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Wednesday, July 15, 2009Attention Florida Rental Property Owners:
Casualty Loss resulting from Chinese Drywall damage
Casualty loss deductions would ease the financial pain of faulty Chinese drywall
Responding to legislators' requests that IRS clarify whether damage caused by defective Chinese drywall can result in a casualty loss deduction, IRS Associate Chief Counsel George Blaine has responded with a conditional “yes.” The damage would be deductible as a casualty loss under Internal Revenue Code 163(h) but only if the Environmental Protection Agency (EPA) and Consumer Product Safety Commission (CPSC) determine that the defective drywall is the source of unusual damage.
Background. To qualify as a casualty loss, a loss must result from a destructive force, such as a fire, shipwreck, automobile collision, hurricane or other storm, flood or similar event.Personal casualty losses are subject to a $100-per-casualty floor and the 10%-of-AGI limitation. Business casualty losses are not subject to any limitations (Rental Properties)
Court decisions and revenue rulings have developed the overall concept that the term casualty refers to an identifiable event of a sudden, unexpected, or unusual nature. Suddenness is an essential element of a casualty. To be sudden, the event must be one that is swift and precipitous and not gradual or progressive. Progressive deterioration of property through a steadily operating cause isn't a casualty loss.
Chinese drywall problem. At the height of the U.S. building boom (largely in Southwest Florida), a scarcity of domestically made drywall resulted in the importation of large quantities of Chinese-made drywall, which was installed in an estimated 100,000 living units. Many news reports have surfaced to the effect that the Chinese drywall is defective, and due to the chemicals it emits, is causing health, as well as construction problems.
Please consult your tax advisor if you feel this may apply to your situation and to the treatment of these losses.
Circular 230 Notice: IRS regulations require us to advise you that, unless otherwise specifically noted, any federal tax advice in this communication (including any attachments, enclosures, or other accompanying materials) was not intended or written to be used, by any taxpayer for the purpose of avoiding tax-related penalties imposed under the U.S. Internal Revenue Code or any other applicable state or local tax law provision; furthermore, this communication was not intended or written to support the promoting, marketing or recommending of any of the transactions or matters it addresses.
Greg Nelson, CPA | Principal | Olsen Thielen & Co. Ltd. | Flagship Corporate Center | 775 Prairie Center Dr. Ste. 480 | Minneapolis, MN 55344 | Phone: 952-829-3402 | Fax: 952-941-0577 | www.otcpas.com
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Show All » 2009 » May
Tuesday, June 02, 2009No deduction for costs before real estate business actually began; training classes nondeductible
Thomas J. Woody, TC Memo 2009-93
Thinking about starting a business in real estate? Dot your 'i's and cross your "t's ! A recent Tax Court decision deals with a taxpayer who spent big money to get into the real estate business but wasn't entitled to deduct his expenses for a couple of reasons 1) because they were incurred before his business began and 2) because they were incurred for a new career as such deemed nondeductible educational expenses.
Background. To be deductible under Internal Revenue Code (IRC) 162, ordinary and necessary business expenses must be directly connected with or pertain to the taxpayer's trade or business. The entity must be functioning as a business when the expenses are incurred. Until the business is functioning as a going concern, expenses related to it are not ordinary and necessary expenses but, rather, startup expenses that may be deductible over a period of time under IRC 195 .
Facts. In 2004, Thomas J. Woody started investigating the real estate market so that he could buy properties for investment or rental purposes. He created a name for his venture (Value Property Investments) and began marketing his services via business cards, flyers, and word of mouth. In May 2004, Mr. Woody completed a business outline for his venture with “buying, remodeling, and renting property” being its stated purpose. On Oct. 17, 2004, Woody paid $21,490 to the Wealth Intelligence Academy for certain training classes, which he subsequently attended to acquire real estate investment skills. After taking the courses, his business plan shifted from merely buying, remodeling, and renting to also include what Woody referred to as “flipping” or “wholesaling.” However, he never completed this type of transaction during 2004. In November of 2004, he got a loan from the U.S. Small Business Administration and got an employer identification number from IRS. In December of 2004, he got a credit card in the name of “Thomas J. Woody Value Property Invest” and opened a checking account in the name of “Mr. Thomas J. Woody D/B/A Value Property Investments.”
Despite his efforts, Woody didn't actually engage in any real estate activity until Dec. 30, 2004, when he bought an investment property. He didn't succeed in renting it out until 2005.
On his 2004 tax return Woody reported $23,373 of expenses on Schedule C, consisting of the cost of his training classes (the majority of $21,515) and expenses for car expenses, supplies, meals and entertainment, and computer and software costs.
IRS disallowed Woody's claimed Schedule C deductions on the ground that he wasn't engaged in the active conduct of a trade or business and determined an income tax deficiency of $4,955. Woody appealed to the Tax Court.
No business deductions until business actually commences. The Tax Court pointed out that in determining whether a trade or business exists, the courts have examined: (1) whether the taxpayer undertook the activity intending to earn a profit; (2) whether the taxpayer was regularly and actively involved in the activity; and (3) whether the taxpayer's activity actually commenced. The Tax Court found the third factor to be determinative in Woody's case. Until he actually began to buy, remodel, or rent— i.e., to perform the activities for which he organized Value Property Investments—he was not carrying on a trade or business for IRC 162 purposes. And until that time, none of his expenses could be claimed as IRC 162 expenses. The Tax Court found that Woody's activities did not rise to the level of a trade or business until, at the earliest, the time he purchased investment property on Dec. 30, 2004, and more likely, did not rise to that level until he held the property out for rent sometime after the close of 2004. If the earliest possible date he was actively carrying on a trade or business was Dec. 30, 2004, then any expenses incurred in that year but incurred before the active trade or business began would be, by definition start-up expenses rather than ordinary and necessary business expenses.
The Tax Court pointed out that Woody's largest expenditure in 2004—$21,515 for workshops and training—was an educational expense incurred to prepare for a new career, i.e., real estate investor and renter, rather than to maintain or improve skills in an ongoing business or career. It was therefore not deductible under IRC 162 nor would of been if classified as a start up expense.
Note: The treatment of start-up costs were different in 2004 where there had to be an election filed with the taxpayers return. The regulations changed in October of 2004 eliminating this election however, only a very small portion of Woody's expenses were incurred after that date and wouldn't have helped him much. Even if Woody had paid for his educational expenses after Oct. 22, 2004, he couldn't have amortized the cost as start-up under IRC 195. A start-up expense must be one that, if paid or incurred in connection with the operation of an existing active trade or business (in the same field as the taxpayer's new business), would be deductible for the year in which paid or incurred. Because the educational expenses would not have been deductible under ordinary and necessary, they could not have been amortized as start-expenses.
Greg Nelson CPA, MBT
Olsen Thielen, CPAs
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Show All » 2009 » May
Monday, May 04, 2009$1,500 Tax Credit for Home Energy Improvements:
Individuals are allowed a nonrefundable personal credit, up to $1,500 of aggregate credits, for improvements to their principal residence in 2009 and 2010 that meet certain energy efficiency standards. The credit is equal to 30% of the sum of amounts paid or incurred during the tax year for (1) energy efficiency improvements to the building envelope and (2) residential energy property expenditures, i.e., expenditures for qualified energy property (Windows and Furnaces are just a few types of expenditures).
For a good resource of what qualifies go to : energystar.gov/taxcredits
Greg Nelson, CPA, MBT
Olsen Thielen CPAs
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