The Tax Court found that the taxpayer was neither continuing operating a prior trade or business nor had begun the conduct of a new trade or business in the case of Estate of Morgan v. Commissioner, TC Memo 2021-104.[1]

Mr. Morgan was a real estate developer whose homebuilding business he had operated for 26 years ran into the real estate crash, going into receivership in 2009.  The Court described the receivership and Mr. Morgan’s actions following the transfer of the operations to the receiver as follows:

Appointed to manage all the affairs of the Morgan entities, LS Associates’ task was to identify, take possession of, and liquidate the Morgan entities’ assets. During the pendency of the receivership proceedings — which included tax years 2010 through 2012 — LS Associates was in sole control of the Morgan entities, under the supervision and subject to the approval of the Indiana superior court. It immediately exercised that exclusive control and did not relinquish it until the receivership concluded in 2013. Given the depressed market and the lenders’ unwillingness to fund the Morgan entities’ operations going forward, LS Associates did not consider using the receivership to retool and find a new buyer.

Mr. Morgan was prohibited from infringing on LS Associates’ authority or incurring expenses on behalf of the Morgan entities, and he never sought permission to incur any expenses. Following the appointment of the LS Associates, Mr. Morgan spent about six months relaxing and spending time with his family. But Mr. Morgan was a hard worker who was not interested in retirement or remaining idle. In September 2009 he wrote:

I am really focused on what my next career is. I[t] has been six months since I shut the Company down and it has been a great summer of rest and time with my family. Career 2 will almost certainly involve acquiring a company * * * or starting another company probably in the real estate building field but approaching it differently than I did in my first career.[2]

Mr. Morgan established a new entity, Legacy, LLC in December of 2008.  The Court described this entity and its operations as follows:

Mr. Morgan conducted a search for a trade or business through Legacy, a single-member limited liability company (LLC) he had formed in December 2008 and which was taxed as a disregarded entity for 2010 through 2012. He was looking for businesses that met certain financial and logistical parameters, and he did not confine his search to any one industry.

Legacy employed certain former CPMC employees, including Kristen Coyer as director of finance. Legacy employees kept timesheets, allocating time not just to Legacy’s business search but also to the Morgans personally and to Falcon. For 2011 and 2012 Mr. Morgan recorded 100% of his time spent working for Legacy as “business search/forward looking”.

In addition to hiring former CPMC employees, Legacy hired various outside consultants to assist in its search for new business opportunities. Generally, the consultants would contact Mr. Morgan with business opportunities; and if he was interested, he would enter into a nondisclosure agreement with the selling entity to discuss the specific opportunity further. Despite these efforts Mr. Morgan did not make an offer to purchase — nor did he acquire or otherwise form — a new business as a result of Legacy’s search before the end of 2012.[3]

Mr. Morgan became involved with a project undertaken by a former vice president of his old operations, as the Court noted:

Apart from Legacy, Mr. Morgan indirectly maintained contact with the homebuilding industry. In 2009 Mr. Pyatt, the former vice president of CPMC and a close friend and business partner of Mr. Morgan, became aware that a number of partially developed properties owned by the Morgan entities were available for [*7] purchase from the receiver. He approached Mr. Morgan about partnering to purchase and develop the properties. Mr. Morgan instead lent Pyatt Builders $180,000 so it could purchase the property from the receiver, using a single-member LLC he owned and used as a vehicle for lending money. Mr. Morgan did not hold an ownership interest in Pyatt Builders and was not involved in the daily activities of the business. The loan was repaid, timely and with interest, in July 2010. Mr. Morgan’s close relationship with Mr. Pyatt influenced his willingness to extend the loan.[4]

Mr. Morgan also continued to operate an entity he had formed in 1996 (Falcon, LLC):

Finally, throughout this time Mr. Morgan continued to fly aircraft owned by Falcon, an entity he had formed in 1996 to hold, operate, and maintain aircraft.

Before the receivership proceedings, Mr. Morgan used Falcon’s aircraft to further the Morgan entities’ real estate development business; he visited potential building sites, researched development strategies, and checked on current developments. CPMC had an aviation department that employed the pilots, mechanics, and recordkeepers that flew, serviced, and kept track of the books and records for the aircraft held by Falcon.

During the receivership proceedings Mr. Morgan continued to use Falcon’s aircraft in his search (through Legacy) for new business opportunities. Falcon did [*8] not lease its aircraft or provide services to any unrelated third parties at any time. Mr. Morgan had a passion for aviation and both before and during the receivership proceedings often would pilot the aircraft himself.

For 2010 and 2011 Falcon was taxed as a partnership, and its partners included Mr. Morgan and an S corporation. For 2012 Mr. Morgan was Falcon’s sole owner, resulting in the partnership’s termination and Falcon’s taxation as a disregarded entity. Falcon’s principal business activity was listed as “Consulting” on its 2010 and 2011 Forms 1065, U.S. Return of Partnership Income, and on petitioners’ 2012 Schedule C.[5]

Mr. Morgan claimed losses from all of these operations for the years before the Court, and net operating losses arising from prior years. 

But the IRS claimed that none of these operations constituted a trade or business for the years in question, and that all claimed expenses were either start-up expenditures under IRC §195 or non-deductible personal expenses under IRC §262.

IRC §195(c)(1) defines a “start-up” expenditure as follows:

The term “start-up expenditure” means any amount—

(A) paid or incurred in connection with—

(i) investigating the creation or acquisition of an active trade or business, or

(ii) creating an active trade or business, or

(iii) any activity engaged in for profit and for the production of income before the day on which the active trade or business begins, in anticipation of such activity becoming an active trade or business, and

(B) which, if paid or incurred in connection with the operation of an existing active trade or business (in the same field as the trade or business referred to in subparagraph (A)), would be allowable as a deduction for the taxable year in which paid or incurred.

If Mr. Morgan was merely continuing his existing business of homebuilding, then IRC §195 would not apply.  And Mr. Morgan argued this was exactly what he was doing:

Petitioners argue that Mr. Morgan need not begin a new trade or business because the last one — homebuilding — never ceased. They point to his continued engagement with the Morgan entities and his new activities, such as the loan to Mr. Pyatt.[6]

The Court rejected the view that this was a continuation of the old business, finding that business had been abandoned by Mr. Morgan when the receiver took control:

As for Mr. Morgan’s continued engagement with the Morgan entities, the on-the-ground cessation of homebuilding activity and the order appointing LS Associates as receiver indicate that his prior homebuilding trade or business ceased in 2009. All CPMC employees were terminated in February 2009, and CPMC did not build additional homes after that point. This practical shutdown is consistent with the Morgan entities’ financial situation and the Indiana superior court’s March 2009 order appointing LS Associates as receiver, which gave it broad and exclusive powers to manage and liquidate assets.

…

Mr. Morgan’s actions and words support our conclusion that he was no longer carrying on a homebuilding trade or business. From his perspective in September 2009, the receivership proceedings “shut the company down” and began a period of transition in his life. And his focus shifted to starting or acquiring a new trade or business. After decades, Mr. Morgan’s homebuilding business had ceased.

…

We therefore find that Mr. Morgan was no longer carrying on a homebuilding trade or business following the appointment of LS Associates as receiver for the Morgan entities. After that time Mr. Morgan was no longer regularly and actively undertaking homebuilding activity with the intent to earn a profit. Appointment of a receiver does not always spell the end of a taxpayer’s trade or business. But here it did. Petitioners recognize this reality, noting that CPMC “did cease its operations”. Their argument that “Mr. Morgan did not likewise cease or abandon his interest in continuing to stay in business, but rather uninterruptedly attempted to continue in business” is unavailing given our finding that petitioners did not commence another homebuilding trade or business before the end of 2012. We therefore reject petitioners’ first theory for an active trade or business to which to attribute Falcon’s aircraft maintenance expenses and Legacy’s business search expenses.[7]

Similarly, the taxpayer’s single loan to Mr. Pyatt was not a continuation of his prior business, nor an establishment of a new lending trade or business:

And as for petitioners’ argument that Mr. Morgan’s lending activity was a continuation of his homebuilding business, his $180,000 loan to Mr. Pyatt in 2009 did not demonstrate regular and continuous activity in a homebuilding trade or business but rather a one-time loan to a friend so the friend could pursue a development opportunity and then repay the loan with interest. If anything, the loan would be part of a lending trade or business, but isolated and irregular loans to trusted individuals do not support that conclusion either. See Imel v. Commissioner, 61 T.C. 318, 323 (1973) (holding that a taxpayer’s eight or nine loans over a four-year period was not a lending trade or business); Heinbockel v. Commissioner, T.C. Memo. 2013-125, at *31-*32 (holding that a taxpayer’s occasional loans to her brother was not a lending trade or business).[8]

The taxpayer argued that even if he had not continued his old business, his search for a new trade or business was itself a trade or business:

We next consider Mr. Morgan’s activities related to Legacy and Falcon. Petitioners argue that Mr. Morgan’s search for a new trade or business to acquire was itself an active trade or business in 2012. They point to the formation and use of Legacy, noting that it hired employees and engaged outside consultants. And they point to the support that Falcon provided Legacy in conducting that search, noting that it facilitated Legacy’s business search as it once facilitated the Morgan entities’ homebuilding — that “Falcon * * * [did] for Legacy what Falcon once did for CPMC.” Respondent characterizes petitioners’ argument as one that Mr. Morgan was “simply in the business of being in business” in an attempt to avoid section 195 by using Legacy and Falcon as “vehicle[s] to deduct all business investigation expenses.”[9]

But the Tax Court finds that looking for a trade or business does not itself constitute a trade or business:

Beginning with Legacy, we conclude that its general business search does not meet the “carrying on any trade or business” requirement of section 162. The “business investigation expenses” that petitioners claimed and attributed to Legacy for the 2012 taxable year fit the definition of start-up expenditures in section 195©(1)(A)(i) as “amount[s] * * * paid or incurred in connection with * * * investigating the creation or acquisition of an active trade or business”. Legacy paid employees and outside consultants to research a variety of industries and Mr. Morgan listed his time on his Legacy timesheets as 100% “business investigation/looking forward”, both of which indicate that Legacy’s activities were carried out in anticipation of beginning a trade or business. And because Mr. Morgan did not acquire a new business by the end of 2012, no business is deemed to have begun in that year under section 195(c)(2)(B).

…

In sum, Mr. Morgan was not carrying on a trade or business through his search for a new trade or business to acquire. We agree with respondent that petitioners cannot squeeze into section 162 and avoid section 195 by claiming that Mr. Morgan's trade or business was searching for a trade or business.[10]

Nor did Falcon have any reason for being at this point other than to support the “non-business” of looking for a trade or business:

Nor can they squeeze into section 162 by arguing Falcon was in the consulting business during the year in issue; its activities by themselves did not constitute an active trade or business independent of the Morgan entities. Before 2009 Falcon aircraft were used by Mr. Morgan to further the Morgan entities' real estate development business. He would fly to various locations to view potential building sites, research development strategies, and check on current developments. Falcon serviced a broader homebuilding trade or business.

Petitioners attached Schedule C for Falcon to their 2012 Form 1040 and listed its principal business as “consulting”, but they never established that the term encompasses anything other than transporting them and related individuals; Falcon did not lease its aircraft or provide services to any unrelated third parties at any time, and its only gross receipts came from petitioners and Legacy.[11]

The Court thus found that Mr. Morgan had no current operating business. Nothing he was doing had yet begun operations to allow for a current deduction of expenses under IRC §162, nor beginning to amortize start-up costs capitalized under IRC §195.

[1] Estate of Morgan v. Commissioner, TC Memo 2021-104, August 23, 2021, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/insolvent-developer-was-not-carrying-on-a-trade-or-business/77792 (retrieved August 24, 2021)

[2] Estate of Morgan v. Commissioner, TC Memo 2021-104, August 23, 2021

[3] Estate of Morgan v. Commissioner, TC Memo 2021-104, August 23, 2021

[4] Estate of Morgan v. Commissioner, TC Memo 2021-104, August 23, 2021

[5] Estate of Morgan v. Commissioner, TC Memo 2021-104, August 23, 2021

[6] Estate of Morgan v. Commissioner, TC Memo 2021-104, August 23, 2021

[7] Estate of Morgan v. Commissioner, TC Memo 2021-104, August 23, 2021

[8] Estate of Morgan v. Commissioner, TC Memo 2021-104, August 23, 2021

[9] Estate of Morgan v. Commissioner, TC Memo 2021-104, August 23, 2021

[10] Estate of Morgan v. Commissioner, TC Memo 2021-104, August 23, 2021

[11] Estate of Morgan v. Commissioner, TC Memo 2021-104, August 23, 2021