Tax Court Disallows Deductions for Failed Home Renovation Business

(Parker Tax Publishing February 2025)

The Tax Court held that a taxpayer was not entitled to deduct payments he made to fund home renovation and demolition/excavation businesses because he was an investor rather than an active participant in the businesses. The court also found that the taxpayer could not deduct any of the payments to the businesses as theft losses after his associate stopped performing work on the properties because he failed to prove that a theft occurred. Weston v. Comm'r, T.C. Memo. 2025-16.

Background

Stewart Weston is a commercial real estate agent in California. In 2011 or 2012 his barber introduced him to Jeffrey Broughton. At the time, Broughton was a construction and renovation manager for a nationwide firm that bought properties in bulk, renovated them, and resold them. In 2014 Weston (in his individual capacity) agreed with Broughton to fund the nationwide firm's acquisition of seven single-family homes in the Midwest, and Weston received a return on his investment within three or four months. Weston made the investment through his single-member limited liability company, ADR Homes, LLC (ADR Homes).

Soon after, Broughton approached Weston about investing in single-family homes in Kokomo, Indiana. This investment would be made between Broughton and (via ADR Homes) Weston - that is, separate from the nationwide firm for which Broughton had been working. Weston traveled from his home in California to Kokomo to meet with Broughton, other investors, and the Kokomo mayor, who promised municipal support for Broughton's vision of revitalizing the city through property renovations.

Weston agreed to give Broughton about $75,000 to acquire 30 homes in Kokomo that were available for purchase at auction because their owners were delinquent on their property taxes (Tax Deed Properties). In 2016, Broughton purchased the 30 Tax Deed Properties on his and Weston's behalf. Broughton effected the transfers of the Tax Deed Properties titles to "ADR Properties, LLC." Weston was not aware that the deeds listed ADR Properties, LLC rather than ADR Homes, LLC. Also in 2016, Weston began supplying funds for a demolition/excavation business run by Broughton through Freedom First Excavating and Demo, LLC (Freedom First). Weston and Broughton orally agreed to split profits from both the home renovation and the demolition/excavation businesses.

Once the title transfers for the Tax Deed Properties had been completed, Broughton or his assistant, Shelley Jackson, would call Weston or his operations manager, Laneshia Stamm, to request funds for ongoing renovations, for demolition and excavation expenses, and for purchasing more homes or other real estate. In February 2017, Stamm visited Kokomo and drove past two of the Tax Deed Properties, noticing that no renovation progress was apparent. Weston nonetheless remained confident in Broughton for a time because of his earlier successful investment and Broughton's perceived good reputation through his relationship with the Kokomo mayor. However, Weston's confidence in Broughton waned towards the end of 2017, when Weston stopped investing in new home renovation projects with Broughton. Weston was concerned about his mounting investments and lack of any returns. Nonetheless, Weston continued to fund the demolition/excavation business, regularly wiring funds to Broughton through the end of 2017 and well into 2018.

At some point after 2017, Stamm edited a spreadsheet that listed amounts paid by Weston in 2016 and 2017 in connection with the home renovation and demolition/excavation businesses. The payments for both businesses listed in the edited spreadsheet (i.e., the "Indiana payments") totaled $2,110,412. In 2018, Weston discovered that the deeds for the Tax Deed Properties listed an incorrect entity as owner. Weston arranged to have the properties transferred to ADR Homes. He then began liquidating all properties that ADR Homes owned in Kokomo, some of which were sold in 2018 and 2019. In 2018, Weston learned that Freedom First had left an incomplete job in Medaryville, Indiana, and failed to respond to phone calls. Weston and his wife, Heather, flew to Indiana to track down Broughton but could not find him. The Westons contacted an attorney in 2019, who recommended speaking with criminal authorities, although the Westons never did so.

The Westons failed to file a 2017 tax return by the deadline. The IRS audited them and executed substitutes for returns (SFRs) showing tax due of $210,500 for Stewart and $169,362 for Heather. Notices of deficiency were mailed to the Westons based on the SFRs. The Westons took their case to the Tax Court, arguing that they were entitled to a deduction of $2,110,412, i.e., the sum of the Indian payments. They listed the following as their primary, secondary, and tertiary positions regarding the claimed deduction: First, the Indiana payments were trade or business expenses under Code Sec. 162(a); second, the Indiana payments gave rise to a trade or business loss under Code Sec. 165(c)(1); and third, the Indiana payments gave rise to a personal theft loss under Code Sec. 165(c)(3).

Analysis

The Tax Court held that the Westons were not entitled to deduct any of the Indiana payments as losses and instead were required to treat them as capitalized into his investments in the home renovation business or the demolition/excavation business.

The court found that Weston did not regularly and actively engage in either the renovation or the demolition/excavation business activities; rather, he was an investor in the businesses. The court noted that Weston was engaged full time with his California real estate brokerage business and rarely visited Kokomo (where the home renovation activity was based) or the Indiana sites where the demolition/excavation activity was occurring. The court also noted Weston's own testimony that he was not Broughton's partner and was not "in the day-to-day operations" of the businesses.

The court also found that the Westons were not entitled to deduct the Indiana payments as business losses. Under Code Sec. 263A(a), taxpayers are required to include in inventory costs both the direct and indirect costs of real or personal property acquired for resale. The court found that all of the payments directed to the renovation business were includible in inventory costs and therefore recoverable for tax purposes only when the properties were sold. The Westons asserted that the Tax Deed properties were worthless in 2017, but the court found that assertion belied by the fact that the Westons collected proceeds on their sales in later years.

As to the demolition/excavation business, the court noted that it was not subject to the rules of Code Sec. 263A since Freedom First did not own the property that it improved. However, the court said that even if that business had an operating loss in 2017, the Westons failed to prove any particular loss amount. There were no grounds, in the court's view, to estimate the demolition/excavation business's gross receipts or the amounts of the Indiana payments that were spent for capital assets or other nondeductible purposes. The court could not even determine how many jobs the business began or complete in 2017, let alone its contract prices.

Determining whether a theft loss has occurred for tax purposes depends on the law of the jurisdiction where the taxpayer's alleged loss occurred. Under Indiana law, a theft occurs when a person "knowingly or intentionally exerts unauthorized control over property of another person, with intent to deprive the other person of any part of its value of use." The court found that some facts supported the Westons' contention that Broughton committed a theft of at least some of the Indiana payments in 2017. First, Weston received no or minimal cash distributions from Broughton in connection with either the home renovation business or the demolition/excavation business. Second, Broughton titled the Tax Deed Properties in the name of "ADR Properties, LLC" rather than "ADR Homes, LLC." Third, in February 2017 Stamm saw in person two of the Tax Deed Properties for whose renovation Weston had sent money, yet she did not see any signs of renovation. Fourth, there was evidence that Broughton cashed a check for Freedom First and kept the proceeds for himself.

But in the court's view, these facts were merely circumstantial evidence of theft. The court found that the record were more consistent with incompetence or mismanagement on Broughton's part - and poor investment decisions by Weston - than with theft. The facts did not support, in the court's view, the Westons' contention that Broughton knowingly or intentionally exerted unauthorized control over Weston's property, with intent to deprive him of any part of its value or use. Rather, the court noted that Weston voluntarily funded both the home renovation business and the demolition/excavation business at least through the end of 2017, and in some respects well into 2018. The court further found that, assuming Broughton stole some portion of the Indiana payments in 2017, the Westons failed to show that they had no reasonable prospect of recovery as of yearend 2017.

For a discussion of the rules for determining if an activity is a trade or business, see Parker Tax ¶90,105. For a discussion of losses incurred in a trade or business, see Parker Tax ¶84,310. For a discussion of the deduction for theft losses, see Parker Tax ¶84,340.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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