The U.S. Tax Court rules that a couple residing in a continuing care retirement community (CCRC) may employ the percentage method in determining the portion of their monthly services fee that is allocable to medical care. However, the couple may not deduct additional amounts for medical use of pool, spa, and exercise facilities. Delbert L. v. Commissioner of Internal Revenue (T.C., No. 448-02, Feb. 19, 2004).
Delbert and Margaret Baker moved to Air Force Village West, a continuing care retirement community (CCRC), in 1984. During the years in question, the Bakers resided in an independent living unit (ILU). The Bakers were guaranteed several medical amenities in exchange for their monthly service fee, including an emergency pull-cord system, nursing services if needed, and the guarantee of a bed in Village West's skilled nursing facility if required. Mr. Baker also used the pool, spa, and exercise facilities at Village West.
In completing their tax returns for 1997 and 1998, the Bakers calculated that the portions of their monthly service fee allocable to medical care were 40.3 percent and 41.6 percent, respectively. They based this on the findings of an ad hoc committee of the CCRC's resident council. The committee employed the "percentage method" in its calculations. Under the percentage method, once the CCRC's total medical expenses are determined, this amount is divided by the facility's costs to determine the medical expense allocation percentage. This percentage is then multiplied by the total monthly fees collected from ILU residents for the year to find the total medical costs allocable to monthly fees revenue. This total is then divided by the number of ILU residents to determine the portion of the fees that is allocable to medical care. The Bakers also claimed additional deductions as a result of Mr. Baker's use of the pool, spa, and exercise facilities, which he said was necessary to alleviate his chronic illnesses.
The Bakers were audited and the IRS issued a notice of deficiency. The agency found that in determining the proper medical expense deduction, the Bakers should have employed the "actuarial method," a procedure based on actuarial projections of longevity and health care utilization. (Village West had switched to the actuarial method in 1998.) This method would permit them about $3,000 less of a deduction for each year. The agency also disallowed the Baker's deductions for Mr. Baker's use of the pool, spa and exercise facilities.
The U.S. Tax Court holds that the Bakers should not be compelled to switch to the actuarial method. The court notes that the IRS has sanctioned use of the percentage method for more than 35 years, and that "the actuarial method is more complex, indeed, so complex as to defy full explanation in testimony and on brief." However, in its ruling the court fine-tunes the Baker's application of the percentage method. The court agrees with the agency that the Bakers are not entitled to deductions for Mr. Baker's use of the pool, spa, and exercise facilities, finding that the couple failed to establish what portion of Mr. Baker's use was for medical purposes.
To download the full text of this decision in PDF format, go to: https://www.ustaxcourt.gov/InOpHistoric/Baker4.TC.WPD.pdf
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