It doesn’t
sound like much, but it can present a difficult tax issue.
When does a
business start?
It helps to
have sales. Sales are good. But sometimes you do not have sales.
Then what?
The issue is
that tax law allows deductions for expenses incurred in a trade or business.
This presumes that the activity has started and is occurring on a regular and continuous
basis. Before that point it is more like an intent or hope than an actual
business.
Let’s set-up
our story.
Taxpayer was
a tax specialist, although I am not sure what that means. His wife was a nurse.
For 2013 and 2014 he reported self-employed real estate losses of $15 and $22
thousand, respectively.
Got it. He
is tax specialist when is he is not working real estate.
In 2010 he
obtained a real estate license. He got together with friends and family and
decided to invest in residential real estate. They were going to flip houses.
The investor group decided to look in West Sacramento, California, (fortuitously,
where he lived). On Saturdays he would leave home, drive 192 miles to Marina,
California and pick-up one or more members of the group. They would return to Sacramento
to check out houses and then back to Marina. At days-end, our protagonist would
finally return home to West Sacramento.
Fortunately,
he kept logs for all this driving. He racked up 24,882 miles in 2013 and 25,220
in 2014.
They never bought
any property.
He also made
no money as a real estate agent.
The IRS
audited 2013 and 2014 and bounced the real estate expenses.
Off they went
to Tax Court.
His argument
was simple: are you kidding me? He was a realtor. He kept mileage logs. He had
third parties who could testify that he did what he said he did. What more did
the IRS want?
The IRS said
that – whatever he was doing – it was not a trade or business.
There was no
evidence that he was regularly and continuously working as a real estate agent
for those years. You know, no income and all.
So, what did
the IRS think he doing with the family-and-friends consortium?
He was
trying to start a business, a business flipping houses. But he and they never
flipped a house, Heck, they never even bought a house. He was as much a house flipper
as I am a retired ex-NFL player.
That put him
in a tough spot.
Here is the Tax
Court:
At best, petitioner husband’s activity in 2013 and 2014 was in the exploratory or formative stages of forming a business of flipping houses. Carrying on a trade or business requires more than initial research into a potential business opportunity; it requires that the business have actually commenced.
Section 162(a) does not permit current deductions for startup or preopening expenses incurred by a taxpayer before beginning business operations.”
He lost.
The IRS now wanted
penalties – “substantial underpayment” penalties. This is a “super” penalty,
for when the regular penalty is just not enough.
Remember
that taxpayer listed his occupation as “tax specialist.”
Bad idea
when you are trying to get penalties abated.
Here is the Court:
Petitioner husband considered his occupation to be a “tax specialist” and operated a tax preparation services business as a sole proprietorship. However, in preparing their tax returns petitioners failed to exercise due care or to do what a reasonable person would do under the circumstances to determine whether petitioner husband was in a trade or business ….”
Ouch.
The case is Samadi v Commissioner, for the home gamers.
