Their Lack of Profit Motive Rules Out Tax Deduction
Don and Margaret owned a five-acre parcel consisting of their home,a work area used by Don in his construction business and a mobile home.They decided to sell this property so they could move to Missouri forsemi-retirement. They planned to buy a campground there.
Their property was listed for sale at $650,000 with a local realtyagent. Several months later, they were contacted by the owner of a nearbyluxury house on a one-acre lot, listed for sale at $529,000. He proposedtrading it for the five-acre parcel.
The parties agreed to exchange properties for $460,000 each. Don andMargaret received $150,000 cash, unsecured notes of $288,000 and $6,740mortgage relief, and paid a $15,260 sales commission to their agent. Theygot a $300,000 mortgage on the luxury home and bought a Missouricampground for $132,500.
They immediately listed the luxury house for sale at $525,000. Afterit was on the market for five months, they sold it for $377,500, claiminga $133,592 capital loss on the sale. After offsetting their profit on thesale of their five acres, the couple claimed a $49,292 capital loss onthe house sale.
However, the IRS denied this loss deduction. The IRS auditor arguedthat Don and Margaret did not have a profit motive in acquiring theluxury house in the trade. He said the real reason for the trade was thatthe house was more easily salable than the five-acre parcel. Don andMargaret took their dispute to U.S. Tax Court.
If you were the U.S. Tax Court judge, would you allow Don and Margaretto claim a $49,292 capital loss on the house sale?
The judge said no.
Because losses on the sale of a personal residence are nottax-deductible, the judge explained, Don and Margaret could deduct theirloss on the luxury home sale only if they had a profit motive foracquiring it.
Four tests apply to determine if there is a profit motive, the judgesaid: (a) the manner in which the taxpayer carries on the activity, (b)the expertise of the taxpayer or his advisors, (c) the time and effortspent by the taxpayer on the activity and (d) the expectation that theassets will appreciate in market value.
There is no evidence Don and Margaret met any of these profit motivetests, the judge ruled. Acquisition of the luxury house was personal,rather than for business, he noted. Because it was more salable thantheir five-acre property, and because Don and Margaret never tried torent it but held title for only a few months, their loss is not taxdeductible, the judge concluded.
Based on the 1998 U.S. Tax Court decision in Taylor vs. Commissioner,T.C. Memo 1998-351.
Letters and comments to Robert J. Bruss, a San Francisco-area lawyer,author and real estate broker, may be sent to P.O. Box 280038, SanFrancisco, CA 94128. Bruss suggests consulting an attorney or tax advisorbefore making important real estate decisions.
