The Tax Court has allowed members of a partnership engaged in the eco-friendly commercial and residential construction business to deduct expenses on a model home in a golf community despite occasional personal use of the home by the partners.
If an activity is a hobby, income is taxable but no deductions are currently allowed, but if there is a profit motive, it is a business and ordinary and necessary costs are deductible.
“There is no hard-and-fast rule for proving a profit motive,” said tax attorney Barbara Weltman, author of “J.K. Lasser’s Small Business Taxes 2022.” “A profit motive is something that is inferred based on a number of factors — no single factor is determinative.”
The partnership consisted of Jessica Walters and her parents, David and Jean Walters. The Walters are all partners of D&J Properties, with David and Jean each holding a 47.4% interest and Jessica holding a 5.2% interest. David and Jean ran a successful line of Laz-Z-Boy stores, and D&J Properties owned buildings that housed the Laz-Z-Boy Stores.
David became certified in LEED (Leadership in Energy and Environment Design), a green building standard, and Jessica received a law degree from a school that offered a focus on environmental law. The Walters decided to position D&J as an eco-friendly commercial and residential construction and consulting business by entering the green real estate market. They sold their La-Z-Boy stores but retained ownership of the buildings that housed the stores.
D&J purchased a lot in Balsam Mountain Preserve, a low-density housing development in the mountains of North Carolina that places emphasis on land conservation. In May 2007, the partnership signed with a general contractor for the construction of Balsam Home.
From the time Balsam Home was completed, the partnership depicted the structure as a model home and the Walters kept the house open for tours. They purchased memberships with BMP, which permitted them access to the golf course and the restaurant. David averaged 11 days a month at Balsam Home in 2011 and six days per month between January and October 2012.
The Internal Revenue Service denied deductions related to Balsam Home for the years 2011 and 2012, contending that the partnership was not engaged in for-profit activities but was used for personal use and enjoyment. The Tax Court disagreed — it found that the partnership activity was engaged in for-profit activities.
Treasury Regulation Section 1.183-2 provides a nonexclusive list of objective factors to be considered in deciding whether an activity is engaged in for profit:
- The manner in which the taxpayer carries on the activity;
- The expertise of the taxpayer or the taxpayer’s advisors;
- The time and effort expended by the taxpayer in carrying on the activity;
- The expectation that assets used in the activity may appreciate in value;
- The success of the taxpayer in carrying on other similar activities;
- The taxpayer’s history of income or loss with respect to the activity;
- The amount of occasional profits, if any, which are earned;
- The financial status of the taxpayer; and,
- Whether elements of personal pleasure or recreation are involved.
“The factors of this case support a conclusion that the partnership was engaged in a for-profit activity,” the Court concluded. “We recognize that the partnership’s efforts were not perfectly executed, but its actions overall fall in favor of a conclusion that it was seeking a profit.”
