Expert: Richard Stolp - 9/2/2009

Question
QUESTION: Hello Mr. Stolp,

I've been audited. I'm a fairly new entrepreneur; in 2005 while earning a BSEB degree I started a business. Moore Property Investments LLC was started to restore, manage and/or sale homes. The long short of it is that my demographic for the properties I invested in were highly risky. I sold one home and broke a little under even after paying off the credit debt incurred to restore the home.

I purchased the home late 2005 and sold it in March of 2006. My wife and I had a 3rd car which was used entirely for the business.  I researched and drove to properties searching for the right one 6 days a week.  I did this while having a full time job, family, children, and taking college courses.

The IRS wanted me to explain our car deductions on the schedule C. Since I had receipts with the mileage for that year and journals documenting every mile I put on the car for 2006 it wasn't hard for me to send them what they requested.

The response I received was: "...although your business was for profit you didn't raise to the level of a trade". Now we owe them money because I can't prove that I was dedicated and "worked" our business 5-6 days a week.

The difference we owe is over 6k which will more than likely result in a 3k bill from the state.

We just received the letter this Friday and I want to get as much advice on this as possible.

Thank you,
WCM


ANSWER: WCM,

I would call the number on your notice and ask what your options are.  I would also search the IRS website: www.irs.gov to be sure you understand the IRS position before you call.  Since a lot of people have a second job and expenses tied to it, you should make another attempt to prove your case.  

You didn't go into a lot of detail, but you may need to break down how the mileage looked on a day to day basis to show that you could really spend that much time in the car looking at properties versus spending time at the property you already owned - fixing it up for sale.  You have the right to fully understand the IRS position and the IRS has the obligation to make clear the part or parts they don't understand or can't go along with.

---------- FOLLOW-UP ----------

QUESTION: Thanks,

Yes, I sent the IRS my mileage journal. I drove 50-100 miles a day and evaluating properties, speaking to Realtors, property owners, lenders and I purchased training materials, paint sprayers, mops, cleaners, flooring tools, just about everything you would need to restore a livable home. The IRS has basically said that because I only sold one property, I didn't pursue the business on a regular basis. Not true.

I understand the IRS's position and I disagree with it.

I've called the number and left a message and I will continue to call until I reach the examiner.

Thanks,
WCM

ANSWER: Is it just the mileage the IRS doesn't like?  If you put, say on average, 75 miles a day on your vehicle - that's probably at least 3 hours a day.  So if you get home at 5:30 from your regular job you were driving for another 3 hours?  To me/My opinion - that doesn't sound credible - not on an "average day" basis. Did you ever live in the first house?  Do you have a second property now?  If you have a second or third property now - do you live in either of them?  I suggest you write the IRS a long letter and describe in detail, perhaps describe a typical day, and see if you can better justify your business. Unless you have a better rationale I don't believe you'll be able to write off the windshield time.  Best time to call the IRS is first thing in the morning - so call at 8 AM local time where ever they are reviewing your case.  If it's Fresno, you're lucky, otherwise you'll need to get up early that day.

---------- FOLLOW-UP ----------

QUESTION: I took equity out in my own property to start Moore Property Investment LLC. I did not live in the property it was purchased as an investment and the loan was tailored at that rate as well. I owned the home I live in now when I purchased the investment property so at that time I held a mortgage on two homes. I had to pay the mortgage for 4 months before the property sold and that is what drove my determination.

Yes; the mileage is what they initially questioned, that was it. Along with the initial request, they also sent a form for me to fill out explaining what type of business "Moore Property Investment LLC" was. This is where I should have been more descriptive to them but I was short. On the other, hand the form was small so I described the business as "buying, restoring and selling homes".

...Nah, this wasn't "windshield time", I was out of the car in crawl spaces, attics and looking at gutters and roofs up close so I could better tally up what it would cost me to fix the properties up to the standards of similar ones that sold in the area.

I worked my full-time job 6:30-3:30pm Mon-Fri off weekends. I definitely drove more on the weekends than I did during the week. During the week I put at least 50 miles a day on my business car starting from my home(office) to the property. Excuse my ignorance but I'm counting 25 miles each way (not sure if that makes all the difference).  But none the less, I did this and it was hard and didn't pay off financially the way I would have hoped but I learned a great deal from it.  

But man oh man, for me to have gotten a business license, an investment loan, buy a home, training materials, research, supplies, fix it up, sell it, look for others to do the same, etc etc.  ...and to be told "you weren't a real business, you were just trying to make a quick buck; is... well you know.

Answer
Sorry for the tough times.  I would still take a few deep breaths and send a letter to the IRS.  The IRS lives on paperwork, so include as much as you can, like copies of your loan - if it shows a business rate. I would include a map that shows your commute.  Explain everything, including your work hours and how you fit everything into your day.  Did you register your company and get a tax ID?  If you have continued the business that would help your case.  Best of luck.  If you do wind up owing be sure to ask what your options are - most people use installments to pay everything off - you can take up to five years.