The Tax Court in Brief – March 7th – March 11th, 2022

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Tax Litigation:  The Week of March 7, 2022, through March 11, 2022

 Walters v. Comm’r. | T.C. Memo 2022-17 | March 7, 2022 | J. Wells| Dkt. Nos. 13060-15, 13097-15.

Opinion

Short Summary: This opinion resolves two separate cases involving the same issues and facts. The IRS denied expenses declared by a partnership in connection with an alleged business activity, which involved a residential property. One case pertained to a husband and wife and, another, to their daughter. She held an approximate 5% interest in the partnership. The IRS argued that the taxpayers’ conduct demonstrated personal use of the home—as opposed to a “for-profit” activity. The taxpayers asserted the partnership built and maintained the residence to promote the “green” real estate consulting business the partnership endeavored to develop. The parties’ tasked the court with resolving whether the activity was “for-profit” in terms of IRC § 183 and, secondly, whether the taxpayers were liable for penalties assessed in addition to the deficiencies.

Primary HoldingsThe Court found that, while not perfectly executed, he taxpayers’ activities–when viewed as a whole–in connection with the house were “for-profit” as defined by Code section 183 and related Treasury Regulations. Because the deficiencies were issued in error on the basis that the activity was not “for profit,” the taxpayers were not liable for the penalties.

Key Points of Law:

  • Section 162 allows for the deduction of business-related and investment expenses. However, under section 183(a), taxpayers may not deduct expenses for an activity “if such activity is not engaged in for profit.” When a partnership is involved in a section 183 analysis, the existence of the requisite profit objective is determined at the partnership level.
  • Treas. Reg. § 1.183-2(b) provides a nonexclusive list of objective factors to be considered in deciding whether an activity is engaged in for profit. Those factors include: (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or the taxpayer’s advisors; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar activities; (6) the taxpayer’s history of income or loss with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved.
  • When weighing factor tests such as the one in issue, the court does not reach conclusions based on a count of factors in favor or against a conclusion because the relative importance of each factor can change the overall analysis depending on the facts of the case.
  • When a partnership is involved in a 183 analysis, the existence of the requisite profit objective is determined at the partnership level, which is dependent on the activities of the managing partners.

Insights: This case identifies the factors involved in determining whether an activity is “for profit” under section 183 such that expenses incurred in the “trade or business” of that activity may be deducted pursuant to section 162. Decisions on the subject will be made on a case-by-case basis.  The manner in means in which an activity or supposed “business” operation is executed, as well as how those operations are documented, planned, intended, and–if necessary–presented to the IRS or the Tax Court, are critically important to ensure that the “for profit” factors, when placed on the scales of justice, favor the taxpayer for applicable tax benefits. If a taxpayer suspects that the IRS may challenge a deficiency in a close case, prior to deciding on the more aggressive position, it is worthwhile to consider: (1) whether the deductions are significant enough to merit funding a tax appeal and (2) establishing a reserve to fund any future litigation any pay any assessment.

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