In Continuing Life Communities Thousand Oaks, LLC v. Commissioner of Internal Revenue (Ninth Circuit, No. 22-70225), the circuit court affirmed the Tax Court’s summary judgment decision, which held that a continuing care facility following its generally accepted accounting principles (“GAAP”) for recognition of certain upfront fees required to be held in a third-party master trust account was a clear reflection of income under Treas. Reg. §1.446-1(a)(2).
Continuing Life Communities Thousand Oaks LLC (the “taxpayer”) operates a continuing care facility in California that provides housing and healthcare services to seniors in need of assistance. Per the agreement between the taxpayer and its residents, there are two main fees: (1) the residents must deposit a large upfront fee (the “contribution amount”) into a third-party managed master trust, which covers lifetime care for the residents; and (2) pay monthly service fees that cover various costs such as utilities. When a resident voluntarily leaves the facility or passes away, taxpayer is entitled to a portion of the contribution amount (the “Deferred Fee”, which is between 5% and 25%, depending on the amount of time that a resident stayed at the facility), which is paid to it by the master trust whenever a new resident moves into the vacant unit.
The Tax Court originally granted summary judgment in favor of the taxpayer. The IRS appealed to the Ninth Circuit and maintained its position that the taxpayer’s deferral of upfront entrance fees did not clearly reflect income because the taxpayer incorrectly deferred such amounts beyond the point at which it met the all-events test under Treas. Reg. §1.451-1(a). The IRS asserted that the all-events test was met when the taxpayer’s customer paid the entrance fees to the third-party master trust because that was the point in time in which the taxpayer had an unconditional right to the payment. Instead, the taxpayer defers the recognition of such amounts into income until such point in time as the customer either departs the facility or passes away, thereby releasing the funds from the third-party master trust to the taxpayer for its use.
The Ninth Circuit affirmed the decision of the Tax Court and held that the taxpayer’s right to receive any deferred entrance fee from a resident becomes fixed only once the taxpayer fulfills its statutory and contractual obligation to provide lifetime care to that resident and, thus, is a condition precedent, not a condition subsequent, to its right to receive any deferred entrance fee. Therefore, the Court held that the taxpayer’s method of accounting clearly reflects income, and the IRS lacks the authority to impose an alternative method they consider to more clearly reflect income.
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