It’s my annual “Taxes from A to Z” series! If you’re wondering whether you can claim home office expenses or whether to deduct a capital loss, you won’t want to miss a single letter.
F is for Found Property.
Now and then, you run across a story like this one where some lucky person stumbles over found money. Complete windfall or taxable event? According to Uncle Sam, it’s the latter. If you find and keep property that doesn’t belong to you that has been lost or abandoned (a so-called “treasure trove”), the property is taxable to you. The value of the property is its fair market value, and it’s taxable in the first year that it’s in “your undisputed possession.”
Sound crazy? The rule has been on the books (Rev.Rul. 61, 1953-1) since the Internal Revenue Service (IRS) started issuing Revenue Rulings. But the guidelines were officially tested in court in 1969. The case, Cesarini v. United States, 296 F. Supp. 3 (N.D. Ohio 1969), is now synonymous with found property.
Here’s the story. Ermenegildo Cesarini and his wife, Mary, were residents of Ohio. In 1957, they bought a used piano at an auction sale for about $15 (about $135 in today’s money). Their daughter used the piano for lessons for a number of years.
In 1964, the Cesarinis were cleaning the piano and found $4,467 (worth about $40,299 today) in old currency. According to the facts of the case, they had planned to dispose of the piano but, I guess owing to their good fortune, decided to hold onto it. But since they didn’t know where the money came from, they exchanged it for new money at the bank and dutifully reported the case on their 1964 income tax return as ordinary income from other sources (that would be line 21 today).
A few months later, the Cesarinis apparently thought better of it and filed an amended return, this time leaving out the $4,467. They also requested a refund in the amount of $836.51 ($7,546.50 in today’s money), which was the amount they claim they overpaid by reporting it in the first place.
The IRS said no, and the Cesarinis filed a lawsuit in March of 1967 for the return of the tax, plus interest. In the lawsuit, the Cesarinis made three arguments:
- The found money was not income under the statute.
- Even if the money could be classed as income, it was due the year that they bought the piano (1957), and the statute of limitations had already run.
- Even if the money was reportable as income and even it had been reportable in 1964, it should be treated as a capital asset.
In response, the government argued:
- The found money was income under section 61 of the Internal Revenue Code.
- The money was reportable in the year it was found (1964).
- The money was properly taxable as ordinary income and was not entitled to capital gains treatment.
The court started with the first argument. Section 61 sets a pretty high bar, stating, in part:
Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items…
The statute then goes on to cite some items which are specifically included in income beginning at section 71 with alimony and some items which are specifically excluded from gross income beginning at section 101 with certain death benefits. Found money isn’t listed at either place. The result? That pretty broad language at section 61 controls: “Gross income means all income from whatever source derived.”
And there was also the matter of that 1953 Revenue Ruling which the court found to be 100% on point. The Ruling stated, in part:
The finder of treasure-trove is in receipt of taxable income, for Federal income tax purposes, to the extent of its value in United States currency, for the taxable year in which it is reduced to undisputed possession. – Rev.Rul. 61, 1953-1, Cum.Bull. 17.
The Cesarinis claimed that the Revenue Ruling didn’t apply in their case but their reasoning – arguments involving gifts and prizes – was found to have no merit.
With respect to timing, in the absence of definitive federal law on the subject, you turn to state law. The court explored a tricky concept here – there was nothing that was completely on point – relying on Niederlehner v. Weatherly, 78 Ohio App. 263, 69 N.E.2d 787 (1946), appeal dismissed, 146 Ohio St. 697, 67 N.E.2d 713 (1946). The Niederlehner case is fascinating (trust me). It centers around a man who had been confined to a mental hospital. He escaped and was eventually recaptured and taken to the police station where they found, on his body, the sum of $6,190 (just under $111,000 in today’s money). The man made several wild claims about how he came to be in possession of the cash, none of which were believable, before he was returned to the mental hospital. At the same time, three more people came forward to claim the cash, each claiming that some version of the mental patient’s story was true. Eventually, the sheriff took possession of the money until the real owner could be determined.
The relevant ruling in Niederlehner is that the owner of real estate where money is found does not have title as against the finder. Under Ohio law, you have to know that the thing (in this case, the money) is there in order to have superior title overall but the true owner. In other words, if the Cesarinis had resold the piano the year after they bought it without ever having found the money, they would not be able to force the new owner to give the money back. The Court found that the money wasn’t “reduced to undisputed possession” until it was discovered in 1964. That means that they couldn’t have reported the cash earlier and the IRS couldn’t have collected the tax earlier. The 1964 date was held to be the proper date for reporting the income.
Finally, the court examined the Cesarinis’ capital gains argument, specifically taking a look at section 1222. The language applies capital gains treatment to gains from the “sale or exchange” of capital assets. In this case, neither the piano nor the cash was ever sold or exchanged. That means that capital gains treatment would not apply and instead, the cash is taxed as ordinary income.
The Cesarinis lost all three of their arguments but they weren’t completely deterred. The following year, they appealed – and lost again (Ermenegildo Cesarini and Mary C. Cesarini, Plaintiffs-appellants, v. United States of America, Defendant-appellee, 428 F.2d 812 (6th Cir. 1970)).
Today, found money is routinely treated as ordinary income. But don’t claim that cash on line 21 just yet. The biggest lesson to take from the Cesarini case is just the opposite: When you’re not sure about how (or when) to report income, don’t act rashly and don’t guess. Ask for help instead. Trying to back a tax argument into the facts afterward doesn’t always end happily.
For your taxes from A to Z, here’s the rest of the series: