Repayment of First Time Homebuyer Credit

[Kram BergGold]

This is a new client. She bought house in 2008. Sold house in 2014. From 2010-13 she paid back $2,000 to IRS. As of now she has a $5,000 gain so she owes $5500. In addition to the improvements that she has records of she paid a man X amount in cash. I would assume IRS would allow some kind of Cohan rule here. My fear is if they disallow the cash payments there will be an accuracy related penalty. Any thoughts or comments?

[ATSMAN]

This is a new client. She bought house in 2008. Sold house in 2014. From 2010-13 she paid back $2,000 to IRS. As of now she has a $5,000 gain so she owes $5500. In addition to the improvements that she has records of she paid a man X amount in cash. I would assume IRS would allow some kind of Cohan rule here. My fear is if they disallow the cash payments there will be an accuracy related penalty. Any thoughts or comments?

If she indeed paid someone in cash she better have a receipt! No one in their right mind will pay cash and not get some sort of receipt. How much was the cash payment?

Assuming she did get a receipt but lost it, does she have any other evidence like a contract, bills for materials, permits etc. to recreate the cost of the job.

Without that I would strongly advise her the possibility of an accuracy related penalty if it is disallowed.

[TaxGuyBill]

This MIGHT be off on a tangent, but I'm not sure. Maybe I'm missing something, but the numbers don't seem right.


Does the 'gain' include the basis adjustment for the Homebuyer credit (see Part 3 of Form 5405)?

If it does include that basis adjustment, wouldn't they only owe $5000 back (not $5500)?

If it did not include the basis adjustment, then the gain would be $10,500. To start reducing the payback, there would need to be OVER $5000 in 'extra' cost of improvements. Did she really pay over $5000 in CASH?

[Kram BergGold]

More information

My client estimates that she spent $15,000 in cash for addtional improvements. This is $5,000 more than is needed to reduce the gain so that no part of the $5500 homebuyer credit has to be repaid. There is absolutley no proof of this expenditure. Just the testimony of the owner, a 69 year old single woman. Based on how the conversation has gone with her, I believe her. But, is this enough to pin our hopes on a Cohan type argument?

[ATSMAN]

My client estimates that she spent $15,000 in cash for addtional improvements. This is $5,000 more than is needed to reduce the gain so that no part of the $5500 homebuyer credit has to be repaid. There is absolutley no proof of this expenditure. Just the testimony of the owner, a 69 year old single woman. Based on how the conversation has gone with her, I believe her. But, is this enough to pin our hopes on a Cohan type argument?

If I were you I would NOT give her any hope that she can "hang her hat" on a Cohen type argument. If she is audited it may open up other areas that could be troublesome.

She would be better off repaying a portion of the credit and not inviting any unwanted attention.

[spanel]

This is a new client. She bought house in 2008. Sold house in 2014. From 2010-13 she paid back $2,000 to IRS. As of now she has a $5,000 gain so she owes $5500. In addition to the improvements that she has records of she paid a man X amount in cash. I would assume IRS would allow some kind of Cohan rule here. My fear is if they disallow the cash payments there will be an accuracy related penalty. Any thoughts or comments?

I'm guessing you have the wrong purchase date as 2008 was the year they didnt have to pay any credit back.

Chris

[TaxGuyBill]

I'm guessing you have the wrong purchase date as 2008 was the year they didnt have to pay any credit back.

Chris

2008 is the ONLY year that usually does need to be paid back. The other years don't need to be repaid if they lived there for a certain amount of time (3 years?).


I agree with ATSMAN. If there is no evidence at all (not even building permits), I would disallow it if I was the IRS auditor.

If she paid somebody that much money in CASH and with no building permits, it extremely probable the man she paid is hiding his income from the IRS. The way I see it, by paying that much in cash, she would be assisting him in his tax evasion. If I was the auditor and saw that, I would 'put her through the wringer' and make her prove absolutely everything on her tax return.

[spanel]

2008 is the ONLY year that usually does need to be paid back. The other years don't need to be repaid if they lived there for a certain amount of time (3 years?).


I agree with ATSMAN. If there is no evidence at all (not even building permits), I would disallow it if I was the IRS auditor.

If she paid somebody that much money in CASH and with no building permits, it extremely probable the man she paid is hiding his income from the IRS. The way I see it, by paying that much in cash, she would be assisting him in his tax evasion. If I was the auditor and saw that, I would 'put her through the wringer' and make her prove absolutely everything on her tax return.

Sorry had it backwards!

Chris

[David1980]

Hmm, if I was trying to defend that in an audit... I'd look for something to show the auditor to try to convince them it actually existed at all. That's a lot of cash, and it just happens to completely eliminate the repayment of the FTHBC. I'd suspect it was completely fabricated and from that view try to disallow it.

Building permits, before/after pictures of the improvements, pretty much anything at all that might show it's not a number made up to avoid tax? Most of my clients if they spent $15,000 on home improvements would have have plastered it all over their facebook accounts along with everything else about their lives.

[DaveinTexas]

Maybe the norm

My Father in Law has renovated, built, repaired, improved commercial structures, apartment complexes, single family homes, duplexes, condos, you name it for over 40 years. He worked about half of that time for the public as a self employed handyman. The stories he has told me (like a woman that had an entire room of bunnies and hay on the floor).

Anyway, he has told me numerous times that he would bid and perform a job for $10K, $12K, even $20K and the client/homeowner would pay him in cash. Don't ask me if he claimed the income because this was before I knew him. The ones that would pay in cash.....older folks, and mostly women. When I say older, I mean over 65 (sorry to anyone over 65). He said they paid in cash because that is the way they were raised (this was in the 80's by the way). Pay cash and don't use credit cards. Why wouldn't she pay with a check? Would you hand over your bank account number to a stranger? You can easily re-print checks with the same account number, wash the check, fraud, etc. And $15,000 isn't a lot of money. You can spend that on a bathroom. We're building a home and it cost us $700 for all of our switches and plugs! One plug in particular cost $20 (GFCI plug).

My point is, why deny a deduction (in this case a basis increase) to the client simply because she paid in cash? Is a deduction invalid because she paid in cash and she has no receipt? Couldn't she show a recent withdrawal of funds from her bank account (within the past year or so)? Could she prove the improvements with before and after pictures? My Mother (65 years old) loves taking pictures. I'm sure this woman took plenty of pictures of before and after the work was completed. Also, if push came to shove, she could attempt requesting a hand written receipt from the contractor that performed the work.

And by the way, this is IF the return is selected for audit would she have to produce these records. Don't be afraid of something that may never happen BUT don't expect to win the audit (if it comes) with the records she doesn't have. I wouldn't give up so easily on this case.

By the way, she may live in an area where city building permits are not required (I do) or if she hired a handyman, typically these guys don't go the permit route because they use this as a bargaining chip to do the work for a lessor price than the competition (Lowes/Home Depot contractors). I'm not saying this is ethical, but it is reality. I wouldn't be afraid of an audit, especially since this woman lives alone and she is 69 years old. Now if the client was male, he's lyin'. I'm just sayin'.

[ATSMAN]

>> I wouldn't be afraid of an audit, especially since this woman lives alone and she is 69 years old. Now if the client was male, he's lyin'. I'm just sayin'.

Do you prepare your client that without substantiation of cash payment there is almost a 100% chance that the IRS will disallow the deduction and additional taxes and penalties will apply, upon audit. It is not the taxes that make people mad but the interest and penalties!

How do you answer your client when they ask what are the chances they will get audited?

[DaveinTexas]

Documentation

>> I wouldn't be afraid of an audit, especially since this woman lives alone and she is 69 years old. Now if the client was male, he's lyin'. I'm just sayin'.

Do you prepare your client that without substantiation of cash payment there is almost a 100% chance that the IRS will disallow the deduction and additional taxes and penalties will apply, upon audit. It is not the taxes that make people mad but the interest and penalties!

How do you answer your client when they ask what are the chances they will get audited?

If you have represented clients before the IRS, you know there is always more than one way to prove a deduction. What if this woman requested a hand written receipt and an affidavit from the contractor stating he received X amount of money in cash for the performance of an improvement contract? I represented a client that had her contractors (she owned a construction company and kept horrific records) sign affidavits stating the same and the auditor allowed it. This auditor had 28 years experience. Would her contractor agree to do this? We don't know. Also, if the woman paid the contractor in cash, who is to say this contractor wasn't someone whom she trusted implicity? Like a family member or a very good friend of a family member? In this case, it may be very simple to obtain a receipt.

Almost 100% chance, I'll take those odds. First I warn the client that if her return is selected for audit, the IRS will require substantiation for the improvements. If she asks me what records she will need, I will list all of the items I mentioned above and in my previous post. It's her return, I will alert her of the risks and if I feel comfortable reporting the basis adjustment as she described, then I would do it. I would also make notes in the file detailing our conversation (I would even let the client see what notes I am typing in her file so we are all on the same page).

This woman is 69 years old, she doesn't own her own business so she probably isn't aware of the requirement to substantiate her expenses; giving her the benefit of the doubt I suppose. And you know, being 69 years old and paying cash to a contractor that does a great job on her home, not that uncommon I would say.

My point is, don't give up so easily. Would I file the return with the story she told? Maybe, but not before I thought it out in the manner I described. I might even want a few days to think on it whilst she goes on an Easter Egg hunt for all of the items I mentioned. She may need to convince me a bit more as this would be a large adjustment if she failed the test, plus an accuracy related penalty and interest (she would owe about $7,000 if she couldn't produce substantiation) so thsi is not a light decision to make.

[ATSMAN]

I guess I am not as aggressive as you are DaveinTexas.

Cohan type arguments generally don't hold up based on what I have read so far.

[DaveinTexas]

I'm really not

I guess I am not as aggressive as you are DaveinTexas.

Cohan type arguments generally don't hold up based on what I have read so far.

I am really not aggressive, not as much as I used to be. I just wanted to give the OP some alternative ideas as to how to treat the situation. I was, however, serious about the thought process. We don't always have to side with the client but we have to at least try to be creative sometimes and within reason.

Would Karen Hawkins (whom is speaking for 2 hours in a seminar I am attending this Wednesday) deny this deduction on its face without substantiation? Most likely yes. Could her department penalize me for acting reasonably, questioning the client, requesting further documentation, coming up with an approach to re-creating alternative records? Maybe I'll ask her on Wednesday.

By the way, this guy might argue with you regarding the applicability of the Cohan Rule: http://www.howardlevyirslawyer.com/2...t-the-expense/

I'm really not trying to be argumentative, really I am just playing devil's advocate a bit but truly trying to help the OP with this case. And I know the Tax Court gives latitude to the Cohan Rule, but also requires some semblance of expense connection and substantiation. "We generally will not estimate a deductible expense unless the taxpayer presents sufficient evidence to provide some basis upon which an estimate may be made. Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). This 69 year old client still has some work to do to convince me of the deduction.

My post isn't about being aggressive, or I should say that is not its intent, merely I am trying to come up with a solution to the problem.

[Roland Slugg]

Part of the OP asked about the Cohan "rule." I would like to comment on that as well as chime in on the debate regarding whether or not to advise the client to claim the additional basis for her undocumented improvements.

I would assume IRS would allow some kind of Cohan rule here.

You should not assume that at all. First of all, the Cohan "rule" is not a "rule" at all. The reference is to a 1930 Appeals Court case in which the judge (Judge Learned Hand) allowed a taxpayer (George M. Cohan) a deduction for a portion of his claimed business expenses for which he had no receipts or other proof. Since then a few taxpayers have won minor court victories by asserting the same idea, but those victories are relatively few, and the amounts allowed by the courts are generally a small fraction of the amounts claimed by the taxpayers. Secondly, the IRS never allows any deductions based on the Cohan case. That precedent has only been followed in a relatively small number of court cases, and usually for what I would characterize as token amounts. Also, the Cohan concept is generally believed to apply only for business expenses, under Code §162, where receipts are not always readily available. I believe it would be very difficult, if not impossible, to win on that argument when a capital expenditure is involved. It may be possible, but I would never assume that, and I would not advise a client to rely on that.

What I do in situations like the one described in the OP is to accept my client's word regarding the cost or basis of something he claims to have paid for but can not prove. I am not an IRS auditor, and it is not my responsibility to require my clients to prove to me all the expenses they claim to have incurred and paid, whether those costs are for deductible expenses or represent capitalized costs, as in the case here. Instead I advise the client that in the event of an audit, if the IRS seeks proof of the house's basis, and the taxpayer can not provide that proof for some of the claimed improvements, then the IRS may, and probably will, disallow those costs, and that disallowance may, in turn, result in additional taxes owed ... along with P&I. I would also advise the client that the IRS may also propose the 20% accuracy penalty based on negligence. At that point, having armed my client with sufficient information regarding the possible risks (and benefits), I would let him make the decision. In a case like the one presented in the OP, I would probably also ask the client to sign a statement ... perhaps on the same sheet listing the added improvements and costs ... that they represent his best estimate of actual sums paid by him for the improvements listed.

I would not be an advocate either for or against using those costs, but would instead seek to advise the client of the rules and let him decide what to do.