For the benefit of any future readers, this post contains the reasoning and authorities that lead me to conclude I do not (yet) have a reporting duty, nor tax liability for the rents I've collected from abandoned Real Estate. On Jan. 16, 2020 I replied with the following on Nicholas Aiola's long running "Ask me (a CPA) Anything Post.
https://www.biggerpockets.com/forums/51-tax-legal-issues-contracts-self-directed-ira/topics/517982-ask-me-a-cpa-anything-about-taxes-relating-to-real-estate?page=53
I had made some changes and asked his opinion. Nick is ever kind and professional. He'll probably be my first pick for a remote CPA, but this time he declined to offer an opinion. For those who wonder what authority I rely upon, here it is.
@Nicholas Aiola, Thanks for your reply and sending good luck. You did respond to a similar question in a different post cited below (page 4), as did several other tax professionals. The essence of your own comment was;
"It doesn't matter that you "haven't spent a dime" of the money collected ... because, ... money went into YOUR bank account as a result of YOUR business activity." Emphasis in your original post, -No authority given.
The other tax professionals who replied, offered varying rationales (some citing; the totality of the circumstances test, or constructive receipt, or economic performance test, transferee liability, economic benefit, etc.) and a few pros offered rationales similar to yours (“if you're renting property you're controlling that's your income to report”). Even though each professional arrived at the same conclusion you did, (that I have a duty to report the rents and a tax liability for them), no one provided applicable authority. It is the lack of authority and lack of consistency in the legal analysis that I found troubling. It seemed worth trying again.
Perhaps you did not notice, but based on the replies received in my other post, https://www.biggerpockets.com/forums/51/topics/743817-unusual-tax-question-is-this-money-for-nothing-is-it-tax-free?page=1 I went ahead and created structures (a Trust, and LLC's) that now completely separate the rents I've collected from my own accounts. Now, once the rents I collect from abandoned real estate are deposited into segregated accounts I no longer have access to them. The only way I'll get them is by court order. I have also dropped any hope of borrowing from the accounts in which they are held.
Thus, even if I have learned nothing else, you and the other tax professionals of BP, have moved me toward a more professional handling of the rental income that I am collecting from abandoned properties.
The following analysis, and the authorities provided, are the result of input from you and others on my prior post. My analysis is included here with no expectation of response. It is provided for your review, or not, with the idea that the authorities used and conclusions drawn may help other readers to understand the rationale for my position that; I have neither a reporting duty nor an income tax liability for the rents I’ve collected. The only authorities I’ve found, require individuals to pay tax on, and to report, only their own income. Here are the citations.
I understand that the IRS may presume that all money deposited in my bank accounts during a given period constitutes taxable income. Bank deposits provide prima facie evidence of income. Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).The IRS is not required to prove the likely source of the income. Estate of Mason v. Commissioner, 64 T.C. 651, 657 (1975), affd. 566 F.2d 2 (6th Cir. 1977). It is the taxpayer (me) who shoulders the burden of establishing that bank deposits “should be excluded from income or allowed as deductions.
However, even when I was depositing the rents directly into my own bank account, the fact that I possessed the rents did not conclusively create a tax liability for me. When proper documentation is presented the Government must take into account any nontaxable source (the unused property of another person) or deductible expenses regarding bank deposits.DiLeo v. Commissioner, 96 T.C. 858, @868 (1991), affd. 959 F.2d 16 (2d Cir. 1992).
Merely holding the funds of another person in my own account is generally not a taxable act.
- "[A] taxpayer need not treat as income moneys which he did not receive under a claim of right, which were not his to keep, and which he was required to transmit to someone else as a mere conduit."
- Diamond v. Commissioner, 56 T.C. 530, 541 (1971), affd. 492 F.2d 286 (7th Cir. 1974).
In my instance, I am not receiving rents under a claim of right, the rents are not mine to keep, and I am required to transmit them to the owner (upon demand). In interpreting what constitutes a claim of right the IRS has stated;
- Section 1341 of the Internal Revenue Code (“Computation of tax where taxpayer restores substantial amount held under claim of right”) The claim of right section applies only when a taxpayer properly reports an amount of income in one taxable year and later repays all or a portion of that same amount in a later taxable year because the taxpayer, in fact, did not have an unrestricted right to that income. Rev. Rul. 2004-29
I need not treat the rents I collect as income because I am acting as a mere conduit and to the property owner. However, since the property owner(s) or heirs are currently unavailable to accept delivery, I am holding the rents in what amounts to a constructive trust. The trust doctrine can apply even though the arrangement does not constitute a trust under state law.
- “[T]here are no specific words of trust in the present case but we conclude . . . that as to all funds received a trust was created…”
- Ford Dealers Advertising Fund, Inc., 55 TC 761, Dec. 30,654, aff’d, CA-5, 72-1 USTC 9228, 456 F2d 255, nonacq., 1974-2 CB 5, and 1974-2 CB 64
In order to avail oneself of the “trust” doctrine, a taxpayer must satisfy two requirements. First, the taxpayer must show that he has a legally enforceable obligation to pay the amount received for a specified purpose (the rents I’ve collected are the lawful property of the owner). The second requirement of the “trust fund” doctrine is that the taxpayer must be obligated to spend (or preserve) the received funds for the benefit of someone other than the taxpayer.
- Ford Dealers Advertising Fund, Inc., 55 TC 761, Dec. 30,654, aff’d, CA-5, 72-1 USTC ¶9228, 456 F2d 255, nonacq., 1974-2 CB 5, and 1974-2 CB 64 (Holding that payments received by a corporation from Ford dealers with the agreement to spend the funds on advertising, constituted funds held in trust, and were not income to the Corporation and setting two basis for their holding.)
In considering various doctrines dealing with the funds received for another, tax law researcher John B. Palmer observed;
- “While the “claim of right” doctrine, the receipt of deposits cases, and the agency, conduit and trust fund authorities all deal with different situations, they have as a common premise the notion that a payment cannot be income if the taxpayer does not have the power to control whether it will retain the payment.”
- Quoted from the Conclusion of - Tax Accounting; By John B. Palmer III, Jan & Feb 2009 “When Can Payments Subject To An Offsetting Obligation Be Excluded From Income?”
It cannot rationally be said that I have the lawful power to retain income which the law specifies to be the property of another person. My actions qualify as holding these rents in trust. It is only in very limited contexts, such as assignments of income that;
- “The power to dispose of income is the equivalent of ownership of it.” -and will be benefit enough to trigger taxation. Helvering v. Horst, 311 U.S. 112, 118, 61 S.Ct. 144, 147, 85 L.Ed. 75 (1940).
However, Court's ruling in Helvering is not applicable to my situation, nor to any trust situation, where the rents are neither acknowledged nor claimed as mine, and therefore there can be no attempt by me to assign the income (rents) to anyone else.
The only circumstance, in which the Courts will hold one individual liable to pay tax on income lawfully belonging to another, is when the taxpayer uses the other person’s income as though it were his own. An enlightening example, is the owner of a corporation diverting unreported corporate funds to a safety deposit box, mixing in his own funds, and then spending $10’s of thousands of the corporate funds for his own personal investments, and use.
- “(W)hen cash, as here, is delivered …in a manner which allows the recipient freedom to dispose of it at will [it is income to the user], even though it may have been obtained by fraud and his freedom to use it may be assailable by someone with a better title to it");
- Dawkins v. Commissioner of Internal Revenue, 238 F.2d 174, 178 (8th Cir.1956) (citing Rutkin.
According to the IRS itself, tax is imposed on the reporting individual’s own income;
- “In most cases, you must include in your gross income all amounts you receive as rent.” IRS Publication 527 Rents (Emphasis mine)
In my case the ownership of the income at issue (rents) is controlled by State law. Here is what the currently valid ruling of the Washington State Supreme Court says regarding the rents I have collected.
- “This opinion but states the obvious. Persons who take possession of real property (the property in question happened to be a store building) without consent of the owner are deemed to be tenants by sufferance, and will be required to pay reasonable rent for the time they actually occupied the premises.”
- Howard v. Edgren, 385 P.2d 41, 62 Wash. 2d 4 (1963) Citing RCW 59.04.050
And here is the Statute which our Supreme Court interpreted in the case cited above.
- “Whenever any person obtains possession of premises without the consent of the owner or other person having the right to give said possession, he or she shall be deemed a tenant by sufferance merely, and shall be liable to pay reasonable rent for the actual time he or she occupied the premises, and shall forthwith on demand surrender his or her said possession to the owner or person who had the right of possession before said entry, and all his or her right to possession of said premises shall terminate immediately upon said demand.” RCW 59.04.050 Tenancy by Sufferance
Further the Washington State ejectment statute holds that rents from real property can be themselves “real property” and belong exclusively to the owner of record. Even a mortgage holder, is not entitled to rents from real estate until a foreclosure has been completed.
- Mortgagee cannot maintain action for Possession, (or) to collect mortgaged, pledged, or assigned rents and profits
- “Until paid, the rents and profits of real property constitute real property for the purposes of mortgages, trust deeds, or assignments whether or not said rents and profits have accrued. The provisions of RCW 65.08.070 [requiring conveyances of interest in rents to be recorded] as now or hereafter amended shall be applicable to such rents and profits, and such rents and profits are excluded from *Article 62A.9 RCW. [Creating Rights for Secured Parties]” RCW 7.28.230
Since, the laws of my state specify that the rents I collect without the consent of the owner constitute real property which belongs to the owner -no matter who collects them, it is hard to see how I could claim them, or be liable for tax on them. In WA State, ownership of the rents is not determined by who did the work (the business activity), but by Statute.
While the rents are certainly income, -they are income only for the property owner. As a matter of law, they are not my income. I have not stolen them (which requires an intent to deprive the owner of them). And I have not used them (which would create a tax liability for me).
- “[I]f (the taxpayer) received an economic benefit from the Swiss Funds, they are liable for tax on at least whatever benefit they received.”
- Rutkin v. United States, 343 U.S. 130, 137, 72 S.Ct. 571, 575, 96 L.Ed. 833 (1952)
The fact that I may expect or hope to eventually acquire ownership of the rents still does not create a current reporting duty or tax liability on me. The rents are the current property (unrealized income) of another person. Indeed, it would take a court decision to transfer title of the property or of the rents to me. If a court should so decide, only then would the rents become my income.
- “The liability for income tax ultimately can be fairly determined without resort to mere estimates, assumptions, and speculation. When the profit, if any, is actually realized, the taxpayer will be required to respond.” Commissioner v. Logan 283 U.S. 404, 51 S.Ct. 550, 75 L.Ed. 1143
Based on the above authorities, I am liable only for tax on my income. The rents I collect and hold in trust from abandoned real estate are lawfully the property (income) of the owners on title. I can find no Statute, regulation, or court case that creates a reporting duty or tax liability on me for the rents that I collect for another person, -unless, I use those funds for my own benefit. Anyone can help me out, if they can show, why this reasoning is faulty, or the authorities relied upon, are inappropriate.
Other authorities.
- We the people granted our government authority to tax “income” (not business activity).
- “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived,…” 16th Amendment to the US Constitution
Our elected representatives then gave the IRS authority to tax “income” (not business activity.)
- “There is hereby imposed on the taxable income of every individual … a tax determined in accordance with the following table:” 26 USC Sect 1 Tax on Individuals: (c)
Our Congress further defined what “taxable income” is;
- “gross income less allowable deductions”, 26 USC Sect 63.
And “Gross Income” is defined as;
- “all income from whatever source derived”, 26 USC Sect 61.
Which specifically includes rents.
- “Gross income includes rental income received or accrued for occupancy of real estate.”
- 26 CFR Sect 1.61.8 (a) Rents; & 26 USC Sect 61.1 (a)(5) Rents
