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For the week of April 4 through April 10, 2001

U.S. Tax Court ruling could affect developers

Express Staff Writer

An opinion by a U.S. Tax Court judge in a case involving Ketchum City Councilman David Hutchinson could make income tax payments more burdensome for developers.

Judge Stephen Swift ruled on March 14 in Portland, Ore., that Hutchinson and his three partners in Valley Ranch Inc. could not deduct estimated future interest paid to finance construction of the Valley Club. The planned 99-home residential development and golf course is just south of Ohio Gulch Road, about midway between Hailey and Ketchum. Sales on the lots began in 1994 and the golf course opened in 1996.

The case arose when the Valley Ranch partners contested an Internal Revenue Service claim that they owed an additional combined $1.1 million on their 1994 taxes. Hutchinson was alleged to be deficient $442,746. The IRS disputed the methods by which the partners had calculated their capital gains from the project.

According to Swift’s 29-page opinion, the case involved two issues: Could the partners allocate estimated costs of future improvements to the golf course and club to their cost of doing business in 1994? And second, could they add the estimated interest on those costs?

On the first issue, the court ruled in favor of the partners, regarding $3.7 million in estimated construction costs. On the second, it ruled in favor of the IRS, regarding $5.8 million in estimated interest.

The court has not yet issued a decision, to be based on Swift’s opinion, setting the amount of additional taxes that will be assessed.

To decide the first issue, Swift relied on an IRS rule that allows deduction of estimated future construction costs, with the intent of spreading those deductions over the life of the project, so long as the developer will not be able to deduct them as depreciation. He determined that the partners’ case fit that criterion, since they could not legally begin to deduct depreciation costs for the $17 million golf facilities until they were opened for business, and once they were opened, they were to be turned over to a new owner, the Valley Club, Inc.

On the second issue, the court concluded that an IRS rule allows deduction of interest only during the year it is incurred.

The partners’ Portland attorney, Neil Kimmelfield, contended in an interview that Swift’s ruling on the second issue was "clearly wrong." He maintained that Swift had misinterpreted the rules.

Kimmelfield said he and his clients have not decided whether to appeal that ruling. He said they will have 90 days after a court decision is handed down to file an appeal.

He said the financing cost issue "could affect many other developers." However, he added, "I think there is a reasonable chance that the IRS will see that the decision was wrong and not apply it."

Kimmelfield said the ruling’s effect on the partners is only to determine what year they could apply the deductions, not the amount. However, he said additional interest payments would accrue if they are deemed to owe more money in 1994 rather than in subsequent years.


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