Hardy v. Comm'r of Internal Revenue

• Decision Date: 13 December 1989
• Docket Number: Docket No. 7856-86.
• Parties: ARTHUR H. HARDY AND JEANNINE C. HARDY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

93 T.C. 684

93 T.C. No. 56

ARTHUR H. HARDY AND JEANNINE C. HARDY, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 7856-86.

United States Tax Court

Filed December 13, 1989.

Taxpayer paid loan fees associated with a purported $20 million loan. Taxpayer intended to use the loan proceeds to purchase large hotel properties. HELD: The taxpayer's effort to become an owner of hotels constituted the start-up of a new business or a new income-producing activity. HELD FURTHER: The loan fees are start-up or pre-opening expenses that are not deductible under either sec. 162 or sec. 212, I.R.C. 1954. Our opinions in Johnsen v. Commissioner, 83 T.C. 103 (1984), revd. 794 F.2d 1157 (6th Cir. 1986), and Hoopengarner v. Commissioner, 80 T.C. 538 (1983), affd. by unpublished opinion 745 F.2d 66 (9th Cir. 1984), are overruled. Arthur H. Hardy, pro se.

Ronald J. Gardner, for the respondent.

SWIFT, JUDGE:

In a statutory notice of deficiency dated January 2, 1986, respondent determined a deficiency in petitioners' 1982 income tax liability of $3,227. After concessions, the issue remaining for decision is whether petitioners are entitled to a deduction under sections 162 or 212 ¹ for loan fees of $8,750.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. Petitioners, Arthur H. and Jeannine C. Hardy, are husband and wife. During the tax year in issue and at the time of filing of the petition, petitioners resided in Sandy, Utah. Jeannine C. Hardy is a petitioner in this action solely because she and her husband timely filed a joint Federal income tax return for 1982. All references to ‘petitioner‘ are to Arthur H. Hardy.

During 1982, petitioner was a full-time employee of the Utah Department of Education. During evenings and weekends, petitioner also managed approximately 45 rental homes owned by Dalton Realty of Palo Alto, California, that were located in the Salt Lake City metropolitan area. With the exception of one three-bedroom home that petitioner rented out, petitioner did not own any investment or business realty.

In early 1982, petitioner contacted Mr. Charles Tisdale (‘Tisdale‘), who held himself out as a loan broker. Tisdale purportedly represented a lender by the name of Bancor, Inc. (‘Bancor‘), a California company. Petitioner sought Tisdale's services in order to obtain a multi-million dollar loan the proceeds of which he intended to use to purchase, on his own behalf, hotel, motel, and resort properties.

According to petitioner, Tisdale represented that Bancor would make a loan of $200 million to a group of borrowers, including petitioner, if the borrowers met certain credit requirements. The borrowers would have to have substantial personal net worth. They would have to provide as collateral security interests in real estate, and they would have to pay up-front loan fees.

Petitioners, whose joint Federal income tax return for 1982 reflected total income in the amount of $34,533, did not have substantial personal net worth. Petitioner, therefore, contacted an acquaintance by the name of Antone Pryor (‘Pryor‘), who apparently had a substantial net worth. Pryor agreed to enter into the loan transaction with Bancor in his own name but to divide the loan proceeds equally with petitioner. Also, as part of petitioner's agreement with Pryor, petitioner was to pay the entire up-front loan fees with respect to the loan proceeds he and Pryor would receive.

Pryor was not obligated to repay petitioner any of the loan fees unless the loan proceeds were actually received. The agreement between petitioner and Pryor was entirely oral; no aspect of the agreement was reduced to writing.

Petitioner and Pryor allegedly comprised one of five groups that were to receive portions of the proceeds of the $200 million loan. Their portion of the loan was to be one-fifth, or $40 million, to be divided equally between them, petitioner to receive $20 million.

The loan fee due Bancor with respect to the loan proceeds petitioner and Pryor were to receive was $5,500. Petitioner obtained a second mortgage loan on the home he owned, and in May of 1982 petitioner used a portion of the second mortgage loan proceeds to pay the $5,500 loan fee. Petitioner and Pryor also were required to pay a $500 ‘local loan fee‘ associated with the $40 million loan. Apparently, petitioner and Pryor each paid one-half or $250 of this fee.

Petitioner was informed by Tisdale that certain individuals in the other groups who were to participate in the $200 million loan were not willing to pay their share of the loan fees and that petitioner would have to pay an additional $3,000 in loan fees in order to prevent the entire $200 million loan from falling through. By cashier's check dated May 6, 1982, petitioner paid an additional $3,000 to Bancor for this purpose.

Following payment by petitioner of the $8,750 in loan fees, petitioner kept in touch with Tisdale on a regular basis to monitor the progress of the loan application. He also placed several phone calls to Bancor in California. Sometime during the summer of 1982, petitioner was told by Tisdale that the loan had been approved but that Bancor was continuing to process the loan and to complete the necessary paperwork. No loan application or any other document relating to the loan is contained in the record.

In the summer of 1982, petitioner began investigating commercial properties that were for sale in anticipation of receiving his $20 million share of the loan proceeds. The properties were large, established hotel, motel, or resort properties, including the Homestead in Heber, Utah, the Roadway Inn in Provo, Utah, and the Lotus Inn in Las Vegas, Nevada.

In July or August of 1982, petitioner learned that Tisdale was serving time in an Idaho state prison. Earlier in 1982 when the loan was being negotiated, Tisdale apparently had been released from prison on bail, pending appeal of a conviction for an unspecified crime. The loan proceeds were not received by petitioner in 1982, 1983, nor in any subsequent year.

On audit, respondent denied the $8,750 ordinary deduction petitioners claimed on Schedule C of their 1982 joint Federal income tax return with respect to the loan fees.

OPINION

Section 162(a) allows a deduction for ordinary and necessary expenses of carrying on a trade or business. ² In order for expenses to be deductible under section 162, the expenses must relate to a trade or business functioning at the time the expenses are incurred. Start-up or pre-opening expenses are not currently deductible under section 162. Richmond Television Corp. v. United States, 345 F.2d 901, 907 (4th Cir. 1965), vacated and remanded on other issues 362 U.S. 68 (1965), original holding on this issue reaffd. 354 F.2d 410, 411 (4th Cir. 1965), overruled on other grounds NCNB Corp. v. United States, 684 F.2d 285, 289 (4th Cir. 1982); Goodwin v. Commissioner, 75 T.C. 424, 433 (1980), affd. without published opinion 691 F.2d 490 (3d Cir. 1982); Polachek v. Commissioner, 22 T.C. 858, 863 (1954). This has been referred to as the ‘pre-opening expense doctrine.‘ See Sorrell v. Commissioner, 882 F.2d 484, 490 (11th Cir. 1989), revg. T.C. Memo. 1987-351, and cases cited.

As indicated, petitioner's part-time work managing 45 rental homes did not include equity ownership of any real property, except for one of the homes. Petitioner did not own or manage any hotels, motels, or resorts. We conclude that petitioner's intent to use anticipated loan proceeds to purchase and thereafter to own and manage large commercial hotel and motel properties was unrelated to petitioner's current business and income-producing activities and constituted the attempted start-up by petitioner of a new trade or business. The loan fees in question were incurred during the pre- opening phase of petitioner's attempted new business and accordingly are not deductible under section 162.

We turn now to the question of whether the loan fees are deductible under section 212. Section 212 allows individual taxpayers current deductions for all ordinary and necessary expenses paid for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income. ³ The pre-opening expense doctrine has been held by the Tax Court in two published opinions to be inapplicable to the deductibility of expenses claimed by individuals under section 212. See Johnsen v. Commissioner, 83 T.C. 103, 119 (1984), revd. 794 F.2d 1157 (6th Cir. 1986); Hoopengarner v. Commissioner, 80 T.C. 538, 543 (1983), affd. by unpublished opinion 745 F.2d 66 (9th Cir. 1984). ⁴

These Tax Court opinions are based primarily on the fact that the language of section 212 does not include the ‘carrying on a trade or business‘ language of section 162. Under these opinions, individual taxpayers are allowed to deduct, under section 212, expenses relating to the start-up of a trade or business or of an income-producing activity even though the expenses are incurred before the new business or the new income-producing activity is functioning.

On appeal, Hoopengarner v. Commissioner, supra, was affirmed in an unpublished opinion of the Ninth Circuit. 745 F.2d 66 (9th Cir. 1984). ⁵ Each of the Tax Court's other published and Memorandum Opinions on this issue, however, that has followed the Hoopengarner authority has been reversed. Sorrell v. Commissioner, T.C. Memo. 1987-351, revd. 882 F.2d 484 (11th Cir. 1989); Lewis v. Commissioner, T.C. Memo. 1986-155, revd. 861 F.2d 1232 (10th Cir. 1988); Fishman v. Commissioner, T.C. Memo. 1986-127, revd. 837 F.2d 309 (7th Cir. 1988), cert. denied 487 U.S. ___, 108 S.Ct. 2902 (1988); Johnsen v. Commissioner, 83 T.C. 103 (1984), revd. 794 F.2d 1157 (6th Cir. 1986). Also, although the appeal did not involve a decision of this Court, in Aboussie v. United States, 779 F.2d 424 (8th Cir. 1985), affg. on this issue 600 F. Supp. 32 (E.D. Mo. 1984), the Eighth Circuit...