Tax Court rules against IRS in model home case
Tax Court allowed members of partnership engaged in green commercial and residential construction to deduct expenses of model home in golf community despite occasional personal use of home by the partners.
If an activity is a hobby, the income is taxable but no deductions are currently allowed, but if it is for profit, it is a business and ordinary and necessary costs are deductible.
“There is no hard and fast rule for proving profit motive,” said tax attorney Barbara Weltman, author of “JK Lasser’s Small Business Taxes 2022.” “A profit motive is something that is inferred based on a number of factors – no single factor is determinative.”
The partnership consisted of Jessica Walters and her parents, David and Jean Walters. The Walters are all partners in D&J Properties, with David and Jean each holding a 47.4% stake and Jessica holding a 5.2% stake. David and Jean ran a successful line of Laz-Z-Boy stores, and D&J Properties owned buildings that housed the Laz-Z-Boy stores.
David earned LEED (Leadership in Energy and Environment Design) certification, a green building standard, and Jessica earned a law degree from a school specializing in environmental law. The Walters decided to position D&J as an environmentally friendly commercial and residential construction and consulting firm by entering the green real estate market. They sold their La-Z-Boy stores but retained ownership of the buildings that housed the stores.
D&J purchased land at Balsam Mountain Preserve, a low-density development in the mountains of North Carolina that emphasizes land conservation. In May 2007, the partnership was signed with a general contractor for the construction of Balsam Home.
From the time Balsam Home was completed, the partnership described the structure as a model home, and the Walters kept the house open for tours. They purchased memberships from BMP, which gave them access to the golf course and restaurant. David worked an average of 11 days per month at Balsam Home in 2011 and six days per month between January and October 2012.
The Internal Revenue Service denied deductions related to Balsam Home for the years 2011 and 2012, saying the partnership was not engaged in profit-making activities but was used for personal gain. The Tax Court disagreed. He concluded that the partnership activity was engaged in profit-making activities.
Article 1.183-2 of the Treasury regulations provides a non-exclusive list of objective factors to be taken into account when deciding whether an activity is carried out for profit:
- The manner in which the taxpayer carries out the activity;
- The expertise of the taxpayer or the taxpayer’s advisers;
- The time and effort expended by the taxpayer in carrying on the business;
- The expectation that assets used in the business may appreciate in value;
- The taxpayer’s success in carrying on other similar activities;
- The taxpayer’s history of income or loss relating to the activity;
- The amount of occasional profits, if any, that are made;
- The financial situation of the taxpayer; and,
- Whether it is elements of personal pleasure or leisure.
“The factors in this case support the conclusion that the partnership was engaged in a for-profit activity,” the court concluded. “We recognize that the partnership’s efforts were not perfectly executed, but its actions as a whole support a conclusion that it was seeking a profit.”