RE: Howdy Brewster
I have reviewed your memo regarding the case of Mr. Howdy Brewster. In 2011 Howdy signed a contract with the Aztec oil and Gas Company to build a pipeline across his property for the pipeline to cross over his property so that it can maintain its useful life. He received a given amount of $9,200 after the contract was signed and to resolve the issue with the neighbor paid an amount of $7,500 in so that the boundary can be sorted out with the neighbor as well. In September the same year, Howdy dammed a stream to have more water available for the consumption of his cattle. The dam cost him an amount totaling to $30,000 with a surface area of an acre. Howdy also paid an amount of $35,000 to people living downstream since they will be having less water that before even though the dam has a spillway that lets the water out once the stream has sufficient water. Howdy’s farm has three homes which he sold one on may 2011 for a stated amount as $225,000 along with 22.5 acres land that he sold to his nephew. His basis is stated as $75,000 from the home and $400 from the land.
It seems clear that Howdy has received income from several sources, but there are several tax issues that must be considered if Mr. Howdy is to claim a deduction from these incidents. Of initial concern is whether the sources of income qualify to be regarded as taxable income as this has other implications whether Mr. Howdy has evaded tax payment or not as the IRS code and regulations demand. Further, there are questions as of how Mr. Howdy received the income as whether the transactions demand tax payment or are to be deducted. These questions must be addressed in order to provide a defensible position with respect to such tax deductions.
THE FARMLAND AND THE PIPELINE: A BUSINESS ASSET OR PERSONAL USE ASSET?
Of initial concern is whether the land upon which he made a contract with the Aztec oil and Gas Company is a trade or business asset or is a land for personal use. The IRS code 165 © places a limitation on the gains made by an individual from an asset based on the use of the asset from which the income gain was received and therefore it can be ruled out whether it is a taxable income or not. An asset that is used for commercial purposes must pay the tax on the income gained from the commercial use. If the farmland and the contract made with Aztec oil and Gas Company qualify to be a commercial agreement then the income must be taxed according to IRS tax returns conditions.
Mr. Howdy has stated that the land is used for dairy farming and ranching activities even though it land that has been inherited from the family for over 125 years. The IRS code states that such commercial activities qualify s taxable income and must be taxed. The contract made with the Aztec oil and Gas Company was that he allows the pipeline to cross through his farm property in order to maintain the useful life of the pipeline. Mr. Howdy received a stated amount of $9,200 from the contract which was partly used to pay an attorney to settle boundary dispute with his neighbor. The amount paid in this case is $7,500 as legal fees. In Kelo v. City of New London the ruling distinguishes between economic development and tax policy. The economic development from land owned to a subject must be taxed for economic development. For Mr. Howdy, there was no income gain from the contract since it was for use in ensuring the pipeline crossing his land is maintained for its useful life.
THE DAM: COMMERCIAL OR PERSONAL
As a result of the dry weather experienced in Texas Mr. Howdy dammed a slow moving stream to create a reservoir for availing water for his cattle. The cattle are kept for dairy commercial farming which is a commercial activity. The dam is built on a natural resource that is to be used freely by all whose land is connected to the river. The use of such a natural resource demands that the person use it fairly and in consideration of those who share the same resource. Mr. Howdy built the dam which reduces the amount of water in the stream and made an agreement with his neighbor to accept the state of the stream for a stated amount of $35,000.
The income gained from the use of such a natural resource as the Code demands is that it should be considered with the expense used to attain the resource. In this case he used the money to build the dam which also has a spillway and also paid the neighbors who are contented with Mr. Howdy’s actions. In the absence of a documentation of such evidence that there is an agreement between Mr. Howdy and those who share the natural resource would be deemed as a crime and wrongful use of such a resource. This is in accordance with the ruling made in chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), whereby it must be determined that the resource is not misused and gains or expenses from such use is in accordance with the constitution. For Mr. Howdy the resource was used for commercial purpose which is taxable and the neighbors also benefited from the actions.
SALE OF ASSETS AND INCOME GAINED FROM ACTIVITIES FROM THE ASSET
Mr. Howdy sold part of the farmland to his nephew for a stated amount of $225,000 and moved to another home with his wife and kids. The sale of land is also another income gain which is to be accounted for and in this case it is qualified as a tax deduction according to the code. With the absence of such evidence in form of receipts of income and tax return forms then it will be deemed that Mr. Howdy has broken the Code even though it must be established that the income is from commercial activities only. In Gates v. Comm’r, 135 T.C the ruling allows exclusion for property above 250,000 dollars for single person application and $500,000 for spouses. The sale by Mr. Howdy was above this limit thus it can be excluded from tax payroll so there is no taxable gain.
INCOME GAINS FROM COMMERCIAL ACTIVITIES THAT ARE TAXABLE
The basis from the home is $75,000 and $400 an acre which is a gain income. Such income from commercial use of the property must be taxed according to the requirements and tax rates stated in the IRS code and the tax return form evidences be presented as evidence. In Wickard v. Filburn, 317 U.S. 111 (1942), Wickard was a farmer who grew wheat for consumption and that he was producing more than the limits and so he had to destroy the wheat and pay a fine. For Mr. Howdy, the land is used for commercial activity and so the gains from the home are a taxable income. He should substantiate using receipts the net gains from the farming activities and the taxable income figures calculated.
CONCLUSION AND RECOMMENDATIONS
It would appear that Mr. Howdy has gained income from several sources throughout the year. However, the income is from sources that do require to be treated as tax deductions.
First, the contract deal is for the purpose of maintaining the useful life of the pipeline and not for income purposes. The amount was partly used for the settling border issues with his neighbor as a result of the pipeline crossing through his land. The remaining amount from the contract is to be substantiated legally as a maintenance cost received from the Aztec oil and Gas Company.
Secondly, the dam was built-in his property and the agreement was made with those sharing the resource. This does not qualify as a misuse of natural resource or unaccounted income gains from the dam built on his land from the stream. The expense from the building of the dam is an investment cost and so it should be regarded as exclusion.
Thirdly, the sale of property is to his nephew and such is treated as a tax deduction since it is asset disposal. The income bases from the land and from the home are also below what is regarded as taxable income and should be well documented.
The recommendation that should be made is that a clear documentation of the income gained from the use of the dam be presented. This is taxable gain since the addition of the dam to his business will increase income and so taxable.
317 U.S. 111
Barbara H. (2003), tax research, London: prentice hall
Dodo J. (1993), tax research, California: university of California