Earnest Money Contract & Sec. 121 Eclusion

[WhiteOleander]

Does the FMV of a residence have to be determined by an appraisal?

Have a client that has his residence on about 60 acres. He has been using approx. 50 acres ranching on Sch F. 10 acres allocated to the residence.

He has an offer to buy his place. $485,000. The house would probably be appraised for about $100,000. (maybe $120,000.) The remaining $385,000 could not qualify for the Sec 121 exemption.

So, if they write in the earnest money contract that the house and 10 acres is being sold for $300,000 and the remaining 50 acres and two barns for $185,000, can this be valid evidence for using Sec. 121 to exclude the $300,000 from taxable income?

It coud be argued that it is a willing seller, a willing buyer, with each party having all knowledge etc. of the sale and therefore sets the FMV of the property.

Since the earnest money contract is a legal binding contract, I think it can be used to set the value. I don't think the buyer will care because I don't believe he plans to do any Sch F activity.

Thanks for your thoughts.

[jainen]

Are you asking

Are you asking board members if it's okay to file a fraudulent return as long as you put together some convincing documents? Well, my vote is no, but let's see what others say.

By the way, the $300,000 wouldn't be "taxable income" in any case. Only the capital gain is taxable.

[WhiteOleander]

No Jainen it is never my goal to file a fraudulent return. I just want to know if appraisals are the only way to establish the FMV.

As has been mentioned in previous posts, even appraisals can vary considerably on the same piece of property. So, are they the only way to determine the value?

What if they got an appraisal for the $300,000? The IRS can't say we don't like that appraisal. Get another one.

So, if the value is established in the earnest money contract, can that be used legitimately?

[jainen]

to establish the FMV

>>The IRS can't say we don't like that appraisal<<

Of course they can. They do it all the time.

>>if the value is established in the earnest money contract<<

That's fine, but it's not what you asked about in original post. You asked about wording the contract in a way that would disguise the true value established otherwise, for the purpose of evading taxes.

>>I just want to know if appraisals are the only way to establish the FMV.<<

No, a formal appraisal is not the only way to establish the FMV.

[OldJack]

The 2006 Pension protection Act changed the appraisal rules and valuation overstatement penalties effective August 19,2006.

The old law imposed accuracy-related penalties on a taxpayer in cases involving a substantial valuation misstatement or gross valuation misstatement relating to an underpayment of income tax. For this purpose, a substantial valuation misstatement generally meant a value claimed that was at least twice (old 200% or more/ new law 150% or more) the amount determined to be the correct value, and a gross valuation misstatement generally meant a value claimed that was at least four times (old 400% or more/ new law 200% or more) the amount determined to be the correct value.

The penalty was 20% of the underpayment of tax resulting from a substantial valuation misstatement and rose to 40% for a gross valuation misstatement. No penalty was imposed unless the portion of the underpayment attributable to the valuation misstatement exceeded $5,000 ($10,000 in the case of a corporation other than an S-corp or Personal Holding Corporation) (PHC). Also, no penalty if understatement was supported by substantial authority or facts were adequately disclosed on the tax return with a reasonable basis for the tax treatment (reasonable cause not accepted in the new law).

Also, a penalty of $1,000 ($10,000 for corp) was imposed on anyone aiding or assisting with respect to the tax return (read tax preparer).

[Bird Legs]

Question

How did your client acquire the property and when?
Buy it, inherit it, gift?

[WhiteOleander]

How did your client acquire the property and when?
Buy it, inherit it, gift?

He purchased it probably about 25 years ago.

Thanks Old Jack for that info.

So, I guess it is agreed that the earnest money contract cannot establish the FMV.

[OldJack]

So, I guess it is agreed that the earnest money contract cannot establish the FMV.

Well sure it can if the values stated in the contract are FMV. FMV is generally a "fact" and not a statement or contract. Farm land generally has a price per acre that is known in every local and then there are the buildings or other things to value. Fair-market-value is going to be close to that reasonable concept.

[Davc]

Well sure it can if the values stated in the contract are FMV. FMV is generally a "fact" and not a statement or contract. Farm land generally has a price per acre that is known in every local and then there are the buildings or other things to value. Fair-market-value is going to be close to that reasonable concept.

Also, you can't assume that only 365K is sale of farmland even if 100K is the FMV of the residence. The land may be worth 400K in which case 80% of the sale is of the land, 20% is the residence. The residual value approach does not apply.