Another hog slaughtered by the Tax Court - are you the next one?

[Michael Plaks]

You know that pigs gets fat while hogs get slaughtered. The Tax Court once again illustrated this cliché in its recent decision in the Harrison v. Commissioner case (T.C. Summary Opinion 2022-6).

Nicole Harrison was a successful business consultant working for Samsung and making a respectable $130k. Apparently she also obtained advanced taxation training somewhere like Grant Cardone YouTube Academy of Living Tax-Free (yes, I'm making this part up). As a result of this solid education, she completely erased her $130k W2 income by claiming various deductions, including a $70k loss from her Schedule C business and a $25k loss from her Schedule E rental activity. 

I hope that Uncle G would be the only person surprised that the IRS decided to take a look into Ms. Harrison's taxes and threw away all these deductions. Not getting the message, or maybe encouraged by another YouTube garbage video from GC, she took the IRS to court where she thoroughly lost on every single item. (If you wonder what personal beef I have with Cardone, I can explain: the guy actually has a degree in accounting and should know better than continuously distribute his dangerous nonsense "information" on taxes and dealing with the IRS.)

Now let's look at the two businesses claimed by Ms. Harrison, shall we?

1. Schedule E rental activity - a rather trivial failure

"...petitioner and a relative cosigned a mortgage for a three-family house in Brooklyn, New York. One floor of the house was occupied by petitioner's relative, while the other two floors were rented to third parties. Petitioner contributed to the mortgage by sending cash payments via Venmo to her relative. She did not receive any income from the property. Petitioner claimed passive activity losses on Schedule E for remediating a flooded basement, insurance, and other house-related expenses..."

and then

"...Petitioner testified that she co-signed the mortgage documents but did not provide copies. She also claims that she contributed to the mortgage payments through Venmo, but she did not provide any receipts or further evidence that she participated in the rental activity. Further, she claimed that she did not receive any income from the property. Thus, petitioner has not demonstrated she qualifies..."

Questions why she lost this one? I hope not. I would not have even bothered to report on this disaster had I not met a good number of investors who claimed to be JV-ing on some deals while having no paperwork or money trail whatsoever. Consider yourself warned.

2. Schedule C consulting - a much more interesting story

If you're planning to casually start in real estate while holding your job - pay attention!

Ms. Harrison decided to take her consulting skills into the private sector and start her own practice on the side. Like so many of us. She needed to establish her brand, so she paid for domains, web design and hosting. She needed to find clients, so she started networking, including travel. She renovated her home office. She bought a laptop for business. 

Let me ask you - does it sound familiar? It certainly does to me. This is pretty much what every second new investor or Realtor tells me they did, usually before they closed on any deals. But they were business expenses, what are you talking about? Uncle G told us we could even 10X them! (OK, I'll stop)

And - drumroll - here is what the Tax Court had to say:

"...While petitioner reported $400 of gross receipts for the venture, she has not demonstrated that she was carrying on a trade or business. Petitioner continued to work full time at Samsung during the year in issue. At best, it appears that her activity for the year in issue was in the exploratory stages of forming a business... To substantiate her expenses, she provided a mileage log of trips taken to various networking events, receipts for home renovations, and an invoice for website creation. Petitioner testified that she was trying to build a brand by creating a website and participating in speaking engagements, precisely to solicit potential clients. Carrying on a trade or business requires more than initial research into business potential and the solicitation of potential customers... Thus, we find that petitioner's activity did not rise to the level of carrying on a trade or business during the year in issue..."

In other words - no deductions. Curtains!

3. Lessons

⦁ see above re: pigs v hogs
⦁ going to networking events does NOT mean you operate a business
⦁ think twice before claiming $70k of expenses against $400 of income
⦁ keep records and documentation, duh!
⦁ don't learn taxes from Facebook and YouTube

[JD Martin]

Interesting case, thanks for the post. Definitely the lesson here is you really need to actually have "a business" before thinking you can wash away your W2 income. And that's going to be hard to do if you have a full-time job unless you have a spouse that's not employed and can claim the business as their job. Not receiving any income at all for the 3-family house was probably a huge red flag that doesn't even make any sense.