T.C. Summary Opinion 2013-91
UNITED STATES TAX COURT
GALE JORDAN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
LORA A. JARRETT, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 3058-12S, 3059-12S. Filed November 18, 2013.
Latif Oduola-Owoo, for petitioners.
Christopher D. Bradley, for respondent.
SUMMARY OPINION
BUCH, Judge: These cases were heard pursuant to section 7463 of the
Internal Revenue Code in effect when the petitions were filed.1 Pursuant to
1
Unless otherwise indicated, all section references are to the Internal
(continued...)
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section 7463(b), the decisions to be entered are not reviewable by any other court,
and this opinion may not be treated as precedent for any other case.
Respondent determined a deficiency of $900 in petitioner Gale Jordan’s
Federal income tax for 2008 and an accuracy-related penalty under section 6662(a)
of $180. Respondent determined a deficiency of $3,385 in petitioner Lora A.
Jarrett’s Federal income tax for 2008 and an accuracy-related penalty under
section 6662(a) of $677. The issues for decision are: (1) whether petitioners were
carrying on a rental property business in 2008 and (2) whether petitioners are
liable for the accuracy-related penalties. We find that the property was not placed
in service in 2008 and thus petitioners may not deduct the expenses relating to the
property for 2008. Further, petitioners are liable for their respective accuracy-
related penalties.
Background
At the time petitioners filed their petitions, they resided in Virginia.
Petitioners purchased a single-family house in Virginia on August 25, 2008.
Petitioner Gale Jordan made repairs of $3,500 and reported other expenses of
$6,622 relating to the property on her 2008 Schedule E, Supplemental Income and
1
(...continued)
Revenue Code (Code) in effect for the year in issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure.
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Loss. Petitioner Lora A. Jarrett made repairs of $5,064 and reported other
expenses of $8,614 relating to the property on her 2008 Schedule E. Petitioners
purchased the house with the intent to rent it, but it was not actually rented at any
time in 2008.
Petitioners’ sole rental applicant in 2008 applied to rent the house on July
16, 2008, which was before petitioners acquired it. However, petitioners did not
check the 2008 applicant’s creditworthiness until November 24, 2008. As a result
of that credit check, petitioners determined they would not rent the house to the
2008 applicant.
Petitioners had a second rental applicant in 2009, a woman who applied to
rent the house on January 30, 2009. The 2009 applicant was eligible for Section 8
housing assistance.2 After the application, HUD sent an inspector, who stated that
additional repairs to the house were required before the applicant could rent it.
Petitioner Lora A. Jarrett testified at trial regarding the inspection, stating:
2
The Section 8 housing program under the United States Housing Act of
1937 authorizes a private landlord who rents to a low-income tenant to receive
assistance payments from the Department of Housing and Urban Development
(HUD) in an amount calculated to make up the difference between the tenant’s
rent payments and the contract rent agreed upon by the landlord and HUD. See
Cisneros v. Albine Ridge Grp., 508 U.S. 10, 12 (1993); see also 42 U.S.C. sec.
1437f (2006).
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because it was Section 8, at the time that she put in her application
and we thought it okay, Section 8 sent an inspector out, and we had a
few additional things that we had to do before they would--took--
finally approved her application. So to us, yes, it was [ready for rent],
until they came back and said, we need you to do these things. And
we did them, and that’s when she was able to move in.
The second applicant moved into the house in March 2009. Petitioners reported a
placed-in-service date for the house of March 1, 2009, on their respective 2009
Forms 4562, Depreciation and Amortization.
On December 1, 2011, respondent issued a notice of deficiency to each
petitioner determining that the house was not ready and available to rent in 2008
and thus the expenses petitioners incurred for the property should have been
capitalized. As a result of that determination respondent recharacterized their
claimed real estate tax payments and mortgage interest payments as itemized
deductions. These adjustments also caused a computational adjustment to
petitioner Lora A. Jarrett’s recovery rebate credit. Additionally, respondent
determined an accuracy-related penalty for each petitioner under section 6662(a).
Petitioners timely filed petitions disputing respondent’s determinations.
Discussion
Section 162(a) generally allows a deduction for ordinary and necessary
expenses paid in connection with carrying on a trade or business. Section 212
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generally allows a deduction for expenses paid or incurred in connection with an
activity engaged in for the production or collection of income or for the
management, conservation, or maintenance of property held for the production of
income. Such expenses, however, must be associated with a trade or business or
other income-producing activity that is functioning at the time the expenses are
incurred.3 A taxpayer is not carrying on a trade or business for section 162(a)
purposes until the business is functioning as a going concern and performing the
activities for which it was organized.4 Business operations with respect to the
activity must have actually commenced.5 “Until that time, expenses related to that
activity are not ‘ordinary and necessary’ expenses currently deductible under
section 162 (nor are they deductible under section 212) but rather are ‘start-up’ or
3
Hardy v. Commissioner, 93 T.C. 684, 687 (1989), aff’d in part, remanded
in part, 1990 U.S. App. LEXIS 19670 (10th Cir. Oct. 29, 1990); see also Woody v.
Commissioner, T.C. Memo. 2009-93, aff’d, 403 Fed. Appx. 519 (D.C. Cir. 2010);
Glotov v. Commissioner, T.C. Memo. 2007-147.
4
Richmond Television Corp. v. United States, 345 F.2d 901, 907 (4th Cir.
1965), vacated and remanded on other grounds, 382 U.S. 68 (1965); see also
Glotov v. Commissioner, T.C. Memo. 2007-147.
5
McKelvey v. Commissioner, T.C. Memo. 2002-63, aff’d, 76 Fed. Appx.
806 (9th Cir. 2003).
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‘pre-opening’ expenses.”6 Startup expenses, although not currently deductible,
may generally be deducted over time pursuant to section 195.7
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.8
The Court has focused on three factors to indicate the existence of a trade or
business: (1) whether the taxpayer undertook the activity intending to earn a
profit; (2) whether the taxpayer is regularly and actively involved in the activity;
and (3) whether the taxpayer’s activity has actually commenced.9
The parties have stipulated to the first factor.
With respect to the second factor, in 2008 petitioners were not yet regularly
and actively involved in the activity. Petitioners’ activity was property rental. To
support the assertion that they were regularly and actively involved in holding out
6
Woody v. Commissioner, T.C. Memo. 2009-93 (citing Hardy v.
Commissioner, 93 T.C. at 687-688).
7
Woody v. Commissioner, T.C. Memo. 2009-93.
8
Woody v. Commissioner, T.C. Memo. 2009-93; see also Commissioner v.
Groetzinger, 480 U.S. 23, 36 (1987); Higgins v. Commissioner, 312 U.S. 212
(1941); O’Donnell v. Commissioner, 62 T.C. 781 (1974), aff’d without published
opinion, 519 F.2d 1406 (7th Cir. 1975).
9
See Woody v. Commissioner, T.C. Memo. 2009-93; see also McManus v.
Commissioner, T.C. Memo. 1987-457, aff’d without published opinion, 865 F.2d
255 (4th Cir. 1988).
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the house for rent in 2008, petitioners state that they engaged in word-of-mouth
advertising throughout 2008. However, the only evidence of actively working to
rent the property is the single 2008 rental application that was completed more
than a month before petitioners owned the property. There is no evidence
supporting any advertising in 2008 after petitioners purchased the house. Instead,
the evidence reflects that petitioners did not attempt to rent the house immediately
after they purchased it; rather, they made repairs to it. It appears the first time they
turned their attention back to renting the house was November 24, 2008, when
they checked the creditworthiness of the first applicant. Alternatively, the facts
supporting petitioners’ claim that they were regularly actively engaged in renting
out the property in 2009 include the 2009 application, the communications with
HUD for the Section 8 program, the HUD inspection, the additional repairs
required and made, and the 2009 applicant’s actually renting the house starting in
March 2009.
The third factor requires that the activity has actually commenced. The
mere purchase of a property is not enough if that property is not held out for rent
or actually rented.10 The fact that a taxpayer was looking for or secured a tenant
before actually purchasing the property is not sufficient to indicate the start of a
10
Charlton v. Commissioner, 114 T.C. 333, 338 (2000).
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business.11 Therefore, petitioners’ word-of-mouth advertising and solicitation of
the 2008 application before they owned the house does not rise to the level of
starting a business. A taxpayer is not carrying on a trade or business under section
162(a) until the business is functioning as a going concern and performing the
activities for which it was organized.12 Therefore, until the repairs are completed
and the house is held out for rent or actually rented, petitioners’ business is not
functioning as a going concern. It is notable that HUD required additional repairs
before it would agree that the house was suitable for rental by the 2009 applicant.
From that, it is clear that the house was not ready to be occupied in 2008.
We also find it noteworthy that both petitioners reported a placed-in-service
date for the house of March 1, 2009, on their 2009 Federal income tax returns.13
A review of the record reflects that petitioners were not regularly and
actively involved in renting out the property in 2008. The activity did not
commence until sometime in 2009, when the 2009 application was submitted,
11
Johnsen v. Commissioner, 83 T.C. 103 (1984), rev’d on other grounds,
794 F.2d 1157 (6th Cir. 1986); Woody v. Commissioner, T.C. Memo. 2009-93.
12
Richmond Television Corp. v. United States, 345 F.2d at 907; see also
Golotov v. Commissioner, T.C. Memo. 2007-147.
13
See Mendes v. Commissioner, 121 T.C. 308, 312 (2003) (finding that
positions taken in a tax return signed by a taxpayer may be treated as admissions).
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petitioners had dealings with HUD, the house was made suitable for occupancy,
and the house was actually rented. Petitioners have not met their burden to show
that the startup phase was completed and that the business began in 2008. Thus,
the repairs and other expenses relating to the property were not ordinary and
necessary business expenses for 2008 and are considered startup expenses that
cannot be currently deducted.
Accuracy-related penalty
Section 6662(a) and (b)(1) imposes a 20% penalty on any portion of an
underpayment that is attributable to negligence or disregard of rules or regulations.
The term “negligence” includes any failure to make a reasonable attempt to
comply with the provisions of the Code; the term “disregard” includes any
careless, reckless, or intentional disregard.14 Neither petitioner disputed the
penalty in her petition or an amended petition. Rule 41(b) provides for issues to
be tried by consent. Petitioners retained counsel for trial, but they did not raise the
issue of penalties at trial. Therefore, each petitioner is liable for the accuracy-
related penalty for 2008.15
14
Sec. 6662(c).
15
See Rule 34(b)(4).
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Conclusion
We conclude that the house was not placed in service in 2008; therefore,
petitioners are not entitled to deduct expenses related to the house on their
respective 2008 Schedules E. Further, petitioners are liable for their respective
accuracy-related penalties for 2008.
To reflect the foregoing,
Decisions will be entered for
respondent.