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TAX MATTERS

What is an item of property?

 

By Charles J. Reichert, CPA
November 2012

The Tax Court held the IRS properly recharacterized income generated from the rental of semi truck tractors and trailers as nonpassive under the self-rental rule, since each tractor or trailer was considered an item of property under Regs. Sec. 1.469-2(f)(6).

Generally, taxpayers’ passive losses are currently deductible only to the extent of their passive income. Rental activities are generally considered passive; however, any net rental income generated from renting an item of property to a business in which the taxpayer materially participates is considered nonpassive under the self-rental rule of Regs. Sec. 1.469-2(f)(6).

In 2005, Joseph Veriha was the sole owner of, and materially participated in, John Veriha Trucking (JVT), a trucking company in Wisconsin. In addition, Veriha was the sole owner of JRV Leasing LLC (JRV) and owned 99% of the stock of Transportation Resources Inc. (TRI). JRV and TRI generated all of their income in 2005 by leasing semi truck tractor and trailer units to JVT. Each individual tractor unit or trailer unit was rented under a separate lease agreement to JVT. Because of the leases in 2005, TRI produced a net profit, while JRV had a net loss. Veriha and his wife treated the net profit from TRI and the net loss from JRV as passive on their 2005 joint tax return and thus netted the loss against the income. The IRS recharacterized the net profit from TRI as nonpassive income under the self-rental rule and assessed a deficiency of $258,785. The taxpayers petitioned the Tax Court for relief.

The taxpayers argued that the entire group of all tractors and trailers owned by both JRV and TRI should be treated as a single item of property for purposes of the self-rental rule, while the IRS maintained that each individual tractor or trailer was an item of property. Since the term “item of property” is not defined in either the Internal Revenue Code or regulations, the court held the ordinary meaning of “item” should be used, and that it meant “a separate thing that is part of a larger collection.” Therefore, the court concluded that each individual tractor or trailer was a separate item of property for purposes of the self-rental rule and that the net income from TRI was nonpassive. The taxpayer argued that, often in the trucking industry, the phrase “item of property” means an entire fleet; however, the court found this implausible and further stated that it appeared that JVT, TRI, and JRV viewed each tractor or trailer as a separate unit of property, since they were owned by two separate companies and a distinct lease agreement was written for each tractor and each trailer.

While each tractor or trailer leased by TRI was held by the court to be a separate item of property, the IRS did not object to the taxpayer’s netting the profitable leases against the unprofitable leases within TRI or JRV. Thus, the court treated only TRI’s overall net profit as nonpassive, which was more favorable to the taxpayer than treating the income from each lease of the two companies as nonpassive.

Veriha, 139 T.C. No. 3 (2012)

By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota–Duluth.

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