Thursday, May 11, 2006
IRS differs with ABC
As a result of her participation in "Extreme Makeover: Home Edition," Carol Crawford Smith might owe taxes on an additional $122,400 in income. Her tax liability could increase by $20,000 or more.
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Alan Kim | The Roanoke Times
Carol Crawford Smith's house that was demolished (above) to make way for her new home.
Matt Gentry | The Roanoke Times
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IRS statement
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BLACKSBURG -- A Blacksburg family and dozens of others across the country who have received new homes from the ABC television show "Extreme Makeover: Home Edition" could face hefty tax bills if audited, according to a nonbinding ruling issued by the Internal Revenue Service.
The IRS released what it calls an "information letter" on March 31 that contradicts the advice ABC representatives and producers of "Extreme Makeover" give to winners on how to avoid paying federal income taxes on their new homes.
The show, now in its third season, chooses needy families from across the country to receive new homes. The episodes feature volunteers demolishing the old houses and building customized replacements in fewer than seven days.
Participants lease their homes to the show for the duration of the shooting, which ABC says will help the families avoid taxes.
Carol Crawford Smith and her sons, Hunter and Garland, were featured in February. A former soloist with the Dance Theatre of Harlem, Smith was diagnosed with multiple sclerosis five years ago and now uses a wheelchair.
She won in part because her old house, with its many stairs, had become unsafe for her. Local contractors, architects and building suppliers donated skilled labor and building materials estimated to be worth more than $750,000 to build her new home. None of the local donations are tax-deductible.
Smith said Tuesday that she had not heard about the IRS letter and could not comment on it until consulting with her accountant and attorney, and talking with ABC.
The show's producers responded with a written statement Wednesday: "We consulted with tax experts and learned that a property owner could lease a home to a production company for the purposes of shooting a television show for up to 14 days, and that lease and any home improvements were exempt from state and federal taxes."
Under the exemption, owners also avoid paying taxes on the rent they collect.
The IRS letter disputes ABC's use of the loophole, saying the houses are prizes similar to lottery winnings and other game show awards.
As such, the difference in value between the old home and the new one should be claimed as income on federal tax returns, University of Cincinnati tax law professor Paul Coran said.
If they "don't report the income, they would run the risk of the IRS coming after them," Coran said.
Smith's old house was worth $144,000, according to Montgomery County records. The new house was recently valued at $266,400, meaning she could be required to claim the $122,400 difference on her income tax.
According to IRS tax tables, on a hypothetical return with standard deductions for a head of household and two dependents, income of $122,400 could result in a tax liability of $21,953.
Montgomery County is scheduled to reassess property next year.
IRS public relations officials repeatedly declined to comment on the implications of the ruling.
The letter is not binding and there will likely be no immediate consequences for families. But it does suggest that the IRS would strictly interpret the code, Coran said.
If a "Makeover" case goes to court, as Richmond certified public accountant and tax preparer Chuck Overbey believes will soon happen, the loophole would be tested.
It's not necessarily illegal or immoral for "Makeover" families to claim the exemption, Overbey said. After all, a court could rule that it applies in these cases. But if the court rules against them, the families, many of whom are already cash-strapped, could end up owing significant taxes and penalties.
Overbey also pointed out that historically the IRS has targeted groups of people it suspects of dodging tax bills.
In fact, the IRS has recently been working to get customer records from online payment service PayPal. The agency suspects some people of using it to deposit money into foreign banks, Overbey said.
But some believe it would be unwise for the IRS to challenge the "Makeover" families in court.
"Judging as a casual viewer, it seems these families do need these renovations and it wouldn't be fair" to sock them with big tax bills, said Brian Hirsch.
Hirsch is a third-year law student who recently published an article about ABC's tax strategy in the University of Cincinnati Law Review.
He also believes the IRS might face public backlash if it tries to collect from "Makeover" winners.
In his article, he recounts what happened in 1998 when the agency signaled it might collect a gift tax from a groundskeeper who tried to return a home run ball to former St. Louis Cardinals first baseman Mark McGwire.
The response from fans was swift and harsh and the IRS quickly backpedaled, Hirsch wrote.
