Yesterday's Lourdes v. IRS, T.C. Memo 2014-224 was a second denial of this taxpayer's attempt to deduct the home mortgage interest payments she made on behalf of her brother. Although Code Sec. 163 allows the legal or equitable owner to take a deduction for mortgage interest payments, the taxpayer must carry her burden of showing equitable ownership under state law. The taxpayer failed to do so under California law in this case. That law would have required overcoming a presumption that the person on the deed is the 100% legal owner by "showing that there exists an agreement or understanding between the parties evidencing an intent contrary to that which is reflected in the deed. In re Marriage of Fossum, 121 Cal. Rptr. 3d 195, 202 (Ct. App. 2011)." Unfortunately, the taxpayer needs to show more than just having paid for the house, which was her only evidence of ownership in this case.
Burrell v. IRS, T.C. Memo 2014-217 (October 14, 2014).
Believe it or not, losses incurred while gambling are deductible for those who are engaged in the “trade or business” of gambling and to the extent the taxpayer has gains attributable to “wagering.” IRC Sec. 165(d). However, the IRS and Tax Court are suspicious of such deductions. A taxpayer who hopes to successfully claim this deduction by means of contemporaneous records (i.e. accurate self-kept records made at or near the time of the transactions they evidence) needs to do more than just record the amount of money with which he or she enters the casino. In yesterday’s** Burrell v. IRS, the taxpayer failed to also record the amount of money with which she left the casino each day. T.C. Memo 2014-217, 7 (October 14, 2014). The IRS and Tax Court affirmed the deficiency against her and the accuracy-related penalties for underreporting based on the taxpayer’s failure of proof.
** At least one Tax Court clerk appears to have celebrated Columbus Day right!
Langert v. IRS, T.C. Memo 2014-210 (Oct. 8, 2014).
In general, the American income tax system taxes net income (only "new money") rather than gross income. Section 166 of the Internal Revenue Code helps further this objective by allowing a taxpayer to deduct a loss of money from his income if that loss occurs in connection with his "trade or business." IRC §§ 166(a) and (b)(2). Non-business bad debt losses are still deductible, but only as short term capital losses. § 166(d)(1). So legally, there is an important business boundary that must be established by the taxpayer to take full advantage of so called "bad debt" deductions.
Wednesday's Tax Court case of Langert v. IRS, T.C. Memo 2014-210 (Oct. 8, 2014) demonstrates the IRS's and the Tax Court's interpretation of this law. That is, a taxpayer seeking to deduct "bad debt" must prove that he makes enough loans on a sufficiently regular basis to elevate that activity to the status of a separate business. Id. at p. 10. In Langert, the taxpayer was a real estate investor who had also made money by lending and re-lending money over his 30 year career. Id. at p. 2. One such loan was not repaid in 2006, and the debtor filed for bankruptcy. Mr. Langert did not exercise any of his rights under the loan document, as a bankruptcy creditor, or in connection with the debtor's property. He then attempted to write off the loan as a complete loss under Section 166. His justification for doing so was that the loan was made "for the sole purpose of obtaining interest income." The IRS and Tax Court disallowed the deduction based on the taxpayer's failure to carry his burden and prove he met the "trade or business" requirements of this law.
So while many small business people may see their various and diverse business activities as related or as part of a continuum (buy low, sell high—any kind of widget), the IRS and Tax Court require more definite boundaries when it comes to deductions for bad debt. This may actually be a good case to appeal based on the language of the statute, but a prudent attorney or accountant would further research along the lines of Bell v. Commissioner, 200 F.3d 545 (8th Cir. 2000).
Crile v. IRS, TC Memo 2014-202 (Oct. 2, 2014).
Yesterday's Crile v. IRS, TC Memo 2014-202 provides an interesting analysis of an artist's successful use of IRC Sec. 162 to deduct her business expenses and losses she incurred as an artist. In Crile, the taxpayer was an artist and a tenured art professor. The IRS successfully separated her artist activities from her art professor activities. However, the IRS's was unsuccessful arguing that the taxpayer's art was too enjoyable and not profitable enough to satisfy the profit motive or "ordinary and necessary" business expense requirements of Sec. 162. Disposed for the taxpayer.
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