Tax Research Case 4

ACCT 5318

Tax Research – Case 4

Fall 2011

Senergy, Inc. is an international company that builds, installs and maintains solar energy generators for large companies and communities around the world. The company’s headquarters are located in Tuscon, Arizona. The company tries to promote from within to build and train its executive team. Most executives work two or three year rotations in several locations around the world. Where possible, they do one of those rotations in the Tuscon office. To minimize the cost to its executives of moving, the company has a contract with a relocation company under which the relocation company will buy an executive’s home at its appraised value, list the home with a professional real estate agent, and sell the home as quickly as possible. The contract with the relocation firm calls for Senergy to reimburse the firm for all costs incurred to purchase and sell the home, including repairs and maintenance, make-ready expenses to prepare the home for sale, realtor commissions, etc. If the relocation company sells the home for less than the amount it paid the executive to purchase the home, Senergy will reimburse the company for its loss. If the relocation company sells the home for more than it paid to purchase the home from the executive, the excess proceeds from sale are paid to the executive. The relocation company’s fee is computed as a percentage of the ultimate selling price of the home.

This arrangement has proven to be very popular with executives. They do not have to wait to sell their home before purchasing another one in their new location. Moreover, any concerns that the relocation company may intentionally undervalue the house are alleviated because the relocation company benefits from selling the house at the highest price it can negotiate. Finally, any excess proceeds from sale of the house (before payment of the relocation company’s fee by Senergy) go to the executive.

In early 2008, Senergy transferred one of its young executives overseas. In accordance with the above program, the relocation company engaged an approved appraisal company to estimate the market value of the home. The appraiser estimated the home’s value at $850,000. The executive has the right, of course, to refuse an offer from the relocation company and try to sell the home on her own. However, she agreed that $850,000 was a fair price for the home and sold it to the relocation company, realizing a $350,000 gain which she properly reported on her individual tax return.

The relocation company spent about $8,000 preparing the home for resale and promptly listed it with a real estate agent. After several months, the realtor recommended that the price of the home be dropped and the relocation company agreed. Eventually, in early 2009, the home was sold for $650,000. After payment of closing costs, the realtor’s commission, etc., the relocation company received just over $600,000. In accordance with its contractual obligations, Senergy reimbursed the relocation company $250,000 for its loss on the sale. On its 2009 tax return, Senergy deducted the $250,000 payment as compensation expense. However, it did not increase the amount reported as compensation to the executive on her Form W-2 for 2009. The IRS has recently finished a preliminary audit of Senergy’s 2009 corporate tax return and has disallowed the $250,000 deduction, citing Azar Nut Co. v. Comm. (67 AFTR 2d 91-987) and asserting that the $250,000 loss is a capital loss incurred on resale of the house. As a corporation, Senergy cannot deduct excess capital losses (i.e., capital losses in excess of capital gains). With penalties and interest, the deficiency with respect to this one item is over $100,000. Senergy has hired us to determine how the “loss” should have been treated on the company’s 2008 tax return. Your senior, who reports to me, believes she saw a Revenue Ruling recently that addressed this type of transaction, but she cannot remember any details. I have a meeting with the Revenue Agent one week from Monday and need to know whether we have any basis for challenging this assessment. Please write a memo to the file analyzing the tax consequences of the transaction by Wednesday.