January 1999 Issue

OUT-OF-STATE PURCHASERS' USE OF RESALE CERTIFICATE FORM ST-120

By Robert A. Reitman, CPA, Frank & Zimmerman & Company LLP

On June 5, 1998, the New York State Tax Department issued TSB-M-98(3)S, which changes the requirements for use of Sales Tax Resale Certificate Form ST-120 by qualified out-of-state vendors not registered in New York State. Previously Form ST-120 could only be used by vendors registered in New York State. Form ST-128, Out-of-State Resale Permit, can continue to be used as a legal exemption document until its expiration date.

Due to this new change in procedures, the department has revised Form ST-120 (Print date 5/98). Registered vendors may continue to accept and issue previous versions of Form ST-120 until they have acquired the new form. Contractors may not use the revised Form ST-120 when purchasing materials and supplies.

The TSB-M states the following:

A qualified out-of-state purchaser is
one who--

* is not registered and is not required to be registered as a sales tax vendor with the New York State Tax Department;

* is registered with another state, the District of Columbia, a province of Canada, or other country, or has its only location in a state, province, or country that does not require registration; and

* is purchasing items that will either be shipped by the vendor to the purchaser's customer or unaffiliated fulfillment company located in New York State, or shipped to the purchaser in New York State, but is resold from a business located outside the state.

An out-of-state purchaser can use Form ST-120 to make tax-exempt purchases when--

* the vendor will drop-ship the item/s purchased for resale to the out-of-state purchaser's customer in New York State;

* the vendor will drop-ship the item/s purchased for resale to the out-of-state purchaser's unaffiliated fulfillment service company in New York State; or

* the out-of-state purchaser takes possession of the item/s in New York State from a business located outside New York State.

Qualified out-of-state purchases may issue Form ST-120 either as a single use certificate or as a blanket certificate. A blanket certificate will apply to the first and any additional purchases of the same type of property or service purchased for resale.

When a New York registered vendor accepts the exemption certificate from an out-of-state purchaser in lieu of collecting sales tax, the New York vendor will be protected from liability if the certificate is received by the vendor within 90 days of the delivery of the property or services rendered and the form has all required entries completed.

Registered vendors should maintain an accounting system that will be able to match the exemption certificate on file with the corresponding sales invoice. Vendors may be required to provide the department with the names and addresses of each of the purchaser's customers or unaffiliated fulfillment service companies receiving a drop shipment where delivery occurs in New York State.

The revised Form ST-120 is available for download from the department's website at www.tax.state.ny.us. *

CONVERSION OF APARTMENT
BUILDINGS MAY BE SUBJECT TO NEW YORK CITY UNINCORPORATED
BUSINESS TAX

By John Thompson, CPA, and Mitchell Eichen, CPA, Perelson Weiner, CPAs

Generally, the income from holding, leasing, or managing real property is not subject to the New York City Unincorporated Business Tax (UBT). However, as noted in the following case, the original purpose of the use of real property can change upon the conversion of apartment buildings to condominiums and cooperative apartments.

In 85th Estates Company v. New York City Tax Appeals Tribunal, a partnership that converted several apartment houses into condominiums and cooperative houses was subject to UBT. It was considered a "dealer" and therefore not exempt from UBT. New York City regulations define a dealer in real or personal property as "an individual or unincorporated entity with an established place of business, regularly engaged in the purchase of property and its resale to customers; that is, one who (as a merchant) buys property and sells it to customers with a view to the gains and profits that may be derived therefrom."

The 85th Estates Company, a New York State general partnership, was the result of a merger of several entities that each owned and operated an apartment building. The partners that owned the buildings were experienced builders and operators of buildings. During 1981, the partners were experiencing problems with renewing leases and with the banks holding the mortgages. It was suggested that, if the apartment buildings were converted to condominiums or cooperatives, the partners would have less trouble with the banks and renewing leases. Prior to the conversion, sales agents were hired who reported to the partnership frequently throughout the process (which lasted approximately five years). Some of the partners had ownership interests in the sales agents. Although the sales agents were experienced in the conversion of buildings to cooperatives and condominiums, they worked with the partnership's counsel to propose the terms that needed final approval from the partnership. The sales agents maintained a sales office (renovated vacant apartments) at each of the buildings being converted. All advertising also needed approval from the partnership.

Subsequent to the partnership reporting the gain on the sale of the buildings as long-term capital gains on their Federal and New York State tax returns, the New York City Department of Finance issued a notice of determination, dated November 13, 1989, asserting a UBT deficiency for 1986 of $1,985,533 including penalties and interest. The explanation was that "a real estate developer who sells property as improved lots is considered to be a dealer for unincorporated business tax purposes." The partnership asserts that it did not hold the property primarily for sale to customers and that it did not regularly purchase and resell property under the definition of the UBT regulations. It claimed that since it held the properties for investment purposes and converted the buildings only to liquidate its investments, it should not be considered a dealer. The City of New York claimed that regardless of the original purpose for the use of the property, the buildings were being held primarily for sale at the time of the conversion.

Who Is a Dealer?

The issue of whether a taxpayer is a dealer is determined by ascertaining whether or not the--

* property was held primarily for sale,

* taxpayer was engaged in the trade or business of selling its property, and

* sales were made in the ordinary course of that trade or business.

The factors to be considered in answering these questions, as set forth in United States v. Winthrop, were as follows:

* Time and effort the taxpayer devoted to the sales

* Extent and nature of the taxpayer's efforts to sell the property

* Number, extent, continuity, and substantiality of the sales

* Extent of subdividing, developing, and advertising to increase sales

* Use of a business office for the sale of property and the character and degree of supervision or control exercised by the taxpayer over the representative selling the property

* Nature and purpose of the acquisition of the property and duration of ownership.

Individual factors will be measured differently depending upon the facts of the case. In the case at issue, the New York City Tax Appeals Tribunal determined that the following applied to the aforementioned factors:

* The conversion process took approximately five years.

* The taxpayers engaged in significant activities directly through its partners.

* The large dollar amounts, the number of individual sales of real property (125 condos), and the large number of subscriptions for apartments (489) received by the taxpayer support the existence of the business of converting buildings and the ordinary sales of each building.

* The taxpayer spent approximately $400,000 on renovations and $70,000 on outside advertising to increase sales.

* Sales offices were maintained at five of the six apartment buildings. Although used by sales agents, they were exclusively used for the sale of the taxpayer's property; unlike a broker's office, which would be used for other clients. Also, by fixing up these apartments, the taxpayer absorbed the cost of the sales offices. The taxpayer set prices and approved and implemented budgets, share allocations, and offering plans. The sales agents reported frequently to the taxpayers and did not have authority to include any provisions on their own.

* Although it is not disputed that the taxpayer held the properties for investment and rental purposes, a taxpayer's primary purpose for holding property may change (Suburban Realty Co.). In Barrios Estate v. Comm'r, the Fifth Circuit has held that "a taxpayer is not holding property primarily for sale if the sale of property previously held for investment is caused by unanticipated, externally induced factors that make the continued pre-existing use of realty impossible." External factors can include acts of God, condemnation, unfavorable zoning regulations, or drainage problems. In this case, the motive for the conversions was not unanticipated, since it was known at the time the balloon mortgage was due that interest rates would be high and refinancing would be very expensive.

In Heller Trust, the Ninth Circuit Court of Appeals, creating a broader exception, held that "if a taxpayer acquired property for investment purposes and the sale is prompted by a liquidation intent, the taxpayer should not lose the benefits provided for by the capital gain provisions." The taxpayer in 85th Estates Company believed the Heller exception should apply due to the "taxpayer's deteriorating health and lack of interest in the younger generation in the business, concerns about pending unfavorable changes in the Federal tax laws, possible changes in New York law that would make converting buildings more difficult, the difficulties of refinancing real estate, and the economic effects of the rent stabilization laws." The court responded to this argument threefold:

* The Ninth Circuit significantly limits the cases to which the "liquidation intent" is applicable. In Parkside, Inc., the Ninth Circuit stated that "sales that take place in the course of 'liquidation' neither automatically compel nor foreclose a finding that property was held primarily for sale in the ordinary course of a trade or business."

* The taxpayer retained interest in 13 unsold apartments from one building and retained commercial space in another. Since the taxpayer did not go out of business and not all the interests were disposed of, the court believed that the taxpayer only changed the nature of the business in order to make it more profitable.

* The claim of threatened changes in New York real property law regarding the conversion of co-ops and condos was invalid because the bills addressing this issue were not introduced into the state legislature until 1985, while the sales agreement to convert one of the buildings is dated February 1983.

This case indicates that the factors used to determine if a taxpayer is a dealer are broad and give the city wide latitude in assessing UBT. Use of alternative structures may help in qualifying for the "owning real property" exemption, thereby minimizing UBT exposure.

Query: Would the city's determination have an adverse effect on the Federal classification of such income being either ordinary or capital gain? *

NEW YORK SPOUSAL TAX RELIEF

By Kenneth Manche, CPA, Polakoff & Michaelson, CPAs, P.C.

On August 5, 1998, New York Governor George Pataki signed legislation (Senate Bill 6468-B) altering the treatment of tax liability of spouses filing joint income tax returns. This legislation amends sections 171 and 651 of the tax law. It provides that, on a joint tax return, under certain circumstances, a spouse's liability for tax will be limited to the proportionate share of the joint tax liability. Such liability is determined by calculating each spouse's tax liability separately and multiplying the joint tax liability by the fraction of that spouse's tax liability over the sum of the individually calculated tax liabilities.

Tax liability remains joint and several for spouses filing joint tax returns where the commissioner establishes a spouse knew or had reason to know that the tax return contained "a substantial understatement of tax attributable to grossly erroneous items." A substantial understatement is defined as any understatement exceeding $100. Grossly erroneous items are defined as any item of New York adjusted gross income that is omitted from New York adjusted gross income and any claim of New York deduction, exemption, credit, or basis in an amount for which there is no basis in fact or law. The new law applies to taxable years beginning on or after January 1, 1999.

Prior to enactment, a spouse's liability for a joint tax return was joint and several. However, if a taxpayer could demonstrate innocent spouse status, he or she would not be held liable for a tax deficiency resulting from a substantial understatement. *

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