Tax Memo
Relevant Facts
Sara in her individual capacity has incurred attorney fees and other costs of $ 11,000 in connection with her litigation with the Texas County Board for changes in zoning law so that her three parcels of land comprising of 30 acres could gain in value which was only $ 15,750 per acre before her appeal. During the pendency of her appeal in the court of law, the Texas County changed the zoning law permitting two residences per acre as against the original law of only one residence per every two acres. And as expected, the value of her land increased to $ 25,000 per acre. To recall, the property Sara received from her mother was only worth $ 15,750 attributable to the then prevailing pattern of land zoning. Stagnation in the land value was due to the said zoning that restricted to one residence per every two acres. Hence, she applied to Texas County in 2010 for changes in the zoning which however was rejected. Sara went on an appeal in 2011 as constitutional challenge of the Texas County’s zoning law which was unsuccessful. Then in October 2011, she appealed to Texas County District Court. By November 2011, the County suo moto effected change in the zoning law allowing two residences per every acre from February 2012 onwards.
Issues identified
The issue now is about the tax treatment of her attorney fees and other costs which she incurred half in 2010 and another half in 2011. Tax treatment means whether expenditure is deductible from one’s income for income tax purposes. In order to decide on deductibility, it should be decided whether the given expenditure is a revenue expenditure or capital expenditure. If former is the case, the expenditure is deductible. If latter, it can only be capitalized. This again depends on whether the expenditure is incurred in the course of business or in individual capacity for personal purposes. Obviously, Sara has incurred attorney fees and other costs in her individual capacity and hence tax law applicable to individual shall be examined in this case.
Conclusion
In Sara’s case, the origin of the claim led her to incur attorney fees and other costs, and hence the expenditure must be capitalized as per Sections 263.
Authorities & Reasoning
Section two hundred sixty three and 263 “A” provide for capitalization of expenditure incurred for betterment of real estate. Thus, attorney fee and other costs incurred for defending or perfecting title are eligible for capitalization by being added to the value of the property and not by being deducted from the income of the individual for relevant period. If this rule is to be followed, Sara has incurred expenses for litigation which have led to the Texas County making changes in zoning norms thus increasing the value of her property. Hence her attorney fees and other costs of $ 5,500 + 5,500 should be added to the value of land as at the end of each year 2010 & 2011respectively regardless of legal outcome in 2012. (CCH (1), (2), Wolters Kluwer, 2013).
In Lee D. and Marjorie L. Hustead v. Commissioner (1994), taxpayers’ claim to treat attorney fees and other costs incurred for constitutional challenge as a deductible expenditure was rejected. This was an identical case in which petitioners had challenged zoning norm that allowed only one residential dwelling per acre. Later on, the township changed the zoning norm to permit 4 dwellings per acre. This led to an increase of fair market value of petitioners’ land by 85 %. Although they had capitalized expenditure they incurred for challenging the original zoning, they claimed the said costs in their income tax returns as deductible expenditures which the respondents rejected as per section 263A. However, the court held that section 263 would apply and still the expenditure could only be capitalized. In view of the above position, Sara can only capitalize the fees paid to attorney and other costs as part of expenses incurred for the purpose of increasing the land value as contemplated under Section 263.
References
AICPA-Store (2007). Treatment of Legal Fees Incurred by Individuals. Web.
CCH (1) Wolters Kluwer (2013) Current Internal Revenue Code, SEC. 263. Capital Expenditures. Web.
CCH (2), Wolters Kluwer (2013) Current internal revenue code, sec. 263a Capitalization and Inclusion in inventory costs of certain expenses. Web.
Lee D. and Marjorie L. Hustead v. Commissioner, 68 T.C. 374 (1994).