T.C. Summary Opinion 2011-92
UNITED STATES TAX COURT
STEPHEN L. AND DARLENE G. MORGAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 22339-09S. Filed July 14, 2011.
Stephen L. and Darlene G. Morgan, pro sese.
Amber N. Becton and Nancy W. Hale, for respondent.
HAINES, Judge: This case was heard pursuant to the
provisions of section 7463 of the Internal Revenue Code in effect
when the petition was filed.1 Pursuant to section 7463(b), the
decision to be entered is not reviewable by any other court, and
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code of 1986, as amended, and Rule
references are to the Tax Court Rules of Practice and Procedure.
Amounts are rounded to the nearest dollar.
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this opinion shall not be treated as precedent for any other
case.
Respondent determined a deficiency in petitioners’ 2006
Federal income tax of $12,979. The deficiency resulted from the
denial of deductions for expenses claimed in connection with
petitioner Stephen Morgan’s (Mr. Morgan) real estate remodeling
activities. We must decide: (1) Whether petitioners are
entitled to deduct section 162 expenses of $625; (2) whether
petitioners are entitled to deduct a section 179 expense of
$33,836; and (3) whether petitioners are entitled to deduct truck
expenses of $2,622.
The parties’ stipulation of facts, supplemental stipulation
of facts, and attached exhibits are incorporated herein by this
reference. Petitioners resided in Tennessee when they filed
their petition.
Mr. Morgan worked in the construction business throughout
most of his career. On July 20, 2006, Mr. Morgan sold his
interest in JBS Enterprises, L.L.C., an Alabama limited liability
company, for $1,206,806, a 2006 Dodge Ram truck, and a travel
trailer (the JBS transaction). The sales document states that
the $1,206,806 comprises a cash distribution of profits from
operations of $870,191, a purchase of Mr. Morgan’s interest in
real estate assets totaling $315,083, and a purchase of Mr.
Morgan’s interest in equipment totaling $21,532. Further, the
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sales document allocates a price of $33,836 to the 2006 Dodge Ram
and $16,836 to the travel trailer.
After the JBS transaction had closed, Mr. Morgan pursued
opportunities in the redevelopment of distressed residential real
estate. With the help of a realtor, Mr. Morgan began searching
for suitable properties. On October 10, 2006, he purchased a
property at 3524 Maxey Road, Cedar Hill, Tennessee (the Cedar
Hill property). On November 10, 2006, he purchased a property at
622 S. 14th Street, Nashville, Tennessee (the Nashville
property). After renovations, Mr. Morgan sold the Nashville and
Cedar Hill properties on November 11 and December 28, 2007,
respectively. His net return on the Cedar Hill property was a
loss of $13,492, and his net return on the Nashville property was
a gain of $12,710. Mr. Morgan kept records and receipts of cell
phone and supply expenses related to the Cedar Hill and Nashville
property renovations in 2006. Mr. Morgan also has detailed
expense logs related to each property for 2007.
Petitioners have not purchased any other properties for
renovation. Mr. Morgan decided that because the real estate
market was weak by the time he sold the Cedar Hill and Nashville
properties in 2007, it would be foolish to continue purchasing
properties when he would be unable to resell them.
Mr. Morgan testified that he used the 2006 Dodge Ram
acquired in the JBS transaction exclusively in his activities
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renovating the Cedar Hill and Nashville properties. Beginning on
October 5, 2006, Mr. Morgan kept a log to track the miles driven
in the 2006 Dodge Ram. Mr. Morgan’s mileage logs show that from
October 5 through December 31, 2006, the 2006 Dodge Ram was
driven 1,138 miles in connection with his renovation activities.
Petitioners claimed truck expense deductions on their 2006
Federal income tax return using the business standard mileage
rate and the difference between readings on the 2006 Dodge Ram’s
odometer from July 20, 2006, the date it was acquired, through
December 31, 2006. Petitioners owned two other vehicles for
their personal use.
Petitioners timely filed their joint Form 1040, U.S.
Individual Income Tax Return, for 2006. On Schedule C, Profit or
Loss From Business, petitioners reported gross receipts of zero
with respect to Mr. Morgan’s renovation activities and deductions
of $2,622 for car and truck expenses, $33,836 for depreciation
and section 179 expenses, and $625 for other expenses. On August
18, 2009, respondent timely issued a notice of deficiency
disallowing petitioners’ Schedule C deductions. Petitioners
timely filed their petition with this Court on September 18,
2009.
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Discussion
I. Trade or Business
Deductions are a matter of legislative grace, and the
taxpayer must prove he is entitled to the deductions claimed.
Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934). Section 162(a) provides that “There shall be allowed as
a deduction all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or
business”. Taxpayers are required to maintain records sufficient
to establish the amounts of allowable deductions and to enable
the Commissioner to determine the correct tax liability. Sec.
6001; Shea v. Commissioner, 112 T.C. 183, 186 (1999).
To determine whether a taxpayer is conducting a trade or
business requires an examination of the facts involved in each
case. Higgins v. Commissioner, 312 U.S. 212, 217 (1941). For a
taxpayer to be engaged in a trade or business, the primary
purpose for engaging in the activity must be for income or
profit. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987).
Factors to be considered in determining whether an activity
is engaged in for profit include: (1) The manner in which the
taxpayer carries on the activity; (2) the expertise of the
taxpayer or his advisers; (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
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success of the taxpayer in carrying on similar or dissimilar
activities; (6) the taxpayer’s history of income or losses 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) the elements of personal pleasure or recreation. Golanty
v. Commissioner, 72 T.C. 411, 426 (1979), affd. without published
opinion 647 F.2d 170 (9th Cir. 1981); sec. 1.183-2(b), Income Tax
Regs. No single factor or group of factors is determinative.
Sec. 1.183-2(b), Income Tax Regs. A final determination is made
only after considering all facts and circumstances. Id.
Respondent argues that petitioners have failed to establish
that Mr. Morgan’s renovation activities qualify as a trade or
business pursuant to section 162. Petitioners argue to the
contrary. We agree with petitioners.
Mr. Morgan’s work and behavior in connection with the search
for, purchase, renovation, and sale of the Cedar Hill and
Nashville properties clearly establish that he treated his
activities as a trade or business. He used his knowledge of the
construction business and interest in real estate to purchase and
renovate the Cedar Hill and Nashville properties. He purchased
and renovated these properties in late 2006 and early 2007, just
before the real estate market crashed. He carefully tracked his
expenses related to each project throughout 2006 and 2007, as
well as his net profits and losses. When Mr. Morgan realized
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that the prospects of future profits from his renovation
activities were bleak, he decided to cut his losses and get out
of the business, thereby demonstrating a profit objective.
Accordingly, Mr. Morgan’s real estate renovation activity in 2006
constitutes a trade or business pursuant to section 162.
II. Other Expenses
Items described in section 274 are subject to strict
substantiation rules. Petitioners reported gross receipts of
zero with respect to Mr. Morgan’s renovation business and
deductions of $2,622 for car and truck expenses, $33,836 for
depreciation and section 179 expenses, and $625 for other
expenses. The other expenses consisted of costs related to Mr.
Morgan’s cell phone and supplies used for renovations. Mr.
Morgan kept records and receipts of cell phone and supply
expenses with respect to the Cedar Hill and Nashville property
renovations in 2006. See secs. 274(d)(4), 280F(d)(4)(A)(v).
Accordingly, petitioners are entitled to their claimed deduction
of $625 for cell phone and supply expenses.
III. Section 179 Expense
Subject to certain limitations, taxpayers purchasing
qualifying property may elect under section 179 to deduct the
cost of the property in the year the property is placed in
service. Qualifying section 179 property includes tangible
property that is depreciable under section 168 and is described
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in section 1245(a)(3) and computer software that is depreciable
under section 167 and described in section 1245(a)(3), but only
if the property is acquired for use in the “active conduct of a
trade or business.” Sec. 179(d)(1). “[A]ctive conduct” means
that the taxpayer actively participates in the management or
operations of the trade or business. Sec. 1.179-2(c)(6)(ii),
Income Tax Regs. As used in section 179 the term “trade or
business” has the same meaning as in section 162 and the
regulations thereunder, and therefore property held merely for
the production of income does not qualify as section 179
property. Sec. 1.179-2(c)(6)(i), Income Tax Regs.
As discussed above, Mr. Morgan’s activities with respect to
the Cedar Hill and Nashville properties constituted a trade or
business pursuant to section 162. Thus, his activities also
qualify as a trade or business pursuant to section 179. He used
the 2006 Dodge Ram exclusively in the active conduct of his trade
or business.
The sales document allocates $33,836 to the 2006 Dodge
Ram, and petitioner deducted that amount as an expense pursuant
to section 179(a). There are two relevant limitations that apply
to the section 179 deduction: (1) The section 179 expense cannot
exceed $100,000, pursuant to section 179(b)(1) as in effect in
2006; and (2) section 179(b)(3) provides that the section 179
deduction cannot exceed the “aggregate amount of taxable income
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of the taxpayer for such taxable year which is derived from the
active conduct by the taxpayer of any trade or business during
such taxable year.” Petitioners reported gross receipts of zero
in 2006 from Mr. Morgan’s renovation business. However, $870,191
of the $1,206,806 in cash Mr. Morgan received as part of the JBS
transaction was a distribution of profits from operations. The
second limitation on the section 179 deduction applies to the
“aggregate” of “any trade or business” during the taxable year.
Accordingly, petitioners have sufficient taxable income from the
active conduct of a trade or business in 2006 and are entitled to
deduct their claimed section 179 expense of $33,836.
IV. Truck Expenses
Pursuant to section 274(d), truck expenses otherwise
deductible as business expenses will be disallowed in full unless
the taxpayer satisfies strict substantiation requirements. The
taxpayer must substantiate the truck expenses by adequate records
or other corroborating evidence of items such as the amount of
each expense, the time and place of the truck’s use, and the
business purpose of its use. See Sanford v. Commissioner, 50
T.C. 823, 827-828 (1968), affd. per curiam 412 F.2d 201 (2d Cir.
1969); Maher v. Commissioner, T.C. Memo. 2003-85. A taxpayer may
also choose to use the business standard mileage rate to
determine a truck expense deduction in lieu of actual expenses.
Nash v. Commissioner, 60 T.C. 503, 520 (1973); Kay v.
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Commissioner, T.C. Memo. 2002-197, affd. 85 Fed. Appx. 362 (5th
Cir. 2003); Rev. Proc. 2005-78, 2005-2 C.B. 1177. However, the
business standard mileage rate may not be used to compute
deductible expenses if the taxpayer has claimed a section 179
expense deduction on the same vehicle. Kay v. Commissioner,
supra; Rev. Proc. 2005-78, supra.
On their 2006 Federal income tax return, petitioners claimed
a truck expense deduction using the business standard mileage
rate and odometer readings from July 20, 2006, the date the 2006
Dodge Ram was acquired, through December 31, 2006. Petitioners
may not claim deductions with regard to the 2006 Dodge Ram for
both the section 179 expense and the standard mileage rate.
Accordingly, as we have determined that petitioners are entitled
to the section 179 expense deduction for the 2006 Dodge Ram, they
are not entitled to a truck expense deduction using the business
standard mileage rate.
In reaching these holdings, the Court has considered all
arguments made and, to the extent not mentioned, concludes that
they are moot, irrelevant, or without merit.
To reflect the foregoing,
Decisions will be entered
under Rule 155.