The Tax Court found that a rental real estate limited liability company (LLC) owner could not deduct expenses related to operating National Basketball Association Hall of Famer and coach Larry Bird's former house as a bed and breakfast (B&B) during years in which the LLC discontinued using the property as a B&B and listed it for sale. The court determined that the taxpayer used the property for personal purposes for more than 14 days during each of the years in question and failed to show that those days were used to perform repairs and maintenance and should not be considered personal-use days.
Facts: During 2007, Christopher Cooke and his partner formed Legend of French Lick LLC for the purpose of operating Bird's former house in French Lick, Ind., as a B&B. Cooke owned a 50% interest in the company, which converted the property into a B&B and began operations in 2008, but by late 2009 listed it for sale and discontinued B&B rentals on Jan. 31, 2010.
Cooke made several trips from his home in Alaska to the property during 2010 and 2011, typically staying in a guest suite there. He kept records of his travel expenses as well as purchases he made during these trips, including for gas, hardware, and meals. However, he did not keep contemporaneous records of his activities while at the property. During most of these trips, Cooke spent at least one night at a resort and casino near Louisville, Ky.
During 2010 and 2011, French Lick LLC paid expenses for advertising, real property taxes, accounting and bookkeeping services, insurance, telephone and cable television services, utilities, landscaping services, and repair and maintenance services. It reported ordinary business losses of $134,273 in 2010 and $127,740 in 2011. In both years, the company claimed deductions for repairs and maintenance, taxes and licenses, depreciation, and "other deductions." It allocated 100% of the profits and losses to Cooke, who reported the losses as nonpassive on Schedule E, Supplemental Income and Loss, of his income tax return and deducted them against other nonpassive income.
Upon audit, the IRS disallowed the deductions related to the Indiana property and assessed an accuracy-related penalty.
Issues: The issues before the Tax Court were which party bore the burden of proof related to the deductions on the property, whether the deductions should be allowed, and whether an accuracy-related penalty applied.
Sec. 162(a) and Secs. 212(1) and (2) state that ordinary and necessary expenses incurred in connection with a business or for the production of income are deductible, but no deductions are allowed for expenses incurred related to activities that are not engaged in for profit.
Sec. 280A(a) provides that no deduction can generally be taken related to a dwelling unit that is used by the taxpayer as a residence during the tax year. Property is treated as a residence if a taxpayer uses it for personal purposes for more than 14 days or 10% of the days during the year that the property is rented for a fair rental value, whichever is greater. If the dwelling unit is used for personal purposes for any part of a day, that day is generally considered a day of personal use for determining whether the unit was a residence during the year.
According to Sec. 280A(d)(2), a day is not treated as a day of personal use if the taxpayer engages in repairs and maintenance work on the unit substantially full time during the day. Further, days spent traveling to or from the property are not considered personal-use days if the trip's primary purpose is to perform repairs and maintenance.
Cooke spent at least a portion of each of 26 days in 2010 and 33 days in 2011 at the property. He claimed that he worked substantially full time in maintenance and repair activities during every day he spent at the property during 2010 and during all but two days in 2011. He argued that the days he spent traveling to and from his home in Alaska should not be treated as personal days because the primary purpose of each trip was to perform repairs and maintenance. Further, Cooke claimed that the days he spent visiting the Louisville area should not be considered personal days because he traveled to spend time away from the Indiana property.
Cooke relied on logbooks to show that he performed repair and maintenance activities during his trips. However, his testimony and logbooks provided no evidence that the property needed any repairs nor specific details of the work done to improve the property. French Lick LLC had a series of caretakers living at the property who were charged with maintaining it, and it employed a landscaping firm that provided services monthly from May through December during the years at issue.
Holding: The Tax Court determined Cooke's records did not establish that he engaged in repairs and maintenance. Further, the Tax Court found that the "business activity" summaries Cooke provided for his trips did not show the time spent on each activity and often combined repair and maintenance activities with other types of activities, such as visiting with past vendors and a local real estate agent. Thus, the Tax Court found that Cooke used the Indiana property for personal purposes for more than 14 days during each year at issue and disallowed the deductions.
Cooke argued that he acted with reasonable cause and in good faith and that he relied on his CPA's advice, so the assessed accuracy-related penalties should not apply. However, he offered no evidence of the CPA's competence as a tax professional or that he provided the CPA with all the necessary and accurate information required to provide proper advice. Thus, the Tax Court found that he was liable for the penalties.
- Cooke, T.C. Memo. 2017-74
—By Beth Howard, CPA, Ph.D., associate professor of accounting at Tennessee Technological University in Cookeville, Tenn.