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Merlo, Accountant
Category: Tax
Satisfied Customers: 9783
Experience:  25+ years tax consulting. Specializing in returns for US citizens living abroad
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You responded to a tax question for me on 7/3/2009. I have

Resolved Question:

You responded to a tax question for me on 7/3/2009. I have a question with your respone. I received a judgment for fraud that provided me some tax relief for tax years prior to the judgment. Your answer indicated I could inclde the amount of the judgment in the basis of the property I was awarded in connection with the judgment. Wouldn't this result in my getting tax relief twice based on the judgment amount? Once as a result of my getting a tax refund for tax years prior to the judgment and a second time in using amounts lost in the fraud as part of my basis in the property?
Submitted: 7 years ago.
Category: Tax
Expert:  Merlo replied 7 years ago.
<p>Let me look at the history on your original question so I can understand your situation here.</p><p> </p>
Customer: replied 7 years ago.
Prior to 2000 I provided a couple with funds to owner-build a home. T received a judgment against the husband for fraud. As a result of this my tax returns for years pior to 2000 were changed and some tax relief received. In addition to the judgment for fraud I was award the property. I then went on to complete the property and sell it. My quetions is since the judgment resulted in some tax relief for years prior to 2000 can I use any of this amount as a basis on the property? Could funds paid directly towards the construction, such as materials received from Home Depot, be used as part of the basis?
No money has been collected on the fraud judgment and no collection is likely to happen in the future. The judgment was for an amount larger than the amount disclosed to the IRS as funds provided to the couple.   
Expert:  Merlo replied 7 years ago.
Hello againCustomer

I just reviewed your question from July, and I do not see in there where I indicated that the amount of the judgement you received would be included in the basis of your property.

Possibly I am not understanding your situation here. But in your original question to me back in July, you stated that you had contributed funds to some friends and also directly to a construction company to help your friends build a home. They apparently then left town and decided not to finish this project. You then went to court and sued for fraud and you were awarded a judgement which was uncollectable. The court then gave you legal ownership of the property. My response to that in figuring your basis was this:

"To determine your capital gain, you take your selling price less your basis, less your selling expenses. In your case, your basis will be the money that you paid directly towards the construction of the home, as well as the money you spent fixing it up prior to the sale. You will deduct your basis from the sale price of $430,000 and you will also deduct any spelling expenses you had, such as cost to advertise or real estate commissions."

I do not see where I indicated that the amount of the judgement could be included in your basis. The only thing I indicated should be included in your basis is money that you spent directly towards the construction of the home prior to your friends leaving town, and then any money you spent after you finished fixing up the property to get it ready for sale.

Your basis in a property is always what you actually paid out of pocket to acquire that property. It would not include the value of any court settlement you received.

If I am not understanding your situation correctly, please let me know. I am happy to try and help you with whatever I can here.

Merlo and other Tax Specialists are ready to help you
Customer: replied 7 years ago.
If I had not gone to court and received the judgment for fraud, then the funds provided by me for the construction of the property prior to my obtaining ownership could be used as part of the basis on the property. I think we are in agreement on this. But I went to court and received a judgment for fraud. The judgment has not and will not be repaid. However, I have received some refunds for taxes paid in 1997, 98 and 99 as a result of this fraud loss -- returns for these three years were ammended. As part of this re-due of my taxes for these three tax years I prepared an exhibit that was submitted to the IRS showing funds paid to the couple. The property was not considered in the judgmetment award. After the court ruled the judge asked what was going to happen to the property. The wife, but not the husband, was in court. Wife said there was nothing she could do about the propety. The court asked me if I want it and if so what would I pay for it. I said I would assume the loan outstanding for the land -- $18,371.58. The judge then said I should pay something. He suggest $1 and I said OK, then he incrased it to $20. My question is did the tax relief I received because of the fraud result which in part was based on funds provided for the construction NOT being available as a basis in the property? If the listing of amounts provided to the IRS as an exhibit ONLY contained payments directly made to the couple are amonts not included in this exhibit that were directly paid to material providers such as home depot available to use as part of the basis in the propety?   
Expert:  Merlo replied 7 years ago.
Hello againCustomer

Can you please tell what tax relief you claimed on your prior year returns?

Did you claim deductions as a bad debt?
Customer: replied 7 years ago.
It is my understanding that because the judgment was for fraud it could be deducted subject to fewer limitations than if the judgment for for any other reason. My revised tax returns are not where I am at the moment. Using amonts that I remember -- which may be off track -- the judgment was for $340,000. I prepared an exhibit for the IRS showig payments to the couple in the amount of $240,000. The $100,000 was just an amount the court came up with. If I can show I paid $50,000 out to Home Depot type business for materials for the ranch would this $50,000 be available to use as part of my basis in the proerty?
Expert:  Merlo replied 7 years ago.
Hello againCustomer

I am assuming from what you said that you may have taken this as a loss under the casualty and theft loss rules which would allow you a larger deduction. Whatever type of deduction you claimed, if you received a tax benefit as a result of this judgement, then all or part of that tax benefit may need to reduce your basis.

You said originally that when all of this first started you gave some money directly to your friends and you also paid money directly to the builder and directly to purchase materials. The amount that you gave to your friends would not be considered in this situation as part of your basis. Only the amounts which you gave directly to the builder or amounts you paid directly for the purchase of materials.

Of those amounts, you would need to deduct any tax refunds that you received as a result of amending your returns to claim a casualty/theft deduction. But you would not need to reclaim any tax refund that was for the money you personally paid to your friends.

You have a rather uncommon situation which is going to be a little more complex to figure your basis. But basically your basis is going to be your total out of pocket expense in acquiring this property. But that would not include amounts you paid personally to your friends, as there is no way to tie that money to the cost of the home, as they could have used that money for anything.

Let's just take this as an example. Suppose you gave $100,000 directly to the builder and another $100,000 directly to your friends. Now if the court gave you a judgement for the entire $200,000 and you deducted all of that on your tax returns, let's say that resulted in tax refunds to you of $50,000. You would figure your starting basis by taking the $100,000 you paid the builder directly, minus $25,000 (half of the tax refund you received which was attributable to the portion paid to the builder). So you now have a starting basis of $75,000 in the property. You would then add to that the cost of any additional money you paid to complete the house after the court awarded you ownership of the property. That will be the basis you use in determining any taxable gain you had from this sale.

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