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Wednesday
May302018

Taxpayer wasn't in the business of flipping houses so couldn't deduct expenses

Samadi, TC Summary Opinion 2018-27

The Tax Court has determined that a taxpayer who decided to flip houses with a group of friends and family and obtained his real estate license wasn't entitled to mileage deductions for taking members of the group to see potential properties. The Court found that the taxpayer's real estate activity didn't rise to the level of a trade or business where the group never actually purchased any properties and the taxpayer never earned any real estate commissions.

Background. Code Sec. 162(a) generally allows a deduction for ordinary and necessary expenses paid or incurred in connection with carrying on a trade or business. Whether a taxpayer's activities constitute the carrying on of a trade or business requires an examination of the facts and circumstances of each case. (Groetzinger, (S Ct 1987) 59 AFTR 2d 87-532)

To be engaged in a trade or business, the taxpayer must be involved in the activity with "continuity and regularity" and for the primary purpose of generating income or profit. "The taxpayer's primary purpose for engaging in the activity must be for income or profit." (Groetzinger)

Facts. In 2010, Mr. Samadi, his brother, and three other individuals (collectively, the group) decided to flip houses—buy homes, renovate them, and sell them for a profit. He became a licensed real estate agent in 2010 and continued to be licensed during 2013 and 2014 but did not earn any commissions from selling real estate in 2013 or 2014. Samadi researched potential investment properties for the group; and because he was a licensed real estate agent, he had access to properties that were for sale.

The group decided to look for potential investment properties in West Sacramento, California, where Samadi lived, because the group expected him to manage the investment properties. He prepared mileage logs for 2013 and 2014 to document the extensive mileage he drove to see the potential investment properties. According to the mileage logs, he drove 24,882 miles in 2013 and 25,220 miles in 2014, driving himself, his brother, and other members of the group to see various properties.

Samadi didn't show any potential investment property to the group during the last four months of 2013 or 2014, and the group did not buy any investment property in either year because its members couldn't agree on any of the potential investment properties Samadi showed them.

Samadi had no gross receipts from his real estate activity for either year, and reported losses from the activity on his Schedules C for 2013 and 2014 of $15,719 and $22,502. IRS audited Samadi's 2013 and 2014 returns and disallowed deductions relating to his real estate activity.

At issue was whether Samadi's real estate activity during 2013 and 2014 rose to the level of carrying on a "trade or business" with respect to which he could claim business expense deductions. Samadi argued that he was a real estate agent during 2013 and 2014, that he was acting in that capacity when he showed the group the potential investment properties, and that any expenses incurred in helping the group see the potential investment properties were deductible business expenses.

No trade or business. The Tax Court sided with IRS, finding that while Samadi was a licensed real estate broker during 2013 and 2014, he wasn't in the trade or business of being a real estate agent during those years. Notably, he didn't earn any commissions during those years, and there was no other evidence to suggest that he was continuously and regularly buying and selling real estate or was a real estate agent to clients.

The Court found that in 2013 and 2014, Samadi and the group were attempting to start a business of flipping houses, but were at most in the "exploratory or formative stages". The Court cited a number of cases for the proposition that carrying on a trade or business requires more than initial research—it requires that the business have actually commenced. (Dean, (1971) 56 TC 895)

Accordingly, since the real estate activity didn't rise to the level of a trade or business, the Court held that Samadi wasn't entitled to deduct any Code Sec. 162(a) expenses, including car and truck expenses, incurred in connection with his real estate activity.

References: For trade or business expenses, see FTC 2d/FIN ¶ L-1000; United States Tax Reporter ¶ 1624

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