                  T.C. Memo. 2009-93



                UNITED STATES TAX COURT



            THOMAS J. WOODY, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 30077-07.             Filed April 30, 2009.


     P alleges that during tax year 2004 he had a real
estate investment and rental business. P deducted
expenses associated with this activity as business
expenses under I.R.C. sec. 162. R disallowed the
business expense deductions. On the basis of this
disallowance, R determined a deficiency in P’s Federal
income tax for 2004. P petitioned this Court for
redetermination of that deficiency.

     Held: P was not actively engaged in a real estate
investment and rental business when he incurred and
paid the expenses he deducted as Schedule C business
expenses in 2004. Therefore, the costs P deducted are
pre-operational start-up expenditures and may not be
deducted as business expenses under I.R.C. sec. 162.
                                 - 2 -

     Bruce E. Gardner, for petitioner.

     Scott L. Little, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GUSTAFSON, Judge: This case is before the Court on

petitioner Thomas J. Woody’s petition for redetermination of his

Federal income tax deficiency for 2004 which the Internal Revenue

Service (IRS) determined to be $4,955.    The issue for decision is

whether Mr. Woody is entitled under section 1621 to deductions

claimed on his 2004 Schedule C, Profit or Loss From Business.    As

a threshold matter, we must decide whether Mr. Woody was actively

engaged in the trade or business of real estate investment and

rental at the time he incurred and paid the expenses that he

reported as business expenses.    We find that he was not.

                        FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts filed October 16, 2008, and the attached

exhibits are incorporated herein by this reference.    At the time

Mr. Woody filed his petition, he resided in Washington, D.C.

     On or about February 15, 2004, Mr. Woody started

investigating the real estate market so he could acquire real


     1
      Unless otherwise indicated, all citations to sections refer
to the Internal Revenue Code of 1986 (26 U.S.C.), as amended, and
all citations to Rules refer to the Tax Court Rules of Practice
and Procedure.
                               - 3 -

estate for investment or rental.   Throughout 2004 Mr. Woody

looked at many properties he was interested in buying for this

real estate investment and rental business.   He made multiple

offers to purchase properties but was out-bid on most of his

offers.   In May 2004 Mr. Woody entered into a contract to

purchase a property on Bradley Avenue in Camden, New Jersey.

However, after a home inspection revealed many defects in the

property, Mr. Woody canceled the contract because the seller was

not willing to make the needed repairs.

     Mr. Woody did not purchase any investment or rental property

until he purchased the property on Randolph Street in Camden, New

Jersey, on December 30, 2004, i.e., the next to last day of the

year at issue.   At that time, there was no tenant in the

property, and he did not secure a tenant until sometime after

2004.   Furthermore, there is nothing in the record to indicate

that Mr. Woody held the property out for rent in 2004.

     Throughout 2004 Mr. Woody performed many other tasks in

conjunction with his alleged business.    He created a name for his

endeavor–-Value Property Investments–-and began marketing his

services via business cards, flyers, and word of mouth.     In May

2004 Mr. Woody completed a business outline with “buying,

remodeling, and renting property” being the stated purpose of

Value Property Investments.   On October 17, 2004, Mr. Woody paid

$21,490 to the Wealth Intelligence Academy for certain training
                               - 4 -

classes, which he subsequently attended to acquire real estate

investment skills.   After Mr. Woody took the Wealth Intelligence

Academy courses, his business plan shifted from merely buying,

remodeling, and renting to also include what Mr. Woody referred

to as “flipping” or “wholesaling”.2    However, he never

consummated this type of transaction during 2004.

     In November 2004 Mr. Woody applied, and was approved, for a

loan from the U.S. Small Business Administration, and he obtained

an employer identification number from the IRS.    In December 2004

Mr. Woody obtained a credit card in the name of “Thomas J. Woody

Value Property Invest” and opened a checking account in the name

of “Mr. Thomas J. Woody D/B/A Value Property Investments”.

     Despite all of the foregoing activity, Mr. Woody did not

purchase any investment property until December 30, 2004, and he

did not buy or sell any other property, rent out any property, or

hold any property out for rent, nor did he engage in “flipping”

or “wholesaling” during tax year 2004.

     For tax year 2004 Mr. Woody filed a Form 1040, U.S.

Individual Income Tax Return, with an attached Schedule C.   On

that Schedule C Mr. Woody reported no gross receipts or sales but

reported total expenses of $23,373, which consisted of:



     2
      “Wholesaling” or “flipping” is entering into a contract for
the purchase of a property and then, before the sale goes to
closing, assigning to a third-party buyer (in return for a fee)
the right to buy the property.
                               - 5 -

           Car and truck expenses           $144
           Supplies                          153
           Meals and entertainment            41
           Workshops and training         21,515
           Computer and software           1,451
           Misc.                              69

Respondent now concedes that Mr. Woody incurred and paid all of

the expenses set forth in his Schedule C (as listed above), and

the parties stipulate that they were incurred and paid before

December 29, 2004.3   However, upon examination of Mr. Woody’s

2004 tax return, the IRS disallowed Mr. Woody’s Schedule C

expenses on the grounds that he had failed to substantiate his

expenses or to prove that they were “ordinary and necessary” to

his business.

     In the statutory notice of deficiency issued to Mr. Woody on

October 9, 2007, the IRS determined an income tax deficiency of

$4,955.   Mr. Woody timely petitioned the Tax Court on December

27, 2007, for a redetermination of that deficiency.   In response

to Mr. Woody’s petition, respondent answered:


     3
      For most of these listed expenses, the record shows
expressly that they were incurred before October 22, 2004, and
there is no indication that any of them was incurred after that
date. (For the relevance of that date, see infra note 7). At
trial Mr. Woody presented additional evidence to establish that
he paid an additional $1,887.82 in expenses that should have been
included on his 2004 Schedule C. Three of those additional
expenditures (a loan application fee of $475; an advertising
expense of $114; and settlement charges of $874, totaling $1,463)
were incurred after October 22, 2004. However, the $874 in
settlement charges incurred with respect to the purchase of the
Randolph Street property is a capital expenditure which is non-
deductible in 2004. See sec. 263; sec. 1.263(a)-2(a), Income Tax
Regs.
                                 - 6 -

     respondent determined that petitioner was not engaged in the
     active conduct of a real estate investment business as
     alleged. Further alleges, in any event, that petitioner has
     not substantiated the amount of, payment of, or the
     specifics of any such expenses.

Therefore, respondent’s justification of his disallowance of

Mr. Woody’s expenses was in fact two-fold:   (1) lack of

substantiation of the expenses, and (2) the determination that

Mr. Woody was not actively engaged in a trade or business as

required by section 162.

     A trial in this case was held on October 16, 2008, in

Washington, D.C.

                                OPINION

I.   The Parties’ Contentions

     Mr. Woody does not dispute that his initial investigation of

properties (and the failed bids thereon) and his research into

the real estate investment and rental business from February to

April 2004 occurred before the commencement of his business.

However, Mr. Woody contends that he commenced his real estate

investment and rental business on May 1, 2004, when he entered

into a contract of sale on the Bradley Avenue property in Camden,

New Jersey (i.e., the contract he ultimately canceled).4   As a


     4
      Mr. Woody also makes much of the fact that since the
contractual rights in relation to the existing tenant at the
Bradley Avenue property would belong to him in the event that he
acquired the property, that implies he offered that property for
rent. However, because Mr. Woody never acquired the property, we
cannot find that he ever had any legal ability to offer that
                                                   (continued...)
                               - 7 -

result, Mr. Woody maintains that all the expenses associated with

his business that were incurred after May 1, 2004, should be

deductible as business expenses under section 162.

      Respondent asserts that Mr. Woody was not actively engaged

in the real estate investment and rental business at any time

during 2004, because Mr. Woody did not become actively engaged in

business, i.e., by buying, selling, renting, or offering to rent

property, until he held the Randolph Street property out for rent

some time after 2004.   As a result, since all of the Schedule C

expenses were incurred and paid before December 30, 2004, i.e.,

before the acquisition of any potential rental property,

respondent contends that none of Mr. Woody’s Schedule C expenses

are deductible under section 162.

II.   Burden of Proof

      At trial and on brief, Mr. Woody argued that the burden of

proof on the question whether he was actively engaged in a trade

or business when he incurred the expenses has shifted to

respondent because respondent raised that issue as a “new matter”



      4
      (...continued)
property for rent. In any event, such activity is not sufficient
to rise to the level of carrying on a trade or business. See
Johnsen v. Commissioner, 83 T.C. 103 (1984) (looking for or
securing a tenant before the taxpayer actually owns the property
and could actually rent the property was not sufficient to
indicate the start of a business), revd. on other grounds 794
F.2d 1157 (6th Cir. 1986), overruled on other grounds Hardy v.
Commissioner, 93 T.C. 684 (1989), affd. in part and remanded in
part per order (10th Cir., Oct. 29, 1990).
                               - 8 -

in his answer.5   See Rule 142(a)(1).   The IRS’s notice of

deficiency stated that Mr. Woody “did not establish * * * that

the expense was ordinary and necessary to your business”.     Mr.

Woody contends that this language did not raise the issue of

whether he was engaged in the business.

     However, in this case the allocation of the burden of proof

does not affect the outcome, because the facts found here are

essentially undisputed, and the parties disagree only on how to

characterize them.   “[E]xcept for extraordinary burdens (e.g., in

fraud cases), the burden of proof is merely a ‘tie-breaker’ * * *

[and] is irrelevant unless the evidence is in equipoise.”

Steiner v. Commissioner, T.C. Memo. 1995-122, 69 T.C.M. (CCH)

2176, 2198 (1995), 1995 T.C.M. (RIA) par. 95,122.    On the basis

of the stipulated facts and the evidence presented at trial, we

do not find the evidence with respect to whether Mr. Woody was

actively engaged in business to be in equipoise.    As a result,

the question of who bears the burden of proof is one we need not

reach.




     5
      A new theory that is presented to sustain a deficiency is
treated as a new matter when it increases the amount of the
original deficiency or requires the presentation of different
evidence. Shea v. Commissioner, 112 T.C. 183, 191 (1999) (and
cases cited thereat). A new theory which merely clarifies or
develops the original determination is not a new matter in
respect of which the Commissioner bears the burden of proof. Id.
                               - 9 -

III. Business Expense Deductions

     Section 162 generally allows a deduction for all the

ordinary and necessary expenses paid or incurred during the

taxable year in carrying on any trade or business.   Such expenses

must be directly connected with or pertain to the taxpayer’s

trade or business that is functioning as a business at the time

the expenses were incurred.   Hardy v. Commissioner, 93 T.C. 684

(1989), affd. in part and remanded in part per order (10th Cir.,

Oct. 29, 1990); Glotov v. Commissioner, T.C. Memo. 2007-147; sec.

1.162-1(a), Income Tax Regs. (26 C.F.R.).   Whether an expenditure

satisfies the requirements of section 162 is a question of fact.

Commissioner v. Heininger, 320 U.S. 467, 475 (1943).     And whether

a taxpayer’s activities constitute the carrying on of a trade or

business requires an examination of the facts and circumstances

of each case.   Commissioner v. Groetzinger, 480 U.S. 23, 36

(1987); Higgins v. Commissioner, 312 U.S. 212 (1941); O'Donnell

v. Commissioner, 62 T.C. 781 (1974), affd. without published

opinion 519 F.2d 1406 (7th Cir. 1975).

     However, “A taxpayer is not carrying on a trade or business

under section 162(a) until the business is functioning as a going

concern and performing the activities for which it was

organized.”   Glotov v. Commissioner, supra.   Until that time,

expenses related to that activity are not “ordinary and

necessary” expenses currently deductible under section 162 (nor
                                - 10 -

are they deductible under section 212) but rather are “start-up”

or “pre-opening” expenses.   Hardy v. Commissioner, supra at 687-

688. “Start-up expenditures”--i.e., expenses incurred “before the

day on which the active trade or business begins,”6

sec. 195(c)(1)(A)(iii) (emphasis added)--may be deducted only

over time under section 195.7

     While all of Mr. Woody’s 2004 expenditures at issue have

been substantiated, the question for decision before the Court is

whether they qualify as section 162 business expenses.    It is

respondent’s position that even though Mr. Woody incurred these

expenses, they are, at best, start-up expenditures, as opposed to

section 162 business expenses.    In determining whether these


     6
      Where expenses are incurred in the same taxable year in
which a business begins to function but before the day on which
it begins to function, the disallowance of the deduction of such
an expense under section 162 arguably constitutes an exception to
the generality that our tax system is annualized. Nonetheless,
the deductibility of an expense under section 162–-or its
relegation to treatment under section 195--does depend on the
date on which the expense was incurred in relation to the date on
which the business began operating; and the expense is not
deductible under section 162 unless the business was functioning
on the day the expense was incurred.
     7
      In his post-trial briefs, Mr. Woody acknowledges that he
would be precluded from the special treatment afforded under
section 195 because he failed to make the requisite election
required by section 195(b). Even without such an election, a
taxpayer might be entitled to section 195 amortization of
expenses that were incurred after October 22, 2004, see sec.
1.195-1T(b), (d), Temporary Income Tax Regs., 73 Fed. Reg. 38913
(July 8, 2008); but only $1,463 of the expenses at issue here was
incurred after that date, see supra note 3, and Mr. Woody has
made no claim for section 195 treatment, so we do not here make
any determination as to section 195 treatment.
                              - 11 -

expenses are in fact section 162 business expenses, the threshold

question is when Mr. Woody completed his start-up phase and

became actively engaged in his business.

     Whether a taxpayer is engaged in a trade or business is

determined using a facts and circumstances test under which

courts have focused on the following three factors that indicate

the existence of a trade or business:   (1) whether the taxpayer

undertook the activity intending to earn a profit; (2) whether

the taxpayer is regularly and actively involved in the activity;

and (3) whether the taxpayer’s activity has actually commenced.

See McManus v. Commissioner, T.C. Memo. 1987-457, affd. without

published opinion 865 F.2d 255 (4th Cir. 1988).   On the basis of

Mr. Woody’s testimony, we may assume that he undertook this

activity to make a profit and that he regularly and actively

engaged in it.8   However, it is the third factor–-whether

Mr. Woody’s business had actually commenced–-that is

determinative here.


     8
      Mr. Woody cites Dreicer v. Commissioner, 78 T.C. 642, 645
(1982), affd. without published opinion 702 F.2d 1205 (D.C. Cir.
1983), for the proposition that because Mr. Woody engaged in his
activity for profit, he must have been actively engaged in
business. Mr. Woody’s reliance on Dreicer is misplaced. Dreicer
deals exclusively with determining whether a taxpayer is engaged
in an activity for profit. However, whether a taxpayer is
engaged in an activity for profit is not the decisive factor in
determining whether he is actively engaged in a trade or
business; rather it is just one of the three factors that needs
to be satisfied. See McManus v. Commissioner, T.C. Memo. 1987-
457, affd. without published opinion 865 F.2d 255 (4th Cir.
1988).
                               - 12 -

     In Mr. Woody’s business outline, dated May 10, 2004, he

indicated that he was starting Value Property Investments “for

the purpose of buying, remodeling and renting property.”

Therefore, until Mr. Woody began to buy, remodel, or rent--i.e.,

to perform the activities for which Value Property Investments

was organized--he was not carrying on a trade or business as

contemplated by section 162.

     We find that Mr. Woody’s activities did not rise to the

level of a trade or business until, at the earliest, the time he

purchased the Randolph Street property on December 30 of the year

in suit.   More likely, Mr. Woody’s activities did not rise to the

level of a trade or business until he held the Randolph Street

property out for rent sometime after the close of the year in

suit.   See Charlton v. Commissioner, 114 T.C. 333, 338 (2000)

(holding that the mere purchase of property did not constitute an

active trade or business since the property was not rented or

held out for rent until a subsequent year).

     Nonetheless, in order to resolve the matter before us, we do

not need to decide whether Mr. Woody’s business started at the

time he purchased the Randolph Street property or at the time he

held it out for rent, because, in any event, the expenses in

question here all occurred before the purchase date, i.e., before
                                - 13 -

December 30, 2004.9   If the earliest possible date Mr. Woody was

actively carrying on a trade or business was December 30, 2004,

then any expenses incurred in that year but incurred “before the

day on which the active trade or business” began,

sec. 195(c)(1)(A)(iii)–-i.e., all the expenses incurred from

January 1 through December 29, 2004–-would be, by definition,

start-up expenses whose deductibility, and possible amortization,

is expressly dealt with by section 195.   Since all the expenses

at issue here were incurred between January 1 and December 29,

2004,10 they would not be deductible for 2004 under section 162

because their timing makes them subject to the provisions of

section 195, and section 195 start-up expenditures are not

deductible under section 162.    See Hardy v. Commissioner, 93 T.C.

684 (1989).   Mr. Woody’s largest expenditure in 2004–-$21,515 for

workshops and training–-was an educational expense incurred to

prepare for a new career, i.e., real estate investor and renter,

rather than to maintain or improve skills in an ongoing business



     9
      If Mr. Woody argued for section 195 treatment for the
$1,463 portion of his 2004 expenses that was incurred after
October 22, then it might be necessary to resolve the precise
date on which he commenced his business (i.e., December 30, 1994,
versus a later date in 2005). However, as stated supra note 7,
Mr. Woody has made no claim for section 195 treatment.
     10
      The settlement expenses associated with the purchase of
the Randolph Street property were incurred on December 30, 2004.
However, as stated supra note 3, the settlement charges are not
deductible business expenses, but rather are capital
expenditures. See sec. 1.263(a)-2(a), Income Tax Regs.
                               - 14 -

or career.   It was therefore not deductible under section 162.

See sec. 1.162-5, Income Tax Regs.

                            Conclusion

     Although we found Mr. Woody’s testimony to be credible, it

established that he was not actively carrying on a trade or

business at the time that the expenses at issue were incurred.

Mr. Woody’s activities in 2004 were, at most, start-up

activities, because he had not yet commenced the activities for

which Value Property Investments was organized, i.e., buying,

selling, renting, or offering to rent property, or even

“flipping” or “wholesaling”.   Accordingly, we hold that the IRS’s

disallowance of Mr. Woody’s 2004 Schedule C deductions was

proper.

     To reflect the foregoing,


                                          Decision will be entered

                                     under Rule 155.
