United States Tax Court

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160 T.C. No. 9

GLADYS L. GERHARDT, ET AL., 1

Petitioners

COMMISSIONER OF INTERNAL REVENUE,

Respondent

—————

Docket Nos. 11127-20, 11128-20,

11129-20, 11146-20.

Filed April 20, 2023.

—————

Ps contributed high-value, low-basis real estate and

other property to charitable remainder annuity trusts

(CRATs). The CRATs sold the contributed property and

purchased five-year single premium immediate annuities

(SPIAs) with most of the proceeds, naming Ps as recipients

of the annuity payments. On their 2016 and 2017 tax

returns, Ps took the position that the payments they

received from the CRAT-funded SPIAs were not subject to

tax, with the exception of small amounts Ps reported as

interest. R examined Ps’ tax returns and determined

deficiencies, taking the position that, under I.R.C. §§ 664

and 1245, the annuity payments Ps received were

distributions from the CRATs and taxable to them as

ordinary income.

Two Ps, J and S, separately relinquished rental

property and cash in exchange for other rental property in

2017. On their tax return for 2017, J and S took the

position that gain from the disposition of the relinquished

1 Cases of the following petitioners are consolidated herewith: Alan A.

Gerhardt and Audrey M. Gerhardt, Docket No. 11128-20; Jack R. Gerhardt and

Shelley R. Gerhardt, Docket No. 11129-20; and Tim L. Gerhardt and Pamela J. Holck

Gerhardt, Docket No. 11146-20.

Served 04/20/23

property should be deferred because the transaction

qualified as a like-kind exchange under I.R.C. § 1031. R did

not dispute that the transaction met the requirements of

I.R.C. § 1031, but determined that I.R.C. § 1245 precluded

deferral of the gain.

J and S also sold certain property (MS) in 2017.

They reported the net gain from the sale as ordinary

income. R recomputed the amount of the gain and

characterized it as long-term capital gain.

For T and P, two other Ps, R determined an

accuracy-related penalty under I.R.C. § 6662(a) for 2016.

T and P claim the penalty should not apply because they

acted with reasonable cause and in good faith reliance on

their advisers.

Held: The annuity payments Ps received from the

CRAT-funded SPIAs in 2016 and 2017 were distributions

from the CRATs and taxable to them as ordinary income

under I.R.C. § 664.

Held, further, Ps have not met their burden of

showing that R erred in characterizing the payments as

ordinary income on the basis of I.R.C. §§ 664(b) and 1245.

Held, further, Ps’ contrary arguments find no

support in the Code, regulations, or caselaw.

Held, further, J and S have not met their burden of

showing that R erred in determining that I.R.C. § 1245

precluded deferral of the gain realized from the disposition

of the relinquished property.

Held, further, J and S offer no argument as to R’s

determinations concerning the sale of MS and have

forfeited any objections on this point, so R’s determinations

with respect to the sale of MS stand.

Held, further, T and P have not met their burden of

showing that they acted with reasonable cause and in good

faith reliance on their advisers.

—————

Anita L. Steburg, for petitioners.

Stephen A. Haller, for respondent.

OPINION

TORO, Judge:

In these consolidated cases, petitioners

(collectively, Gerhardts) contributed high-value, low-basis properties to

charitable remainder annuity trusts (CRATs). The CRATs promptly

sold the properties, purchased immediate annuities with most of the

proceeds, and designated the Gerhardts as the recipients of the

payments under the annuity contracts. In 2016 and 2017, the Gerhardts

received payments from the CRAT-funded annuity contracts. The

principal issue before us (which affects all petitioners) is whether those

annuity payments are taxable to the Gerhardts. We conclude they are.

The Gerhardts maintain, essentially, that selling the high-value,

low-basis properties through the CRATs and having the CRATs buy

immediate annuities for their benefit allowed them to have most of the

sale proceeds returned to them tax free over time. That view finds no

support in the law governing CRATs or elsewhere. Rejecting the

Gerhardts’ “too good to be true” arguments and consistent with our

holding in Furrer v. Commissioner, T.C. Memo. 2022-100, we conclude

that the annuity payments they received in 2016 and 2017 are

distributions from the CRATs and taxable to them as ordinary income

under section 664. 2

Also before us are three additional issues each affecting only some

petitioners: (1) whether Jack and Shelley Gerhardt should have

recognized ordinary income under section 1245 when they disposed of

depreciated property as part of a section 1031 like-kind exchange,

(2) whether Jack and Shelley Gerhardt’s gain from the sale of

depreciated property is long-term capital gain, and (3) whether Tim and

2 Unless otherwise indicated, all statutory references are to the Internal

Revenue Code, Title 26 U.S.C. (Code), in effect at all relevant times, all regulation

references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all

relevant times, and all Rule references are to the Tax Court Rules of Practice and

Procedure. We round all monetary amounts to the nearest dollar.

Pamela Gerhardt are liable for an accuracy-related penalty under

section 6662(a). We find for the Commissioner on each issue. 3

Docket Nos. 11127-20, 11128-20, 11129-20, 11146-20 (CRAT

Issue) 4

Background

The Gerhardts’ CRATs

The Gerhardts apparently learned about using CRATs as a

wealth-preservation strategy from John Eickhoff of Hoffman Associates,

LLC, in 2015. Mr. Eickoff referred the Gerhardts to Aric Schreiner of

Columbia CPA Group, LLC, for tax advice. In 2015, Mr. Schreiner

presented the Gerhardts with a “CRAT strategy.” The record does not

disclose the substance of Mr. Schreiner’s presentation, but soon after

that presentation, the Gerhardts formed CRATs with Mr. Schreiner’s

involvement. 5

Although they are broadly similar, we describe the facts for each

petitioner below. For clarity, we refer to individual petitioners by their

first names.

3 The parties have filed Stipulations of Settled Issues in each case making

concessions with respect to other issues, which we do not discuss further in this

Opinion.

For ease of analysis and readability, our Opinion proceeds in four parts.

Part I addresses the issue common to each of the consolidated cases. Part II addresses

two issues related to Docket No. 11129-20. Part III addresses an issue related to

Docket No. 11146-20. Part IV sets out our conclusion. Within each Part (other than

Part IV), we first provide the relevant factual background and then discuss the

applicable legal rules.

The parties submitted these cases fully stipulated under Rule 122. The facts

set out in the background sections below are based on the pleadings and the parties’

Stipulations of Facts as amended once, including the Exhibits attached thereto. The

Stipulations of Facts (as amended) with accompanying Exhibits are incorporated

herein by this reference.

Gladys, Alan, Audrey, Jack, and Shelley Gerhardt were residents of Minnesota

when they timely filed their Petitions in these cases. Tim and Pamela Gerhardt were

residents of Illinois.

5 We note only for context that both Mr. Eickoff and Mr. Schreiner also were

involved in the formation of the CRATs in Furrer. See Stipulation of Facts ¶¶ 9(a),

10(a), 13(a), 14(a), 15(a), 16(a), 17(a), 18(a), 19(a), 22–25, Furrer v. Commissioner, T.C.

Memo. 2022-100 (No. 7633-19).

Gladys Gerhardt 6

The Albert and Gladys CRAT was created on November 2, 2015.

Albert and Gladys were the CRAT’s grantors and noncharitable

beneficiaries. The CRAT instrument listed five organizations as

charitable remaindermen. Gray, Lawrence & Jenkins, LLC, was the

CRAT’s trustee.

Relevant here, the CRAT instrument required the trustee to pay

to the beneficiaries for a five-year period an “Annuity Amount” “equal to

the greater of: (1) ten percent of the initial net fair market value of all

property transferred to [the CRAT] . . . or (2) the payments received . . .

from one . . . or more Single Premium Immediate Annuities [(SPIAs)]

purchased by the Trustee.” Stipulation of Facts Ex. 13–J, at 23.

The CRAT instrument listed Albert and Gladys Gerhardt as the

beneficiaries of the Annuity Amount. But the CRAT instrument also

provided that “[n]either the Recipients nor the Recipients’ Children

shall have any right title, interest, or incident of ownership in or to any

[SPIA] transferred to or purchased by the Trustee.” Id. at 22. The CRAT

instrument defined the term “Recipients” as those “entitled to receive

the current annuity payment” and identified Albert and Gladys as the

Recipients. Id. at 15.

Albert and Gladys contributed real estate to the Albert and

Gladys CRAT on November 10, 2015. The Albert and Gladys CRAT filed

Form 5227, Split-Interest Trust Information Return, for the 2015 tax

year reporting the total fair market value of the contributed properties

as $1,808,000. With Mr. Schreiner’s assistance, Gladys filed Form 709,

United States Gift (and Generation-Skipping Transfer) Tax Return,

with her and Albert’s 2015 income tax return, reporting total adjusted

basis of $97,517 in the contributed properties. In December 2015 and

March 2016, the trustee of the Albert and Gladys CRAT sold the

properties for at least $1,658,000. 7

6 Gladys engaged in the transactions described here and filed joint federal

income tax returns with her husband, Albert, who is now deceased.

7 The parties’ stipulations regarding the total sales price are inconsistent. One

stipulation reflects total proceeds of $1,808,000, First Am. First Stipulation of Facts

¶ 32(e); another lists total proceeds of $1,658,000, id. ¶ 41. The discrepancy of

$150,000 appears to be attributable to the fact that the Albert and Gladys CRAT owned

only 50% of one of the properties it sold and thus received only 50% of the proceeds for

that property. The discrepancy does not affect the result for the years before us.

Using the proceeds from the sales, the Albert and Gladys CRAT

purchased a SPIA from Symetra Life Insurance Co. (Symetra) for

$1,537,822 on March 7, 2016. The SPIA contract identified the Albert

and Gladys CRAT as the “Owner” of the SPIA, but listed Albert as the

annuitant and Gladys as the joint annuitant. 8 Under the SPIA contract,

Symetra was required to pay an annuity of $311,708 to Albert and

Gladys beginning on April 6, 2016, and on each April 6 thereafter until

five total payments were made.

Albert and Gladys received an annuity payment of $311,708

($155,854 each) in each of 2016 and 2017. For 2016 and 2017, the Albert

and Gladys CRAT reported these annuity payments as CRAT

distributions to Albert and Gladys on Form 5227:

Recipient

Albert Gerhardt

Gladys Gerhardt

Distributions

2016

2017

Ordinary Income

$2,026

Corpus

153,828

2,026

153,828

Ordinary Income

Corpus

The Albert and Gladys CRAT issued Schedules K–1 (Form 1041),

Beneficiary’s Share of Income, Deductions, Credits, etc., to both Albert

and Gladys for 2016 and 2017. For each year, the Schedules K–1

reported interest income of $2,026 paid to each of Albert and Gladys.

The Schedules K–1 reported no other income.

Albert and Gladys jointly filed their federal income tax returns

for the 2016 and 2017 tax years. Damon T. Eisma of Eisma & Eisma

Attorneys at Law prepared the returns. On these returns, Albert and

Gladys reported the interest income reported to them by the Albert and

Gladys CRAT. They did not report the remaining payments from the

CRAT-funded annuity on either the 2016 or the 2017 tax return.

On Forms 5227, the Albert and Gladys CRAT reported its assets

at the end of 2015 to 2017 as follows:

8 The SPIA contract defined the term “Annuitant” in relevant part as “the

natural person intended to receive payments under this Contract.” The SPIA contract

also provided that “[t]here may be a joint Annuitant.” Stipulation of Facts Ex. 38–J,

at 3.

2015

2016

2017

$1,774,271

$1,410,953

$1,103,298

Undistributed

Income

–

Undistributed

Capital Gains

–

Undistributed

Nontaxable

Income

–

Trust Principal or

Corpus

The Commissioner examined Albert and Gladys’s 2016 and 2017

tax returns as well as the Albert and Gladys CRAT trust accounting and

reporting for those years. During the examination, the Commissioner

determined that the Albert and Gladys CRAT trust accounting was

inaccurate and adjusted it in relevant part as follows:

CRAT Trust Accounting According to IRS Examination

2015

2016

2017

Prior Year Accumulated Ordinary

Income

-0-

$1,159,807

Ordinary Income: Interest Income

-0-

$4,052

Capital Gain or Loss: Form 4797

-0- 9

1,467,462 10

Current Net Ordinary Income Before

Distributions

-0-

1,471,514 11

Total Distributable Income

(Cumulative)

-0-

1,471,514

1,163,859

Distributions to Noncharitable

Beneficiaries

-0-

311,707

Undistributed Ordinary Income

-0-

1,159,807

852,152

4,052

-04,052

The Commissioner also determined that the income the Albert

and Gladys CRAT realized on sales of the contributed properties was

ordinary income under section 1245.

Thus, according to the

Commissioner, all the payments Albert and Gladys received in 2016 and

2017 from the CRAT-funded annuity were ordinary income to them

under section 664(b).

The Commissioner issued Albert and Gladys a notice of deficiency

for 2016 and 2017. Among other items not relevant here, the

Commissioner increased Albert and Gladys’s gross income by $307,656

for each of 2016 and 2017 to reflect the adjustments to their ordinary

income from the CRAT-funded annuity payments.

The record reflects that the Albert and Gladys CRAT sold some of the

contributed property in 2015 rather than 2016. So, it would appear that some of the

gain and income included in the chart for 2016 should have been included for 2015

instead. But, because the CRAT made no distributions in 2015, this possible error does

not affect its total distributable income (cumulative) for 2016 and 2017.

10 The parties stipulate that the Commissioner determined that the Albert and

Gladys CRAT sold the real estate contributed by Albert and Gladys for $1,658,000 and

that it had a cumulative adjusted basis in the properties of $190,538. See supra note 7.

In view of these amounts, the Albert and Gladys CRAT realized gain of $1,467,462

from the sale of the real estate. Relying on section 1245, the Commissioner further

determined that the gain should be treated as ordinary income.

11 The “Current Net Ordinary Income Before Distributions” amount consists of

interest income of $4,052 and capital gain treated as ordinary income under

section 1245 of $1,467,462.

Alan and Audrey Gerhardt

The Alan and Audrey CRAT was created on November 10, 2015.

Alan and Audrey were the CRAT’s grantors and noncharitable

beneficiaries. The CRAT instrument listed one organization as a

charitable remainderman. Gray, Lawrence & Jenkins, LLC, was the

CRAT’s trustee.

The terms of the Alan and Audrey CRAT instrument are similar

to those discussed in the previous section, see Part I.B above, so we will

not repeat them here. 12 The CRAT instrument identified Alan and

Audrey as the beneficiaries and recipients of the Annuity Amount

required to be paid out by the trustee.

Alan and Audrey contributed real estate to the Alan and Audrey

CRAT on November 10, 2015. The Alan and Audrey CRAT filed

Form 5227 for the 2015 tax year reporting the total fair market value of

the contributed properties as $1,222,000.

With Mr. Schreiner’s

assistance, Alan and Audrey filed Forms 709 with their 2015 income tax

return, each reporting total adjusted basis of $42,079 in the contributed

properties. In March 2016, the CRAT’s trustee sold the properties for

$1,222,000.

Using the proceeds from the sale of the properties, the Alan and

Audrey CRAT purchased a SPIA from Symetra for $1,022,618 on

March 22, 2016. The SPIA contract identified the Alan and Audrey

CRAT as the “Owner” of the SPIA, but listed Alan as the annuitant and

Audrey as the joint annuitant. 13 Under the SPIA contract, Symetra was

required to pay an annuity of $207,232 to Alan and Audrey beginning

on April 6, 2016, and on each April 6 thereafter until five total payments

were made.

Alan and Audrey received an annuity payment of $207,232

($103,616 each) in each of 2016 and 2017. For 2016 and 2017, the Alan

and Audrey CRAT reported these annuity payments as CRAT

distributions to Alan and Audrey on Form 5227:

12 The same applies to the CRAT instruments for the remaining CRATs.

13 The SPIA contract defined the term “annuitant” in the same way as the

Albert and Gladys CRAT SPIA contract and also provided for the possibility of a joint

annuitant. See supra note 8.

Recipient

Alan Gerhardt

Audrey Gerhardt

Distributions

2016

2017

Ordinary Income

$1,347

Corpus

102,269

1,347

102,269

Ordinary Income

Corpus

The Alan and Audrey CRAT issued Schedules K–1 to both Alan

and Audrey for 2016 and 2017. For each year, the Schedules K–1

reported interest income of $1,347 paid to each of Alan and Audrey. The

Schedules K–1 reported no other income.

Alan and Audrey jointly filed their federal income tax returns for

the 2016 and 2017 tax years. Damon T. Eisma of Eisma & Eisma

Attorneys at Law prepared the returns. On these returns, Alan and

Audrey reported the interest income reported to them by the Alan and

Audrey CRAT. They did not report the remaining payments from the

CRAT-funded annuity on either the 2016 or the 2017 tax return.

On Forms 5227, the Alan and Audrey CRAT reported its assets

at the end of 2015 to 2017 as follows:

2015

2016

2017

$1,200,685

$818,080

$613,542

Undistributed

Income

–

Undistributed

Capital Gains

–

Undistributed

Nontaxable Income

–

Trust Principal or

Corpus

The Commissioner examined Alan and Audrey’s 2016 and 2017

tax returns as well as the Alan and Audrey CRAT trust accounting and

reporting for those years. During the examination, the Commissioner

determined that the Alan and Audrey CRAT trust accounting was

inaccurate and adjusted it in relevant part as follows:

CRAT Trust Accounting According to IRS Examination

2015

2016

2017

Prior Year Accumulated Ordinary

Income

-0-

$904,201

Ordinary Income: Interest Income

-0-

$2,694

Capital Gain or Loss: Form 4797

-0-

1,108,739 14

-0-

Current Net Ordinary Income Before

Distributions

-0-

1,111,433 15

2,694

Total Distributable Income

(Cumulative)

-0-

1,111,433

906,895

Distributions to Noncharitable

Beneficiaries

-0-

207,232

Undistributed Ordinary Income

-0-

904,201

699,663

2,694

The Commissioner also determined that the income the Alan and

Audrey CRAT realized on sale of the contributed properties was

ordinary income under section 1245.

Thus, according to the

Commissioner, all the payments Alan and Audrey received in 2016 and

2017 from the CRAT-funded annuity were ordinary income to them.

The Commissioner issued Alan and Audrey a notice of deficiency

for 2016 and 2017. Among other items not relevant here, the

Commissioner increased Alan and Audrey’s gross income by $204,538

for each of 2016 and 2017 to reflect the adjustments to their ordinary

income from the CRAT-funded annuity payments.

Jack and Shelley Gerhardt

Jack and Shelley created two CRATs, Jack and Shelley CRAT I

and Jack and Shelley CRAT II, on November 10, 2015, and February 17,

2016, respectively.

Jack and Shelley were the grantors and

noncharitable beneficiaries of the CRATs. The CRAT instruments also

14 The parties stipulate that the Commissioner determined that the Alan and

Audrey CRAT sold the properties contributed by Alan and Audrey for $1,222,000 and

that it had a cumulative basis in the properties of $113,261. In view of these amounts,

the Alan and Audrey CRAT realized income of $1,108,739 from the sale of the

properties.

15 The “Current Net Ordinary Income Before Distributions” amount consists of

interest income of $2,694 and capital gain treated as ordinary income under

section 1245 of $1,108,739.

listed Jack and Shelley as the beneficiaries and recipients of the Annuity

Amount required to be paid by trustee. The Jack and Shelley CRAT I

instrument listed two organizations as charitable remaindermen, and

the Jack and Shelley CRAT II instrument listed four organizations as

charitable remaindermen. Gray, Lawrence & Jenkins, LLC, was the

trustee of both CRATs.

Jack and Shelley contributed real estate to Jack and Shelley

CRAT I in November 2015 and to Jack and Shelley CRAT II in May

2016. Each CRAT filed Form 5227 in the year of its creation, reporting

the fair market values of the contributed properties at the time of

contribution. Jack and Shelley CRAT I reported the total fair market

value of the contributed properties it held as $1,530,000. Jack and

Shelley CRAT II reported the fair market value of the contributed

property it held as $440,550. With Mr. Schreiner’s assistance, Jack and

Shelley each filed Forms 709 with their 2015 and 2016 income tax

returns reporting their contributions to Jack and Shelly CRAT I and

Jack and Shelley CRAT II. Jack and Shelley each reported total

adjusted basis of $62,548 in the properties contributed to Jack and

Shelly CRAT I and adjusted basis of $72,359 in the property contributed

to Jack and Shelley CRAT II.

In March 2016, Jack and Shelley CRAT I sold the contributed

properties it held for $1,455,000. Later in 2016, Jack and Shelley

CRAT II sold the contributed property it held for $440,550.

Both CRATs used proceeds from the sales of the contributed

properties to purchase SPIAs from Symetra. Jack and Shelly CRAT I

purchased a SPIA for $1,287,283. The SPIA contract identified the

CRAT as “Owner” of the SPIA, but listed Jack as the annuitant and

Shelley as the joint annuitant. See supra note 13. Under the SPIA

contract, Symetra was required to pay an annuity to Jack and Shelley

of $260,902, beginning on April 6, 2016, and each April 6 thereafter until

five payments were made.

Jack and Shelley CRAT II purchased a SPIA for $367,302. The

complete SPIA contract is not in the record, but the parties stipulated

that Jack was listed as the annuitant of the SPIA, and Shelley was the

joint annuitant. Under the SPIA contract, Symetra was required to pay

an annuity to Jack and Shelley of $73,678, beginning in July 2016 and

each July 16 thereafter until five payments were made.

Jack and Shelley received an annuity payment of $260,902

($130,451 each) from the SPIA purchased by Jack and Shelley CRAT I

and an annuity payment of $73,678 ($36,839 each) from the SPIA

purchased by Jack and Shelley CRAT II in 2016 and 2017. For each

year, Jack and Shelley CRAT I reported the annuity payments as CRAT

distributions to Jack and Shelley on Form 5227:

Recipient

Jack Gerhardt

Shelley Gerhardt

Distributions

2016

2017

Ordinary Income

$1,696

Corpus

128,755

1,696

128,755

Ordinary Income

Corpus

Similarly, Jack and Shelley CRAT II filed Forms 5227 with the

Commissioner reporting the annuity payments as CRAT distributions

to Jack and Shelley as follows:

Recipient

Jack Gerhardt

Shelley Gerhardt

Distributions

Ordinary Income

Corpus

Ordinary Income

Corpus

2016

2017

$111

36,729

110

36,728

In addition to filing the Forms 5227, each CRAT issued to Jack

and Shelley Schedules K–1 for 2016 and 2017. The Schedules K–1

reported total interest income paid to Jack and Shelley equal to the total

interest income listed on the Forms 5227. The Schedules K–1 reported

no other income to Jack and Shelley.

16 The parties have stipulated that the annuity payments were to begin in June

2016 and continue in June of each following year until five payments were made. Our

review of the record shows that the SPIA contract for Jack and Shelley CRAT II

required Symetra to make the payments beginning in July 2016 and in July of each

following year until five payments were made, and we so find. See Cal-Maine Foods,

Inc. v. Commissioner, 93 T.C. 181, 195 (1989) (holding that we are not obliged to accept

a stipulation between the parties when it is clearly contrary to facts disclosed by the

record).

Jack and Shelley jointly filed federal income tax returns for the

2016 and 2017 tax years. Damon T. Eisma of Eisma & Eisma Attorneys

at Law prepared the returns. On these returns, Jack and Shelley

reported the interest income reported to them by the CRATs on the

Schedules K–1. They did not report the remaining payments from the

CRAT-funded annuities on the 2016 or the 2017 return.

On Forms 5227, Jack and Shelley CRAT I reported its assets at

the end of 2015 to 2017 as follows:

2015

2016

2017

$1,530,000

$1,182,759

$925,248

Undistributed

Income

–

Undistributed

Capital Gains

–

Undistributed

Nontaxable Income

–

Trust Principal or

Corpus

On Forms 5227, Jack and Shelley CRAT II reported its assets at

the end of 2016 and 2017 as follows:

2016

2017

$298,938

$220,388

Undistributed Income

–

Undistributed Capital

Gains

–

Undistributed Nontaxable

Income

–

Trust Principal or Corpus

The Commissioner examined Jack and Shelley’s 2016 and 2017

tax returns as well as the CRATs’ trust accounting and reporting for

those years. During the examination, the Commissioner determined

that the Jack and Shelley CRAT I trust accounting was inaccurate and

adjusted it as follows:

CRAT Trust Accounting According to IRS Examination

2015

2016

2017

Prior Year Accumulated Ordinary

Income

-0-

$1,052,385

Ordinary Income: Interest Income

-0-

$3,392

Capital Gain or Loss: Form 4797

-0-

1,309,085 17

-0-

Current Net Ordinary Income Before

Distributions

-0-

1,312,477 18

3,392

Total Distributable Income

(Cumulative)

-0-

1,312,477

1,055,777

Distributions to Noncharitable

Beneficiaries

-0-

260,902

260,092

Undistributed Ordinary Income

-0-

1,052,385

795,685

3,392

The Commissioner also adjusted the Jack and Shelley CRAT II

accounting as follows:

The parties stipulate that the Commissioner determined that Jack and

Shelley CRAT I sold the properties contributed by Jack and Shelley for $1,455,000 and

that it had a cumulative basis in the properties of $145,915. In view of these amounts,

Jack and Shelley CRAT I realized income of $1,309,085 from the sale of the properties.

18 The “Current Net Ordinary Income Before Distributions” amount consists of

interest income of $3,392 and capital gain treated as ordinary income under

section 1245 of $1,309,085.

CRAT Trust Accounting According to IRS Examination

2016

2017

Prior Year Accumulated Ordinary Income

-0-

$366,872

Ordinary Income: Interest Income

-0- 19

-0-

Capital Gain or Loss: Form 4797

$440,550 20

-0-

Current Net Ordinary Income Before

Distributions

440,550 21

-0-

Total Distributable Income (Cumulative)

440,550

366,872

Distributions to Noncharitable

Beneficiaries

73,678

Undistributed Ordinary Income

366,872

293,194

The Commissioner also determined that the income Jack and

Shelley CRAT I and Jack and Shelley CRAT II realized on sales of the

contributed properties was ordinary income under section 1245. Thus,

according to the Commissioner, all the payments Jack and Shelley

received in 2016 and 2017 from the CRAT-funded annuities were

ordinary income to them.

The Commissioner issued Jack and Shelley a notice of deficiency

for 2016 and 2017. Among other items, the Commissioner increased

Jack and Shelley’s gross income by $330,967 for each of 2016 and 2017

to reflect the adjustments to their ordinary income from the CRATfunded annuity payments.

Tim and Pamela Gerhardt

Tim and Pamela Gerhardt created two CRATs, Tim and Pamela

CRAT I and Tim and Pamela CRAT II, on November 10, 2015, and

19 We do not readily see why the Commissioner’s trust accounting omits

interest income of $221 reported by Jack and Shelley CRAT II on its Forms 5227 for

2016 and 2017. But this omission does not affect our analysis for the years before us.

The parties stipulate that the Commissioner determined that Jack and

Shelley CRAT II sold the property contributed by Jack and Shelley for $440,550 and

that it did not have any basis in the property. In view of these amounts, Jack and

Shelley CRAT II realized income of $440,550 from the sale of the property.

21 The “Current Net Ordinary Income Before Distributions” consists solely of

capital gain treated as ordinary income under section 1245 of $440,550.

January 21, 2016, respectively. Tim and Pamela were the grantors and

noncharitable beneficiaries of the CRATs. The CRAT instruments also

listed Tim and Pamela as the beneficiaries and recipients of Annuity

Amount required to be paid by the trustee. The Tim and Pamela CRAT I

instrument and the Tim and Pamela CRAT II instrument listed six

organizations each as charitable remaindermen. Gray, Lawrence &

Jenkins, LLC, was the trustee of both CRATs.

Tim and Pamela contributed real estate to Tim and Pamela

CRAT I in November 2015 and to Tim and Pamela CRAT II in February

2016. Each CRAT filed Form 5227 in the year of its creation, reporting

the fair market values of the contributed properties at the time of the

respective contributions. Tim and Pamela CRAT I reported the fair

market value of the contributed property it held as $310,000. Tim and

Pamela CRAT II reported the fair market value of the contributed

property it held as $549,450. With Mr. Schreiner’s assistance, Tim and

Pamela filed Forms 709 with the Commissioner reporting the

contributions to Tim and Pamela CRAT I and Tim and Pamela CRAT II.

Tim and Pamela reported no adjusted basis in the property contributed

to Tim and Pamela CRAT I. They reported an adjusted basis of $90,245

in the property contributed to Tim and Pamela CRAT II.

In December 2015, Tim and Pamela CRAT I sold the contributed

property it held for $310,000. In May 2016, Tim and Pamela CRAT II

sold the contributed property it held for $549,450.

Both CRATs used proceeds from the sales of the contributed

properties to purchase a SPIA from Symetra. Tim and Pamela CRAT I

purchased a SPIA for $252,158. The SPIA contract identified the “Tim

Leroy and Pamela Holck Gerhardt [CRAT]” as the SPIA’s “Owner.” Tim

was listed as the annuitant and Pamela as the joint annuitant. See

supra note 13. Under the SPIA contract, Symetra was required to pay

an annuity to Tim and Pamela of $50,967, beginning on March 1, 2016,

and on March 1 of each year thereafter until five payments were made.

Tim and Pamela CRAT II purchased a SPIA for $456,410. The

record does not include a copy of the SPIA contract for Tim and Pamela

CRAT II, but the parties stipulated that Tim was the annuitant and

Pamela was the joint annuitant. Under the SPIA contract, Symetra was

required to pay an annuity to Tim and Pamela of $92,204, beginning on

June 1, 2016, and on June 1 of each year thereafter until five payments

were made.

Tim and Pamela received an annuity payment of $50,967 from

Tim and Pamela CRAT I and an annuity payment of $92,205 22 from Tim

and Pamela CRAT II in 2016 and 2017. For each year, Tim and Pamela

CRAT I reported the annuity payments as CRAT distributions to Jack

and Shelley on Form 5227:

Recipient

Tim Gerhardt

Pamela Gerhardt

Distributions

2016

2017

Ordinary Income

$255

25,229

255

25,228

Corpus

Ordinary Income

Corpus

Similarly, Tim and Pamela CRAT II reported the annuity payments as

CRAT distributions to Tim and Pamela on Form 5227:

Recipient

Tim Gerhardt

Pamela Gerhardt

Distributions

2016

2017

Ordinary Income

$139

45,964

138

45,964

Corpus

Ordinary Income

Corpus 23

In addition to filing the Forms 5227, each CRAT issued to Tim

and Pamela Schedules K–1 for 2016 and 2017. The Schedules K–1

reported total interest income paid to Tim and Pamela equal to the total

interest income listed on the Forms 5227. The Schedules K–1 reported

no other income to Tim and Pamela.

Tim and Pamela jointly filed federal income tax returns for the

2016 and 2017 tax years. Anthony J. Baldassano prepared the returns.

Tim and Pamela reported the interest income reported to them by the

22 The Stipulation of Facts filed by the parties is inconsistent as to the annual

amounts paid to Tim and Pamela by the Tim and Pamela CRAT I-funded annuity and

the Tim and Pamela CRAT II-funded annuity. Based on our review of the record, we

find that the correct number for the Tim and Pamela CRAT I-funded annuity is

$50,967 and the correct number for the Tim and Pamela CRAT II-funded annuity is

$92,205.

23 The parties stipulated that the corpus distributions to Pamela were reported

on Forms 5227 as $46,964 for both 2016 and 2017, due perhaps to what appears to be

a scrivener’s error in the 2016 Form 5227. Based on our review of the record, we find

the correct amount is $45,964.

CRATs on the Schedules K–1. They did not report the remaining

payments from the CRAT-funded annuities on the 2016 or the 2017

return.

On Forms 5227, Tim and Pamela CRAT I reported its assets at

the end of 2015 to 2017 as follows:

2015

2016

2017

$288,685

$201,728

$151,271

Undistributed

Income

–

Undistributed

Capital Gains

–

Undistributed

Nontaxable Income

–

Trust Principal or

Corpus

On Forms 5227, Tim and Pamela CRAT II reported its assets at

the end of 2016 and 2017 as follows:

2016

2017

$372,652

$275,631

Undistributed Income

–

Undistributed Capital

Gains

–

Undistributed Nontaxable

Income

–

Trust Principal or Corpus

The Commissioner examined Tim and Pamela’s 2016 and 2017

tax year returns as well as the CRATs’ trust accounting and reporting

for those years. During the examination, the Commissioner determined

that the Tim and Pamela CRAT I trust accounting was inaccurate and

adjusted it as follows:

CRAT Trust Accounting According to IRS Examination

2015

2016

2017

Prior Year Accumulated

Ordinary Income

-0-

$238,228

Ordinary Income: Interest

Income

-0-

$510

Capital Gain or Loss: Form

4797

-0-

288,685 24

Current Net Ordinary Income

Before Distributions

-0-

289,195 25

Total Distributable Income

(Cumulative)

-0-

289,195

238,738

Distributions to Noncharitable

Beneficiaries

-0-

50,967

Undistributed Ordinary

Income

-0-

238,228

187,771

510

-0510

The Commissioner also adjusted the Tim and Pamela CRAT II

accounting as follows:

The parties stipulate that the Commissioner determined that Tim and

Pamela CRAT I sold the property contributed by Tim and Pamela for $310,000 and

that it had a cumulative basis in the property of $21,315. In view of these amounts,

Tim and Pamela CRAT I realized income of $288,685 from the sale of the property.

25 The “Current Net Ordinary Income Before Distributions” amount consists of

interest income of $510 and capital gain treated as ordinary income under section 1245

of $288,685.

CRAT Trust Accounting According to IRS Examination

2016

2017

Prior Year Accumulated Ordinary

Income

-0-

$457,246

Ordinary Income: Interest Income

-0-

Capital Gain or Loss: Form 4797

$549,450 26

-0-

Current Net Ordinary Income Before

Distributions

549,450 27

-0-

Total Distributable Income (Cumulative)

549,450

457,246

Distributions to Noncharitable

Beneficiaries 28

92,204

Undistributed Ordinary Income

457,246

365,042

The Commissioner also determined that the income Tim and

Pamela CRAT I and Tim and Pamela CRAT II realized on sales of the

contributed properties was ordinary income under section 1245. Thus,

according to the Commissioner, all the payments Tim and Pamela

received in 2016 and 2017 from the CRAT-funded annuities were

ordinary income to them.

The Commissioner issued Tim and Pamela a notice of deficiency

for 2016 and 2017. Among other items, the Commissioner increased Tim

and Pamela’s gross income by $142,385 for each of 2016 and 2017 to

reflect the adjustments to their ordinary income from the CRAT-funded

annuity payments.

26 The parties stipulate that the Commissioner determined that Tim and

Pamela CRAT II sold the property contributed by Tim and Pamela for $549,450 and

that it did not have any basis in the property. In view of these amounts, Tim and

Pamela CRAT II realized income of $549,450 from the sale of the property.

27 The “Current Net Ordinary Income Before Distributions” consists solely of

capital gain treated as ordinary income under section 1245 of $549,450.

28 As described above, we find that the amount of the annuity distributions was

actually $92,205 for each year.

Discussion

General Background

A CRAT is a type of a charitable remainder trust. I.R.C. § 664.

“[A] staple among estate planners,” a charitable remainder trust is often

a vehicle used by “individuals with substantial appreciated capital gain

property, a charitable intent, and a need for a stream of income during

their lifetimes.” Richard Fox, Charitable Giving: Taxation, Planning,

and Strategies ¶ 25.01 (2023), Westlaw WGL-CHARGIV (footnotes

omitted). “The basic concept of a [CRAT] involves a [grantor’s] transfer

of property to an irrevocable trust, the terms of which provide for the

payment of a specified amount, at least annually, to the grantor or other

designated noncharitable beneficiaries for life or another predetermined

period of time up to twenty years.” Id. (footnotes omitted); see also I.R.C.

§ 664(d). What remains in the trust after the expiration of that period

(which cannot be less than “10 percent of the initial net fair market

value of all property placed in the trust,” I.R.C. § 664(d)(1)(D)) “must be

transferred to one or more qualified charitable organizations or continue

to be held in the trust for the benefit of such organizations.” Fox, supra,

¶ 25.01. In short, unlike an immediate gift to charity, a contribution to

a CRAT “blends the philanthropic intentions of a donor with his or her

financial needs or the financial needs of others.” Id.

As a rule, the grantor recognizes no gain when transferring

appreciated property to a CRAT. See Buehner v. Commissioner, 65 T.C.

723, 740 (1976) (“A gift of appreciated property [to a CRAT] does not

result in income to the donor . . . .” (quoting Humacid Co. v.

Commissioner, 42 T.C. 894, 913 (1964))); see also Furrer, T.C. Memo.

2022-100, at *8–9 (discussing treatment of CRATs). 29 Moreover,

because CRATs are exempt from income tax, a CRAT can sell

appreciated property without itself paying tax on the sale. See I.R.C.

§ 664(c)(1); Treas. Reg. § 1.664-1(a)(1)(i); Fox, supra, ¶ 25.01.

But that does not mean that the grantor or other noncharitable

CRAT beneficiaries do not have to pay tax with respect to distributions

from the CRAT. “Although a [CRAT] is itself exempt from income tax

and, therefore, pays no tax on any of its taxable income, the annuity . . .

payments made to the noncharitable beneficiaries carry out taxable

29 In addition, the grantor may be entitled to a charitable contribution

deduction equal to the present value of the remainder interest at the time of the

transfer to the CRAT. See I.R.C. § 170(f)(2)(A); Treas. Reg. § 1.170A-6(b).

income that is subject to tax at the beneficiary level.” Fox, supra,

¶ 25.50 (footnote omitted); see also Alpha I, L.P. v. United States, 682

F.3d 1009, 1015 (Fed. Cir. 2012) (stating the rule and citing

section 664(b) and (c)(1)). This is so because when property is

transferred to a CRAT, the basis of the property in the CRAT’s hands

generally is the same as it would be in the hands of the grantor. See

I.R.C. § 1015(a) and (b); Treas. Reg. §§ 1.1015-1(a)(1), 1.1015-2(a)(1).

And when the CRAT sells the property, it realizes gain to the extent the

amount realized from the sale exceeds its adjusted basis. I.R.C. § 1001;

see also Treas. Reg. § 1.664-1(d)(1)(i) (discussing the assignment of

income to categories at the CRAT level). Although not taxable to the

CRAT, that gain must be tracked and affects the treatment of

distributions from the CRAT. 30 See, e.g., Treas. Reg. § 1.664-1(d)(1)(viii)

(providing examples illustrating the rules).

Congress has established specific ordering rules that govern the

characterization and reporting of annuity amounts distributed by a

CRAT to its income beneficiaries. See I.R.C. § 664(b). Under this

regime, distributions from a CRAT to income beneficiaries are deemed

to have the following character and to be distributed in the following

order:

(1)

as ordinary income, to the extent of the CRAT’s current and

previously undistributed ordinary income;

(2)

as capital gain, to the extent of the CRAT’s current and

previously undistributed capital gain;

(3)

as other income, to the extent of the CRAT’s current and

previously undistributed other income; and

(4)

as a nontaxable distribution of trust corpus.

30 The tax treatment set out in the text sometimes leads commentators

describing the benefits of a CRAT to say that “[a]ppreciated assets held by an

individual can be disposed of on a tax-free basis.” Fox, supra, ¶ 25.02. But, as we have

explained, and as the same commentators recognize, that is not quite right: “Although

assets may be sold on a tax-free basis by a [CRAT], because distributions from the trust

to noncharitable beneficiaries are subject to tax, a more accurate statement might be

that a [CRAT] defers the payment of income tax [until noncharitable beneficiaries

receive distributions from the CRAT].” Id. n.24.

I.R.C. § 664(b)(1)‒(4); Fox, supra, ¶ 25.50. 31

CRATs are subject to strict reporting requirements to ensure

compliance with the statutory ordering rules. See I.R.C. § 4947(a);

Treas. Reg. § 1.664-1(a)(1)(ii). A CRAT must file an annual information

return on Form 5227 reflecting its income, deductions, accumulations,

and distributions for the year. See I.R.C. § 6011(a); Treas. Reg.

§ 53.6011-1(d). And it must issue to each income beneficiary a Schedule

K–1 properly describing the tax character of all distributions. See I.R.C.

§ 6034A(a); Treas. Reg. § 1.6034-1(a).

Burden of Proof

The Commissioner’s determinations in a notice of deficiency are

generally presumed correct, and the taxpayer bears the burden of

proving those determinations erroneous. See Rule 142(a)(1); Welch v.

Helvering, 290 U.S. 111, 115 (1933). The parties have stipulated that

the Gerhardts received the payments from the CRAT-funded annuities

at issue, and the Gerhardts do not otherwise argue that the burden is

on the Commissioner to connect the Gerhardts with the income. See

Pittman v. Commissioner, 100 F.3d 1308, 1313 (7th Cir. 1996), aff’g T.C.

Memo. 1995-243; Page v. Commissioner, 58 F.3d 1342, 1347 (8th Cir.

1995), aff’g T.C. Memo. 1993-398; Day v. Commissioner, 975 F.2d 534,

537 (8th Cir. 1992), aff’g in part, rev’g in part on other grounds, and

remanding T.C. Memo. 1991-140. Instead, the issue before us is

whether those payments are taxable to the Gerhardts. As to the annuity

payments, the Gerhardts have not alleged, and the evidence does not

establish, that the burden of proof as to any factual issues before us has

shifted to the Commissioner under section 7491(a). Accordingly, the

burden remains with the Gerhardts to prove the Commissioner’s

determinations are erroneous.

Application to the Gerhardts

As we have already discussed, distributions from a CRAT

typically are taxable in the hands of noncharitable beneficiaries to the

extent of the CRAT’s income. See I.R.C. § 664(b). Each of the CRATs

here received appreciated property from the Gerhardts. The Gerhardts

did not recognize gain on the transfers to the CRATs, and the CRATs

have the same bases in the properties as the Gerhardts did before the

31 See also Miller v. Commissioner, T.C. Memo. 2009-182, 2009 WL 2432375.

contributions. 32 See I.R.C. § 1015(a) and (b); Veterans Found. v.

Commissioner, 38 T.C. 66, 72 (1962), aff’d, 317 F.2d 456 (10th Cir. 1963);

Treas. Reg. §§ 1.1015-1(a)(1), 1.1015-2(a)(1). 33 After receiving the

properties, the CRATs sold them and used the proceeds to purchase

SPIAs. The Gerhardts then received annual distributions from the

CRATs in the form of annuities paid by the CRAT-funded SPIAs.

The CRATs realized gains on the sales of the contributed

properties. See I.R.C. § 1001(a). Although the CRATs did not have to

pay tax on those gains because of section 664(c), under section 664(b),

the income they earned was relevant for determining the character of

the distributions the Gerhardts received. See Treas. Reg. § 1.6641(d)(1)(ii)(a); see also Alpha I, L.P., 682 F.3d at 1015 (“[T]he income of a

CRUT is taxable to its income beneficiaries upon distribution.”); Fox,

supra, ¶ 25.50. 34

As we have already discussed, the character of CRAT

distributions to noncharitable beneficiaries follows the character of the

income to the CRAT. See I.R.C. § 664(b). The distributions are

characterized in the following order: (1) ordinary income, (2) capital

gains, (3) other income, and (4) trust corpus.

Id.

Here, the

Commissioner determined that the income the CRATs earned was

ordinary income because the properties the CRATs sold were subject to

the rules of section 1245—a point not disputed by the Gerhardts. 35 On

32 The Gerhardts have made no argument that the adjusted bases in the

properties increased by reason of section 1015(d)(1) (adjustment to basis for gift tax

paid). They have therefore forfeited any argument on that front. We note further that

the record does not show that they actually paid gift tax on the contributions to the

CRATs.

The Gerhardts also concede on brief that, if they had sold the properties

instead of contributing them to the CRATs, they would have taxable gains in the

amounts determined by the Commissioner. See Pet’rs’ Reply to Resp’t’s Opening

Br. 3–9.

33 See also Magness v. Commissioner, T.C. Memo. 1965-260, 1965 Tax Ct.

Memo LEXIS 70, *8–9, *9 n.3 (stating the rule and providing background on its

adoption).

34 See also Miller v. Commissioner, 2009 WL 2432375, at *2.

35 The Gerhardts state in their answering brief that the Commissioner’s

characterization of the gains from the CRATs’ sales of the contributed properties was

“of little or no consequence.” Pet’rs’ Reply to Resp’t’s Opening Br. 20. They are

mistaken. This characterization is indeed consequential. But the Gerhardts do not

argue that the gains should be characterized in any other way (for example, as capital

the basis of this determination and well-established law, see I.R.C. §§ 64,

1245(a), the Gerhardts had ordinary income from the CRATs as follows:

Ordinary Income from CRATs, Including Interest Income Already Reported by the

Gerhardts

Petitioner

CRAT

2016

2017

Gladys

Albert and Gladys CRAT

$311,708

Alan and Audrey

Alan and Audrey CRAT

207,232

Jack and Shelley

Jack and Shelley CRAT I

260,902

Jack and Shelley CRAT II

73,678

Tim and Pamela CRAT I

50,967

Tim and Pamela CRAT II

92,205

Tim and Pamela

The Gerhardts resist the straightforward analysis set out above.

In their telling, the Code does a lot more than exempt the CRATs from

paying tax on built-in gains realized when contributed property is sold.

According to the Gerhardts, the Code also relieves them from paying tax

on the distributions that were made possible by the CRATs’ realization

of the built-in gains. As they put it, “all taxable gains (on the sale of the

asset[s contributed to the CRATs]) disappear and the full amount of the

proceeds [is] converted to principal to be invested by the CRAT.” Pet’rs’

Opening Br. 6–7 (emphasis added). In the Gerhardts’ view, “[i]t becomes

obvious that Congress intended [this treatment] to promote charitable

giving while offering large tax benefits as incentives.” Id. at 7. The gain

disappearing act the Gerhardts attribute to the CRATs is worthy of a

Penn and Teller magic show. But it finds no support in the Code,

regulations, or caselaw.

In Furrer, we considered facts and arguments nearly identical to

those before us now and reached the same conclusion. We invited the

Gerhardts to distinguish Furrer and even extended the briefing schedule

to allow them to do so. But, tellingly, their briefs fail to mention the case

gains). Therefore, they have forfeited the argument. See, e.g., Smith v. Commissioner,

No. 5191-20, 159 T.C., slip op. at 41 (Aug. 25, 2022); see also Hackett v. City of S. Bend,

956 F.3d 504, 509 (7th Cir. 2020); Jenkins v. Winter, 540 F.3d 742, 751 (8th Cir. 2008)

(“Claims not raised in an opening brief are deemed waived.”).

at all. 36 Their silence confirms our view that the reasoning in Furrer

applies with equal force here.

As best we can tell, the Gerhardts maintain that the bases of

assets donated to a CRAT are equal to their fair market values. See

Pet’rs’ Reply to Resp’t’s Opening Br. 10–11 (“Utilizing CRATs, the assets

are donated to a CRAT and book at the fair market value of the asset at

that time. The donor’s basis is a moot point as the controlling fair

market value is the price at the time the asset is donated to the CRAT.”);

id. at 13 (“The trustee of the CRAT has no way to know the cost basis of

any asset donated to it, nor is it required to obtain such information

since that is not required by the Internal Revenue Code.”). Section 1015

flatly contradicts their position. Section 1015(a) governs transfers by

gift, and section 1015(b) governs transfers in trust (other than transfers

in trust by gift). Under either provision, the basis in the property “shall

be the same as it would be in the hands of the donor” under

section 1015(a) or “in the hands of the grantor” under section 1015(b). 37

And the Gerhardts’ claim that section 1015 does not govern transfers to

CRATs because it does not specifically mention them is meritless.

Nothing in the text of the provision excludes CRATs from its scope.

The Gerhardts also seek shelter in the rules governing the

taxation of annuities in section 72. But, if one respects the form of the

transactions the Gerhardts chose, the Gerhardts did not buy any

annuities from Symetra. The CRATs did so and directed how payments

under the annuities were to be made. 38 Thus, any amounts paid by

36 This is particularly notable given that the Gerhardts’ counsel in these cases

also represented the Furrers. Moreover, neither the Gerhardts’ Opening Brief nor

their Reply to Respondent’s Opening Brief cites a single case in support of their

position. As we have already explained, no such support exists.

37 The position the Gerhardts advance has not been the law for more than a

century. As Treasury Regulation § 1.1015-3(a) provides: “In the case of property

acquired by gift or transfer in trust before January 1, 1921, the basis of such property

is the fair market value thereof at the time of the gift or at the time of the transfer in

trust.” (Emphasis added.) For property transferred after December 31, 1920, “the

basis of the property for the purpose of determining gain is the same as it would be in

the hands of the donor.” Treas. Reg. § 1.1015-1(a)(1) (governing “property acquired by

gift . . . (whether by transfer in trust or otherwise)”); see also Treas. Reg. § 1.10152(a)(1) (setting out the same rule for “property acquired . . . by transfer in trust (other

than by a transfer in trust by gift, bequest, or device)”).

38 As we have already noted, under the SPIA contracts, the Gerhardts did not

have “any right title, interest, or incident of ownership in or to any [SPIA] transferred

to or purchased by the Trustee.” Stipulation of Facts Ex. 13–J, at 22. Symetra appears

Symetra as directed by the CRATs constitute amounts distributed by

the CRATs for purposes of section 664(b). Contrary to the Gerhardts’

view, nothing in section 72 overrides their obligation to comply with the

rules of section 664(b) with respect to those amounts.

In light of the foregoing, it is plain that the Gerhardts have not

shown that the determinations in the notices of deficiency on this issue

were incorrect. Therefore, they must be upheld.

II.

Docket No. 11129-20 (Additional Issues Relating to Jack and

Shelley Gerhardt’s Returns)

(1)

Section 1031 Like-Kind Exchange Issue

Next we consider whether, for the 2017 tax year, Jack and Shelley

Gerhardt properly excluded gain from the disposition of other property

(Armstrong Site) from gross income under section 1031 or whether that

gain must be recognized under section 1245. The Commissioner does

not dispute that the transaction at issue met the requirements of

section 1031.

Instead, the Commissioner argues that, despite

section 1031, the gain must be recognized as ordinary income because

the property was depreciated “section 1245 property.” See I.R.C. § 1245.

After finding the facts that follow, for the reasons set out below, we

decide this issue in the Commissioner’s favor.

Background

Located in Armstrong, Iowa, the Armstrong Site was held by Jack

and Shelley as rental property for the production of income. It

comprised hog buildings and equipment as well as raw land. On

January 19, 2017, Jack and Shelley relinquished the Armstrong Site to

Andrew Gerhardt intending that it be exchanged for like-kind property.

On February 28, 2017, a new property, the Cape Coral property, was

identified as the exchange property. On March 17, 2019, Jack and

Shelley received the Cape Coral property from Andrew Gerhardt.

Jack and Shelley treated this exchange as a section 1031 like-kind

exchange on their 2017 tax return. They reported a fair market value

to have followed this contractual provision by issuing Forms 1099–R, Distributions

From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance

Contracts, etc., reflecting each year’s annuity payments to the CRATs, not the

Gerhardts. And the Gerhardts have stipulated that the CRATs reflected the annuity

payments as distributions on their Forms 5227, Schedule A, Part II-A, Current

Distributions Schedule, for each relevant year.

of $390,000 for the Cape Coral property. They also reported $104,338

as “[a]djusted basis of like-kind property [they] gave up, net amounts

paid to other party, plus any exchange expenses” not used elsewhere on

their return. 39 Stipulation of Facts Ex. 10–J, at 17. Consistent with

these amounts, Jack and Shelley reported deferred gain of $285,662 on

the exchange of the Armstrong Site.

As already noted, the Commissioner examined Jack and Shelley’s

2017 return. The revenue agent conducting the audit accepted the fair

market value of the Cape Coral property and agreed that Jack and

Shelley paid for the property with the Armstrong Site (valued at

$300,000) and $90,000 in cash. But the agent made adjustments to Jack

and Shelley’s reported exchange expenses, as well as their reported

basis in the Armstrong Site. And he determined that the gain from the

Armstrong Site was subject to the rules of section 1245 and that the gain

should not be deferred but should be treated as ordinary income.

Consistent with these determinations, the Commissioner increased Jack

and Shelley’s income for 2017 by $284,746. 40

Discussion

Recognition Under Section 1245

Typically, under section 1031, no gain or loss is recognized on a

like-kind exchange of property if all requirements of section 1031 are

met. But, if “section 1245 property” is disposed of in a section 1031 likekind exchange, then gain from the disposition of that property may be

recognized as ordinary income. 41 See I.R.C. § 1245(a)(1) (flush

language), (b)(4); Treas. Reg. § 1.1245-6(b). If both section 1245 property

The basis amount of $104,338 reported on Jack and Shelley’s return

consisted of reported basis of $14,338 in the Armstrong Site and exchange expenses,

plus $90,000 in cash.

This amount was equal to 100% of the gain from the exchange of the

Armstrong Site as determined by the Commissioner. The Commissioner calculated

the amount by subtracting selling costs and the adjusted basis of the land, buildings,

and equipment, all as determined by the Commissioner, from the $300,000 sale price.

The amount was slightly less than the amount Jack and Shelley reported as deferred

gain because the Commissioner made certain favorable adjustments to Jack and

Shelley’s basis in the property.

41 As relevant here, the amount recognized generally is limited to the amount

by which the lesser of (1) the depreciation deductions claimed with respect to the

property and (2) the amount realized in the transaction exceeds the taxpayer’s

adjusted basis in the property. See I.R.C. § 1245(a) and (b).

and non-section 1245 property are disposed of in the same transaction,

then gain is allocated between the section 1245 property and the nonsection 1245 property in proportion to their respective fair market

values. Treas. Reg. § 1.1245-1(a)(5). Section 1245 property includes

“property which is or has been property of a character subject to the

allowance for depreciation provided in section 167” that, as relevant

here, is either (1) personal property or (2) a single-purpose agricultural

or horticultural structure. I.R.C. § 1245(a)(3)(A), (D).

Application to Jack and Shelley

The Commissioner determined that the hog buildings and

equipment on the Armstrong Site were section 1245 property and

therefore that Jack and Shelley’s gain from disposing of the property

was ordinary income to them for 2017. Jack and Shelley dispute that

the gain should be recognized as ordinary income. They argue that the

gain should be deferred because they exchanged the Armstrong Site for

the Cape Coral property in a properly executed section 1031 transaction.

Essentially, they say that section 1031 trumps section 1245, at least as

to the timing of gain recognition.

There is no dispute that Jack and Shelley followed the formalities

of section 1031. But Jack and Shelley’s argument ignores that gain may

still be recognized under section 1245 if the property disposed of is

“section 1245 property.” See I.R.C. § 1245(a)(1) (flush language) (“[G]ain

[from the disposition of section 1245 property] shall be recognized

notwithstanding any other provision of this subtitle.”); see also I.R.C.

§ 1245(b)(4) (providing rules for gain recognition in the context of a

section 1031 transaction). Besides their broad assertion that “[t]he

buildings on the [Armstrong Site] are incidental to the property and part

of the property,” Pet’rs’ Opening Br. 20, Jack and Shelley offer no

arguments with respect to the Commissioner’s determination that the

Armstrong Site was depreciated section 1245 property. Nor do they

contend that the limitations in section 1245(b)(4) assist them.

So far as Jack and Shelley may be arguing that their gain from

the Armstrong Site is allocable primarily to non-section 1245 property,

they have not set forth any facts supporting that view. The record does

not show how much (if any) of the gain from the Armstrong Site could

be allocable to non-section 1245 property. 42

In short, Jack and Shelley have not met their burden to

demonstrate that the Commissioner’s determination is incorrect, and we

find for the Commissioner on this issue.

(2)

Sale of Mosloski Site Issue

We turn next to the Commissioner’s determination that Jack and

Shelley did not properly report gains from the sale of an additional

property, which the parties refer to as the Mosloski Site.

Background

Jack and Shelley purchased the Mosloski Site in 1995. The

Mosloski Site consisted of land, a hog-finishing barn, and hog

equipment. On November 10, 2015, Jack and Shelley donated a partial

interest in the Mosloski Site to their CRAT. Then on November 17,

2016, they sold their remaining interest in the Mosloski Site for $75,000.

Jack received a Form 1099–S, Proceeds from Real Estate Transactions,

that same day reporting the sales proceeds.

On their Form 1040, U.S. Individual Income Tax Return, for the

2016 tax year, Jack and Shelley reported total gain of $66,070 from the

sale of the Mosloski Site as ordinary income. Along with their 2016

return, Jack and Shelley attached Form 4797, Sales of Business

Property. On Form 4797, they reported a loss of $1,009 from the sale of

the Mosloski Site land and gain of $67,079 from the sale of the Mosloski

Site hog-finishing barn and hog equipment.

In the notice of deficiency issued to Jack and Shelley, the

Commissioner determined that the sale of the Mosloski Site was subject

to depreciation recapture under section 1245. And because “the

recapture amounts [from the Mosloski Site] under [section 1245] and

land basis amounts are included in the charitable remainder annuity

trust amounts,” the Commissioner determined that the gain reported on

42 We note in this regard that, according to the revenue agent’s workpapers,

when Jack and Shelley purchased the Armstrong site they allocated approximately

1.6% of the purchase price to land (the non-section 1245 property) and the remaining

98.4% to buildings and equipment (the section 1245 property) for depreciation

purposes.

Form 4797 was zero and that the entire $75,000 of sale proceeds was

long-term capital gain to Jack and Shelley for 2016.

Discussion

Jack and Shelley offer no argument as to this adjustment in either

of their briefs. Therefore, they have forfeited any objection as to this

adjustment, and the Commissioner’s determination stands. See Smith,

159 T.C., slip op. at 41; see also Muhich v. Commissioner, 238 F.3d 860,

864 n.10 (7th Cir. 2001), aff’g T.C. Memo. 1999-192; Schneider v.

Kissinger, 412 F.3d 190, 200 n.1 (D.C. Cir. 2005) (“[A] litigant has an

obligation to spell out its arguments squarely and distinctly, or else

forever hold its peace.” (quoting United States v. Zannino, 895 F.2d 1,

17 (1st Cir. 1990))).

III.

Docket No. 11146-20 (Tim and Pamela Gerhardt Section 6662(a)

Penalty Issue)

Finally, we consider whether Tim and Pamela are liable for an

accuracy-related penalty under section 6662(a) and (b)(2) for a

substantial understatement of income tax for 2016.

Background

Tim and Pamela reported total tax of $4,836 on their 2016 income

tax return. The Commissioner determined that they had a tax

deficiency of $39,448 for that year. During the examination of the 2016

return, IRS Revenue Agent Michael Lumpp proposed the imposition of

an accuracy-related penalty under section 6662(a).

Supervisory

Revenue Agent Emily McDowell, Revenue Agent Lumpp’s immediate

supervisor, personally approved the assertion of the penalty in writing

on July 22, 2019. Revenue Agent Lumpp had not communicated the

penalty determination to Tim and Pamela or their representative before

obtaining written supervisory approval.

In the notice of deficiency, mailed to Tim and Pamela on

March 10, 2020, the Commissioner determined an accuracy-related

penalty of $7,890 under section 6662(a) and (b)(2) for an underpayment

due to a substantial understatement of income tax.

Discussion

The Commissioner’s Burden of Production

Section 6662(a) imposes an accuracy-related penalty equal to 20%

of the portion of an underpayment of tax required to be shown on a

return that is attributable to any substantial understatement of income

tax. See I.R.C. § 6662(a) and (b)(2). An understatement of income tax

is “substantial” if it exceeds the greater of “10 percent of the tax required

to be shown on the return for the taxable year” or “$5,000.” Id.

subsec. (d)(1)(A).

Under section 7491(c) the Commissioner bears the burden of

production with respect to the liability of an individual for any penalty.

See Higbee v. Commissioner, 116 T.C. 438, 446 (2001). The record shows

that Tim and Pamela’s understatement of income tax for 2016 exceeded

the threshold amount under section 6662(d)(1)(A), so the Commissioner

has met his burden to show the penalty under section 6662(a) was

proper when the notice of deficiency was issued.

The Commissioner must also show compliance with the

procedural requirements of section 6751(b)(1). See I.R.C. § 7491(c);

Graev v. Commissioner, 149 T.C. 485, 493 (2017), supplementing and

overruling in part 147 T.C. 460 (2016). Section 6751(b)(1) provides that

no penalty shall be assessed unless “the initial determination” of the

assessment was “personally approved (in writing) by the immediate

supervisor of the individual making such determination.” The parties’

stipulations show that the section 6662 penalty was properly approved.

Reasonable Cause

No penalty is imposed under section 6662 with respect to any

portion of an underpayment “if it is shown that there was a reasonable

cause for such portion and that the taxpayer acted in good faith with

respect to [it].” I.R.C. § 6664(c)(1). Tim and Pamela have the burden to

establish that they are excused from the penalty for reasonable cause.

See United States v. Boyle, 469 U.S. 241, 245 (1985); Sugarloaf Fund,

LLC v. Commissioner, 911 F.3d 854, 861 (7th Cir. 2018), aff’g Kenna

Trading, LLC v. Commissioner, 143 T.C. 322 (2014); Neonatology

Assocs., P.A. v. Commissioner, 115 T.C. 43, 98 (2000), aff’d, 299 F.3d 221

(3d Cir. 2002).

“The determination of whether a taxpayer acted with reasonable

cause and in good faith is made on a case-by-case basis, taking into

account all pertinent facts and circumstances.” Treas. Reg. § 1.66644(b)(1). Generally, “the most important factor is the extent of the

taxpayer’s effort to assess [his] proper tax liability.” Id. Circumstances

that may indicate reasonable cause and good faith include “an honest

misunderstanding of fact or law that is reasonable in light of all of the

facts and circumstances, including the experience, knowledge, and

education of the taxpayer.” Id.

Tim and Pamela argue that they have reasonable cause for the

underpayment of tax for 2016 because they lacked relevant legal

training and relied on tax advisers both in pursuing the CRAT

transactions discussed above and in preparing their 2016 return. To

show that their reliance on tax advisers constitutes reasonable cause,

Tim and Pamela must show that their reliance was reasonable. Boyle,

469 U.S. at 250–51; Treas. Reg. § 1.6664-4(b)(1) (“[A taxpayer’s reliance

on] professional advice . . . constitutes reasonable cause and good faith

if, under all the circumstances, such reliance was reasonable and the

taxpayer acted in good faith.”).

Our Court applies a three-prong test to determine whether a

taxpayer reasonably relied on professional advice. Specifically, we

analyze whether “(1) [t]he adviser was a competent professional who had

sufficient expertise to justify reliance, (2) the taxpayer provided

necessary and accurate information to the adviser, and (3) the taxpayer

actually relied in good faith on the adviser’s judgment.” Neonatology

Assocs., P.A., 115 T.C. at 99. Reasonable reliance on a professional “is a

fact-specific determination with many variables, but the question ‘turns

on “the quality and objectivity of the professional advice obtained.”’”

Am. Boat Co. v. United States, 583 F.3d 471, 481 (7th Cir. 2009) (quoting

Klamath Strategic Inv. Fund, LLC v. United States, 472 F. Supp. 2d 885,

904 (E.D. Tex. 2007), aff’d sub nom. Klamath Strategic Inv. Fund ex rel.

St. Croix Ventures v. United States, 568 F.3d 537 (5th Cir. 2009)).

“Reliance may be unreasonable when it is placed upon insiders,

promoters, or their offering materials, or when the person relied upon

has an inherent conflict of interest that the taxpayer knew or should

have known about.” Neonatology Assocs., P.A., 115 T.C. at 98.

Application to Tim and Pamela

Based on the record before us, we are unable to determine that

Tim and Pamela reasonably relied on tax advisers in preparing the

return or pursuing the positions reflected in the return. The record does

not demonstrate the qualifications of the advisers, the nature of Tim and

Pamela’s communications with them, or the quality or objectivity of the

advice Tim and Pamela received. These facts are necessary to our

analysis, and it was Tim and Pamela’s burden to provide them. This

they did not do. 43 Accordingly, we sustain the determination of the

section 6662(a) penalty.

IV.

Conclusion

For the reasons stated above, we find for the Commissioner on all

issues.

We have considered all of the parties’ arguments and, to the

extent not discussed above, conclude they are irrelevant, moot, or

without merit.

To reflect the foregoing and the concessions of the parties,

Decisions will be entered under Rule 155.

43 Statements made in the Gerhardts’ brief without any citations of the record

are not facts on which we may rely.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.