Peter Morton, one of the cofounders of the Hard Rock Cafe chain, and the creator and developer of the Hard Rock brand, conducted his business through a number of S corporations. He owned a Gulfstream III and decided to trade it--as an IRC Section 1031 tax-deferred exchange --for a Gulfstream IV. The IRS was unhappy for two reasons.
First, the IRS felt that the G-III was not used as business property due to the amount of personal usage (flying Morton's friends and family). Morton argued that, in determing whether it was used as business property, he could take into account the use by his S corporations. The IRS objected. The IRS said that, based on very important Supreme Court decisions--Deputy v. Du Pont (1940) and Moline Properties, Inc. v. Commissioner(1943)--a shareholder must be treated separately from his corporations. The Court of Federal Claims held that while that might be true for C corporations, it is not true for S corporations, since an S is virtually the same as the individual shareholder.
Second, the IRS seized upon a mistake by the escrow agent during the 1031 exchange: the escrow agent accidentally wired funds from the escrow account to one of Morton's S corporations. That violated the 1031 rule that the taxpayer not benefit from the money held by the QI (qualified intermediary). The IRS tried to disallow the 1031 exchange even though Morton immediately returned the funds. The court held that Morton should not be penalized for someone else's mistake. However, this shows a danger of a 1031 transaction: any mistake will lead to an IRS or FTB attack.
Morton has not won the case yet. Substantiation on personal use is still up in the air.
http://riles52.blogspot.com/2011/05/hard-rock-case-still-up-in-air-though.html
Posted by: Peter Reilly | May 09, 2011 at 12:47 PM