Donald R. Golan & Sheila E. Golan v. Commissioner

T.C. Memo. 2018-76UNITED STATES TAX COURT
DONALD R. GOLAN AND SHEILA E. GOLAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13999-14. Filed June 5, 2018.
Walter D. Channels, for petitioners.
Jeri L. Acromite, Matthew A. Houtsma, and Miles Friedman, for
respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: With respect to petitioners’ 2011 Federal income tax,
respondent determined a deficiency of $150,694 and an accuracy-related penalty
of $30,138.80 under section 6662(a).1
1
All section references are to the Internal Revenue Code (Code) in effect
(continued...)
-2-
[*2] After concessions,2 the issues for decision are whether petitioners:
(1) established a basis in solar panels and related equipment for purposes of
claiming an energy credit under sections 46 and 48 and a special allowance for
depreciation under section 168(k); (2) satisfied the requirements of section
168(k)(5); (3) had sufficient amounts at risk under section 465; (4) materially
participated in their solar energy venture under section 469; and (5) are liable for
the accuracy-related penalty under section 6662(a).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. We incorporate
the parties’ first stipulation of facts, second stipulation of facts, and accompanying
exhibits by this reference. Petitioners resided in California when they timely filed
their petition.
Petitioner Donald R. Golan is a precious metals account representative for
Monex Deposit Co., and petitioner Sheila E. Golan is a fashion consultant. In
2010 Mr. Golan sought an investment that would provide him with extra income.
1
(...continued)
for the tax year in issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
2
In their petition, petitioners dispute respondent’s determination that they
had “other income” of $100,000. At trial respondent conceded this issue.
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[*3] In furtherance of this goal, a tax attorney acquaintance introduced him to Ken
Salveson.
Mr. Salveson is a licensed contractor and attorney with a history of
constructing and selling subsidized low-income housing. Sensing a business
opportunity in the solar energy sector, Mr. Salveson formed Solar Energy Equities
LLC (LLC or Mr. Salveson’s LLC). Through the LLC, Mr. Salveson identifies
property owners and offers them discounted electricity in exchange for permission
to install solar panels and related equipment (solar equipment) on their properties
(host properties). The LLC remains the owner of the solar equipment and
temporarily retains the burdens and benefits of ownership (including all resulting
tax credits and rebates). Then the LLC sells the solar equipment (and all rights
and obligations therewith) to a buyer. One such buyer was Mr. Golan, who
purchased solar equipment on three host properties.
Host Property 1
Tim Mann owns a warehouse in Indio, California (warehouse or host
property 1). With Mr. Salveson’s assistance, Mr. Mann filed an application with
the local utility company for an Interconnection Agreement for Net Energy
Metering from Residential and Commercial Solar or Wind Electric Generating
Facilities of One Megawatt or Less (interconnection agreement) on March 1,
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[*4] 2010. On June 29, 2010, Mr. Mann received a permit from the City of Indio
to install a “solar system” on the warehouse.
Mr. Salveson’s LLC and Mr. Mann entered into a power purchase
agreement (PPA) dated July 1, 2010. Under the PPA Mr. Mann agreed to
purchase discounted electricity from the LLC, which would generate the electricity
by installing solar equipment on the warehouse. The LLC retained ownership of
the solar equipment and was responsible for any servicing and/or repairs.
Although the PPA had a five-year term, it was contingent on the LLC’s receiving
“certain financial incentives from the local public utility district and/or the United
States Treasury Department.” The PPA prohibited Mr. Mann from assigning the
PPA to another party without the LLC’s consent. Conversely, the LLC could
assign its interest in the PPA to another party with 30 days’ notice to Mr. Mann.
Mr. Salveson installed the solar equipment on the warehouse in July 2010.
In November 2010 the City of Indio inspected the solar equipment. On December
30, 2010, a representative from the utility company signed the interconnection
agreement. Under this agreement the utility company agreed to connect the solar
equipment on the warehouse to the electric grid. Mr. Mann was required, as a
precondition to connecting the solar equipment to the electric grid, to install “[a]
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[*5] dual meter socket with separate meters to monitor the flow of electricity in
each direction” (bidirectional meter).3
On a date not established by the record, the utility company informed Mr.
Mann that he was eligible for a rebate of $19,641.38. Mr. Mann assigned the
rebate to Mr. Salveson’s LLC.
Host Property 2
Mr. Mann also owns a rental property in Indio, California (rental property or
host property 2). With Mr. Salveson’s assistance, Mr. Mann filed an application
with the local utility company for an interconnection agreement on March 1, 2010.
On July 8, 2010, Mr. Mann received a permit from the City of Indio to install a
“solar system” on the rental property.
Mr. Mann and Mr. Salveson’s LLC entered into a PPA dated August 1,
2010, with terms nearly identical to those of the PPA for host property 1: (1) the
LLC would sell Mr. Mann electricity from solar equipment it installed on the
rental property; (2) Mr. Mann would receive discounted electricity for a five-year
term while the LLC would retain ownership of the solar equipment and the right to
any tax or other financial benefits; (3) Mr. Mann could not assign the agreement to
3
Once connected to the grid, the solar equipment could send excess energy
to the utility company. This process, called “net metering”, facilitates keeping the
cost of the solar-generated electricity low.
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[*6] another party without the LLC’s consent, but the LLC could do so with 30
days’ notice; and (4) the LLC would remain responsible for servicing and
repairing the solar equipment.
On a date not established by the record, Mr. Salveson installed the solar
equipment on the rental property. On September 20, 2010, a utility company
representative signed the interconnection agreement and agreed to connect the
rental property solar equipment to the electric grid. As a precondition Mr. Mann
was required to install a bidirectional meter. That same day the utility company
issued a letter to Mr. Mann stating that he was entitled to a rebate of $21,658.73.
Mr. Mann assigned the rebate to Mr. Salveson’s LLC.
Host Property 3
Scott and Betty Fisher own a residential property in La Quinta, California
(residential property or host property 3). With Mr. Salveson’s assistance, the
Fishers filed an application with the local utility company for an interconnection
agreement on March 1, 2010.
The Fishers entered into a PPA with Mr. Salveson’s LLC on July 1, 2010,
with terms nearly identical to those of the PPAs for host properties 1 and 2: (1)
the LLC would sell the Fishers electricity from solar equipment it installed on the
residential property; (2) the Fishers would receive discounted electricity for a five-
-7-
[*7] year term while the LLC would retain ownership of the solar equipment and
the right to any tax or other financial benefits; (3) the Fishers could not assign the
agreement to another party without the LLC’s consent, but the LLC could do so
with 30 days’ notice; and (4) the LLC would remain responsible for servicing and
repairing the solar equipment.
Mr. Salveson installed the solar equipment on the residential property in
November 2010. On December 30, 2010, a utility company representative signed
the interconnection agreement and agreed to connect the residential property solar
equipment to the electric grid. As a precondition the Fishers were required to
install a bidirectional meter. That same day the utility company issued a letter to
the Fishers stating that they were entitled to a rebate of $16,449.89. The Fishers
assigned the rebate to Mr. Salveson’s LLC.
Sale of Solar Equipment
In January 2011 Mr. Golan purchased the solar equipment for host
properties 1, 2, and 3 from Mr. Salveson. The sale was effected by several
documents including: (1) a Solar Project Asset Purchase Agreement between Mr.
Golan and Mr. Salveson dated January 10, 2011 (purchase agreement);4 (2) Mr.
4
The PPAs indicate that Mr. Salveson’s LLC owned the solar equipment.
However, for reasons not explained in the record, the purchase agreement names
(continued...)
-8-
[*8] Golan’s promissory note dated January 15, 2011; (3) Mr. Golan’s Guaranty
dated January 10, 2011; and (4) a Bill of Sale and Conveyance dated January 10,
2011 (bill of sale).
Under the purchase agreement Mr. Golan agreed to buy the solar equipment
on host properties 1, 2, and 3, in addition to the rights and obligations under the
corresponding PPAs.5 The purchase agreement specified that the “original use” of
the solar equipment “shall commence on or after the Closing Date.” The stated
purchase price was $300,000, which is the sum of (1) a $90,000 downpayment
(due on the closing date); (2) a $57,750 credit for the rebates Mr. Mann and the
Fishers had assigned to Mr. Salveson’s LLC; and (3) Mr. Golan’s promissory note
in the principal amount of $152,250.
With respect to the promissory note, Mr. Golan promised to pay Mr.
Salveson the principal amount with interest at 2% per annum. Described by Mr.
4
(...continued)
Mr. Salveson as the seller rather than the LLC. Neither party has argued that this
discrepancy affects the outcome of this case.
5
Technically Mr. Golan agreed to purchase the “Project Assets”, a defined
term meaning “[a]ny and all property, whether tangible or intangible * * * related
to, or used in connection with the generation of electricity at * * * [host properties
one, two, and three] pursuant to the PPA[s]”. As defined in the purchase
agreement, the term includes the solar equipment, the PPAs, and the rights to all
revenues, tax benefits, and other benefits therefrom.
-9-
[*9] Salveson as a “cash flow” instrument, the note had a maturity date of January
14, 2041, but did not have a fixed payment amount. Instead it required Mr. Golan
to pay towards the note all monthly revenue generated by the solar equipment.
The note provided that the “total amount due * * * during any calendar month
shall not exceed the amount of such [m]onthly [r]eceipts.” If the accrued interest
exceeded the monthly receipts in any month, the difference would be “carried
forward and owed by * * * [Mr. Golan] in future months.” Conversely, monthly
receipts in excess of accrued interest and amortized principal would accelerate the
loan’s repayment.
The note was secured by the solar equipment, and, in the event of a default,
Mr. Salveson agreed to seek recourse against the solar equipment before
exercising any rights or remedies against Mr. Golan. However, the note also
stated that Mr. Golan “shall be liable to pay any deficiency owed to * * * [Mr.
Salveson] in the event * * * foreclosure and sale of the Project Assets is
insufficient to pay all amounts owed to * * * [Mr. Salveson] under this Note.” Mr.
Golan also signed a guaranty, in which he agreed to pay Mr. Salveson the
outstanding balance of the note in the event the “Borrower” failed to pay the note.6
6
We infer that Mr. Golan’s guaranty of his own note was an attempt to
ensure that he would be personally liable for the amounts borrowed under the note.
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[*10] In addition to the purchase agreement and promissory note, Mr. Golan and
Mr. Salveson signed a bill of sale. In the bill of sale Mr. Salveson acknowledged
that he had received “good and valuable consideration” and was “selling,
assigning, and conveying to * * * [Mr. Golan] all right, title, and interest in and to
the Project Assets”.7 In order to further evidence transfer of the solar equipment,
Mr. Golan signed copies of the PPAs for host properties 1, 2, and 3. Although the
PPAs were dated July 1, August 1, and July 1, 2010, respectively, Mr. Golan
signed them in January 2011.8
After the Sale
After the January 2011 sale, on a date not established by the record, the
utility company connected the solar equipment on host properties 1, 2, and 3 to the
electric grid. The solar equipment started generating electricity, and Mr. Mann
and the Fishers began making monthly payments pursuant to the PPAs.
7
As described supra note 5, the term “Project Assets” refers to the solar
equipment, the PPAs, and the rights to all revenues, tax benefits, and/or other
benefits therefrom.
8
The record also contains a Call Option Agreement between Mr. Golan and
Mr. Salveson dated September 22, 2011. Therein Mr. Golan granted Mr. Salveson
an option to purchase the solar equipment for the outstanding balance of the
promissory note. The period during which Mr. Salveson could exercise the option
commenced October 22, 2016, and ended on March 22, 2017. Neither party
mentioned this agreement at trial or on brief.
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[*11] Mr. Golan was unable to pay Mr. Salveson the $90,000 downpayment in
2011. Although Mr. Golan was in default of the purchase agreement, Mr.
Salveson continued to honor his end of the contract. At Mr. Golan’s direction,
Mr. Mann and the Fishers made direct payments of their electricity bills to Mr.
Salveson. Mr. Salveson credited these payments towards the promissory note,
which was never amended to account for the unpaid downpayment.
Mr. Golan made partial payments toward the downpayment to Mr. Salveson
of $75,000 and $5,000 in 2012 and 2013, respectively. Although Mr. Golan was
still in default for the remaining $10,000, Mr. Salveson did not cancel the contract
or otherwise assert any claims for breach of contract.
Petitioners’ Tax Return
Certified public accountant (C.P.A.) Dennis Klarin prepared petitioners’
2011 joint income tax return.9 Before preparing the return, Mr. Klarin met with
Mr. Golan and Mr. Salveson on four separate occasions. During these meetings
Mr. Klarin and Mr. Salveson extensively discussed Mr. Golan’s investment in the
solar equipment and the tax consequences thereof. Mr. Salveson also provided
Mr. Klarin with copies of the above-referenced agreements and other documents.
9
Mr. Klarin has prepared Mr. Golan’s income tax returns since 1977.
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[*12] Petitioners attached to their return a Schedule C, Profit or Loss From
Business, on which Mr. Golan purported to be a “consultant” for “Golan Solar
Energy Service”. On the Schedule C petitioners reported no income, claimed
various deductions, including depreciation of $255,000, and stated that they were
using the cash method of accounting.10 On a Form 4562, Depreciation and
Amortization, petitioners specified that the $255,000 deduction was a “[s]pecial
depreciation allowance for qualified property”. Petitioners also attached to their
return a Form 3468, Investment Credit, on which they claimed an energy credit of
$90,000 (30% of $300,000).
Notice of Deficiency
After selecting petitioners’ return for examination, respondent issued
petitioners a notice of deficiency. Therein respondent disallowed petitioners’
special allowance for depreciation, stating: “We have disallowed the deduction
you claimed for a Section 179 expense because the property does not qualify as
Section 179 property.”11 Respondent also disallowed petitioners’ energy credit,
10
The $255,000 figure is the difference between $300,000, petitioners’
purported basis in the solar equipment, and $45,000. Because petitioners also
claimed an energy credit of $90,000, they were required to reduce their basis in the
solar equipment by $45,000 pursuant to sec. 50(c)(1) and (3)(A).
11
Respondent disallowed all other Schedule C deductions for “Golan Solar
(continued...)
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[*13] stating: “Your expenses do not qualify for the Rehabilitation Credit shown
on Form 3468.” In addition, respondent determined that petitioners were liable for
an accuracy-related penalty under section 6662(a).12
OPINION
I. Burden of Proof
Generally, the Commissioner’s determination of a deficiency is presumed
correct, and the taxpayer has the burden of proving it incorrect. Rule 142(a);
Welch v. Helvering, 290 U.S. 111, 115 (1933).13
An exception to the general rule exists when the Commissioner raises a new
matter. Rule 142(a); Shea v. Commissioner, 112 T.C. 183, 197 (1999); Tabrezi v.
Commissioner, T.C. Memo. 2006-61. Generally, the Commissioner has raised a
11
(...continued)
Energy Service”. Although in their petition, petitioners challenged the
disallowance of these expenses, they did not mention them at trial or on brief. We
therefore deem this issue abandoned and sustain respondent’s determination as to
these deductions. See Petzoldt v. Commissioner, 92 T.C. 661, 683 (1989); Money
v. Commissioner, 89 T.C. 46, 48 (1987).
12
Other than the adjustment respondent has conceded, see supra note 2, the
remaining adjustments are computational and will be resolved under Rule 155.
13
Sec. 7491(a) shifts the burden of proof to the Commissioner as to any
factual issue relevant to a taxpayer’s liability for tax if the taxpayer meets certain
preliminary conditions. See Higbee v. Commissioner, 116 T.C. 438, 442-443
(2001). Petitioners did not establish that sec. 7491(a) should apply to the instant
case.
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[*14] new matter when the Commissioner “attempts to rely on a basis that is
beyond the scope of the original deficiency determination”. Shea v.
Commissioner, 112 T.C. at 191. In particular, a new matter is raised when the
Commissioner’s new theory “either alters the original deficiency or requires the
presentation of different evidence.” Id. (quoting Wayne Bolt & Nut Co. v.
Commissioner, 93 T.C. 500, 507 (1989)). The Commissioner generally must bear
the burden of proof on a new matter. Rule 142(a); Shea v. Commissioner, 112
T.C. at 191.
In the notice of deficiency respondent disallowed petitioners’ special
allowance for depreciation because the solar equipment was not “Section 179
property”. Respondent disallowed petitioners’ energy credit because their
expenses did “not qualify for the Rehabilitation Credit” under section 47. Given
that petitioners did not claim a section 179 deduction or a section 47 rehabilitation
credit on their return, respondent’s references to these sections were in error.
Respondent now acknowledges that sections 179 and 47 are inapplicable to this
case.
Respondent nevertheless maintains that petitioners cannot claim the special
allowance for depreciation or the energy credit. On brief respondent asserts the
following grounds for his position: (1) petitioners failed to establish a basis in the
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[*15] solar equipment; (2) petitioners have not satisfied certain requirements of
section 168(k)(5); (3) petitioners did not have sufficient amounts at risk under
section 465; and (4) losses and credits attributable to Mr. Golan’s solar energy
venture are subject to the passive activity loss limitations of section 469.
We first address respondent’s failure-to-establish-basis theory.14 There is
nothing in the notice of deficiency that indicates respondent was disputing the
amount or existence of petitioners’ basis in the solar equipment. Since this theory
necessitates additional evidence regarding the cost of the solar equipment, it is a
new matter for which respondent bears the burden of proof. See Rule 142(a); Shea
v. Commissioner, 112 T.C. at 191, 197.
With respect to respondent’s second theory, the deficiency notice does not
mention section 168(k)(5) or otherwise state that petitioners failed to satisfy that
provision’s requirements.15 For property to qualify for a 100% special
depreciation allowance under section 168(k)(5), the taxpayer must acquire the
14
Respondent first raised this issue in his pretrial memorandum, which was
filed several weeks before trial. Petitioners have neither argued nor established
that the trial of this issue unfairly prejudiced them. See Niemann v.
Commissioner, T.C. Memo. 2016-11, at *14-*15. We therefore find that the issue
was tried by consent. See Rule 41(b).
15
Respondent first disputed petitioners’ entitlement to a sec. 168(k) special
depreciation allowance in his answer to petitioners’ amendment to petition.
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[*16] property after September 8, 2010, and before January 1, 2012. Additionally,
the original use of the property must commence with the taxpayer after December
31, 2007. Section 179, which respondent erroneously referenced in the notice of
deficiency, does not have these requirements. Because petitioners would need to
introduce additional evidence of the purchase date and the property’s original use,
respondent’s second theory is a new matter for which respondent bears the burden
of proof. See Rule 142(a); Shea v. Commissioner, 112 T.C. at 191, 197.
The same goes for respondent’s reliance on the at-risk rules of section 465,
which generally requires a taxpayer to deduct losses only to the extent he is
economically or actually at risk for the investment.16 The notice of deficiency
does not mention section 465. Because this theory necessitates additional
evidence pertaining to Mr. Golan’s financing of the solar equipment, it is a new
matter for which respondent bears the burden of proof. See Rule 142(a); Shea v.
Commissioner, 112 T.C. at 191, 197.
16
Respondent first raised this issue in his pretrial memorandum, which was
filed several weeks before trial. Petitioners have neither argued nor established
that the trial of this issue unfairly prejudiced them. See Niemann v.
Commissioner, at *14-*15. We therefore find that the issue was tried by consent.
See Rule 41(b).
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[*17] Respondent’s reliance on the passive activity loss limitations of section 469
is also a new matter.17 Section 469 generally limits deductions for business
activities in which the taxpayer does not materially participate. As discussed infra,
a taxpayer generally proves material participation by establishing, inter alia, that
he participated in the activity for a specified number of hours. See, e.g., Kline v.
Commissioner, T.C. Memo. 2015-144, at *18-*19. The deficiency notice does not
mention section 469 or question the amount of time Mr. Golan spent on his solar
energy venture. Because this theory requires additional evidence of the amount of
time Mr. Golan participated in his solar energy venture, it is a new matter for
which respondent bears the burden of proof. See Rule 142(a); Shea v.
Commissioner, 112 T.C. at 191, 197.
Having assigned the burden of proof, we turn to an analysis of the
applicable law as it relates to the issues presented.
17
Respondent first raised this issue in his pretrial memorandum, which was
filed several weeks before trial. Petitioners have neither argued nor established
that the trial of this issue unfairly prejudiced them. See Niemann v.
Commissioner, at *14-*15. We therefore find that the issue was tried by consent.
See Rule 41(b).
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[*18] II. Petitioners’ Basis in the Solar Equipment
We first decide whether and to what extent petitioners have a basis in the
solar equipment. For the reasons stated supra part I, respondent bears the burden
of proof.
The allowance of depreciation and the energy credit are both dependent on a
taxpayer having a basis in the property. See secs. 38(b)(1), 46, 48(a)(1) (energy
credit), secs. 167(c)(1), 1011(a), 1012 (depreciation); see also Zirker v.
Commissioner, 87 T.C. 970, 979 (1986); sec. 1.168(k)-1(a)(2)(iii), Income Tax
Regs. The taxpayer’s basis in property is generally a question of fact. See Bryant
v. Commissioner, 790 F.2d 1463, 1465 (9th Cir. 1986), aff’g Webber v.
Commissioner, T.C. Memo. 1983-633; Biltmore Homes, Inc. v. Commissioner,
288 F.2d 336, 341-342 (4th Cir. 1961), aff’g T.C. Memo. 1960-53; Wilson v.
Commissioner, T.C. Memo. 1996-418.
Under section 1012 basis is generally the property’s cost. “Cost” is any
“amount paid for such property in cash or other property.” Sec. 1.1012-1(a),
Income Tax Regs. Although cost basis generally equals the price paid for
property, irrespective of its actual value, this rule might not apply “where a
transaction is based upon ‘peculiar circumstances’ which influence the purchaser
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[*19] to agree to a price in excess of the property’s fair market value.” Lemmen v.
Commissioner, 77 T.C. 1326, 1348 (1981) (quoting Bixby v. Commissioner,
58 T.C. 757, 776 (1972)) (holding that a taxpayer’s basis in a cattle herd was
limited to its fair market value at the time of purchase where excess purchase price
was allocable to maintenance contracts).
Cost generally includes promissory notes issued in exchange for property.
Commissioner v. Tufts, 461 U.S. 300, 307-308 (1983); Crane v. Commissioner,
331 U.S. 1 (1947); see sec. 1.1012-1(g), Income Tax Regs. However, when a
transaction is structured so that, taking economic realities into account, there is no
realistic expectation that the taxpayer will repay the entire nominal debt, the
amount recognized as actual debt should be limited accordingly. See Bridges v.
Commissioner, 39 T.C. 1064, 1077 (1963) (“While it is true that technically
petitioner was personally obligated on his note * * * there was no reason to think
that petitioner could or would have been called upon to pay the note out of his
own funds[.]”), aff’d, 325 F.2d 180 (4th Cir. 1963); Roe v. Commissioner, T.C.
Memo. 1986-510, 52 T.C.M. (CCH) 778 (1986) (discussing cases in which
recourse notes have been held not to be genuine indebtedness for purposes of
determining basis in acquired property), aff’d without published opinion sub nom.
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[*20] Haag v. Commissioner, 855 F.2d 855 (8th Cir. 1988), and aff’d without
published opinion sub nom. Sincleair v. Commissioner, 841 F.2d 394 (5th Cir.
1988).
For purposes of calculating the special allowance and energy credit,
petitioners reported a basis in the solar equipment of $300,000. This amount is the
sum of the following: (1) the $90,000 downpayment; (2) the $57,750 credit for
the utility company rebates the host property owners assigned to Mr. Salveson’s
LLC; and (3) the $152,250 principal amount of Mr. Golan’s promissory note.
Respondent argues that petitioners did not have a basis in the solar equipment for
2011 because no money changed hands between Mr. Golan and Mr. Salveson that
year.
We first address the $90,000 downpayment. The record establishes that Mr.
Golan did not pay anything towards the downpayment in 2011. Accordingly,
there was no payment in cash or other property during 2011, and petitioners
cannot add the downpayment to their basis for that year. See sec. 1.1012-1(a),
Income Tax Regs.
We also agree with respondent with respect to the $57,750 credit. The
record establishes the host property owners assigned the utility company rebates to
Mr. Salveson’s LLC prior to the sale of the solar equipment. Mr. Golan neither
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[*21] received nor reported the rebates as income. We therefore find on the record
before us that the credit was really a price reduction to account for the LLC’s
receipt of the rebates prior to the sale of the solar equipment to Mr. Golan.
Because the rebates were not part of the solar equipment’s cost to Mr. Golan,
petitioners cannot add the $57,750 credit to their basis in the solar equipment. See
sec. 1012; sec. 1.1012-1(a), Income Tax Regs.
We reach a different conclusion with respect to Mr. Golan’s $152,250
promissory note. Mr. Golan’s recourse note was issued in exchange for the solar
equipment; petitioners can therefore include the face amount of the note in their
basis. See Commissioner v. Tufts, 461 U.S. at 307-308; Crane v. Commissioner,
331 U.S. at 11; see also sec. 1.1012-1(g), Income Tax Regs. Respondent has not
argued that Mr. Golan cannot reasonably be expected to repay the face amount of
the note.18 See Bridges v. Commissioner, 39 T.C. at 1077; Roe v. Commissioner,
T.C. Memo. 1986-510. Nor has respondent introduced credible evidence that the
solar equipment was overvalued. See Lemmen v. Commissioner, 77 T.C. at 1348.
18
Respondent does not contend that Mr. Golan’s promissory note to Mr.
Salveson was, or should be treated as, nonrecourse debt. Cf. Estate of Franklin v.
Commissioner, 544 F.2d 1045, 1049 (9th Cir. 1976) (holding that nonrecourse
debt used to acquire property was not true indebtedness to the extent it exceeded
the property’s fair market value), aff’g 64 T.C. 752 (1975); see also Odend’hal v.
Commissioner, 80 T.C. 588 (1983), aff’d, 748 F.2d 908 (4th Cir. 1984).
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[*22] Accordingly, we find that petitioners’ basis in the solar equipment for 2011
was $152,250.
III. Section 168(k)
We next decide whether petitioners are entitled to a special allowance for
depreciation under section 168(k). For the reasons stated supra part I, respondent
bears the burden of proof.
Section 167 allows a deduction for the exhaustion and wear and tear of
property used in a trade or business or held for the production of income.19 To
determine the annual wear and tear of tangible property, the Code generally
requires taxpayers to use the modified accelerated cost recovery system (MACRS)
outlined in section 168. Under section 168(k)(1)(A), the depreciation deduction
provided by section 167 includes a special allowance for qualified property “for
the taxable year in which such property is placed in service”. The special
allowance is a percentage of the property’s adjusted basis; the amount of the
percentage generally depends on when the property was acquired and placed in
service.
19
Respondent’s opening brief includes the following requested finding of
fact: “Mr. Golan was interested in investing in the solar property because it would
take very little time and would provide him with income.” We construe this
requested finding of fact as a concession that Mr. Golan held the solar equipment
for the production of income pursuant to sec. 167.
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[*23] Section 168(k)(5) provides for a special allowance of 100% of the adjusted
basis of certain qualified property. For purposes of section 168(k)(5), qualified
property is property that meets the following requirements: (1) the property was
MACRS property with an applicable recovery period of 20 years or less, unless it
was certain computer software, water utility property, or qualified leasehold
improvement property; (2) the original use of the property commenced with the
taxpayer after December 31, 2007; (3) the taxpayer acquired the property after
September 8, 2010, and before January 1, 2012; and (4) the taxpayer placed the
property in service before January 1, 2012. Although he appears to concede that
petitioners met the first and second of these requirements,20 respondent contends
that petitioners failed to satisfy the third and fourth requirements.
We start with the third requirement, namely, that the taxpayer acquire the
property after September 8, 2010, and before January 1, 2012. Respondent argues
that, because Mr. Salveson installed the solar panels on two of the host properties
20
Respondent does not address these requirements on brief. See Muhich v.
Commissioner, 238 F.3d 860, 864 n.10 (7th Cir. 2001) (holding that issues not
addressed or developed on brief are deemed waived; it is not the Court’s
obligation to research and construct the parties’ arguments), aff’g T.C. Memo.
1999-192; 330 W. Hubbard Rest. Corp. v. United States, 203 F.3d 990, 997 (7th
Cir. 2000) (same); Larson v. Northrop Corp., 21 F.3d 1164, 1168 n.7 (D.C. Cir.
1994) (declining to reach issues neither argued nor briefed); Jafarpour v.
Commissioner, T.C. Memo. 2012-165 (same).
- 24 -
[*24] in the summer of 2010, he must have acquired them before September 8,
2010. However, section 168(k)(5) applies to “property acquired by the
taxpayer * * * after September 8, 2010”. (Emphasis added.) Respondent has not
cited, and we have not found, any authority for the proposition that the special
allowance is available only to the original purchasers of manufactured property.21
See also sec. 1.168(k)-1(b)(3)(ii)(B), Income Tax Regs. (“If a person initially
acquires new property and holds the property primarily for sale to customers in the
ordinary course of the person’s business and a taxpayer subsequently acquires the
property * * * primarily for the taxpayer’s production of income, the taxpayer is
considered the original user[.]”). Since the record establishes that Mr. Golan
acquired the solar equipment in January 2011, we find that the solar property was
“acquired by the taxpayer * * * after September 8, 2010, and before January 1,
2012”. See sec. 168(k)(5).
21
To be sure, if Mr. Salveson or anyone else had used the solar equipment
prior to Mr. Golan’s acquisition of it, petitioners would not be entitled to the
special allowance. See sec. 168(k)(2)(A)(ii) (original use requirement); Weekend
Warrior Trailers, Inc. v. Commissioner, T.C. Memo. 2011-105; sec. 1.168(k)-
1(b)(3)(i), Income Tax Regs. (“[O]riginal use means the first use to which the
property is put[.]”). As explained supra note 20, respondent did not address the
“original use” requirement of sec. 168(k) on brief. Even if respondent had done
so, the record does not establish that anyone used the solar equipment prior to Mr.
Golan.
- 25 -
[*25] Respondent also questions whether petitioners satisfied the fourth
requirement, namely, that the solar equipment was placed in service before
January 1, 2012. Before we address respondent’s argument, we will briefly
summarize the placed-in-service rules.
“Property is first placed in service when first placed in a condition or state
of readiness and availability for a specifically assigned function”. Sec. 1.167(a)-
11(e)(1)(i), Income Tax Regs. We have held that property is not placed in service
until it is ready and available for full operation on a regular basis for its intended
use. Brown v. Commissioner, T.C. Memo. 2013-275, at *31-*32, *36 (citing
Consumers Power Co. v. Commissioner, 89 T.C. 710 (1987)). For example, in
Brown v. Commissioner, T.C. Memo. 2013-275, the taxpayer sought a section
168(k) special allowance for an airplane he purchased in 2003. He took delivery
of the plane in December 2003 but insisted that the plane undergo various
modifications so that it could serve his particular business needs. Although the
plane was fully functional and available to the taxpayer in December 2003, we
held that it was first placed in service in January 2004 upon the completion of the
modifications. We reasoned that, until the modifications were complete, the
taxpayer could not use the plane as he had intended for his particular business
needs.
- 26 -
[*26] With these principles in mind, we return to respondent’s argument.
Respondent argues that, because Mr. Salveson installed the solar panels on the
host properties in 2010, they were placed in service in 2010.22 We disagree.
Section 168(k)(5) applies to property “placed in service by the taxpayer before
January 1, 2012”. (Emphasis added.) Given that Mr. Golan did not purchase the
solar property until January 2011, we fail to see how the property was ready and
available to him for full operation on a regular basis in 2010. See Brown v.
Commissioner, at *31-*32, *36.
Furthermore, there is no evidence that the solar equipment was placed in
service by anyone before 2011. The record establishes that the intended use of the
solar property was the provision of discounted electricity through a net metering
arrangement with the utility company. Accordingly, the solar equipment needed
to be connected to the electric grid. The utility company agreed to the
interconnection for one of the host properties on September 20, 2010. With
22
In order to qualify for the sec. 168(k)(5) special allowance for the year in
issue, Mr. Golan needed to place the solar property in service in 2011. See sec.
168(k)(1)(A) (authorizing the special allowance “for the taxable year in which
such property is placed in service”); sec. 1.168(k)-1(d)(1), Income Tax Regs. (the
special allowance “is allowable in the first taxable year in which the qualified
property * * * is placed in service by the taxpayer * * * for the production of
income.”); see also Rev. Proc. 2008-54, 2008-2 C.B. 722 (rules similar to the rules
in sec. 1.168(k)-1 for “qualified property” apply for purposes of sec. 168(k) as
presently in effect).
- 27 -
[*27] respect to the other two host properties, the utility company agreed to the
interconnection on December 30, 2010. Each of the three interconnection
agreements required, as a precondition to connecting the solar equipment to the
electric grid, the installation of a bidirectional meter. However, the precise dates
of each bidirectional meter’s installation and the interconnection with the electric
grid are unclear.
On the basis of these facts, we conclude that the solar equipment was not
ready and available for full operation on a regular basis for its intended use until it
was connected to the electric grid. It is respondent’s burden to show the solar
equipment was connected to the electric grid before 2011, and he has not done
so.23 The foregoing considered, we hold that Mr. Golan placed the solar
equipment in service in 2011 and that petitioners satisfied the requirements of
168(k)(5).
IV. Section 465
We next decide whether petitioners were at risk under section 465 with
respect to Mr. Golan’s $152,250 promissory note. For the reasons stated supra
part I, respondent bears the burden of proof.
23
From the testimony at trial, we believe the solar equipment began
providing electricity to the host properties in 2011.
- 28 -
[*28] Section 465 limits a taxpayer’s loss deductions only to those amounts for
which the taxpayer is at risk with respect to the activity. A taxpayer is at risk to
the extent of any money and the adjusted basis of any property contributed to the
activity. Sec. 465(b)(1)(A). A taxpayer also is generally considered to be at risk
to the extent that he is personally liable for the repayment of amounts borrowed
for use in the activity. Sec. 465(b)(2)(A). For purposes of the at-risk rules,
however, amounts borrowed from any person having an interest in the activity
(other than an interest as a creditor) are not considered to be at risk. Sec.
465(b)(3).24
The regulations provide that a person has a prohibited continuing interest
under section 465(b)(3) “only if the person has either a capital interest in the
activity or an interest in the net profits of the activity.” Sec. 1.465-8(b)(1), Income
Tax Regs. A capital interest is defined as “an interest in the assets of the activity
which is distributable to the owner of the capital interest upon the liquidation of
the activity.” Id. subpara. (2).
24
Sec. 465(b)(4) provides that “a taxpayer shall not be considered at risk
with respect to amounts protected against loss through nonrecourse financing,
guarantees, stop loss agreements, or other similar arrangements.” Because
respondent did not address the applicability of this provision on brief, we deem it
waived. See Muhich v. Commissioner, 238 F.3d at 864 n.10; 330 W. Hubbard
Rest. Corp., 203 F.3d at 997; Northrop Corp., 21 F.3d at 1168 n.7; Jafarpour v.
Commissioner, slip op. at 11 n.13.
- 29 -
[*29] A person may have an interest in the net profits of an activity even though
he does not possess any incidents of ownership in the activity. Id. subpara. (3).
For example, an employee or independent contractor whose compensation is
wholly or partially determined with reference to the net profits of the activity is
considered to have an interest in the net profits of the activity. Id. Conversely, an
employee or independent contractor whose compensation is based on the gross
receipts of the activity would not be regarded as having a prohibited continuing
interest. See id. subpara. (4), Example (2).
Section 465(b)(3) contemplates fixed and definite rights or interests that
realistically may cause creditors to act contrary to how independent creditors
would act with respect to their rights under the debt obligations in question.25
Levy v. Commissioner, 91 T.C. 838, 868 (1988). That a creditor was a promoter
25
Much of our caselaw on this provision predates the issuance of final
regulations interpreting sec. 465(b)(3) in May 2004. See T.D. 9124, 2004-1 C.B.
901. However, the current definitions of a “capital interest” and “an interest in net
profits” are nearly identical to those in proposed regulations issued by the
Secretary in 1979. See sec. 1.465-8(b), Proposed Income Tax Regs., 44 Fed. Reg.
32239 (June 5, 1979). We have used the text of the proposed regulations as a
guideline in determining whether creditors in transactions had prohibited
continuing interests. See Levy v. Commissioner, 91 T.C. 838, 867 (1988); Larsen
v. Commissioner, 89 T.C. 1229, 1270 (1987), aff’d on this issue sub nom.
Casebeer v. Commissioner, 909 F.2d 1360, 1364-1365 (9th Cir. 1990); Jackson v.
Commissioner, 86 T.C. 492, 529 (1986), aff’d, 864 F.2d 1521 (10th Cir. 1989).
Thus, our pre-2004 caselaw remains useful in interpreting and applying the final
regulations.
- 30 -
[*30] with respect to a particular transaction does not necessarily mean that he has
a prohibited continuing interest in the transaction. Krause v. Commissioner, 92
T.C. 1003, 1024 (1989). We apply these rules to the facts of a transaction as they
exist at the end of each taxable year. Id. at 1025; see also sec. 465(a)(1).
Respondent contends that Mr. Salveson had a prohibited continuing interest
in the solar equipment activity under section 465(b)(3). We disagree. Respondent
has not identified any provision of Mr. Golan’s and Mr. Salveson’s agreement
under which Mr. Salveson would be entitled to the assets of Mr. Golan’s solar
energy venture upon its liquidation. See sec. 1.465-8(b)(2), Income Tax Regs.
Nor has respondent shown that Mr. Salveson had an interest in the net profits of
Mr. Golan’s solar energy venture.26 See id. subpara (3). To be sure, the
promissory note requires Mr. Golan to pay Mr. Salveson all monthly revenue
generated by the solar equipment towards the note. However, Mr. Salveson’s right
to all monthly revenue is a gross receipts interest, which the regulations permit.
See id. subpara (4), Example (2).
26
As stated supra note 8, Mr. Salveson had an option to repurchase the
solar equipment for a five-month period commencing October 22, 2016. Neither
party mentioned the existence of the option at trial or on brief. We deem
respondent’s failure to address the option as a concession that it was not a
prohibited continuing interest. See Muhich v. Commissioner, 238 F.3d at 864
n.10; 330 W. Hubbard Rest. Corp., 203 F.3d at 997; Northrop Corp., 21 F.3d at1168 n.7; Jafarpour v. Commissioner, slip op. at 11 n.13.
- 31 -
[*31] We therefore hold that Mr. Salveson did not have a prohibited continuing
interest in the solar equipment activity under section 465(b)(3). The fact that Mr.
Salveson may have been a promoter of the transaction does not change this result.
See Krause v. Commissioner, 92 T.C. at 1024. Accordingly, because respondent
has failed to show otherwise, we hold that petitioners were at risk with respect to
Mr. Golan’s $152,250 promissory note.
V. Section 469
We next address whether petitioners’ loss and credit attributable to Mr.
Golan’s solar energy venture are subject to the passive activity loss limitations of
section 469. For the reasons stated supra part I, respondent bears the burden of
proof.
Section 469 generally prohibits using a loss from a passive activity to
reduce income from nonpassive activities during any taxable year.27 Sec. 469(a),
(d)(1). In general, a passive activity is a trade or business in which the taxpayer
27
Losses from a passive activity are generally allowed in the year they are
sustained only to the extent of passive activity income. Sec. 469(a)(1)(A), (d)(1).
Credits attributable to a passive activity are generally allowed only to the extent of
the taxpayer’s regular tax liability for the year with respect to all passive activities.
Sec. 469(a)(1)(B), (d)(2).
- 32 -
[*32] does not materially participate.28 Sec. 469(c)(1). A taxpayer materially
participates in an activity when he is involved in the activity on a regular,
continuous, and substantial basis. Sec. 469(h)(1). Participation generally means
all work done in connection with an activity by an individual who owns an interest
in the activity. Sec. 1.469-5(f), Income Tax Regs.
A taxpayer can establish material participation by satisfying any one of
seven tests provided in the regulations. Sec. 1.469-5T(a), Temporary Income Tax
Regs., 53 Fed. Reg. 5725-5726 (Feb. 25, 1988); see, e.g., Miller v. Commissioner,
T.C. Memo. 2011-219. Of these, petitioners assert that the following test is
relevant to this case:
(3) The individual participates in the activity for more than 100
hours during the taxable year, and such individual’s participation in
the activity for the taxable year is not less than the participation in the
activity of any other individual (including individuals who are not
owners of interests in the activity) for such year;
Sec. 1.469-5T(a)(3), Temporary Income Tax Regs., 53 Fed. Reg. 5726 (Feb. 25,
1988).
28
A passive activity generally includes any rental activity. Sec. 469(c)(2).
The Code defines a rental activity as any activity where payments are principally
for the use of tangible property. Sec. 469(j)(8). Respondent does not contend that
Mr. Golan’s arrangement with the host property owners was a rental activity.
- 33 -
[*33] Petitioners maintain that Mr. Golan participated in his solar energy venture
for at least 100 hours in 2011 and that his participation was not less than that of
any other individual.29 Respondent, who bears of burden of proof, has not
established otherwise. We therefore find that petitioners are not subject to the
passive activity loss limitations with respect to Mr. Golan’s solar energy venture
for 2011.
VI. Accuracy-Related Penalty
Finally we consider whether petitioners are liable for an accuracy-related
penalty under section 6662(a). Petitioners argue that they should not be liable for
the penalty because they acted on the advice of their return preparer. Respondent
argues that he met his burden of production with respect to the penalty and that
petitioners have not established that they acted with reasonable cause in relying on
their return preparer.
Section 6662(a) and (b)(2) provides that taxpayers will be liable for a
penalty equal to 20% of the portion of an underpayment of tax attributable to a
substantial understatement of income tax. Section 6662(d)(1)(A) provides that an
29
We found Mr. Golan’s testimony credible. See Diaz v. Commissioner,
58 T.C. 560, 564 (1972) (stating that the process of distilling truth from the
testimony of witnesses, whose demeanor we observe and whose credibility we
evaluate, “is the daily grist of judicial life”).
- 34 -
[*34] understatement of income tax is substantial if the amount of the
understatement exceeds the greater of (1) 10% of the tax required to be shown on
the return or (2) $5,000.
The accuracy-related penalty is not imposed with respect to any portion of
the underpayment as to which the taxpayer shows that he acted with reasonable
cause and good faith. Sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. 438,
448 (2001). Generally, the most important factor is the extent of the taxpayer’s
effort to assess his proper tax liability. Humphrey, Farrington & McClain, P.C. v.
Commissioner, T.C. Memo. 2013-23; sec. 1.6664-4(b)(1), Income Tax Regs.
Reliance upon the advice of a tax professional may establish reasonable cause and
good faith for the purpose of avoiding liability for the section 6662(a) penalty.
See United States v. Boyle, 469 U.S. 241, 250-251 (1985). Whether reasonable
cause exists when a taxpayer has relied on a tax professional to prepare a return
must be determined on the basis of all the facts and circumstances. See
Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 98 (2000), aff’d, 299
F.3d 221 (3d Cir. 2002).
This Court has stated that reasonable cause and good faith are present where
the record establishes by a preponderance of the evidence that: (1) the taxpayer
reasonably believes that the professional upon whom the reliance is placed is a
- 35 -
[*35] competent tax adviser who has sufficient expertise to justify reliance; (2) the
taxpayer provides necessary and accurate information to the adviser; and (3) the
taxpayer actually relies in good faith on the adviser’s judgment. Id. at 99.
The Commissioner bears the initial burden of production. Sec. 7491(c);
Higbee v. Commissioner, 116 T.C. at 446-447. The Commissioner’s burden of
production under section 7491(c) includes establishing compliance with the
supervisory approval requirement of section 6751(b).30 Graev v. Commissioner,
149 T.C. ___, ___ (slip op. at 14) (Dec. 20, 2017), supplementing and overruling
in part 147 T.C. 460 (2016); see also Chai v. Commissioner, 851 F.3d 190, 222
(2d Cir. 2017) (citing Higbee v. Commissioner, 116 T.C. at 446). If the
Commissioner satisfies his burden, the taxpayer then bears the ultimate burden of
persuasion. Higbee v. Commissioner, 116 T.C. at 446-447.
Assuming (without finding) that respondent has met his burden of
production in the instant case, we nevertheless conclude that petitioners carried
their burden with respect to reasonable cause and good faith.31
30
Sec. 6751(b) requires written supervisory approval of the initial
determination of certain penalties.
31
Because we hold that petitioners acted in good faith and with reasonable
cause, we need not decide whether respondent carried his burden of production
under sec. 7491(c).
- 36 -
[*36] Mr. Klarin, petitioners’ C.P.A., prepared their 2011 joint Federal income tax
return. On the basis of the record before us, we find that Mr. Klarin had sufficient
expertise to justify petitioners’ reliance, that petitioners provided him with
necessary and accurate information, and that petitioners relied upon him in good
faith. At trial respondent’s counsel acknowledged that Mr. Klarin is a “qualified
professional”. We view this statement as a concession that Mr. Klarin had
sufficient expertise to justify petitioners’ reliance. Furthermore, Mr. Klarin
credibly testified that he met with Mr. Golan to discuss the solar venture on at
least four occasions and that petitioners provided him with all the information he
needed to prepare their return. We are also satisfied from Mr. Golan’s credible
testimony that petitioners relied on Mr. Klarin in good faith.
In sum, the record as a whole establishes that petitioners made a good faith
effort to assess their proper tax liability and reasonably relied on the advice of
their return preparer. We therefore hold that petitioners are not liable for the
accuracy-related penalties.
In reaching all of our holdings herein, we have considered all arguments
made by the parties, and to the extent not mentioned above, we find them to be
irrelevant or without merit.
- 37 -
[*37] To reflect the foregoing,
Decision will be entered under
Rule 155.