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NEW ADVENTURES IN LEGAL REASONING

May 27, 2005

Our post on "Humpty Dumpty Law at Iowa Department of Revenue and Finance" triggered an enlightening three-way correspondence among Mike Ralston, Director of the Iowa Department of Revenue and Finance; attorney George Davis, and your author.

As expected, we haven't (yet) persuaded the Director to change the Department's eccentric interpretation of the word "held." The department doesn't adopt the federal tax rules that say asset holding periods survive tax-free exchanges. We have learned more about the origin of the Department's position, though. Per Mr. Ralston:

I'm told there has been only one Iowa case litigated regarding the Iowa capital gain exclusion since the change in 1998 to remove the cap on the amount of the deduction. In James & Linda Bell, the Administrative Law Judge and the Director ruled that the reference to "held" in Iowa Code Section 422.7(21) is to ownership. To the best of my knowledge, the department has taken a consistent position that any transfer of property starts a new ten year holding period.

The Bell discussion of this issue is a jaw-dropper:

The capital gain tax laws originate with the sale of an asset. An asset cannot be sold unless it is owned. As a result, the reference to "held" is to ownership. "The holding period for a capital asset is the length of time that the taxpayer owned the property before disposing of it through sale or exchange." 2001 U.S. Master Tax Guide 1777, p.465 CCH Editorial Staff Publication. The mingling of the "material participation" with a leasehold interest is not sufficient. The clear meaning of the statute is for "held" to mean ownership. The protester does not meet the holding requirement when it is defined as ownership.

It is astounding that the Department would rely on an out-of-context quote from the "Master Tax Guide" for its position on interpreting its statute. The "Master Tax Guide" is certainly a handy reference, but it is about as authoritative as a recent Tax Update post. The reference is the classic freshman mistake of drawing a conclusion from the first paragraph read without digging further for the details

Even more astounding, as George Davis points out, is the tacit admission that they think they are relying on the federal rules for holding periods. After all, the "Master Tax Guide" is a reference to the federal tax law. If they had accurately followed through all of the references in the guide to their sources, they would have found that held doesn't equate to "owned," and that there are many instances where holding period tacks when an asset changes hands.

If the Department follows the approach of Bell, it is compelled to follow the federal holding period rules, as Bell purports to do. Of course, Bell misreads the federal rules, as an accurate reading of those rules shows that holding periods in fact do survive like-kind exchanges. If the Department corrects the Bell misreading, its position has no basis.

It remains to be seen whether the Department will relent before somebody has to take this to district court. I would love to see the look on the judge's face when the Department attorneys fall back on their "Master Tax Guide" cite.

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