It is important to learn from the mistakes of others. Detailed documentation of expenses is absolutely vital to sustain a tax deduction.
In a recent Tax Court case (Charles F. Schuetze, TC Memo 2017-74), an attorney formed an LLC with another person to purchase a bed & breakfast property located in Indiana in 2007. It was the former residence of Larry Bird. Due to mounting losses, the B&B was closed in 2010 and put up for sale. The LLC’s losses totaled more than $250,000 and included repairs and maintenance deductions.
The IRS contended that Schuetze used the B&B for personal use. The tax rule is that if a taxpayer uses a residence for more than the greater of 14 days or 10% of the number of days during the tax year that the property is rented at a fair rental value, it is used for personal use and tax deductions are limited. The court noted that a pass-through entity, such as the LLC, is considered to have made personal use of a dwelling unit on any day on which any beneficial owner made personal use of the dwelling.
The taxpayer argued that the days he spent at the B&B were mostly to perform repairs and maintain the property. If a taxpayer is engaged in repairs and maintenance of the dwelling unit substantially full time on any day, that day will not constitute personal use of the unit. When determining if a taxpayer can exclude the time spent at the dwelling as not constituting personal use, the IRS considers the amount of time devoted to repair and maintenance work, the frequency of use for repair and maintenance work, and the presence and activity of companions.
The taxpayer’s argument that his time at the property was for business purposes and not for personal use did not influence the Tax Court based on the facts of the case. The court found that the taxpayer failed to provide specific details about the activities that he performed. The taxpayer testified that he performed some work on the grounds of the property. However, the court found no evidence of disrepair on the property and no details of what repair activities were performed. No other witnesses testified to verify that petitioner conducted repairs and maintenance during his trips. The court concluded that the taxpayer’s records did not substantiate his claimed deductions. The court also noted that a caretaker resided on the property and that the taxpayer had engaged the services of a landscape company.
The taxpayer requested that the court forgive the accuracy related penalty assessed by the IRS, claiming that he had asked a tax professional for advice. The court found that the taxpayer failed to show he had acted with reasonable cause and good faith to avoid penalties and his testimony did not persuade the court that penalties should be removed.
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