A Precedential Ruling by the NY Division of Tax Appeals

This precedential ruling from a three-judge panel of the New York Division of Tax Appeals may signal a more aggressive approach from New York tax auditors, although the facts were unusual enough that other explanations remain possible.

The taxpayers were members of Tov Enterprises LLC, which in turn owned substantially all of Fulton Center LLC. Fulton owned and operated the Fulton Street property in Brooklyn for 16 years before selling it in 2015 through a Section 1031 exchange for a gross sale price of $33,000,000.

Fulton later acquired a tenant-in-common interest in the West Cliff property in Las Vegas. The precise ownership percentages and pricing are somewhat unclear in the opinion, but the court's discussion focused on whether various claimed deductions were valid exchange expenses or instead taxable boot.

New York's burden of proof

An important backdrop to the case is that New York required the taxpayers to prove their position with clear and convincing evidence. That is a heavier burden than the preponderance standard that usually applies in federal tax appeals and many other civil disputes.

With that standard in place, the court reviewed a series of deductions and adjustments the taxpayers claimed in connection with the relinquished and replacement properties.

Brokerage commissions on the sale

Fulton treated large payments to David Goldberg and Edith Lesser as brokers' fees on the sale of the Fulton Street property. The court acknowledged that commissions are ordinarily transactional items that may be deductible as exchange expenses, but the taxpayers did not supply agreements, proof of services actually performed, or evidence that either payee was a licensed broker.

Because the record did not clearly show what services were provided or why the payments were owed, the court held that the taxpayers failed to prove the amounts were exchange expenses.

The writer's view was that the payment demanded by the buyer should at least have been treated as a reduction in the purchase price, but the court did not accept that framing on this record.

Liens and other property-level obligations

The taxpayers also paid off bankruptcy-related legal liens, an Environmental Control Board lien, and a Fulton Lumber lien when the relinquished property was sold. The court held that these were not exchange expenses because they arose from owning, operating, or maintaining the property rather than from the transfer itself.

That analysis meant the amounts were treated as boot when they were paid from exchange proceeds. The commentary in the article notes that while these items were not transactional, they were still debts secured by the relinquished property and could potentially have been offset by replacement-property debt if the transaction had been structured and documented differently.

Title services and consulting fees

A small title-services charge on the relinquished property closing statement was disallowed because no one explained what the charge covered. Likewise, a $360,000 consultation fee paid to Gemma Capital in connection with the replacement property was disallowed because testimony alone did not persuade the court without supporting documentation.

The practical lesson is straightforward: even routine closing items can become problems years later if records are missing or the support for them is vague.

The syndication fee dispute

One of the most significant issues was a $9,300,000 fee tied to David Horowitz's role in controlling the contract to purchase the replacement property. The taxpayers described this as a lump-sum alternative to a more traditional syndication arrangement.

The court was not persuaded. It emphasized that the fee did not appear on the closing statement or on the Form 8824 worksheet, that the amount was extraordinarily large relative to the purchase price, and that it remained unpaid more than five years later even though it was allegedly due.

On those facts, the court concluded the fee was not a valid exchange expense. The article suggests the taxpayers may have had a stronger position if the obligation had been structured and secured more clearly, perhaps more like an assignment-of-contract fee or a documented financing obligation.

Capitalization, passive losses, and penalties

The taxpayers argued in the alternative that some disputed items should increase basis in the replacement property or be treated as passive losses. The court rejected those arguments as well, finding that the claims were not adequately proven and, in the capitalization context, questioning how relinquished-property costs could be added after that property was gone.

The article strongly questions that basis analysis, noting that basis in relinquished property generally rolls over in a valid exchange and therefore remains relevant.

The court also upheld penalties. It pointed to the complexity of the transaction, the failure to maintain or produce adequate records, late and incomplete tax reporting, and claims for amounts that did not appear on the closing statements and in some instances were never paid.

Takeaways for New York exchanges

The author's broader takeaway is that the taxpayers lost through a combination of poor records, incomplete explanations, confusion between exchange expenses and debt offset concepts, and weak litigation support.

Whether this case is an outlier or an early sign of a new audit strategy, New York practitioners and taxpayers should treat documentation as a central part of exchange planning. Closing statements, Form 8824 worksheets, debt treatment, side agreements, and due-diligence invoices all need to line up with the taxpayer's story before the return is ever filed.