In a recent Tax Court decision, the Court again approached the critical issues surrounding loss deductions and tax compliance.[1] This case involves Heather and Stewart Weston, a married couple from California, who claimed a $2.1 million loss deduction on their 2017 tax return tied to failed business ventures in Indiana. The Internal Revenue Service (“IRS”) disallowed the deductions and imposed penalties for late filing, late payment, and failure to make estimated tax payments. Ultimately, the Tax Court upheld the IRS’ position, offering the usual lessons for taxpayers and practitioners alike.
Background: Investments Gone Awry
Stewart Weston (“Stewart”), a commercial real estate agent based in California, ventured into two business endeavors in Kokomo, Indiana, with a gentleman by the name of Jeffrey Broughton (“Broughton”), a purported professional in the home renovation and demolition/excavation businesses. Through Stewart’s personal entity, ADR Homes, LLC, a single-member California limited liability company that was treated as a disregarded entity for tax purposes, Stewart provided substantial funding—over $2.1 million by the end of 2017—expecting returns from renovated property sales and demolition contracts.
The home renovation business undertaken by Stewart and Broughton aimed to acquire distressed properties at tax auctions, renovate them, and sell them at a profit. Stewart and Broughton orally agreed that Stewart would recover his investment plus an 8% preferred return, with remaining profits split evenly. The demolition/excavation business, operated through Freedom First Excavating and Demo, LLC to bid on municipal contracts to demolish structures and remediate land.[2]
However, these ventures did not pan out. By late 2017, Stewart’s investments via ADR Homes, LLC had not received meaningful returns, and concerns mounted about Broughton’s management—properties remained unrenovated, and funds seemed misdirected.[3] Despite these red flags, Stewart continued funding into 2018, even purchasing properties from Broughton for over $700,000. On their 2017 joint tax return, filed late in 2020, the Westons claimed a $2.1 million loss deduction, which the IRS disallowed after issuing notices of deficiency based on substitutes for returns (“SFRs”).[4] The Westons petitioned the Tax Court, arguing the loss was deductible under three theories: a business expense, a trade or business loss, or a theft loss.
The Court’s Analysis: Three Theories, Three Rejections
The Tax Court systematically rejected each of the Westons’ arguments as follows:
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Business Expense Deduction under Section 162(a)
The Westons contended that the $2.1 million in payments were ordinary and necessary business expenses deductible under Internal Revenue Code (IRC) Section 162(a), which allows deductions for expenses incurred in carrying on a trade or business. Specifically, Section 162(a) provides that “There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business […].” The Court found that Stewart Weston was not actively engaged in the Indiana businesses, a prerequisite for Section 162(a). Stewart described himself as an investor, not a partner in day-to-day operations, stating, “I’m not [Broughton’s] partner; I am an investor…. It was all investor-based.” He rarely visited Indiana and relied on Broughton to manage operations. Additionally, the Westons failed to maintain proper books and records—submitting what the Court called a “shoebox full of papers,” including invoices and a spreadsheet, which didn’t substantiate business expenses. Citing Whipple v. Comm’r, 373 U.S. 193 (1963), the Court emphasized that managing investments, no matter how extensive, does not constitute a trade or business under Section 162(a). Thus, Stewart’s payments were investments, not deductible expenses.
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Trade or Business Loss under Section 165(c)(1)
Alternatively, the Westons claimed the payments resulted in a trade or business loss under Section 165(c)(1), which permits deductions for losses incurred in a trade or business. The Court, reflecting upon its Section 162 analysis, above, reiterated Stewart’s lack of active involvement, undermining the trade or business classification.[5] Beyond that, the nature of the payments precluded an immediate deduction:
- Home Renovation Business: Payments were for acquiring and improving real estate—capital expenditures under Section 263A, which must be capitalized and recovered upon sale, not deducted in 2017. No properties were sold that year, and later sales (12 properties in 2018) showed the investments retained value, contradicting claims of worthlessness.
- Demolition/Excavation Business: Some payments were made in 2016, not 2017, and others funded capital assets like an excavator, which are not immediately deductible, absent a Section 179 election (not claimed here). Without evidence of 2017 gross receipts or expenses, the Court could not estimate an operating loss.
Thus, no deductible trade or business loss under Section 165(c)(1) was sustained in 2017.
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Theft Loss under Section 165(c)(3)[6]
The Westons also asserted that Broughton stole the funds, entitling them to a theft loss deduction under IRC Section 165(c)(3), which covers losses from theft discovered in the taxable year with no reasonable prospect of recovery. The Court applied Indiana law, where theft requires intent to deprive another of property’s value or use (Ind. Code § 35-43-4-2(a)). Evidence was circumstantial—unrenovated properties, mis-titled deeds, and a cashed check—but insufficient to prove theft. The following key facts undermined their claim:
- Stewart continued funding through December 2017 and into 2018, even acquiring properties in January 2018, suggesting he had not yet abandoned hope of recovery.
- Stewart never pursued criminal charges against Broughton, a factor courts consider in theft loss cases.
- The Court found the situation “much more consistent with incompetence or mismanagement on Mr. Broughton’s part—and poor investment decisions on Mr. Weston’s part—than with theft.”
Even if theft occurred, Stewart did not discover it in 2017, and his ongoing investments indicated a reasonable prospect of recovery, barring a 2017 deduction per Treas. Reg. § 1.165-1(d)(3).
The Court concluded the $2.1 million should be treated as capital investments, potentially recoverable upon future sales, and not as a 2017 loss.
Penalties
The IRS imposed additions to tax under Sections 6651(a)(1) (late filing), 6651(a)(2) (late payment), and 6654 (failure to pay estimated tax). The Westons contested these, but the Court upheld them:
- Late Filing: The Westons missed their extended October 15, 2018, deadline, filing in 2020. They argued Broughton’s failure to provide information excused them, but the Court held taxpayers must file with available data and amend later if needed. No reasonable cause was shown.
- Late Payment: Claiming financial hardship, the Westons offered no evidence that timely payment would cause undue hardship (e.g., forced sale of assets at a loss). The SFRs established the tax due, and the Westons’ failure persisted.
- Estimated Tax: With a 2017 tax liability and no 2016 return filed by April 2017, the Westons had a required annual payment they did not meet. Section 6654 offers no general reasonable cause exception, and their investment losses were not “unusual circumstances” like a casualty or disaster.
Key Takeaways for Taxpayers and Practitioners
This case offers critical lessons:
- Active Engagement Matters: Deductions under Sections 162 or 165 require active participation in a trade or business, not passive investment. Stewart’s hands-off approach did not support his claims.
- Capital vs. Deductible Costs: Expenditures for capital assets—like real estate or equipment—typically are not immediately deductible. Taxpayers must track these costs and recover them appropriately.[7]
- Theft Loss Hurdles: Proving theft demands clear evidence under state law, discovery in the claimed year, and no prospects of recovery. Continued investment or inaction against the alleged thief can undermine this deduction.
- Compliance is Non-Negotiable: Timely filing and payment are essential, even with incomplete information. The IRS and courts rarely excuse delays without extraordinary justification.
- Burden of Proof: Taxpayers must substantiate deductions and defenses against penalties. The Westons’ lack of records and evidence were extremely detrimental to their case.
Conclusion: Proceed with Caution
This case underscores the pitfalls of aggressive tax positions without proper documentation or compliance. For taxpayers venturing into business investments, maintaining meticulous records and understanding tax treatment—capital versus deductible and substantiating the appropriate tax year for which a deduction applies—is crucial. For practitioners, Weston reinforces the need to counsel clients on substantiation and timely obligations.
[1] Weston v. Comm’r, T.C. Memo. 2025-16.
[2] The Opinion notes the actual profit split for the demolition and excavation venture was not known as the record did not reflect the details of the profit split. See Footnote 2 of the Opinion.
[3] The Opinion also notes that an employee of Stewart drove by two properties in February 2017 which had no renovation progress.
[4] Pursuant to Section 6020(b), SFRs were issued on September 26, 2019, following an examination of the Westons’ 2017 tax year. Section 6020 allows the IRS to prepare a substitute return for taxpayers who fail to file a tax return.
[5] Section 165(c) provides a strict limitation on the ability to deduct such losses, providing specifically that “In the case of an individual, the deduction under subsection (a) shall be limited to – (1) losses incurred in a trade or business […].”
[6] See also Parker Durham, Taxpayer Loses Theft Loss Deduction Case, https://esapllc.com/theft-loss-shaut-case-2024/ (last visited Mar. 4, 2025).
[7] Certain exceptions exist under Sections 168 and 179.
