What does a tax CPA do a few days after the filing
deadline?
This one is reviewing a 17-page Tax Court case.
Yes, I would rather be watching the new Batman movie.
There isn’t much time for such things during busy season. Maybe tomorrow.
Back to the case.
There is a mom and dad and daughter. Mom and dad (the
Walters) lived in Georgia. They had launched three successful business in
Michigan during the 70s and 80s. They thereafter moved to Georgia to continue
their winning streak by developing and owning La-Z-Boy stores.
During the 90s dad invested in and subsequently joined
the board of an environmentally oriented Florida company. He followed the environmental
field and its technology, obtained certifications and even guest lectured at Western Carolina University.
Daughter received an undergraduate degree in
environmental science and then a law degree at a school offering a focus on environmental
law.
After finishing law school, daughter informed her
parents that she was not interested in the furniture business. Mom and dad sold
the La-Z-Boy businesses but kept the real estate in an entity called D&J Properties.
They were now landlords to La-Z-Boy stores.
The family decided to pivot D&J by entering the
green real estate market.
Through the daughter’s connections, mom and dad became
aware of a low-density housing development in North Carolina, emphasizing land
conservation and the incorporation of geothermal and solar technologies.
You know this caught dad and daughter’s attention.
They bought a lot. They built a house (Balsam Home). They
stuck it in D&J Properties. The house received awards. Life was good.
They received an invitation to participate in a “Fall
Festival of Color.” Current and potential property owners would tour Balsam
Home, meet with members of the team and attend a panel discussion. Word went
out to the media, including the Atlanta Journal-Constitution.
Balsam Home became a model home for the development.
Awards and certificates were hung on the walls, pamphlets about green technology
were placed on coffee tables. A broker showed Balsam Home when mom and dad were
back at their regular residence.
Sometimes the line blurred between model home and “home”
home. Mom and dad registered cars at the Balsam Home address, for example, and
dad availed himself of a golf membership. On the flip side, the green technology
required one to be attentive and hands-on, and mom and dad did most of that work
themselves.
Where is the tax issue here?
Balsam Home never showed a profit.
The La-Z-Boy stores did.
The IRS challenged D&J Properties, arguing that Balsam
Home was not a business activity conducted for profit and therefore its losses
could not offset the rental income from the furniture stores.
This “not engaged in for profit” challenge is more
common than you may think. I am thinking of the following from my own recent-enough
experience:
· A
mom supporting her musically inclined twin sons
· A
young golfer hoping to go pro
· A
model certain to be discovered
· A
dancer determined she would join a professional company
· A
dressage rider meeting “all the right people” for later success
The common thread is that some activity does not make
money, seems likely to never make money but is nonetheless pursued and
continued, normally by someone having (or subsidized by someone having) enough
other income or wealth to do so. It can be, in other words, a tax write-off.
But then again, someone will be the next Bruno Mars,
Scottie Scheffler or Stevie Nicks. Is it a long shot? Sure, but there will be
someone.
Not surprisingly, there is a grid of questions that
the IRS and courts go through to weigh the decision. It is not quite as easy as
having more “yes” than “no” answers, but you get the idea.
Here is a (very) quick recap of the grid:
· Manner
in which taxpayer carried on the activity
· Taxpayer’s
expertise
· Taxpayer’s
advisors’ expertise
· Time
and effort expended by the taxpayer
· Expectation
that activity assets will appreciate in value
· Success
of the taxpayer on carrying on similar activities
· History
of activity income and loss
· Financial
status of the taxpayer
· Elements
of personal pleasure or recreation
Let’s review a few.
· Seems
to me that mom, dad and daughter had a fairly strong background in green
technology. The IRS disagreed, arguing “yes this but not that.” The Court disagreed with the IRS.
· Turns
out that mom and dad put a lot of time into Balsam House, and much of that time
was as prosaic as fertilizing, weeding and landscaping. The Court gave them
this one.
· Being
real estate, it was assumed that the asset involved would appreciate in value.
o
BTW this argument is often used in
long-shot race-horse challenges. Win a Kentucky Derby, for example, and all those
losses pale in comparison to the future income.
· I
expected financial status to be a strong challenge by the IRS. Mom and dad
owned those La-Z-Boy stores, for example. The Court took pains to point out
that they had sold the stores but kept the real estate, so the ongoing income was
not comparable. The Court called a push on this factor, which I considered
quite generous.
The Court decided that the activity was conducted for
profit and that losses could be used to offset income from the furniture stores.
A win for the taxpayers.
Could it have gone differently?
You bet. Court decisions in this area can be …
quixotic.
Our case this time was Walters v Commissioner,
T.C. Memo 2022-17.
