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...it being understood that Seller and Seller's agents make no representations or warranties
pertaining to the fixtures or state of repair of the World or any of its systems.


Wednesday, October 06, 2004
  Crane v. Commissioner : In every tax course I suspect that there is a lecture about five weeks into the semester exactly like the one I attended this a.m., during which the professor lays bare the secrets of Crane, 331 U.S. 1 (1947) and Tufts, 461 U.S. 300 (1983). And my prof--none other than the man himself, unveiled the meaning of these cases with characteristic flair.

(-- WARNING: Enthusiatic description of a 1947 tax case to follow. Big-time yawn for all non-green-eye-shade types --)

The Crane/Tufts rule on it's face is rather simple. The Court required a taxpayer, in calculating her taxable gain on the sale of some property, to acknowledge the benefit derived from being relieved of her mortgage indebtedness following the sale. It is both a simple and a necessary rule. (Consider the effect on taxes, otherwise, whenever people sold property that hadn't been fully paid off yet.)

And, becasue the rule forces taxpayers to acknowledge the full benefit of a sale, it tracks with the principle that you should reimburse the tax commissioner for any deductions you take for depreciation in property value--if and when it turns out that the sale price of such property exceeds the depreciation estimates. That is, if you've persuaded someone to reimburse you for everything you put into the property, plus the remainder of the mortgage, then your depreciation deductions should be recaptured by the commissioner.

But here we stumble through the rabbit hole.

Say I borrow 100,000 to buy an apartment building. I take periodic depreciation deductions. In ten years' time I "sell" the building to someone. The price? Take over my mortgage and you can have the damn thing. I have paid only interest on the mortgage, so the principal is still at 100,000. Taxable gain on the sale? Recaptured depreciation deductions--nothing more.

Yep. That is what we call a tax shelter. All the interest payments on the mortgage are deductable. And although in the end I paid tax on the amount I took each year as a depreciation deduction (say $2500/yr), I've deferred the tax for ten years--using that money, of course, to buy valuable stock in the Green Bay Packers. And I can even get a better tax rate if I manage to work it out so that the deductions are taken against ordinary income, but the tax is paid on a capital gain. Is your mouth watering yet?

Imagine a lecture-hall filled with law students learning about this stuff. After class was over we all stood around, buzzed, chattering about the case and its ramifications, like we'd all been injected with caffine.

Actually I don;t know whether to get mad about the Crane/Tufts rule or just laugh about it. As a citizen I have a stake in tax equity for all. But short of doing away with taxation altogether, there is not much that can be done about the loophole. If Congress or the Court were to reverse the Crane/Tufts rule, closing the loophole, they would arguably create an even bigger problem going the other way.

So in the meantime... America--land of opportunity, land of drooling law students.
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