Harlan Douglass, one of Spokane Countys largest developers, land owners, and taxpayers, and his wife, Maxine, are appealing an Internal Revenue Service order to pay $931,000 in back federal income taxes.


The couple have filed a petition in U.S. Tax Court, in Washington, D.C., claiming the IRS erred by denying them deductions for depreciation and losses. The alleged deficiency is for the 1994 tax year.


Neither John M. Colvin nor Darrell D. Hallett, the two Seattle attorneys identified in court documents as representing the Douglasses, could be reached for comment. Harlan Douglass also couldnt be reached.


The Douglasses have designated Seattle as the place of trial for the case, but a trial date hasnt been set, according to court documents.


The IRS notified the Douglasses of the tax deficiency last May, the documents show. It informed the couple that it had disallowed their deductions of about $1.19 million for a 1993 passive loss and a total of $1.16 million for 1993 and 1994 asset catch-up depreciation and other recalculated depreciation.


Those changes, together with other income adjustments to which the Douglasses earlier had agreed totaling about $976,000, raised the couples taxable income to more than $3.6 million from the $223,874 shown on their filed return, according to the documents. Their total tax liability, meanwhile, jumped to $1.38 million from the $117,376 listed on their filed return. That latter tax amount was adjusted in a partial agreement to $451,546, resulting in the contested $931,000 deficiency, the documents show.


The IRS held that the Douglasses didnt have a suspended $1.19 million rentals-related passive loss from 1993 that they could carry over to 1994, as they claimed in their return. Passive losses are losses from passive activity that can be carried forward to later years tax returns if not used as a deduction in the year they occur. Adjustments the IRS made to the Douglasses tax return, though, reduced that 1993 loss to zero.


Also, the IRS ruled that the couple wasnt entitled to take catch-up depreciation of about $278,000 in 1993 and $381,000 in 1994, because they hadnt substantiated cost figures transferred from a building account into a land-improvement account and because the 10-year depreciation period they used for land improvements was incorrect. In addition, it said they failed to obtain necessary IRS permission before changing that recovery period to 10 years from 30 years.


Finally, it disallowed another $502,000 in depreciation involving assets that it said had been changed incorrectly from a 30-year to a 10-year depreciation schedule and without IRS consent.


In their petition filed last August contesting the IRS findings, the Douglasses contend that all of the deductions are justified. They say they buy and develop properties that they then rent to commercial tenants. Developing the properties requires doing worksuch as adding roads, sidewalks, and landscapingthats proper to depreciate as land improvements, they say.


On their tax returns prior to 1993, though, they say they had recorded all of their construction costs for 41 propertiesincluding land improvementsin a single asset account and had depreciated the entire amount as nonresidential real estate.


In 1993, while reviewing their tax filings, the Douglasses say, they discovered that land-improvement costs on 29 of those properties had been lumped incorrectly with other construction costs. To correct that error, they say they then transferred those costs into a separate category for depreciation purposes, and adjusted the depreciation to account for the shorter useful life of land improvements as a tax deduction. Those changes, they say, resulted in a sizable passive-activity loss. The next year, they say, they made similar bookkeeping changes for another 12 properties.


In their petition, they ask the U.S. Tax Court to overturn the IRS finding of a tax deficiency. They also ask that if the depreciation they claimed in 1993 and 1994 is found to be improper, the court rule it was claimed in the wrong year or years and would be allowable later.


Harlan Douglass owns considerable commercial property here and also has developed a number of multi family housing projects.


For years, Douglass has ranked among the largest property taxpayers in the county and as the largest individual property taxpayer. Research for a Journal article on the countys largest taxpayers published in December of 2000 showed that he ranked fifth overall, with a county property tax bill of nearly $1.3 million on properties with a total assessed value of slightly over $84 million.