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IRS: reasonable cause requires legal inquiry.

Although the Tax Court agreed with the IRS in PateL, 138 T.C. No. 23 (2012), that taxpayers improperly deducted the value of a. house they donated to a fire department to burn for training, the court overturned the IRS's imposition of an accuracy-related penalty against the taxpayers in the case.

In Action on Decision 2012-005 issued Jan. 17, the IRS said it will not acquiesce to the Tax Court's finding in Pate/that, with regard to the accuracy-related penalty under Sec. 6662, the taxpayers acted with reasonable cause and in good faith (see Tax Matters, "No Deduction for Bringing Down the House," Oct. 2012, page 63).

On the charitable deduction, the court found that under state law, the taxpayers' land included the house and any other structures and fixtures on it. Because the taxpayers retained title to the land after the fire department destroyed the house, if the donation was a real property interest at all, it was a partial interest. Finding that none of the categories qualifying as deductible contributions of partial interests in property under Sec. 170(f)(3)(B) applied, the court upheld the disallowance of the deduction.

Regarding the penalty, the court said that when the Patels filed the return at issue, in 2006, the legal issues were unsettled. In Scharf, T.C. Memo. 1973-265, the Tax Court had allowed a similar deduction, but for a contribution made before 1969, when Congress enacted the restrictions on contributions of partial interests in property. After the Patels filed their return, the Tax Court held against tax-payers on similar facts in Rolls, 135 T.C. 471 (2010), aff'd 668 F.3d 888 (7th Cir. 2012). Given the Patels' facts and circumstances, including the uncertain state of the law at the time, the court said, they acted with reasonable cause and in good faith and were not liable for the penalty.

In the action on decision, the IRS said the court should not have concluded the uncertain state of the law was a factor supporting reasonable cause and good faith without considering whether the Patels investigated the current state of the law, including whether they sought competent professional advice. According to the IRS, "A taxpayer cannot act in good faith and have reasonable cause on the basis of the unsettled state of the law if the taxpayer was unaware of the state of the law and did not make reasonable attempts to become aware."
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Publication:Journal of Accountancy
Date:Apr 1, 2013
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