Tag: Appellate Court

Purchaser Collection of Pre-Closing Rent Deficiency

In the purchase and sale of real property which is leased to tenants, sellers and purchasers must pay particular attention to the allocation of rent collected both before and after the closing.  A typical purchase and sale agreement will include, among other things, language addressing the allocation of rent by the parties for the current period as well as the collection of delinquent rent after closing which is attributable to the seller’s period of ownership prior to closing.  In negotiating a contract, the parties will need to determine whether the purchaser is responsible for attempting to collect pre-closing delinquent rents and the rights of the seller to pursue tenants after closing for any such pre-closing delinquent rents.

Collection of pre-closing delinquent rent can be a complicated issue for purchasers and sellers to resolve.  On the one hand, the purchaser may be reluctant to allow the seller to undermine the financial condition of a tenant by pursuing lawsuits against a tenant that may be paying current rent to the new landlord.  On the other hand, a former owner does not have a full range of typical landlord remedies at its disposal to effectively induce tenants to pay delinquent rent as the former owner cannot assert an eviction action against a tenant and terminate the tenant’s right of occupancy.

The tension between purchasers and sellers with respect to pre-closing, delinquent rent is further complicated by a recently decided opinion issued by the Illinois Appellate Court in 1002 E. 87th Street LLC v. Midway Broadcasting Corporation (2018 IL.) App. 1st 171691, June 5, 2018).  In that case, the Court upheld a lower court ruling that Illinois law does not permit the purchaser of real estate to pursue claims against a tenant for pre-closing, unpaid rent under a lease assigned to the purchaser at closing.  The purchase and sale agreement between the purchaser and seller in that case contained standard provisions confirming that the “landlord” under the lease included any successors and assigns.  It also provided that all obligations and liabilities of the original landlord were binding on the purchaser, as successor landlord.  That would include any pre-closing landlord defaults that remained uncured.  Notwithstanding the successor landlord’s assumption of the lease, including, potential liability for pre-closing defaults of its predecessor, the Court ruled that the successor landlord did not have the right to recover pre-closing rent.  The Court specifically stated that the rule in Illinois is that rent in arrears is not assignable.

The lesson to be learned from the 1002 E. 87th Street case is that it is important to negotiate and set the expectations of the parties with respect to pre-closing delinquent rents at the time of contract.  Since a predecessor landlord may have little power other than initiating litigation (which is not desired by the successor landlord) against a tenant for delinquent rent and the successor landlord is unable to maintain an action for that delinquent rent, parties must give careful thought to the method of addressing the collection of pre-closing delinquent rent.  Fortunately, there are a number of different approaches that the parties may employ to coordinate and enhance the collection of pre-closing, delinquent rent.

For further information regarding the purchase and sale of commercial real estate as well as matters involving the rights of sellers, purchasers and tenants, please contact:

Jeffrey M. Galkin at:

jgalkin@lgattorneys.com or 312-368-0100.

Is It a Hobby or a Business and What Does the IRS Think?

A taxpayer may deduct “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” But if the activity giving rise to the expenses “is not engaged in for profit,” these activities are not considered a “trade or business” and are commonly referred to as “hobbies”. Hobby expenses may only be deducted from hobby profits and not from any other income that the taxpayer may have.

In 2014 the Tax Court held that a taxpayer had deducted the expenses of his horse-racing enterprise on his federal income tax returns for 2005 and 2006 erroneously because the enterprise was a hobby rather than a business. The court assessed tax deficiencies.  But it also ruled that the business had ceased to be a hobby, and had become a bona fide business, in 2007. He challenged the assessments for 2005 and 2006.

The Tax Court’s ruling that the horse-racing enterprise was a hobby in 2005 and 2006 but became a business in 2007 and remained so in 2008, and every year thereafter (the IRS failed to challenge any deductions for any year after 2008) was held by the Seventh Circuit Court of Appeals to be “untenable; it amounts to saying that a business’s start-up costs are not deductible business expenses-that every business starts as a hobby and becomes a business only when it achieves a certain level of profitability.”

The Seventh Circuit then cited what it felt to be a “goofy regulation” (Treas.Reg. § 1.183-2) and addressed the various factors used to determine whether an activity is engaged in for profit:

(1)  Manner in which the taxpayer carries on the activity.
(2)  The expertise of the taxpayer or his advisors.
(3)  The time and effort expended by the taxpayer in carrying on the activity.
(4)  Expectation that assets used in activity may appreciate in value.
(5)  The success of the taxpayer in carrying on other similar or dissimilar activities.
(6)  The taxpayer’s history of income or losses with respect to the activity.
(7)  The amount of occasional profits, if any, which are earned.
(8)  The financial status of the taxpayer.
(9)  Elements of personal pleasure or recreation.

The Court went on to note, “a business will not be turned into a hobby merely because the owner finds it pleasurable; suffering has never been made a prerequisite to deductibility. Success in business is largely obtained by pleasurable interest therein.”

This case recognizes that every start-up business is not a hobby just because there is no profit at the beginning. Here that Tax Court seemed to take the position that the taxpayer started in the horse racing business as a hobby and then turned it into a business. The Appellate Court rejected this and held for the taxpayer.

If you have any questions regarding start-up businesses, please contact:

Morris R. Saunders at:

(312) 368-0100 or msaunders@lgattorneys.com

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