss is recognized on a
like-kind exchange of property if all requirements of section 1031 are
met. But, if “section 1245 property” is disposed of in a section 1031 like-
kind exchange, then gain from the disposition of that property may be
recognized as ordinary income. 41 See I.R.C. § 1245(a)(1) (flush
language), (b)(4); Treas. Reg. § 1.1245-6(b). If both section 1245 property
39 The basis amount of $104,338 reported on Jack and Shelley’s return
consisted of reported basis of $14,338 in the Armstrong Site and exchange expenses,
plus $90,000 in cash.
40 This amount was equal to 100% of the gain from the exchange of the
Armstrong Site as determined by the Commissioner. The Commissioner calculated
the amount by subtracting selling costs and the adjusted basis of the land, buildings,
and equipment, all as determined by the Commissioner, from the $300,000 sale price.
The amount was slightly less than the amount Jack and Shelley reported as deferred
gain because the Commissioner made certain favorable adjustments to Jack and
Shelley’s basis in the property.
41 As relevant here, the amount recognized generally is limited to the amount
by which the lesser of (1) the depreciation deductions claimed with respect to the
property and (2) the amount realized in the transaction exceeds the taxpayer’s
adjusted basis in the property. See I.R.C. § 1245(a) and (b).
30
and non-section 1245 property are disposed of in the same transaction,
then gain is allocated between the section 1245 property and the non-
section 1245 property in proportion to their respective fair market
values. Treas. Reg. § 1.1245-1(a)(5). Section 1245 property includes
“property which is or has been property of a character subject to the
allowance for depreciation provided in section 167” that, as relevant
here, is either (1) personal property or (2) a single-purpose agricultural
or horticultural structure. I.R.C. § 1245(a)(3)(A), (D).
B. Application to Jack and Shelley
The Commissioner determined that the hog buildings and
equipment on the Armstrong Site were section 1245 property and
therefore that Jack and Shelley’s gain from disposing of the property
was ordinary income to them for 2017. Jack and Shelley dispute that
the gain should be recognized as ordinary income. They argue that the
gain should be deferred because they exchanged the Armstrong Site for
the Cape Coral property in a properly executed section 1031 transaction.
Essentially, they say that section 1031 trumps section 1245, at least as
to the timing of gain recognition.
There is no dispute that Jack and Shelley followed the formalities
of section 1031. But Jack and Shelley’s argument ignores that gain may
still be recognized under section 1245 if the property disposed of is
“section 1245 property.” See I.R.C. § 1245(a)(1) (flush language) (“[G]ain
[from the disposition of section 1245 property] shall be recognized
notwithstanding any other provision of this subtitle.”); see also I.R.C.
§ 1245(b)(4) (providing rules for gain recognition in the context of a
section 1031 transaction). Besides their broad assertion that “[t]he
buildings on the [Armstrong Site] are incidental to the property and part
of the property,” Pet’rs’ Opening Br. 20, Jack and Shelley offer no
arguments with respect to the Commissioner’s determination that the
Armstrong Site was depreciated section 1245 property. Nor do they
contend that the limitations in section 1245(b)(4) assist them.
So far as Jack and Shelley may be arguing that their gain from
the Armstrong Site is allocable primarily to non-section 1245 property,
they have not set forth any facts supporting that view. The record does
31
not show how much (if any) of the gain from the Armstrong Site could
be allocable to non-section 1245 property. 42
In short, Jack and Shelley have not met their burden to
demonstrate that the Commissioner’s determination is incorrect, and we
find for the Commissioner on this issue.
(2) Sale of Mosloski Site Issue
We turn next to the Commissioner’s determination that Jack and
Shelley did not properly report gains from the sale of an additional
property, which the parties refer to as the Mosloski Site.
Background
Jack and Shelley purchased the Mosloski Site in 1995. The
Mosloski Site consisted of land, a hog-finishing barn, and hog
equipment. On November 10, 2015, Jack and Shelley donated a partial
interest in the Mosloski Site to their CRAT. Then on November 17,
2016, they sold their remaining interest in the Mosloski Site for $75,000.
Jack received a Form 1099–S, Proceeds from Real Estate Transactions,
that same day reporting the sales proceeds.
On their Form 1040, U.S. Individual Income Tax Return, for the
2016 tax year, Jack and Shelley reported total gain of $66,070 from the
sale of the Mosloski Site as ordinary income. Along with their 2016
return, Jack and Shelley attached Form 4797, Sales of Business
Property. On Form 4797, they reported a loss of $1,009 from the sale of
the Mosloski Site land and gain of $67,079 from the sale of the Mosloski
Site hog-finishing barn and hog equipment.
In the notice of deficiency issued to Jack and Shelley, the
Commissioner determined that the sale of the Mosloski Site was subject
to depreciation recapture under section 1245. And because “the
recapture amounts [from the Mosloski Site] under [section 1245] and
land basis amounts are included in the charitable remainder annuity
trust amounts,” the Commissioner determined that the gain reported on
42 We note in this regard that, according to the revenue agent’s workpapers,
when Jack and Shelley purchased the Armstrong site they allocated approximately
1.6% of the purchase price to land (the non-section 1245 property) and the remaining
98.4% to buildings and equipment (the section 1245 property) for depreciation
purposes.
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Form 4797 was zero and that the entire $75,000 of sale proceeds was
long-term capital gain to Jack and Shelley for 2016.
Discussion
Jack and Shelley offer no argument as to this adjustment in either
of their briefs. Therefore, they have forfeited any objection as to this
adjustment, and the Commissioner’s determination stands. See Smith,
159 T.C., slip op. at 41; see also Muhich v. Commissioner, 238 F.3d 860,
864 n.10 (7th Cir. 2001), aff’g T.C. Memo. 1999-192; Schneider v.
Kissinger, 412 F.3d 190, 200 n.1 (D.C. Cir. 2005) (“[A] litigant has an
obligation to spell out its arguments squarely and distinctly, or else
forever hold its peace.” (quoting United States v. Zannino, 895 F.2d 1,
17 (1st Cir. 1990))).
III. Docket No. 11146-20 (Tim and Pamela Gerhardt Section 6662(a)
Penalty Issue)
Finally, we consider whether Tim and Pamela are liable for an
accuracy-related penalty under section 6662(a) and (b)(2) for a
substantial understatement of income tax for 2016.
Background
Tim and Pamela reported total tax of $4,836 on their 2016 income
tax return. The Commissioner determined that they had a tax
deficiency of $39,448 for that year. During the examination of the 2016
return, IRS Revenue Agent Michael Lumpp proposed the imposition of
an accuracy-related penalty under section 6662(a). Supervisory
Revenue Agent Emily McDowell, Revenue Agent Lumpp’s immediate
supervisor, personally approved the assertion of the penalty in writing
on July 22, 2019. Revenue Agent Lumpp had not communicated the
penalty determination to Tim and Pamela or their representative before
obtaining written supervisory approval.
In the notice of deficiency, mailed to Tim and Pamela on
March 10, 2020, the Commissioner determined an accuracy-related
penalty of $7,890 under section 6662(a) and (b)(2) for an underpayment
due to a substantial understatement of income tax.
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Discussion
A. The Commissioner’s Burden of Production
Section 6662(a) imposes an accuracy-related penalty equal to 20%
of the portion of an underpayment of tax required to be shown on a
return that is attributable to any substantial understatement of income
tax. See I.R.C. § 6662(a) and (b)(2). An understatement of income tax
is “substantial” if it exceeds the greater of “10 percent of the tax required
to be shown on the return for the taxable year” or “$5,000.” Id.
subsec. (d)(1)(A).
Under section 7491(c) the Commissioner bears the burden of
production with respect to the liability of an individual for any penalty.
See Higbee v. Commissioner, 116 T.C. 438, 446 (2001). The record shows
that Tim and Pamela’s understatement of income tax for 2016 exceeded
the threshold amount under section 6662(d)(1)(A), so the Commissioner
has met his burden to show the penalty under section 6662(a) was
proper when the notice of deficiency was issued.
The Commissioner must also show compliance with the
procedural requirements of section 6751(b)(1). See I.R.C. § 7491(c);
Graev v. Commissioner, 149 T.C. 485, 493 (2017), supplementing and
overruling in part 147 T.C. 460 (2016). Section 6751(b)(1) provides that
no penalty shall be assessed unless “the initial determination” of the
assessment was “personally approved (in writing) by the immediate
supervisor of the individual making such determination.” The parties’
stipulations show that the section 6662 penalty was properly approved.
B. Reasonable Cause
No penalty is imposed under section 6662 with respect to any
portion of an underpayment “if it is shown that there was a reasonable
cause for such portion and that the taxpayer acted in good faith with
respect to [it].” I.R.C. § 6664(c)(1). Tim and Pamela have the burden to
establish that they are excused from the penalty for reasonable cause.
See United States v. Boyle, 469 U.S. 241, 245 (1985); Sugarloaf Fund,
LLC v. Commissioner, 911 F.3d 854, 861 (7th Cir. 2018), aff’g Kenna
Trading, LLC v. Commissioner, 143 T.C. 322 (2014); Neonatology
Assocs., P.A. v. Commissioner, 115 T.C. 43, 98 (2000), aff’d, 299 F.3d 221(3d Cir. 2002).
“The determination of whether a taxpayer acted with reasonable
cause and in good faith is made on a case-by-case basis, taking into
34
account all pertinent facts and circumstances.” Treas. Reg. § 1.6664-
4(b)(1). Generally, “the most important factor is the extent of the
taxpayer’s effort to assess [his] proper tax liability.” Id. Circumstances
that may indicate reasonable cause and good faith include “an honest
misunderstanding of fact or law that is reasonable in light of all of the
facts and circumstances, including the experience, knowledge, and
education of the taxpayer.” Id.Tim and Pamela argue that they have reasonable cause for the
underpayment of tax for 2016 because they lacked relevant legal
training and relied on tax advisers both in pursuing the CRAT
transactions discussed above and in preparing their 2016 return. To
show that their reliance on tax advisers constitutes reasonable cause,
Tim and Pamela must show that their reliance was reasonable. Boyle,
469 U.S. at 250–51; Treas. Reg. § 1.6664-4(b)(1) (“[A taxpayer’s reliance
on] professional advice . . . constitutes reasonable cause and good faith
if, under all the circumstances, such reliance was reasonable and the
taxpayer acted in good faith.”).
Our Court applies a three-prong test to determine whether a
taxpayer reasonably relied on professional advice. Specifically, we
analyze whether “(1) [t]he adviser was a competent professional who had
sufficient expertise to justify reliance, (2) the taxpayer provided
necessary and accurate information to the adviser, and (3) the taxpayer
actually relied in good faith on the adviser’s judgment.” Neonatology
Assocs., P.A., 115 T.C. at 99. Reasonable reliance on a professional “is a
fact-specific determination with many variables, but the question ‘turns
on “the quality and objectivity of the professional advice obtained.”’”
Am. Boat Co. v. United States, 583 F.3d 471, 481 (7th Cir. 2009) (quoting
Klamath Strategic Inv. Fund, LLC v. United States, 472 F. Supp. 2d 885,
904 (E.D. Tex. 2007), aff’d sub nom. Klamath Strategic Inv. Fund ex rel.
St. Croix Ventures v. United States, 568 F.3d 537 (5th Cir. 2009)).
“Reliance may be unreasonable when it is placed upon insiders,
promoters, or their offering materials, or when the person relied upon
has an inherent conflict of interest that the taxpayer knew or should
have known about.” Neonatology Assocs., P.A., 115 T.C. at 98.
35
C. Application to Tim and Pamela
Based on the record before us, we are unable to determine that
Tim and Pamela reasonably relied on tax advisers in preparing the
return or pursuing the positions reflected in the return. The record does
not demonstrate the qualifications of the advisers, the nature of Tim and
Pamela’s communications with them, or the quality or objectivity of the
advice Tim and Pamela received. These facts are necessary to our
analysis, and it was Tim and Pamela’s burden to provide them. This
they did not do. 43 Accordingly, we sustain the determination of the
section 6662(a) penalty.
IV. Conclusion
For the reasons stated above, we find for the Commissioner on all
issues.
We have considered all of the parties’ arguments and, to the
extent not discussed above, conclude they are irrelevant, moot, or
without merit.
To reflect the foregoing and the concessions of the parties,
Decisions will be entered under Rule 155.
43 Statements made in the Gerhardts’ brief without any citations of the record
are not facts on which we may rely.