Entrance Fee Taxation

"Classic Residence [CR] by Hyatt, a group of businesses that run upscale retirement communities, is battling the [IRS] over allegations it underpaid its taxes by more than $107 million, in a dispute over the tax treatment of entrance fees paid by incoming residents. ... [CR] is chaired by 51-year-old Penny Pritzger, part of the Chicago-based Pritzger business dynasty, whose holdings range from Hyatt Hotels Corp. to TransUnion, the big credit-reporting company. She founded [CR] in 1987. Entrance fees can range from the low six figures to more than $2 million per person, depending on the size and amenities of the living unit involved. ... The IRS contends that the venture under-reported income by more than $300 million in 2005 alone. ... In court filings, [CR] attorneys say that a substantial portion of the entrance fee-in many cases at least 90%--is refundable when a resident leaves or dies; therefore, they say, the refundable portions should be treated as interest-free loans to the residence operator. As such, the filings add, the fees wouldn't be taxable as income. ... In its Dec. 30 tax-deficiency notice, the IRS said it 'determined that entrance fees constitute income from rental/occupancy of the living units, and as such, must be included in the income in the year received.' Given the federal government's huge revenue needs, the IRS is interpreting tax laws more aggressively, says David L. Rice, a Los Angles tax attorney and incoming chairman of the American Bar Association's Individual and Family Tax Committee. ... However, Mr. Rice adds that some some aspects of the [CR] entrance fees might lead the US Tax Court to agree with the IRS. To the degree entrance fees help hold down residents' monthly living charges, the payments could be viwed as a form of prepaid rent, which the IRS treats as income, he says. Plus the residence operator has free use of the funds, sometimes for 20 to 30 years. So 'technically, it might loook like a loan, but from the IRS's perspective, it smells like income,' he says", my emphasis, John Emshwiller at the WSJ, 3 June 2010, link: http://online.wsj.com/article/SB10001424052748704515704575282362670440450.html.

The IRS might not win this. If the entrance fees are income, and I conclude in part they are, can the residents can claim nursing home care expense? If not, why not? Depending on CR and its residents relative marginal tax rates, the IRS may get nothing from this.