Gary owns a condominium in Pennant Village. After attending homeowner association meetings, he became convinced the association was being mismanaged and large profits were retained by the association rather than being used to repair deteriorating condo balconies.
“In his view, members of the board refused to allow him to formally address the board, refused to allow him to vote at meetings, alleged that he did not actually purchase his property, called him a liar, harassed him in other ways, belittled him, derided him, and threatened him,” the judge later reported.
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Gary filed a lawsuit against the condo homeowner’s association. He alleged the association funds were being mismanaged and he sought return of his share of the allegedly more than $500,000 in misappropriated funds.
On his income tax returns, Gary deducted his costs of the lawsuit against the condo homeowner’s association, even though his lawsuit failed.
The IRS audited Gary’s income tax return and disallowed his costs for suing the homeowner’s association. The IRS auditor said the lawsuit costs were personal, non-deductible expenses.
But Gary argued such costs are tax deductible under Internal Revenue Code 212 for the production of income because his lawsuit might have produced more than $500,000 for the condo owners.
If you were the tax court judge would you allow Gary to deduct his costs of suing the condo homeowner’s association?
The judge said no!
The purpose of Internal Revenue Code 212, the judge began, is to allow taxpayers to deduct “ordinary and necessary business expenses.”
Although Gary argues the purpose of his lawsuit against the condo homeowner’s association was to obtain his share of the $500,000 in alleged misappropriated funds, the judge continued, even if he had been successful there is little probability of returning those funds to the individual condo owners.
Because the lawsuit involved Gary’s personal residence, his legal fees for suing the homeowner’s association were personal, non-business expenses, the judge ruled. Therefore, his costs do not qualify as IRC 212 deductible business expenses and Gary must pay additional income tax, the judge concluded.
Based on the 2004 U.S. Tax Court decision in Gary Lee Colvin v. Commissioner, T.C. Memo 2004-67.
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