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UPDATE: IRS Withdraws Tax Challenge Against Senior Living Operator

Industries Served
Legal Services
07.14.10

The IRS has edged away from the aggressive stance that it took in June regarding tax treatment of refundable entrance fees by retirement community operator Vi (f/k/a/ Classic Residences by Hyatt). In its answer to Vi's petition, the IRS admitted an error in increasing Vi's taxable income and imposing a negligence penalty, but also stated that this admission of error applied only to Vi's facts and would not prevent the Service from making the same arguments in other situations. Although the IRS admitted in its answer that the refundable portion of an entrance fee is a loan and not taxable income under certain circumstances, it continues to assert that under other, unspecified circumstances, the entrance fee would be correctly considered income.

[As published, June 24, 2010]

Senior Living Industry Rocked by IRS Tax Challenge

The Internal Revenue Service surprised and alarmed retirement community operators recently when it challenged the tax treatment of refundable entrance fees by an operator of luxury continuing care retirement communities.

Classic Residence by Hyatt, which changed its name to Vi recently, owns more than 18 senior living communities. The company followed industry practice by treating the refundable portions of residents' entrance fees as loans with obligations to repay. In December 2009, the IRS sent Classic a notice of deficiency for almost $129 million for the 2005 tax year, insisting that the company should have treated the more than $318 million it received in mostly refundable entrance fees that year as taxable income "from rental/occupancy of the living units."

Classic has petitioned the Tax Court for redetermination of the deficiency and penalty, contending that because the refundable part of the fee bears an obligation to repay the resident, it is a loan and should be treated as such for tax purposes.

What makes the IRS stance surprising is that there is case law supporting Classic's position directly on point. In a 2007 federal court decision involving a resident of a Hyatt facility, John O. Finzer et ux. v. United States, 496 F. Supp. 2d 954 (N.D. Ill. 2007), the court explicitly described the refundable portion of a retirement community entrance fee "as a loan." The agreement at issue in Finzer provided that if the agreement was terminated for any reason, including the death of the resident, there would be a refund. In addition to Finzer, there are other court rulings and several advice memoranda from the IRS that support treatment of a truly refundable "fee" as a loan.

Because each provider may treat the fees differently, the underlying documents should be reviewed to see if the treatment as a loan is appropriate. The underlying documents should be clear as to the refundability and use correct and clear language to minimize IRS "confusion." In Finzer, for example, there was a promissory note that was to bear interest if there was a default in payment. The documents described the fee as a loan, and the provider testified that it considered the fee to be a loan.

For additional information, please contact Carla Fenswick or any member of Waller Lansden's Senior Living or Tax practices at 800-487-6380.

WE ARE REQUIRED BY IRS CIRCULAR 230 TO INFORM YOU THAT THE PRECEDING DISCUSSION WAS NOT INTENDED OR WRITTEN TO BE USED, AND IT CANNOT BE USED, NOR RELIED UPON, BY ANY TAXPAYER FOR THE PURPOSE OF AVOIDING ANY PENALTIES THAT MAY BE IMPOSED UNDER FEDERAL TAX LAW. THE ADVICE WAS WRITTEN TO SUPPORT THE PROMOTION OR MARKETING OF THE TRANSACTIONS OR MATTERS ADDRESSED IN THE DISCUSSION. EACH TAXPAYER SHOULD SEEK ADVICE BASED ON ITS PARTICULAR CIRCUMSTANCES FROM AN INDEPENDENT TAX ADVISOR.

The opinions expressed in this bulletin are intended for general guidance only.  They are not intended as recommendations for specific situations.  As always, readers should consult a qualified attorney for specific legal guidance.

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