This involves purchasing collapsible housing units offered by a Utah-based company where supposedly, you can claim a tax deduction of five times your cash outlay with a rapid depreciation deduction. According to the pitch, purchasers can then rent the unit to government agencies like the Federal Emergency Management Agency, to collect rental income.
The scheme works like this…
1 – : The buyer funds an irrevocable grantor trust with a cash payment plus a one-time administrative fee of $5,000.
2 – The grantor trust acquires 99 percent of a new series limited liability company. The parent of that series retains 1 percent and acts both as manager of the series LLC and as trustee of the grantor trust, with broad powers to act on behalf of both entities.
3 – The series LLC then purchases the housing unit using the trust’s contributed cash and a seller-financed loan.
4 – As part of the tax strategy, the duplex requires an up-front cash payment of $130,000 and is assigned a value of five times that amount.
5 – An appraisal provided with the unit, places the value of the housing unit at $663,333. That translates to $1,745 per square foot for a factory-built box house, a valuation on par with a co-op or condominium in Manhattan and higher than one in Palm Beach, Florida.
6 – According to the scheme, the purchaser then takes a rapid depreciation deduction of $650K.
7 – Again, according to the pitch, it can then be rented to the Federal Government to provide cash flow. But there’s no evidence suggesting that any federal agency has an agreement to rent any of these structures or has actually done so in the past.
Let me leave you with this…
Did I mention that the company producing the housing units, was founded by a businessman and philanthropist convicted of a felony in connection with a previous business, and its director of investor relations had been accused of deceptive business practices by the Federal Trade Commission?
It appears that the suggested trust structure is modeled after the tax shelters that existed before the Tax Reform Act of 1986 added Section 469 to the IRC, which established passive activity loss limitations to restrict tax shelter abuses. Almost anything that looks, acts, or even smells like one of the old tax shelter schemes is a huge no-no in today’s tax environment.
It’s true that leveraged deduction tax strategies can involve using debt to finance an investment, So the full amount of the loan, not just the investor’s out-of-pocket cost, can be deducted to lower or eliminate taxable income.
This is akin to purchasing an apartment building for $1M, putting down $200K, financing the other $800K, and then using $1M as your depreciation base.
It’s also true that tax strategies can leverage the difference between actual costs and an appraised value. But the appraisal must be reasonable.
And who in their right mind, would ever buy something similar to a mobile home for $650K?
If the IRS determines that the arrangements lack economic substance, a legal term meaning the transaction serves no financial purpose other than to minimize or avoid tax obligations, it can disregard the tax benefits. Even if a taxpayer relied on opinion letters used to promote the strategy to investors, they will probably face additional tax, interest, and penalties.
With that in mind, let me explain the final chapter of this nightmare. This entire scheme is set up to allow the trusts to abandon the investment before the first monthly payments are due.
The financing documents indicate that loan payments wouldn’t begin until January 2027, giving taxpayers time to claim the full bonus depreciation in the first year and potentially exit the strategy before any loan payment is made.
The assumption is that the debts would then be forgiven and the housing unit would then be taken back by the seller and resold to another buyer. The trust would be empty and the financing arm of the company would have nothing to pursue other than repossessing the housing unit.
Please understand that under IRS Rules, forgiveness of debt is a taxable transaction. If you owe a bank $100K and the debt is forgiven, perhaps through bankruptcy, you would then have an economic gain of $100K which is fully taxable.
But if at the time of forgiveness you are considered insolvent under IRS Specifications, you don’t have to pay the tax. In this instance, the trust that abandoned the housing unit would have no other assets, and would probably be considered insolvent.
And that’s the whole thing in a nutshell. According to their pitch, you pay $150K and get a $650K tax deduction.
I don’t know how everyone involved in this isn’t already in the slammer. There are any number of reasons why this would never pass an IRS Audit that I’ve already discussed.
But remember that tax law is an adjunct to criminal law. As such, intent is always a factor.
If your intent was solely to screw the government, what do you think the IRS is going to do? Be nice, shake a bony finger at you, and say that they hope you’ve learned your lesson?
Or are you the next contestant on that fun-filled family game show titled, “Don’t Drop The Soap?”
The thing about these tax schemes is that the Service is slow to act. The old tax shelters that are now completely illegal were sold for 20 years before being outlawed.
Stay away from these schemes like the plague that they are. And realize that anything too good to be true, probably is.
As always, if you’re having problems with your accounting and tax work, we’d love to help. Please contact us today.
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