Taxpayers' Software Development and Construction Activities Were Engaged in For Profit

(Parker Tax Publishing March 2026)

The Tax Court held that a married couple's software development activities were engaged in for profit and therefore, Code Sec. 183 did not limit their business expense deductions for that activity. The court also found that the couple had a profit motive with respect to a portion of their home construction activities that involved building homes and an office for their software company; however, the court also found that the taxpayers' construction of a single-family home for their personal use was not engaged in for profit and disallowed their expenses with respect to that activity. Sullivan v. Comm'r, T.C. Memo. 2026-13.

Background

James Sullivan has decades of experience in telecommunications engineering. In 2003, he began developing equity trading software through Traders Abacus, a single-member limited liability company. In 2005, after 18 unprofitable months, James abandoned his pursuits with respect to trading software. He revived the business in 2009 to invest in his wife Colleen's music career. Traders Abacus never earned a profit from its music recording activities.

James again revived Traders Abacus in 2013 or 2014 to develop an internet-based application to address what James perceived as the overwhelming use of internet pornography. His perception was based on his experience working as the director of engineering and operations for a telecommunications company, where James learned that approximately half of internet bandwidth was used for accessing pornography. James conducted surveys and read published research articles to learn about the addictive nature of pornography. He spent considerable time and money over the course of 2015 and 2016 in his attempt to develop and monetize an application that eventually took the name SelfChanger. In 2016, he halted the development of SelfChanger because he believed that the technology was not advanced enough.

In 2018, James reengaged his development efforts with respect to SelfChanger, using a new development approach. He worked approximately 20 hours per week on the application. In 2019, Traders Abacus hired its first employee. That year, James also generated a business plan for SelfChanger. He purchased advertising and generated financial projections for the monetization of SelfChanger. The app generated no income from 2013 to 2019. Throughout 2017 through 2019 (the years at issue), Traders Abacus maintained a general ledger and its own bank account. Early prototypes of the app were functional by 2020, when James hired two full-time software engineers to further develop the application. James ceased development on SelfChanger in 2022 because of an inability to retain customers.

In 2017, the Sullivans and Traders Abacus purchased a 51.6-acre lot in Lincolnville, Maine (Lincolnville lot) for $300,000. The lot comprised two parcels: a 47.71-acre parcel and a 3.89-acre parcel. The Sullivans planned to develop a small group of "passive homes" -- homes that require minimal energy to operate and do not need to be connected to the electricity grid. In December 2017, they bought a Bobcat excavator and a track loader for use in developing the Lincolnville lot. Most of James's salary was devoted to developing the lot, and the Sullivans worked weekends on it before moving to it full time in 2018. The couple lived a spartan existence on the Lincolnville lot; they slept in a pop-up tent with an electric blanket and used the facilities at a nearby YMCA. They eventually set up a more robust tent where they lived year-round from 2019 until 2025.

On a land use application with respect to the 3.89-acre parcel, the Sullivans described the proposed project as consisting of a residence, a barn, and six temporary storage units. The application indicated that the project was not a commercial building. James viewed the proposed residence and barn project as a temporary reprieve from the less-than-ideal conditions of living in their camp. However, rising building material prices put the project financially out of reach for the Sullivans, and they ultimately never built the proposed residence or barn.

From 2017 to 2019, Colleen led the Sullivans' efforts to develop the 47.71-acre parcel. She used the Bobcat to clear the land and build access roads, working nearly every day. In 2018, the Sullivans identified a location for Traders Abacus's office on the 47.71-acre parcel. However, they did not begin construction of the office until 2019. James designed the office to be built by bolting together two modified shipping containers and obtained the necessary building permits. He moved Traders Abacus into the office in early 2020. Ultimately, the passive homes never materialized. The Sullivans' development efforts with respect to the 47.71-acre parcel culminated in the construction of access roads on the property. In January 2025, the Sullivans sold the 47.71-acre parcel of the Lincolnville lot for $565,000.

For each of the years at issue, the Sullivans claimed business expense deductions for James's software development activities and the couple's home construction activities. The IRS denied the deductions after determining that the Sullivans did not engage in the activities for profit. The Sullivans took their case to the Tax Court.

Under Code Sec. 183(a), business expense deductions are generally not allowed if an activity is not engaged in for profit. Reg. Sec. 1.183-2(b) sets forth a list of nine factors that are relevant to an analysis of whether a taxpayer engages in an activity with the objective of realizing a profit. The factors are (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisors; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, which are earned from the activity; (8) the financial status of the taxpayer; and (9) elements of personal pleasure or recreation. The factors are nonexclusive and no one factor is dispositive.

Analysis

The Tax Court held that the Sullivans engaged in the software development activities for profit and that they engaged in the home construction activities, in part, for profit. Specifically, the court found that the Sullivans held a profit motive with respect to the 47.71-acre parcel of the Lincolnville lot, but that aspects of personal use and the lack of a plan to commercialize the 3.89-acre parcel suggested they did not hold a profit motive with respect to it.

The court found that the businesslike manner in which James approached his software development activities demonstrated a profit motive. The court noted that James created a business plan, conducted surveys to identify the consumer base, hired employees to help him develop the app, and ran advertisements. James's business decisions to adopt new ideas for SelfChanger and to entirely shelve its development at times he felt it had no profitable outlook were, in the court's view, consistent with having a profit motive. The court also thought that the Sullivans pursued their home construction activities with respect to the 47.71-acre parcel in a businesslike manner given that they hired employees to work as laborers and used software to organize and track payroll. The lack of a formal business plan was not determinative, in the court's view, considering that the Lincolnville lot aligned with the Sullivans' plan to develop a subdivision of passive homes. On the other hand, the court found that the Sullivans generally treated the 3.89-acre parcel as their primary residence.

Other factors weighing in favor of a profit motive were: (1) the expertise that James brought to bear in his software development and home construction activities; (2) the time and effort James spent developing SelfChanger and the fact that Colleen devoted nearly all of her free time to developing the Lincolnville lot; (3) James's expectation that SelfChanger would appreciate in value, and the fact that the Sullivans acquired the Lincolnville lot with the expectation that it would appreciate in value; (4) the Sullivans' extensive past success in home construction, having sold for a profit two out of three of their prior homes, which they either built or significantly remodeled; (5) the fact that, despite having significant income, the Sullivans did not live a lavish lifestyle and forwent leisure and recreational pursuits in order to continue their work; and (6) the lack of evidence of personal pleasure in James' software development work as well as the Sullivans' deriving minimal personal enjoyment or benefit with respect to their efforts to develop the 47.71-acre parcel.

James's lack of success with respect to software development, going back to his trading software business and continuing with SelfChanger, was a factor weighing against a profit motive. However, the court agreed with the Sullivans' contention that the losses they sustained during the years at issue from SelfChanger were within the project's startup period. The court observed that the disputed losses were incurred only give years after James began pursuing the development of SelfChanger. Further, there were times when James was not pursuing development of SelfChanger, and when he reengaged his efforts he employed new business strategies that extended the time required to develop the application. The court viewed five years as a reasonable startup period for a software business operating at Traders Abacus's scale.

For a discussion of determining whether an activity is engaged in for profit, see Parker Tax ¶97,505.

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