While the tax law allows deductions for expenses incurred in a trade or business, it does not allow a taxpayer to claim a current deduction while the taxpayer is merely investigating the possibility of entering into a trade or business. In the case of Samadi v. Commissioner, TC Summary Opinion 2018-27 the Tax Court determined the taxpayer was in just such an investigatory stage and not actually conducting a trade or business.
In this case the taxpayer’s proposed business was described as follows by the Court:
In 2010 petitioner husband decided to invest in homes with his friends and family (hereinafter referred to as the group). The group consisted of five individuals, including petitioner husband’s brother. The group intended to buy homes, renovate them, and sell them for a profit (i.e., to flip houses). Petitioner husband became a licensed real estate agent in 2010 and continued to be licensed during 2013 and 2014. He did not earn any commissions from selling real estate in 2013 or 2014. Petitioner husband 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.
While their plan was to buy real estate to flip, the group never got past looking at real estate, for which the taxpayer was claiming auto mileage. As the Court outlines their activities for the years in question.
The mileage logs reflect that every Saturday from January 5 through August 27, 2013, and every Saturday from January 4 through August 16, 2014, petitioner husband drove 192 miles from his home in West Sacramento to the same “client’s house” in Marina, California; drove back about 190 miles to the Sacramento area for a “house showing with client”; drove back about 190 miles to “return client to his home” in Marina; and then drove 192 miles back home to West Sacramento. The “client’s home” in Marina was the home of petitioner husband’s brother. The “house showing” consisted of picking up his brother or one of the other individuals in the group (i.e., the “client”) from his brother’s home in Marina and driving that individual to the Sacramento area to look at a potential investment property.
Petitioner husband did not show any potential investment property to the group from late August through December in either 2013 or 2014. The group did not buy any investment property in either 2013 or 2014; its members could not agree on any of the potential investment properties petitioner husband had shown them.
The IRS argued that no deduction is possible in this case because the taxpayer had not yet commenced operation of a trade or business, a position with which the Court agreed.
The taxpayer attempted to argue that the showing of these properties to the other members of the group were part of his activity as a real estate agent. After all, he held an active license to act as a real estate agent. But merely having the license isn’t enough to create a trade or business. The Court noted:
Petitioner husband argues 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 are deductible business expenses. Although petitioner husband was a licensed real estate agent during 2013 and 2014, he was not in the trade or business of being a real estate agent during the years at issue. Petitioner husband testified that he did not earn any commissions during 2013 or 2014 as a real estate agent. There is no other evidence in the record to suggest that he was continuously and regularly buying and selling real estate as a real estate agent to clients.
That left only the house-flipping business—but the Court found this business had not actually commenced in the years in question.
At best, petitioner husband’s activity in 2013 and 2014 was in the exploratory or formative stages of forming a business of flipping houses. Carrying on a trade or business requires more than initial research into a potential business opportunity; it requires that the business have actually commenced. Dean v. Commissioner, 56 T.C. 895, 902-903 (1971); Frank v. Commissioner, 20 T.C. 511, 513-514 (1953); see Christian v. Commissioner, T.C. Memo. 1995-12, 1995 Tax Ct. Memo LEXIS 12, at *10-*12 (finding that activities relating to only “exploratory or formative stages” do not rise to the level of a trade or business). Section 162(a) does not permit current deductions for startup or preopening expenses incurred by a taxpayer before beginning business operations. See sec. 195(a).
Under IRC §195, these expenses will be held until such time as the business begins. At that time, under IRC §195(b) the expenses will be deducted and/or amortized over 180 months. If the business never begins, the expenses end up never being deductible.