Property-related litigation costs held includible in home office deduction

The IRS failed to show that combating 'running wild' dogs, mold, and noise was exclusively a personal expense.
By Kim T. Mollberg, CPA, CGMA, CMA, MBT

The Tax Court held that a portion of legal fees and sheriff's department and court costs paid by a sole proprietor in court proceedings related to use of her residence where she maintained a home office were deductible. 

Facts: In arriving at the $14,809 net income reported on her 2009 Schedule C, Profit or Loss From Business, for her information technology and database management business, Denise McMillan deducted as legal and professional service costs 100% of the $26,312 she paid for legal fees and sheriff's department and court costs. The expenses related to a 2005 civil complaint she filed in state court against her condominium homeowners association and neighbors, and a 2009 criminal complaint against her relating to her information gathering for the civil complaint. In the civil complaint, she claimed breach of contract, breach of fiduciary duty, and nuisance, stating that dogs were running wild, barking, and defecating around her property. She also claimed construction defects contributed to mold in her bathroom and noise problems in her condominium.

Also included in her 2009 Schedule C deductions were $17,913 in qualified home office expenses from Form 8829, Expenses for Business Use of Your Home. The Form 8829 reported 50% as the business-use-of-home percentage. On a second Schedule C for 2009, McMillan reported zero receipts and $7,486 in expenses for her activity as a horse rider and trainer.

Upon examination, the IRS disallowed all of the legal fees and related costs, noting that Sec. 262(a) generally disallows deductions for personal, living, or family expenses. The IRS also disallowed the loss from her equine activity.

Issues: The IRS argued that the legal expenses claimed for McMillan's information technology and database management business did not arise from, or were not proximately related to, a business activity but rather were personal expenses. The Service also argued that McMillan's equine activity was not a going concern or engaged in for profit.

Holding: The Tax Court held that since the IRS failed to prove the noise and other factors had no impact on McMillan's business use of the condominium, the legal fees and related costs were not exclusively personal. Since the IRS had previously accepted 50% as the business-use-of-home percentage, the court allowed 50% ($13,156) of the legal fees and related costs as business expenses.

With respect to the equine activity, the court noted the taxpayer had reported net losses for the activity for 2004 through 2009 totaling $154,656, and that with respect to two of those years, the court had previously upheld disallowances of deductions, holding that McMillan did not show she engaged in the activity for profit (McMillan, T.C. Memo. 2013-40). Finding that McMillan also did not engage in this activity for profit in 2009, the court again upheld the IRS's determination with respect to it, except for an interest expense for debt relating to an expenditure in an earlier tax year.

  • McMillan, T.C. Memo. 2015-109

By Kim T. Mollberg, CPA, CGMA, CMA, MBT, associate professor, Minnesota State University Moorhead.


Year-end tax planning and what’s new for 2016

Practitioners need to consider several tax planning opportunities to review with their clients before the end of the year. This report offers strategies for individuals and businesses, as well as recent federal tax law changes affecting this year’s tax returns.


News quiz: Retirement planning, tax practice, and fraud risk

Recent reports focused on a survey that gauges the worries about retirement among CPA financial planners’ clients, a suit that affects tax practitioners, and a guide that offers advice on fraud risk. See how much you know with this short quiz.


Bolster your data defenses

As you weather the dog days of summer, it’s a good time to make sure your cybersecurity structure can stand up to the heat of external and internal threats. Here are six steps to help shore up your systems.