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Establishing Cost-Basis in Foreign Real Estate | IRS Audit Tax Lawyer & Attorney

One of the most challenging issues during an IRS audit is establishing cost-basis in foreign real estate.  This issue most frequently comes up in the context of real estate that was obtained through inheritance or gift many years ago.  In this article, based on my IRS audit experiences, I would like to discuss the main challenges and case strategies associated with establishing the cost-basis in foreign real estate in a manner that would satisfy the IRS during an audit.

An important note: I will not be discussing this issue in the context of an IRS audit of an offshore voluntary disclosure and how it would affect the calculation of an Offshore Penalty.  This essay is strictly limited to an IRS audit that involves US international tax issues without the taxpayer ever going through a voluntary disclosure.

Another important note: this article is written more for the benefit of other international tax lawyers, not the general public.

Establishing Cost-Basis in Foreign Real Estate: Importance

Before we discuss the problems associated with establishing the cost-basis in foreign real estate, we need to first understand why this issue is so important.  There are three main consequences to establishing cost-basis in the context of an IRS audit. 

First, the income tax impact of failure to establish cost-basis in a foreign property on the audited taxpayer may be truly disastrous.  Obviously, if you cannot prove any cost-basis in a property (or you can only convince the IRS that there was minimal cost-basis), you will have to recognize all proceeds from the sale of this property as capital gains (or potentially subpart F income if you owned a property though a foreign corporation).

Second, there is a very important psychological impact on the entire audit if you have a large unreported gain from sale of foreign real estate.  The IRS agent in charge of an audit is likely to take a more aggressive position not only on this issue, but also on other issues irrespective of whether they are directly related to unreported gain.   The most frequent victims of this hardened attitude of an IRS agent are the legal arguments in support of a reasonable cause.

Finally, a large gain from a sale of foreign real estate is likely to encourage the IRS to dig deeper and even expand the audit to more years.  In one of my audit cases, an IRS agent initially believed that there was a large capital gain and expanded the audit to five prior years; however, he reversed this decision once I was able to show that the sold real property had a much higher cost-basis due to numerous improvements that were made by my client over a number of years.

In other words, establishing cost-basis in a sold real estate property may be one of the most crucial issues in an IRS audit.

Establishing Cost-Basis in Foreign Real Estate: Top 3 Challenges

The challenges to establishing cost-basis in foreign real estate are highly dependent on the facts of the case.  However, there are three main themes that usually appear in one form or another in every IRS audit case.

The first challenge is absence of documentation.  This is by far the most common and most important battleground between the IRS and the taxpayer during the vast majority of IRS audits in this area, especially if the direct documentation is absent due to passage of time.

The second challenge is the potential opposition from the IRS to proving cost-basis indirectly through usage of circumstantial evidence and third-parties.

The third challenge is establishing the credibility of evidence. For example, in one of my cases, the IRS initially refused to accept a valuation report prepared by a local professional valuation expert because the report lacked a proper explanation of how he arrived at the proposed values.

Establishing Cost-Basis in Foreign Real Estate: Top 4 Strategies for Overcoming Challenges

There are numerous strategies to deal with the cost-basis establishment challenges. Your choice among them should depend on the facts and circumstances of your case.  Sometimes, you will even come up with a brand-new strategy tailored specifically to the unique challenges of your case.

Nevertheless, there are four common themes to the strategies used in overcoming the aforementioned challenges.  First, you need to recreate the logical history of the property and capital improvements to the property in order to convince the IRS that the valuation your client supplied is logical and reasonable.

Second, demonstrate to the IRS agent in charge of your client’s audit that you are a reliable source of information.  The more objective you appear (and you actually are), the more the IRS sees that you will not allow false facts or statements to enter the record, the more the IRS sees that your client shares both of these traits, the more likely the IRS agent will accept your position or be willing to achieve a compromise with you (see below).

Third, utilize indirect and circumstantial evidence as well as third-party affidavits/testimony to support the valuation of the property.  In other words, if you have no ability to directly establish the cost-basis of a property, then you need to find creative ways to build the necessary records and establish their credibility through usage of supporting documents and/or testimony. 

For example, in one of my previous audits, the client had no documentation whatsoever except one isolated receipt to prove the substantial improvements made to her foreign real estate over the past almost forty (!) years.  My solution to this problem was to first get an affidavit from my client fully stating all improvements made with approximate cost based purely on her memory.  Then, I obtained additional signed statements from neighbors largely supporting the estimates as well as the fact that these improvements were indeed made. Finally, I obtained a statement from a local construction company owner who stated that he recalled these improvements and confirmed the estimated amounts.  Additionally, all of the improvements were properly explained by the history of how the property was obtained, for what purpose and why so many improvements were needed.  All of these facts and circumstances were explained in a letter to the IRS agent together with the legal basis (i.e., case law) showing how courts have accepted similar evidence in the past. Under the weight of this substantial record (and some other circumstances of this case), the IRS finally agreed to accept all improvements as part of an overall compromise.

Finally, use creative legal strategies to convince the IRS to accept a different cost-basis in a property through operation of tax rules.  This is a very complex strategy, but it is more commonly employed than one may believe.  For example, in one of my prior audit cases, the IRS agreed to disregard the foreign corporation that owned the foreign property allowing the stepped-up basis for this inherited property.

Contact Sherayzen Law office for Professional Help with IRS Audits Involving Foreign Real Estate

If you have foreign assets and you are audited by the IRS, contact Sherayzen Law Office for professional help.  We have helped hundreds of US taxpayers around the world to bring their tax affairs in full compliance with US tax laws, including during IRS audits.  We can help you!

Contact Us Today to Schedule a Confidential Consultation!

IRS Large Corporate Compliance Program | IRS Lawyer & Attorney

On May 16, 2019, the IRS Large Business and International Division (“LB&I”) announced the creation of a new compliance program for the large corporations – Large Corporate Compliance program.

The Large Corporate Compliance program will cover the oversight of the LB&I’s largest corporate taxpayers. It replaces the existing Coordinated Industry Case program.

The replacement of the Coordinated Industry Case program is not unexpected. Ever since the IRS announced that it would switch to compliance campaigns for case selection purposes, the future of the old program was in doubt. Moreover, the Coordinated Industry Case program used criteria that did not incorporate many of the advancements made by the IRS in the area of data analysis. Hence, it is not surprising that the May 16 announcement came right after the LB&I began on May 15, 2019 a new application of data analytics for determining the population of its largest and most complex corporate taxpayers.

The IRS stated that the Large Corporate Compliance program will determine on a different, automatic basis who should be covered by the program. In fact, the program employs automatic application of the large case pointing criteria to determine the LCC population. For example, pointing criteria include such items as gross assets and gross receipts. In the past, this was done on a manual, localized basis. Automated pointing allows a more objective determination of the taxpayers that should be part of the population.

After the population is determined, data analytics is used to identify the returns that pose the highest compliance risk. The Large Corporate Compliance program further improves LB&I’s ability to efficiently focus its resources on noncompliance.

The Large Corporate Compliance program will coordinate its work with the LB&I agents and examiners who apply their experience and expertise in undertaking compliance actions and determining compliance treatment streams of the biggest and most-complex corporate taxpayers. The IRS happily stated that each enhances the other.

The IRS further shared that the program includes continuous improvement using an agile model principle to continually monitor and improve based on feedback from stakeholders including field teams, practice networks, and data scientists.

Sherayzen Law Office carefully watches the new IRS moves with respect to its compliance programs to determine their impact on the firm’s clients.

Schedule C IRS Audit | Business Tax Lawyer & Attorney

One of the most common types of IRS audits is the Schedule C IRS audit. In this article, I would like to introduce the readers to the Schedule C IRS audit. In particular, I would like to discuss the type of taxpayers who are affected by an IRS audit of Schedule C and the key legal issues associated with such an audit.

Schedule C IRS Audit: Who is Affected?

A Schedule C IRS audit primarily concerns two groups of taxpayers: owners of sole proprietorships and owners of single-member LLCs. These are the taxpayers who conduct business in either unincorporated form (i.e. sole proprietorship) or the incorporation is disregarded by the IRS (i.e. single-member LLC).

Schedule C IRS Audit: the Focus of the Audit

A typical Schedule C IRS audit focuses on two critical areas: full reporting of revenue and substantiation of expenses.

Generally, the reporting of business revenue should not be too difficult as long as there are sufficient records, but there are exceptions. One of such exceptions is the reporting of foreign income earned by the taxpayer because of the issues of income recognition and currency translation.

Unfortunately, a typical Schedule C IRS audit rarely involves a business with well-kept records. In a purely cash-based business, this is most problematic for obvious reasons – absent records of receipt of cash, it is extremely difficult to recreate an accurate picture of the revenue intake by the business. Similarly, a lot of work will be needed to reconstruct the revenue of a business with multiple revenue conduits, constant transfers between accounts, inexplicable cash withdrawals and deposits, disorganized prepayments and other similar complications.

Schedule C IRS Audit: Substantiation of Expenses

The problems associated with the second part of a Schedule C IRS audit (i.e expenses), however, dwarf the difficulties of revenue identification. The substantiation of expenses is by far the most difficult task in a Schedule C IRS audit. Let’s explore the reasons for this problem in more detail.

During a Schedule IRS C audit, the revenue agent in charge of the audit will only allow a business expenses if it satisfies all of the following three requirements:

1. Expense is Incurred by Business Identified on Schedule C

In this context, the primary problem that plagues taxpayers is the commingling of personal and business expenses. Oftentimes, the taxpayers will pay for business expenses using a personal bank account or a personal credit card. Actually, I have had clients who used credit cards of third parties to pay for business expenses. Proving that these expenses were actually incurred by the business, as opposed to the taxpayer or the third party, can be very challenging.

2. Expense is Supported by Records

The IRS will generally require that a business expense is supported by records. If a taxpayer uses only his own memory as the basis for an expense, an IRS agent is likely to disallow such an expense.

Ideally, the taxpayer should have actual receipts for all business expenses, but IRS agents generally accept bank and credit card statements that would allow them to identify the nature of an expense. The generosity of an IRS agent in this aspect often depends on the general “flow” of a Schedule C IRS audit – i.e. cooperation of the taxpayer, his credibility and the non-willfulness of his prior noncompliance.

3. Expense is Allowable Business Deduction from Income

Even if the audited taxpayer has good records in support of a business expense, the expense must still be an allowable business deduction. The critical issue here is whether the law actually allows the taxpayer to reduce his business income by the expense in question.

In order to qualify for being a deductible business expense, the expense must be both ordinary (i.e. common and accepted in the relevant area of trade or business) and necessary (i.e. helpful and appropriate for your trade or business). It is also should be kept in mind that some of the business expenses are either capitalized or added to cost of goods sold. There are also limitations on certain types of business deductions (such as business meals).

One of the most frequent problems that arise during a Schedule C IRS audit is the issue of personal expenses paid by the business. Personal expenses are never deductible as a business expense. I already described this problem above in the context of business expenses paid through personal accounts or by a third party; here, I am discussing the opposite situation – personal expenses paid using a business bank account or credit card.

It is important to understand that the fact that an expense is paid by a business, does not automatically mean that this is a deductible business expense. An expense still needs to comply with the “ordinary and necessary” requirement and be separated from personal expenses.

Sometimes, it is fairly easy to identify personal expenses, but this is not always the case; on the contrary, a vast number of expenses can be interpreted either as a business expense or a personal expense. For example, if a business owner buys tickets to a baseball game for himself, his family, potential clients and their families, how much of it is deductible? How about a personal membership at a gold club to which the business owner often invites his prospective clients and pays for their games?

The answers to these questions should not be left to the judgment of the IRS agent in charge of the question; instead, the attorney who represents the audited taxpayer should look at the precise facts, IRS revenue rulings and similar cases to promote the argument that will benefit his client.

Contact Sherayzen Law Office for Professional Help with a Schedule C IRS Audit

If the IRS is auditing the Schedule C of your tax return, contact Sherayzen Law Office. Our professional audit team, headed by attorney Eugene Sherayzen, is highly experienced in the IRS audits of Schedule C, especially with respect to upper middle-class and high net-worth clients. We can Help You!

Contact Us Today to Schedule Your Confidential Consultation!

Amending Tax Returns during An IRS Audit | IRS Audit Lawyer & Attorney

One of the most interesting questions that arise during an IRS audit is whether a taxpayer (or his tax attorney) should amend his tax returns during an IRS audit. Amending tax returns during an IRS audit may offer great benefits as long as it is done properly, but this is not a strategy available in every case. In this article, I would like to discuss the benefits and dangers of amending tax returns during an IRS audit.

Potential Benefits of Amending Tax Returns During an IRS Audit

The main job of a tax attorney during an IRS audit is to protect his client as well as make it easy and convenient for the IRS agent to make a decision that will favor his client. One of the ways to accomplish this is to do the necessary audit groundwork for the IRS agent by amending all tax returns subject to audit before your initial meeting with the IRS agent.

In such cases, amending tax returns is likely to bring the taxpayer various benefits. I will concentrate here on the three main benefits. First, amending tax returns shows that the taxpayer is willing to cooperate with the IRS far and beyond his prescribed obligations.

Second, by amending tax returns and providing supporting documentation, the tax attorney is likely to “buy” a lot of goodwill from the agent, who will appreciate that the attorney is trying to reduce his workload and make all information easily accessible. In some situations, such extensive cooperation may convince the agent not to expand the audit beyond the already audited years.

Finally, depending on the situation, it may show a rift between past noncompliance and present compliance for reasonable cause purposes. This is especially relevant in situations where the original tax preparer can be held accountable for the taxpayer’s past noncompliance.

Potential Drawbacks of Amending Tax Returns During an IRS Audit

There are, however, various risks associated with this strategy. Again, I will concentrate on the three main drawbacks of the strategy. First, the amended tax returns have to be prepared correctly. If the amended returns are incorrect, then the taxpayer would be getting himself into even bigger troubles.

Second, in some situations, a taxpayer may not benefit from prolonging the case, especially where there are Statute of Limitations issues concerning unaudited years. By prematurely exposing the taxpayer’s mistakes on the original return, the taxpayer may give the IRS additional time to open up another year for audit. It is questionable whether this concern outweighs the benefits of amending tax returns; one really should look at the totality of circumstances of the specific case in question and make the decision based on this analysis.

Third, by shifting the workload from the IRS agent to the taxpayer’s tax attorney, the taxpayer is likely to incur substantially higher legal fees. Therefore, a cost-benefit analysis must be done by the attorney to make sure that the proposed strategy of amending tax returns is cost-effective and does not result in unduly high legal fees.

Procedural Concerns: Do NOT File Amended Tax Returns; Send Them to the IRS Agent

One of the biggest procedural mistakes with respect to the strategy of amending tax returns that I see in my practice is incorrect filing of amended tax returns. By “incorrect filing”, I mean here the filing of amended tax returns directly with the IRS bypassing the IRS agent in charge of the audit.

This is a big mistake, because it goes against the proper procedure of having all adjustments to the audited original returns done by the IRS agent in charge of the case. Moreover, the IRS agent will feel ignored and to some degree betrayed by the taxpayer, and the taxpayer will likely lose all goodwill that he has accumulated with the agent up to that point.

The proper procedure for amending tax returns during an IRS audit is to prepare the amended tax returns and send them to the IRS agent in charge of the audit with supporting documentation.

Contact Sherayzen Law Office for Amending Tax Returns During an IRS Audit

Amending tax returns may not a be a strategy that is available in all cases. If done properly, in many cases, it will offer great benefits to a taxpayer, while it may result in augmenting the already existing problems in other cases. This type of a decision should not be made by the taxpayer, but by an experienced IRS audit lawyer.

Contact the professional IRS audit team of Sherayzen Law Office. Headed by our highly-experienced tax attorney, Mr. Eugene Sherayzen, Sherayzen Law Office has helped US taxpayers around the world to deal with various types of IRS audits, including audits of offshore voluntary disclosures and high net-worth audits.

Contact Us Today to Schedule Your Confidential Consultation!

Streamlined Submission Audit | SDOP Audit Tax Lawyer

An increasing number of submissions under the Streamlined Domestic Offshore Procedures are subject to an IRS audit (hereinafter “Streamlined Submission Audit”). In this article, I will explain what a Streamlined Submission Audit is and what a taxpayer should expect during the Audit.

Streamlined Submission Audit: Background Information on Streamlined Domestic Offshore Procedures

Streamlined Domestic Offshore Procedures (“SDOP”) is a voluntary disclosure option offered by the IRS since June of 2014 to noncompliant US taxpayers to settle their past tax noncompliance concerning foreign assets and foreign income at a reduced penalty rate. In order to participate in SDOP, a taxpayer must meet three main eligibility requirements – US tax residency, non-willfulness of prior noncompliance and absence of IRS examination.

SDOP is likely to be the most convenient and the least expensive voluntary disclosure option for taxpayers whose prior tax noncompliance was non-willful. SDOP is very popular; in fact, it has quickly surpassed the traditional IRS Offshore Voluntary Disclosure Program (“OVDP”) in the number of participants with over 18,000 submissions just in 2016.

The Origin of the Streamlined Submission Audit

Streamlined Submission Audit originates within the very nature of SDOP. Unlike OVDP, SDOP voluntary disclosures are not immediately subject to a comprehensive IRS review of tax return items (although, there is a review process which may lead to a Streamlined Submission Audit, but it is not as comprehensive as that of the OVDP prior to the Audit). Hence, the IRS reserved the right to audit any SDOP submission at any point within three years after the submission of the original SDOP voluntary disclosure package.

Streamlined Submission Audit: Process

The exact process of a Streamlined Submission Audit varies from case to case, but all of such audits have a similar format: initial letter with request for a meeting, meeting with an interview, review of submitted documents and (very likely) additional requests for information, interview of other involved individuals (such as a tax preparer) and, finally, the results of an audit are provided by the IRS to taxpayer(s) and/or the representative indicated on Form 2848.

A Streamlined Submission Audit commences in a way very similar to a regular IRS audit: a letter is sent to taxpayers and (if there is a Form 2848 on file) to their representative. The letter explains that the IRS decided to examine certain tax returns (usually all three years of amended tax returns) and asks for submission of all documentation and work papers that were used to prepare the amended returns. Additionally, the letter requests that the taxpayers’ representative (or taxpayers if not represented) contact the IRS agent in charge of the audit to schedule the initial meeting.

During the initial meeting, the IRS agent will review (at least to make sure he or she has what is needed) the documents supplied. In larger cases, the IRS will need a lot more time to later examine all of the submitted documents and see if additional documents are needed. If a case is very small, it is possible for an agent to cover everything in the first meeting, but it is very rare.

Also, during an initial meeting, there is going to be an interview of the taxpayer(s). I will discuss the interview separately in a different article.

Once the review of the initial package of documents is concluded, it is very likely that the IRS agent will have questions and additional document requests. The questions may be answered by the taxpayers’ attorney during a separate meeting with the agent; smaller questions may be settled over the phone.

If additional documentation is needed, an IRS agent will send out an additional request to taxpayers and/or their attorney. The answer will most likely need to be provided in writing.

Once the IRS completes its interview of other involved parties and reviews all evidence, it will make its decision and submit the results of the audit to the taxpayers and their tax attorney in writing. The taxpayers’ attorney will need to build a strategy with respect to the taxpayers’ response to the audit results depending on whether the taxpayers agree or disagree with the results of the audit.

Differences Between Streamlined Submission Audit and Regular IRS Audit

At first, it may seem that there are no big differences between a regular IRS audit and a Streamlined Submission Audit. While procedurally this may be correct, substantively it is not.

The greatest difference between the two types of IRS audits is the subject-matter involved. While a regular IRS audit will concentrate on the tax returns only, a Streamlined Submission Audit will involve everything: amended tax returns, FBARs, other information returns and, most importantly, Non-Willfulness Certification. In other words, a Streamlined Submission Audit will focus not only on whether the tax forms are correct, but also on whether the taxpayer was actually non-willful with respect to his prior tax noncompliance.

This difference in the subject-matter examination will carry over to other aspects of a Streamlined Submission Audit: the taxpayers’ interview will focus on their non-willfulness arguments, third-party interviews of original tax preparers become a regular feature (this is very different from a regular IRS audit when tax preparers may never be interviewed), and the final IRS results must necessarily make a decision on whether to challenge the taxpayers’ non-willfulness arguments.

Failure by a taxpayer to sustain his non-willfulness arguments may result in a disaster during a Streamlined Submission Audit with a potential referral to the Tax Division of the US Department of Justice for a criminal investigation.

This is why it is so important for a taxpayer subject to a Streamlined Submission Audit to retain the services of an experienced international tax lawyer to handle the audit professionally.

Contact Sherayzen Law Office for Professional Help With A Streamlined Submission Audit

If your submission under the Streamlined Domestic Offshore Procedures is being audited by the IRS, contact Sherayzen Law Office as soon as possible. Our international tax law firm is highly experienced in offshore voluntary disclosures (including OVDP (now closed), SDOP, SFOP, “noisy disclosures”, “quiet disclosures”, et cetera) and the IRS audits of a voluntary disclosure.
In fact, we have handled voluntary disclosure cases at every stage of the process of a Streamlined Submission Audit described above. We can Help You!

Contact Us Today to Schedule Your Confidential Consultation!