Please file
a tax return when you have significant carryovers.
Let’s look
at the Mosley case.
In 2003
Sonji Mosley bought four residential properties in North Carolina.
In 2007 she
bought undeveloped land in South Carolina.
In 2009 all the properties were foreclosed.
On her 2009
return she reported approximately $20 grand of net rental expenses and a
capital loss of approximately $182 grand.
On her 2014
return she claimed an (approximately) $17 thousand loss from one of the 2009
foreclosures.
On her 2015
return she claimed an (approximately) $28 thousand loss from one of the 2009
foreclosures.
On to n 2018.
It seemed an ordinary year. She worked for the city of Charlotte. She also broke two retirement accounts. The numbers were as follows:
Wages $ 40,656
Retirement
plan distributions $216,871
The retirement plan distributions were going to hurt as she was under 59 ½ years of age. There would be a 10% penalty for early distribution on top of ordinary income taxes.
Well, there
would have been - had she filed a return.
The IRS
prepared one for her. The IRS already had her W-2 and 1099s through computer
matching, so they prepared something called a Substitute for Return (SFR).
Taxes, penalties, and interest added to almost $60 grand. The implicit bias in
the SFR is transparent: everything is taxable, nothing is deductible. The IRS
wants you to see the SFR, clutch your chest and file an actual return.
To her
credit, she did reply. She did not file a return, though; she replied with a
letter.
COMMENT: She should have sent a return.
She
explained that - yes – she should have filed a return, but the IRS was not
giving her credit for prior year carryovers. If anything, she still had a
credit with the IRS. She also requested the IRS to remove all penalties and
interest.
COMMENT: She definitely should have sent a return.
The IRS could
not understand her letter any more than you or I. They sent a Notice of
Deficiency, also called a “NOD,” “SNOD,” or “90-day letter.” It is the ticket
to Tax Court, as we have discussed before.
Off to Court
they went.
Mosley next submitted
four handwritten calculations to the IRS.
- The
first showed a net operating loss (NOL) of $444,600 and a capital loss of
$206,494, both originating in 2009.
- The second and third ones broke down those
numbers between South and North Carolina.
- The fourth one was an updated calculation of
her 2018 taxes. According to her numbers, she had a remaining NOL of $211,308
going into 2018. Since the total of her 2019 income was approximately $257 grand,
she had very much separated the thorn from the stalk.
The IRS had questions. The tax impact of a foreclosure
can be nonintuitive, but – in general – there are two tax pieces to a
foreclosure:
(1)
The
borrower may have income from the cancellation of income. That part makes
sense: if the bank settles a $150,000 debt for $100 grand, one can see the $50
grand entering the conversation. Then follows a bramble of tax possibilities – one
is insolvent, for example – which might further affect the final tax answer but
which we will leave alone for this discussion.
(2)
Believe it or not, the foreclosure is also considered
a sale of the property. There might be gain or loss, and the gain might be
taxable (or not), and the loss might be deductible (or not). Again, we will avoid
this bramble for this discussion.
The IRS
looked at her calculations. She had calculated a 2009 NOL of $444,600 and
$78,025 capital loss from her North Carolina properties. The IRS recalculated North
Carolina and arrived at taxable gain of $55,575.
Not even
close.
You can anticipate the skepticism the Tax
Court brought to bear:
(1)
She
did not file a 2009 return, yet she asserted that there were carryovers from
2009 that affected her 2018 return.
(2)
She
reported the same transactions in 2009, 2014 and 2019.
(3)
The
tax reporting for foreclosures can be complicated enough, but her situation was
further complicated by involving rental properties. Rentals allow for
depreciation, which would affect her basis in the property and thereby her gain
or loss on the foreclosure of the property.
(4)
The
IRS recalculations were brutal.
The Court
pointed out the obvious: Mosley had to prove it. The Court did not necessarily
want her to recreate the wheel, but it did want to see a wheel.
Here is the
Court’s sniff at the net operating loss carryover:
It is apparent that the record is devoid of evidence to properly establish both the existence and the amount of petitioner’s NOLs in 2009.”
Here is the
Court on the capital loss carryover:
“ … petitioner initially reported the foreclosure on the South Carolina land resulted in $182,343 of net long-term capital losses, and for each of 2009-17, she claimed $3,000 of that amount as a long-term capital loss deduction pursuant to section 1211(b). But on the 2015 return … petitioner also improperly claimed an ordinary loss deduction of 110,257 from the sale or exchange of the South Carolina land despite the foreclosure on that land in 2009. Thus, petitioner effectively double counted the loss …."
Mosley lost
on every count, She owed tax, penalty, and interest.
And there is
a lesson. If you have significant tax carryovers spilling over several
years, you should file even if the result is no taxable income. The IRS wants
to see the numbers play out. Get yourself in hot water and the Tax Court will
want to see them play out also.
You might even
catch mistakes, like double-counting things.
Our case this time was Mosely v Commissioner, T.C. Memo 2025-7.
