Friday, August 28, 2009

Tax Court Rules Against Real Estate Investor

In a recent decision (Woody v. Commissioner, TC Memo 2009-93), the US Tax Court has held that a real estate investor was not “in business” when he incurred expenses and thus could not claim his expenses as “ordinary and necessary” business expenses. In February 2004, Mr. Woody began to investigate the local real estate market so he could begin to accumulate properties for investment or rental purposes. He began to market his services, had business cards printed and began to actively promote his business (and had a business plan in place). In addition, he took a few courses to increase his real estate skills. He made multiple offers on properties in 2004 but failed to actually acquire any properties during this year (he did have one contract in place that was cancelled after the inspection revealed many defects). He claimed more than $23,000 of expenses for 2004. The IRS subsequently examined his return for 2004 and denied all expenses, asserting that the expenses were not tax deductible because Mr. Woody was not in business.

The Tax Court noted that there are three factors to decide if an expense is a business expense for tax purposes:

(1) Did the taxpayer intend to make a profit?

(2) Was the taxpayer regularly engaged in the business activities?

(3) Whether or not the activity actually commenced

Mr. Woody satisfied the first two factors and the IRS conceded that he had sufficient records to prove the expenses were in fact actually incurred. Thus, the only issue was whether or not Mr. Woody had actually began his business. The Tax Court ruled that he had not and denied the deductions, stating that the deductions were at most “start-up” expenses for which elections and amortizations came into play. The Court stated that the business did not begin before Mr. Woody acquired his first rental property, rejecting Mr. Woody’s argument that the business began when the first contract was accepted (even though he did not close due to the defects).

There is not much more that Mr. Woody could do in this case. He maintained excellent records, had a business plan and basically did everything that a business advisor would recommend in getting his business started. However, as we have stated many times in the past, until the business becomes a “going concern,” the expenses are not currently deductible but instead become “start-up” expenses.

Wednesday, August 12, 2009

Q&A - Summer Job and IRA Contributions


My 16 year old son is working this summer and I wondered if he can contribute to an IRA?

Michael L., Des Moines, Iowa


Michael, your son is in luck, as he can contribute up to $5,000, or the amount of his earnings, whichever is less, to an IRA in 2009. You can even gift this amount to him, although this will count against the $13,000 annual gift amounts.

If a 16 year old contributes $5,000 to his Roth IRA (the most attractive IRA for younger workers) this year, it would be worth about $137,000 when he turns 65 and $193,000 at age 70, assuming an annual rate of return of 7% per year. You can imagine if he does this for the first ten years of his working career. He will retire a millionaire (whatever that may be worth when he retires)!

A Roth IRA is tax free when withdrawn and the funds can also be used for other purchases, such as a first home. In addition, these funds can be placed into a self-directed IRA to provide more flexibility in terms of available investment vehicles.