Yesterday, we discussed Chang Yi Chen v Zhen Huang 2014 NY Slip Op 50517(U) Decided on March 31, 2014 Supreme Court, Kings County Schmidt, J. . Put in short, Plaintiff initiated a 1031 like-kind real estate exchange, only to have it fail because the attorney returned the escrow money to Plaintiff in order to do the purchase. Plaintiff paid capital gains taxes. Are they recoverable? No.
""Damages in a legal malpractice case are designed to make the injured client whole’" (Rodolf v Shayne, Dachs, Stanisci, Corker & Sauer, 8 NY3d 438, 443 , quoting Campagnola v Mulholland, Minion & Roe, 76 NY2d 38, 42 ). Generally, the same compensatory damages rules applicable in contract cases apply to damages allowed in legal malpractice cases (Campagnola, 76 NY2d at 42). Such damages are not intended to provide a party with a windfall (id. at 45). However, in light of the unique fiduciary and ethical obligations of attorneys, public policy, at times, requires that traditional contract rules of damages be applied in a different manner in cases involving legal malpratice (id. at 43-44).
Here, defendant correctly asserts that taxes paid are generally not recoverable as damages under New York law (see Menard M. Gertler, M.D., P.C. v Sol Masch & Co., 40 AD3d 282, 283 [1st Dept 2007]; Alpert v Shea Gould Climenko & Casey, 160 AD2d 67, 71-72 [1st Dept 1990]; see also Lama Holding Co. v Smith Barney, 88 NY2d 413, 422-423 ). This is because tax liability results from a taxable event and allowing recovery for the payment of such tax would therefor constitute a windfall for a plaintiff (see Alpert, 160 AD2d at 71-72; Apple Bank for Sav. v PricewaterhouseCoopers, LLP, 23 Misc 3d 1126 [A], 2009 NY Slip Op 50948 * 6 [U] [Sup Ct, New York County 2009], modified on other [*4]grounds 70 AD3d 438 [1st Dept 2010]; see also, Lama Holding Co., 88 NY2d at 423; Gaslow v KPMG LLP, 19 AD3d 264, 265 [1st Dept 2005], lv dismissed 5 NY3d 849 ). In addition, damages that are uncertain or unduly speculative may not be recovered in New York (Ashland Mgt. Inc. v Janien, 82 NY2d 395, 403 ; Farrar v Brooklyn Union Gas Co., 73 NY2d 802, 804 ; see also Solin v Domino, 501 Fed Appx 19, 22 [2d Cir 2012]).
In conjunction, these principles preclude plaintiff from recovering as damages the amount he paid to the IRS as capital gains taxes, at least on the facts here, where plaintiff has not sold the replacement property. In this regard, in a properly completed section 1031 exchange, the basis from the property sold becomes the basis for the replacement property, and the recognition of any gain or loss is deferred until the replacement property is sold in a sale that does not involve a section 1031 exchange (see Ocmulgee Fields, Inc. v C.I.R., 613 F3d 1360, 1364-1365 [11th Cir 2011]). The tax consequences of such a deferral depend on many factors, including any change in the capital gains tax rate, IRS rules for determining capital gains, market forces affecting the value of the property, and plaintiff’s ability to offset the gain against the losses (see generally Internal Revenue Code [USC] § 1001; Internal Revenue Code [USC] subtitle A, Chapter 1, subchapter P; IRS, Topic 409 – Capital Gains & Losses, http://www.irs.gov/taxtopics/tc409.html [last reviewed or updated Feb. 27, 2014, accessed March 28, 2014]). As plaintiff has not sold the Purchase Property, any determination at this time that his capital gains liability would be less at the time of a future sale of the Purchase Property than he was actually required to pay involves future changeable events, and is thus inherently speculative (see Farrar, 73 NY2d at 804; Solin, 501 Fed Appx at 22; see also Ashland Mgt. Inc, 82 NY2d at 403; see also Menard M. Gertler, M.D., P.C., 40 AD3d at283; Alpert, 160 AD2d at 71-72).[FN4] "
What about interest paid to the IRS? It maybe recoverable. "On the other hand, plaintiff may be entitled to recover the amounts paid to the IRS as interest and penalties. Interest imposed by the IRS based on a failure to pay a tax generally may not be recovered as damages because the interest represents a payment to the IRS for the taxpayer’s use of the money while the taxpayer was not entitled to the use of the money (see Shalam v KPMG LLP, 43 AD3d 752, 754 [1st Dept 2007]; Alpert, 160 AD2d at 72). Here, however, plaintiff, but for defendant’s alleged malpractice, would have been entitled to the use of this money during the time for which IRS imposed interest. As such, plaintiff suffered a loss as the result of the IRS’s imposition of interest and plaintiff’s recovery of damages for such a loss would not constitute a windfall (see Jamie Towers Hous. Co. v William B. Lucas, Inc.,, 296 AD2d 359, 359-360 [1st Dept 2002]; Ronson v Talesnick, 33 F Supp2d 347, 355 [DNJ 1999]; see also Liebowitz v Kolodny, 24 AD3d 733, 733 [2d Dept [*5]2005]; Apple Bank for Sav., 2009 NY Slip Op 50948 * 6-7). For the essentially the same reasons, any penalty imposed by the IRS may be recovered as damages.[FN5]"