T.C. Memo. 2008-298

UNITED STATES TAX COURT

WILLIAM C. AND CRISTINA LOWE, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15592-06. Filed December 29, 2008.

In 1985, P husband (H) invested in DA, a limited

partnership engaged in renting real estate, and he

retained that investment until DA’s termination in

2003. DA generated losses in every year of its

existence except 1995 and 2003. On the basis of a 1985

conversation with his return preparer, H believed the

losses to be nondeductible, although the 1991 and 1993

losses were deducted on his returns for those years. 

Frequent job changes caused H to move several times

after 1993, but, because he believed DA would continue

to generate nondeductible losses, he (1) did not advise

DA of his changes of address, (2) never received the

1994-2003 Schedules K-1 from DA and, therefore, was

unable to continue his prior practice of turning over

the Schedules K-1 to his return preparers, and (3) did

not report the gains and losses reflected on those

Schedules K-1. The 1994 and 1996-2003 returns confirm

that Ps reported neither the 2003 gain nor the losses

for the other years. The parties stipulate that Ps did

not report the 1995 gain. Ps were unable to furnish

copies of the 1985-90 and 1992 returns. R alleges that

Ps are taxable on $292,853 of unreported long-term

capital gain reflected on the 2003 Schedule K-1 issued

to H by DA. Ps allege that, pursuant to sec. 469(b)
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and (g), I.R.C., they may carry forward $484,065 of

suspended passive activity losses from 1985-90, 1992,

1994, and 1996-2002 as a complete offset to the

unreported 1995 and 2003 gains. R also determined that

Ps are liable for the sec. 6662, I.R.C., accuracyrelated penalty.

1. Held: The 1994 and 1996-2002 losses

constitute suspended passive activity losses, and the

excess of those losses over the unreported 1995 gain

may be carried forward as a partial offset to Ps’

unreported 2003 long-term capital gain from DA.

2. Held, further, Ps have not produced credible

evidence that there are any suspended passive activity

losses from 1985-90 or 1992 available for carryover to

2003, and, therefore, no carryover from those years is

permitted.

3. Held, further, R’s penalty against Ps is

sustained, in part, under sec. 6662, I.R.C.

Patrick J. O’Brien, for petitioners.

Kelly R. Morrison-Lee, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

HALPERN, Judge: By notice of deficiency dated May 9, 2006,

respondent determined a deficiency in petitioners’ 2003 Federal

income tax of $69,351 and an accuracy-related penalty of

$13,870.20. Petitioners assign error to both of those

determinations. The issues for decision are (1) the extent, if

any, to which there exist unused or suspended passive activity

losses arising in taxable years before 2003 and attributable to

petitioner William C. Lowe’s (Mr. Lowe’s) interest in a real

estate limited partnership that, pursuant to section 469(b) and
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1 Unless otherwise indicated, all section references are to

the Internal Revenue Code of 1986, as amended and in effect for

the year at issue, and all Rule references are to the Tax Court

Rules of Practice and Procedure.

2 Pursuant to Rule 151(e)(3), each party, in the answering

brief, is required to “set forth any objections, together with

the reasons therefor, to any proposed findings of any other

party”. Petitioners have filed an answering brief, but they have

failed to set forth objections to respondent’s proposed findings

of fact. Accordingly, we must conclude that petitioners have

conceded that respondent’s proposed findings of fact are correct

except to the extent that those findings are clearly inconsistent

with either evidence in the record or petitioners’ proposed

findings of fact. See, e.g., Jonson v. Commissioner, 118 T.C.

106, 108 n.4 (2002), affd. 353 F.3d 1181 (10th Cir. 2003).

(g),1 are available to petitioners as offsets to the unreported

2003 long-term capital gain Mr. Lowe realized upon the

termination of his investment in the partnership, and (2) whether

petitioners are liable for the accuracy-related penalty under

section 6662(a).

The notice contains certain other adjustments that are

purely computational. Their resolution depends upon our

resolution of the first issue in dispute.

FINDINGS OF FACT2

Some facts are stipulated and are so found. The stipulation

of facts, with accompanying exhibits, is incorporated herein by

this reference.

At the time the petition was filed, petitioners resided in

Lake Forest, Illinois.
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Mr. Lowe’s Background and Job History

Mr. Lowe earned a B.S. in physics from Lafayette College in

1962. He then was employed by IBM as an engineer and, by 1985,

had become a corporate vice president and president of IBM’s

entry systems division. Although his formal training was in

physics, he had some responsibilities for business decisions in

his area. In general, however, Mr. Lowe depended upon the chief

financial officer to support the financial decisions relating to

the products with which he was concerned.

During 1985, Mr. Lowe resided in Chappaqua, New York. He

became an executive for Xerox Corp. in 1988 and remained at Xerox

until 1991. During that period, he continued to reside in

Chappaqua. He then embarked upon a series of job changes and

relocations: In 1991, he became the chief executive officer

(CEO) of Gulfstream Aerospace in Savannah, Georgia, and he moved

to Hilton Head, South Carolina; in 1993, he became the CEO of New

England Business Services in Groton, Massachusetts, and he moved

to Concord, Massachusetts; and, in 1996, he became executive vice

president, North America, for Moore Corp., headquartered in Lake

Forest, Illinois, which became his new place of residence. Then,

in late 1998 or early 1999, petitioner Cristina Lowe’s (Mrs.

Lowe’s) mother passed away, and petitioners moved to Tucson,

Arizona, to be with Mrs. Lowe’s father. In 2004, petitioners

moved back to Lake Forest, Illinois.
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Mr. Lowe’s Investment in Douglas Associates

In 1985, while Mr. Lowe was at IBM, a financial adviser from

Chase Bank, used by Mr. Lowe and a number of other IBM

executives, advised Mr. Lowe to get involved in some limited

partnerships. He specifically recommended that Mr. Lowe invest

in Douglas Associates, a limited partnership engaged in renting

real estate. Thereupon, Mr. Lowe invested $200,000 in Douglas

Associates in exchange for a limited partnership interest.

Douglas Associates issued Schedules K-1, Partner’s Share of

Income Credits, Deductions, etc. (the Schedules K-1), to Mr. Lowe

for each year of its existence (1985-2003), and Mr. Lowe retained

his limited partnership interest in Douglas Associates for that

entire period. The Schedules K-1 reported Mr. Lowe’s annual

share of Douglas Associates’ gains and losses as follows:

Year Gain (Loss)

1985 ($7,961)

1986 (31,817)

1987 (61,526)

1988 (71,581)

1989 (63,587)

1990 (58,029)

1991 (49,152)

1992 (49,336)

1993 (46,596)

1994 (43,615)

1995 107,580

1996 (15,102)

1997 (15,469)

1998 (16,667)

1999 (14,257)

2000 (20,645)

2001 (6,638)
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3 The 1998-2002 Schedules K-1 were addressed to Mr. Lowe at

his address in Lake Forest, Illinois, which indicates that

someone had advised Douglas Associates that Mr. Lowe resided at

that address. Presumably, Mr. Lowe’s failure to receive them is

attributable to petitioners’ late 1998 or early 1999 move from

Lake Forest to Tucson, Arizona. The 2003 Schedule K-1 was

mistakenly addressed to Mr. Lowe at a different address in Lake

Forest, Illinois, at a time when petitioners were still residing

in Tucson.

2002 ($7,835)

2003 1292,853 

 

1 The 2003 Schedule K-1 (which covered

Douglas Associates’ final taxable year, ending

July 15, 2003) also reported that Mr. Lowe’s share

of unrecaptured depreciation gain from “flow

through entity” was $109,913. Respondent does not

argue that that amount reduces the amount of

suspended passive activity losses that may be

available to offset the $292,853 long-term capital

gain Mr. Lowe realized upon the termination of his

investment in Douglas Associates. Therefore, we

will ignore that amount in determining the amount

of suspended passive activity losses, if any,

available for that purpose.

The 1985 and 1986 Schedules K-1 reported Mr. Lowe’s losses

for those years on line 1, “Ordinary income (loss)”. The

Schedules K-1 for all subsequent years (1987-2003) reported his

gains or losses on the line entitled “Reconciliation [or

‘Analysis’] of partner’s capital account”, and/or that entitled

“Income [or ‘Net income’] (loss) from rental real estate

activities”.

Mr. Lowe received the 1985-93 Schedules K-1 and turned them

over to his tax return preparer. Having failed to notify Douglas

Associates of his various changes of address between 1994 and

2003, Mr. Lowe did not receive any of the Schedules K-1 issued

for those years.3
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4 The 1995 return is also not in evidence, but the parties

stipulate that petitioners did not report on that return the

$107,580 gain reported on the Douglas Associates 1995 Schedule K1.

Tax Reporting of the Gains and Losses Reflected on the

Schedules K-1

Mr. Lowe reported the losses attributed to him on the 1991

and 1993 Schedules K-1 (jointly with his former spouse for 1991

and jointly with Mrs. Lowe for 1993) as currently deductible on

the returns filed for those years. On the joint returns

petitioners filed for 1994 through 2003, they reported neither

the gains, for 1995 and 2003, nor the losses, for the other

years, reflected on the Schedules K-1 for those years. Mr. Lowe

was unable to obtain copies of his 1985-90 and 1992 returns, and

those returns are not in evidence.4

Mr. Lowe’s 1985-92 returns were prepared by Joseph Cannistra

& Co., in Mount Kisco, New York. His 1993-2003 returns were

prepared by at least six different tax preparers, generally

located near his residence, which, as noted supra, changed

several times during those years.

OPINION

I. Petitioners’ Entitlement to a Passive Activity Loss Carryover

A. Applicable Law

Section 469, dealing with passive activity losses and

credits, was added to the Internal Revenue Code by section 501 of

the Tax Reform Act of 1986 (TRA), Pub. L. 99-514, sec. 501, 100

Stat. 2233. Theretofore, there had been no generally applicable

limitation on a taxpayer’s ability to use losses from a
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5 With exceptions not here relevant, an individual is not

treated as materially participating in any activity of a limited

partnership of which he is a limited partner (e.g., Mr. Lowe is

not treated as materially participating in Douglas Associates’

activities). See sec. 469(h)(2); sec. 1.469-5T(e), Temporary

Income Tax Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988).

particular trade or business activity to offset income from other

such activities. That circumstance gave rise to the

proliferation of tax shelters permitting taxpayers to reduce or

avoid taxes on salary or other positive income through the use of

losses (often in excess of real economic costs) incurred in

advance of any income from the shelters. See H. Conf. Rept. 99-

841 (Vol. II) at II-137 (1986), 1986-3 C.B. (Vol. 4) 1, 137; S.

Rept. 99-313, at 713 (1986), 1986-3 C.B. (Vol. 3) 1, 713.

In pertinent part, section 469(a)(1) provides that an

individual’s “passive activity loss” for any taxable year shall

not be allowed. Section 469(c)(1) defines a “passive activity”

as one which involves the conduct of any trade or business in

which the taxpayer does not materially participate.5 Section

469(d)(1) defines a passive activity loss as the amount, for the

taxable year, by which aggregate losses from all passive

activities exceed aggregate income from those activities. Thus,

losses arising from a passive activity are deductible only

against income from that activity or another passive activity. 

See S. Rept. 99-313, supra at 722, 1986-3 C.B. (Vol. 3) at 722.

Section 469(b) provides that any passive activity loss disallowed

under subsection (a) shall be treated as a deduction allocable to

that same passive activity in the next taxable year. If the
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6 Because disallowed or suspended losses from a passive

activity are allowable in full upon a fully taxable disposition

of that activity (see discussion infra), it is necessary to

determine the portion of each year’s passive activity loss

carryover that is allocable to each of the taxpayer’s passive

activities, assuming the taxpayer owns interests in more than

one. See S. Rept. 99-313, at 722 (1986), 1986-3 C.B. (Vol. 3) 1, 

722; sec. 1.469-1(f)(4)(i), Income Tax Regs.; sec. 1.469-

1T(f)(2), Temporary Income Tax Regs., 53 Fed. Reg. 5706 (Feb. 25,

1988).

7 In this case, the nonpassive activity loss

characterization would apply only to the extent Mr. Lowe’s

suspended loss carryover exceeded his unreported capital gain on

the disposition of his interest in Douglas Associates.

carried-over passive activity loss becomes a nonallowable passive

activity loss for the carryover year, it is carried over to the

succeeding year. Disallowed or suspended losses may be carried

over indefinitely until they are used.6 See S. Rept. 99-313,

supra at 722, 1986-3 C.B. (Vol. 3) at 722; Bittker & Lokken,

Federal Taxation of Income, Estates and Gifts, par. 28.9, at 28-

91 (3d ed. 1999). Pursuant to section 469(g)(1)(A) and (B), if a

taxpayer disposes of his entire interest in a passive activity to

an unrelated person in a transaction in which all gain or loss is

recognized, suspended passive activity losses (remaining after

the application of section 469(b)) are deductible without

limitation (i.e., they are treated as losses “not from a passive

activity”) in the year of disposition.7

Section 469 generally applies to taxable years beginning

after December 31, 1986, and does not apply to losses from pre1987 taxable years carried forward to post-1986 taxable years. 

TRA sec. 501(c)(1) and (2). Section 469(m) provides a 5-year

phase-in for passive activity losses from interests held before
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8 The parties stipulate (and the 1991 and 1993 returns

verify) that the losses reported on the 1991 and 1993 Schedules

K-1 were deducted as nonpassive or “active” losses, and

petitioners concede that the alleged passive activity loss

carryover is “net of claimed active losses”.

9 Petitioners do not dispute the status of the unreported

1995 gain as an offset to their alleged suspended passive

activity loss carryover to 2003. What they seek is to “apply all

passive * * * [losses] (net of claimed active losses and

unreported gains) to offset any tax liability for 2003.” 

(Emphasis supplied.)

the new law’s date of enactment, October 22, 1986, pursuant to

which an increasing percentage of such losses becomes subject to

the new rules, with 100 percent of such losses becoming subject

thereto for taxable years beginning in or after 1991.

B. Arguments of the Parties

Petitioners argue that the losses set forth on the Schedules

K-1 issued to Mr. Lowe by Douglas Associates for 1985-90, 1992,

1994, and 1996-2002, totaling $484,065, and from which they “have

received no tax benefit”,8 are passive activity losses, which

“more than offset any gains from Douglas Associates”; i.e., the

1995 and 2003 gains totaling $400,433.9

Respondent argues: “Because petitioners have failed to

substantiate the transactions surrounding the alleged passive

activity losses * * * , petitioners cannot satisfy the statutory

requirements for carrying forward suspended * * * [passive

activity losses]”. He concludes that those alleged losses

“cannot be properly carried forward because they are not

suspended * * * [passive activity losses] pursuant to * * *
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10 As explained infra sec. I.D., respondent believes that

petitioners’ duty to be consistent forecloses their claim that

the 1985-93 losses are available to offset their unreported 2003

passive activity gain.

[section] 469.” Alternatively, respondent argues that, even if

we decide that the losses set forth on the 1994 and 1996-2002 

Schedules K-1, totaling $140,228, constitute suspended passive

activity losses available as a carryover,10 they must be offset

by the unreported 1995 gain of $107,580, leaving only $32,648 in

suspended passive activity losses as an offset to the unreported

2003 gain of $292,853, resulting in net unreported gain of

$260,205.

C. Burden of Proof

In pertinent part, Rule 142(a)(1) provides, as a general

rule: “The burden of proof shall be upon the petitioner”. In

certain circumstances, however, if the taxpayer introduces

credible evidence with respect to any factual issue relevant to

ascertaining the proper tax liability, section 7491 places the

burden of proof on the Commissioner. Sec. 7491(a)(1); Rule

142(a)(2). Credible evidence is evidence that, after critical

analysis, a court would find constituted a sufficient basis for a

decision on the issue in favor of the taxpayer if no contrary

evidence were submitted. Baker v. Commissioner, 122 T.C. 143,

168 (2004); Bernardo v. Commissioner, T.C. Memo. 2004-199 n.6. 

Section 7491(a)(1) applies only if the taxpayer complies with

substantiation requirements, maintains all required records, and

cooperates with the Commissioner’s requests for witnesses,
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information, documents, meetings, and interviews. Sec.

7491(a)(2).

For the reasons discussed infra section E.3.a., we find that

petitioners have failed to introduce credible evidence that any

of the losses reflected on the Schedules K-1 for 1985-90 and 1992

(the pre-‘93 losses) constitute suspended passive activity

losses. It follows that petitioners retain the burden of proving

that those losses are available to offset their 2003 gain on the

disposition of Mr. Lowe’s interest in Douglas Associates, a

burden that, because of the absence of credible evidence on that

issue, petitioners cannot sustain. See Bernardo v. Commissioner,

supra n.7; see also Rendall v. Commissioner, 535 F.3d 1221, 1225

(10th Cir. 2008) (citing Bernardo v. Commissioner, supra), affg.

T.C. Memo. 2006-174. Therefore, our discussion of that issue may

be viewed as setting forth the basis for our determination that

petitioners have failed to (1) introduce credible evidence and

(2) carry their burden of proof. See Bernardo v. Commissioner,

supra; see also Rendall v. Commissioner, supra at 1225.

The parties also disagree as to the status of the losses

reflected on the Schedules K-1 for 1994 and 1996-2002 (the post-

‘93 losses) as suspended passive activity losses. We need not

decide whether section 7491(a) applies to that issue because we

resolve it upon a preponderance of the evidence. Therefore,

resolution of the issue does not depend upon which party bears

the burden of proof. See, e.g., Bergquist v. Commissioner, 131

T.C. , (2008) (slip op. at 30).
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11 As noted supra note 8, the parties stipulate that the

losses reported on the 1991 and 1993 Schedules K-1 were deducted

as active losses for those years.

12 The “Amendment To Answer” filed with the motion

erroneously refers to “passive gains in 2004”. 

D. Respondent’s Motion for Leave To File

 Amendment to Answer To Conform to the Evidence

On January 31, 2008, respondent moved, pursuant to Rule

41(b), for leave to file an amendment to the answer to conform to

the evidence (the motion). In the motion, respondent raises the

duty of consistency as an affirmative defense to what he

considers petitioners’ attempt to characterize the 1985-93

losses, alleged by respondent to have been reported as active

losses on the 1985-93 returns,11 as suspended passive activity

losses available to offset their unreported 2003 passive activity

gain.12 Petitioners oppose the motion.

We need not rule upon the motion because, as noted supra, we

find that petitioners have failed to introduce credible evidence

that the pre-‘93 losses constitute suspended passive activity

losses. That finding, together with the parties’ stipulation

that petitioners reported the 1991 and 1993 losses as active

losses (so that petitioners concede they may not be carried

forward as suspended passive activity losses) renders moot

respondent’s motion, which, in substance, seeks the same result.
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E. Discussion

1. Introduction

The parties’ joint exhibits include copies of petitioners’

1994 and 1996-2002 returns. Those returns show that petitioners

did not report or deduct the post-‘93 losses. Petitioners’ tax

treatment of the pre-‘93 losses is not evidenced by copies of

returns filed for those years. The only support for petitioners’

argument that those losses were never deducted and, therefore,

remain available for carryover to 2003 is Mr. Lowe’s testimony to

that effect. Because of that evidentiary difference, we

separately consider those two groups of alleged passive activity

losses.

2. The Post-‘93 Losses

a. Analysis

Respondent states that petitioners have failed to provide a

“valid explanation as to why * * * [Mr. Lowe] invested in Douglas

Associates” and that Mr. Lowe “failed to explain why he had very

limited records relating to his roughly 20-year participation in”

that partnership and why he never inquired further relating to

his $200,000 investment therein. Respondent concludes: “Because

petitioners have failed to substantiate the transactions

surrounding the alleged passive activity losses * * * [they]

cannot satisfy the statutory requirements for carrying forward

suspended * * * [passive activity losses].” Respondent also

cites a taxpayer’s right, under section 469(g)(1), to carry

forward suspended passive activity losses to the year in which
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the taxpayer disposes of his entire interest in the passive

activity to an unrelated party, provided all gain or loss on the

disposition is recognized. He then states: “[Mr. Lowe] has not

substantiated that this [i.e., that there is a suspended loss] is

true for any of the * * * [passive activity losses], and thus,

[he] cannot carry any of * * * [them] forward.” (Emphasis

supplied.) We disagree as regards the post-‘93 losses.

Mr. Lowe testified that he invested in Douglas Associates

upon the advice of a financial adviser who provided investment

advice to IBM executives like him. The adviser suggested that he

become involved in limited partnerships and, specifically, that

he invest in Douglas Associates. The parties have stipulated

that from 1985 through 2003 Douglas Associates was a limited

partnership engaged in the activity of renting real estate, and

that Mr. Lowe held a limited partnership interest therein. 

According to the Schedules K-1 issued by Douglas Associates,

which are unchallenged, Mr. Lowe’s investment in Douglas

Associates did give rise to the alleged losses (both pre- and

post-‘93), and the 1994 and 1996-2002 returns provide

unchallenged verification that the post-‘93 losses were not

claimed on those returns and did not give rise to any tax benefit

to petitioners before 2003. Moreover, pursuant to section

469(c)(1) and (h)(2) and section 1.469-5T(e), Temporary Income

Tax Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988), which, together,

establish that Mr. Lowe’s limited partnership interest in Douglas

Associates constituted a passive activity, it is clear that the
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post-‘93 losses constituted passive activity losses. Lastly,

there is no dispute that all of the other requirements of section

469(g)(1) for carrying forward the post-‘93 losses to offset the

2003 capital gain on termination of Mr. Lowe’s interest in

Douglas Associates have been met. Respondent does not dispute

that, as reflected on the 2003 Schedule K-1, the partnership was

terminated in a fully taxable transaction, and respondent does

not allege that that termination constituted a “disposition [of

the limited partnership interests] involving [a] related party”

within the meaning of section 469(g)(1)(B).

b. Conclusion

The post-‘93 losses constitute suspended passive activity

losses that may be carried forward to 2003 pursuant to section

469(b) and (g)(1)(A).

3. The Pre-‘93 Losses

a. Analysis

Because the 1985-90 and 1992 returns are not in evidence,

petitioners’ position that the pre-‘93 losses constitute

suspended passive activity losses available for carryover to 2003

is based solely upon Mr. Lowe’s testimony. That testimony is not

persuasive.

Mr. Lowe testified that, beginning with his receipt of the

1985 Schedule K-1, his “process was to turn * * * [the Schedules

K-1] over to my tax preparer, who I depended upon to deal with
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13 Mr. Lowe’s practice of turning over the Schedules K-1 to

his accountants of course ceased after 1993 when he no longer

received any from Douglas Associates.

them properly and put my returns in proper form.”13 He further

testified that the C.P.A. firm that prepared his 1985 return (as

well as all subsequent returns through 1992) told him that the

1985 loss was a “passive loss”, that he could not “do anything

with” the loss, and that his “expectation from that point forward

was that’s the way they would be treated”. Mr. Lowe expressed

his “belief” that the 1985-90 losses reflected on the Schedules

K-1 for those years “were never claimed”, and that the same was

true for 1992. He had no explanation as to why the 1991 and 1993

losses were reported as “active losses” on the returns for those

years, and he testified that “it was a surprise to me to discover

that those losses had been claimed.”

Mr. Lowe’s testimony that the pre-‘93 losses were not

claimed is implausible in several respects. To begin with,

before the enactment of section 469 in 1986, the concept of

active versus passive losses did not exist for deductibility

purposes, and, with the exception of the section 1211(b)

limitations on the deductibility of capital losses, losses

incurred by an individual in connection with a trade or business

or in a transaction entered into for profit were fully deductible

under section 165(c)(1) and (2). Moreover, as noted supra

section I.A., section 469 did not become effective until 1987;

and, until 1991, it only affected a portion of the losses from

preenactment investments such as Mr. Lowe’s interest in Douglas
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14 For subsequent years, the Schedules K-1 listed Mr. Lowe’s

pass-through gain or loss on a line entitled “Income [or ‘Net

income’] (loss) from rental real estate activities” and/or on a

line entitled “Reconciliation of partner’s capital account”.

Associates. Lastly, the Schedules K-1 for 1985 and 1986 listed

the losses for those 2 years on a line entitled “Ordinary income

(loss)”.14 Under those circumstances, we find incredible Mr.

Lowe’s testimony that his professional tax-advisor (1) did not

deduct the losses reflected on the Schedules K-1 for 1985 and

1986 and (2) told him, in connection with the preparation of his

1985 return, that the 1985 loss was a “passive loss” and that he

“couldn’t do anything with it.”

Petitioners’ argument that the pre-‘93 losses subject to

section 469, in whole or in part (1987-92), were not deducted is

not based upon the returns for those years (which are not in

evidence) or even upon Mr. Lowe’s recollection based upon his

prior review of those returns but, instead, upon his “belief”

that those losses “were never claimed”. That belief, based upon

an alleged conversation that took place some 22 years earlier, is

belied by the 1991 return, which shows that the firm responsible

for preparing the 1985-92 returns treated the loss reflected on

the 1991 Schedule K-1 as a deductible, ordinary loss. The 1991

return, at the very least, implies that neither the return

preparer nor the reviewer(s) (if any) were aware of the section

469 limitations on the deductibility of passive activity losses,

and that they, therefore, continued to deduct in full, after
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15 The ordinary loss treatment in 1993 by a new return

preparer of the loss reflected on the 1993 Schedule K-1 is,

perhaps, explainable if we assume that that preparer followed the

questionable practice of treating the Schedule K-1 loss for 1993

just as the Schedule K-1 losses had been treated by the prior

return preparer for prior years. Of course, that practice, if it

existed, necessarily stopped, beginning in 1994, when Mr. Lowe

stopped receiving Schedules K-1 from Douglas Associates and,

therefore, was unable to furnish them to his return preparers.

16 The 1991 and 1993 returns, both of which reflect

investments in partnerships other than Douglas Associates,

indicate that Mr. Lowe may very well have maintained such

investments during the entire 1987-92 period.

1986, the losses reflected on the Schedules K-1.15 On the other

hand, if we assume that Mr. Lowe’s return preparers applied

section 469 to Mr. Lowe’s passive activity losses reflected on

the Schedules K-1 for 1987-90 and 1992, including the phase-in

rules of section 469(m) applicable to 1987-90, there is no

evidence of the extent to which those passive activity losses may

have been used as offsets to passive activity income or gain from

interests other than Mr. Lowe’s interest in Douglas Associates,

thereby making them unavailable for carry forward to 2003.16

b. Conclusion

Mr. Lowe has not provided credible evidence of the existence

of pre-‘93 passive activity losses available for carry forward to

2003 pursuant to section 469(b) and (g)(1)(A).

F. Conclusion

Petitioners may carry forward to 2003 post-‘93 losses of

$32,648.
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II. Section 6662(a) Penalty

A. Applicable Law

Section 6662(a) provides for a penalty equal to 20 percent

of the portion of any underpayment of tax attributable to, among

other things, negligence or intentional disregard of rules or

regulations (without distinction, negligence), any substantial

understatement of income tax, or any substantial valuation

misstatement. See sec. 6662(b)(1)-(3). Although the notice

states that respondent bases his imposition of the penalty of

$13,870.20 on “one or more” of the three above-referenced

grounds, on brief he relies upon only the first two of those

grounds: negligence and substantial understatement of income tax.

Negligence has been defined as lack of due care or failure

to do what a reasonably prudent person would do under like

circumstances. See, e.g., Hofstetter v. Commissioner, 98 T.C.

695, 704 (1992). It also “includes any failure to make a

reasonable attempt to comply with the provisions of the internal

revenue laws or to exercise ordinary and reasonable care in the

preparation of a tax return.” Sec. 1.6662-3(b)(1), Income Tax

Regs.

For individuals, a substantial understatement of income tax

exists “if the amount of the understatement for the taxable year

exceeds the greater of--(i) 10 percent of the tax required to be

shown on the return for the taxable year, or (ii) $5,000.” Sec.

6662(d)(1)(A).
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17 Mr. Lowe Petitioners’ taxable unreported long-term

capital gain for 2003 as determined herein is $260,205 ($292,853

- $32,648). Applying the 15-percent maximum capital gain rate

under sec. 1(h)(1)(C) applicable to net capital gain realized in

taxable years ending on or after May 6, 2003, petitioners’

understatement of tax attributable to that gain is $39,031 (15

percent of $260,205). That understatement exceeds $5,000 and 10

percent of the tax required to be shown on petitioners’ 2003

return, which, as computed by respondent is $71,820, an amount

that, presumably, will be reduced by our allowance of a portion

of the passive activity loss carryover claimed by petitioners.

Section 6664(c)(1) provides that the accuracy-related

penalty shall not be imposed with respect to any portion of an

underpayment if it is shown that there was reasonable cause for

that portion and the taxpayer acted in good faith with respect to

that portion. Further:

The determination of whether a taxpayer acted with

reasonable cause and in good faith is made on a caseby-case basis, taking into account all pertinent facts

and circumstances. * * * Circumstances that may

indicate reasonable cause and good faith include an

honest misunderstanding of * * * law that is reasonable

in light of all of the facts and circumstances,

including the experience, knowledge, and education of

the taxpayer. * * * [Sec. 1.6664-4(b)(1), Income Tax 

Regs.]

B. Analysis

Even with a $32,648 offset to petitioners’ unreported

capital gain for 2003, it is clear that there was a substantial

understatement of petitioners’ 2003 income tax within the meaning

of section 6662(d)(1)(A).17 Alternatively, we find that that

understatement was attributable to negligence, within the meaning

of section 6662(c), on Mr. Lowe’s part. He did not exercise due

care or do what a reasonably prudent person would do; rather, he

adopted an attitude of total indifference to his investment in
- 22 -

Douglas Associates. That indifference caused him not to notify

Douglas Associates of his various changes of address after 1993,

and that inaction resulted in his not receiving the 2003 Schedule

K-1 or including, on his 2003 return, the long-term capital gain

of $292,853 reflected on that Schedule K-1. Mr. Lowe’s stated

assumption that Douglas Associates would perpetually generate

nondeductible losses (so that there was no reason for him to make

certain that he would receive the Schedules K-1 after he changed

his address in 1993) was not a reasonable or prudent assumption,

even if it was based upon advice from a professional tax return

preparer. The reasonableness of Mr. Lowe’s predicating such an

assumption upon that advice is undercut by his testimony that the

advice related only to the initial year of the investment, 1985,

a year which preceded the effective date of the passive loss

provisions, and that it was his own “expectation from that point

forward” that the losses would continue to be nondeductible. 

Moreover, it was not reasonable for an individual of Mr. Lowe’s

background and experience to make a $200,000 investment with the

sole expectation that it would do no more than generate perpetual

losses of no economic benefit to him. He knew, or should have

known, that Douglas Associates owned real estate of some

potential value, which might be sold at some time, and that such

a sale, in part because of the property’s depreciated tax basis,

might produce a taxable gain to the investors. For that reason

alone Mr. Lowe was negligent in turning his back on the Schedules

K-1.
- 23 -

The same reasons that form the basis for our finding that

petitioners’ underpayment of the 2003 tax liability was

attributable to Mr. Lowe’s negligence also form the basis for our

finding that there was no reasonable cause for that underpayment,

and that Mr. Lowe failed to act in good faith with respect

thereto. See sec. 6664(c)(1).

C. Conclusion

Petitioners are liable for the section 6662(a) penalty as

applied to the underpayment of tax determined herein.

To reflect the foregoing,

Decision will be entered

under Rule 155.