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Opus 17 · ‎July 18, 2023

@jfields1 wrote:

I called the IRS today, and the person I spoke with said I needed to file an amended Schedule C. Does that make sense, given the previous details I have provided?

It is a possible answer. It's not wrong, but it's not what I would do since this was not intended to be a for-profit business. But if you spoke to the office that sent the notice, then that's definite, they want to see a schedule C. The last question is do they want you to file the amended return via the normal process or send it directly to their office? Probably the latter. And I would include a letter of explanation in which you state your case in detail in writing.

If you report this as a "business", I still believe the actual item sales are reported on schedule D, because this is the sale of tangible personal property subject to capital gains rather than "business inventory." You would list the items, date acquired, cost basis (stepped fair market value on the date you inherited them), and selling price and date. That net gain or loss should flow to schedule C. You can also include your selling expenses (shipping, credit card fees). You will probably show a net loss, which will be deductible against your other taxable income and may even result in a refund. You may want to upgrade to Turbotax Home & Business, which has more built-in support for schedule C.

The problem you will face is proving your cost basis. There is a recent Tax Court case involving a woman (who happened to be an IRS agent, fancy that) who sold around $20,000 on eBay. She claimed it was only her own used items sold at less than cost, and so not taxable. The court viewed this explanation with skepticism because of the dollar amount, and noted that the taxpayer had no records of the items, including their original purchase date and price, to support that claim. In the end, the court determined the entire sales proceeds were taxable income because the taxpayer didn't have proof.

So your key is accurate, complete and reliable documentation. For each item you sold, you want a description with enough detail that a fair value can be determined, the date you inherited it, the value you assigned, how you assigned the value (market price, similar listings on eBay, appraisal, etc.), the selling date, selling price, and selling expenses. If you are selling items in a public place like eBay, I would probably say that the final sales price is also the fair market value/cost basis, so you have no gain or loss on the sale. This would be true assuming there is nothing special about the items and you sold them within a reasonably short time after the person's death. If there were unusual items that sold for less than their market value, you would really have to prove that as a loss. If there were items that sold for more than fair market value, that difference is taxable income.

Then if you report all or most of the sales as being at fair market value, so there is no gain or loss, then when you add the selling expenses, your business will show an overall loss. That loss may be deductible against your other taxable income, meaning the amended return will show a refund.

I fully expect that when the IRS gets that, they will deny the refund, saying that losses on the sale of personal items are not deductible. It's their way of having it both ways, your sales are a business when the IRS thinks it is to their advantage, but if it is to your advantage, suddenly its personal. But that's the way things go.

Don't file an amended state return when you mail the federal return. Wait and see if the federal return is accepted without change. (They should send a letter when they close the case.) If it is accepted, then you can file the amended state return that goes with the federal return. If the IRS wants more changes, only file the amended state return at the end of everything.

The other route is to write a letter explaining that this is not a business. Because they told you they want a schedule C, if you wrote a letter to say "no, this is not a business and I am not sending a schedule C", you would want a tax professional to write the letter for you so they can cite tax code, regulations and Tax Court cases that support your position. You would still need to include a complete record of your sales as I described above (item description, inherited value, selling price, etc.) that shows that all the sales were at or below your stepped up cost basis and therefore none of the sales are taxable.

And lastly, if you can't provide a reliable written record of the sales, you may be forced to concede that the sales are taxable and pay tax. The IRS is not required to allow any deduction or adjustment if it is not adequately proven with reliable records.