T.C. Mem o. 2 01 4- 95

UNITED STAT ES TAX COURT

ALEXAND ER HERW IG AND JENNIFER K. HERW IG, Pet it io ne rs v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 17 68 2- 11
. Fi le d M ay 20 , 20 14
.
Tho m as F. Hud gi ns , forpe ti ti on ers . Ann e M. Cra ig an d J eremy D. Cam ero n, fo r res po nd en t.

MEMORANDUM FINDINGS OF FACT AND OPINION GUY, Spec ia l Tri al Ju dg e: Res po nd en t d et erm in edth atpe ti ti on ers are li ab le forFed eral in co m e ta x d efi ci en ci es an d a ccu racy-rela te d p en al ti es forth e ta xabl e y ears 20 07 , 20 08 , and20 09 (y ears inis su e) as fol lo ws:- 2 -

[* 2] Penal ty

Year Defi ci en cy sec . 66 62 (a) 20 07 $2 6,7 95 $5 ,35 9 20 08 18 ,96 9 3,7 94 20 09 30 ,36 2 6,0 72 Pet it io ne rs , hu sb an d andwife , fil eda ti m el y pe ti ti on forred et erm in at io n wi th th e Co urt p ur su an t t o s ect io n 6 21 3( a). At th e ti m e th e p et it io n was fil ed , pet it io ne rs 1
res id edinFlo rid a. 2

Unl es s o th erwi se in di cat ed , sec ti on refe ren ces are t o the Int ern al Rev enue 1 Co de , as a m en de d a ndineffe ctforth e y ears inis su e, an d R ul e ref eren ces are t o th e Tax Co urt Ru le s o f Prac ti ce an d P ro cedur e. All m on et ary am ou nt s ar e ro un de d t o t he ne ares t d ol la r. Whe n t he pe ti ti on was fi le d, the Co urt i na dv ert en tl y ad de d t he let te r “ S” t o 2 th e d oc ke t n um

be r de si gn at in g t hi s ca se as asm al l t ax cas e d es pi te pe ti ti on ers ’ reque stinth e p et it io n t ha t the cas e n otbe pro ces se d und er the Ru le s g ov ern in g sm al l t ax cas es . See Ru le s 1 70 -1 74 . Upo n d is co ve rin g t he erro r aft er tria l, the Co urt h el d aco nf

eren ce ca ll with t he pa rti es , con firm edth atpe ti ti on ers di d n ot in te ndto ele ctsm al l t ax cas e st atus , andis su edanord er s tri ki ng th e le tt er “ S” fro m th e d oc ke t n um

be r.- 3 -

[* 3] Afte r co nc es si on s, th e is su es forde ci si on are wh ethe r pe ti ti on ers : 3 (1 ) di sp os edof t he ir i nt eres ts ina pa ss iv e act iv it y du rin g 2 00 8 o r 20 10 , th ereb y al lo win g t he m

to de du ctwhatot he rwis e are su sp en de d p as si ve lo ss es ari si ng du rin g t he y ears inis su e, an d (2 ) are li ab le foraccu racy-rela te d p en al ti es forth e y ears inis su e. FINDINGS OF FACT So m e o f th e fac ts ha ve be enst ip ul at edan d a re s o fo un d. Th e st ip ul at io n o f fact s, the supp le m en ta l s ti pu la ti on of f act s, an d t he acco m

pa nyin g e xh ib it s ar e in co rp or at edhe rei n b y

th is refe ren ce.

Pet it io ne rs co nc ed e th atres po nd en t co rrec tl y di sa ll owe d $ 34 ,12 1, $ 17 ,09 9, 3 an d $ 12 ,96 4 o f th e lo ss es th ey rep orte d o n S ch edul es E, Sup pl em en ta l In co m e an d Los s, fo r 20 07 , 20 08 , and20 09 , res pe ct iv el y . Res po nd en t ac kn owl ed ge s tha t pe ti ti on ers m ay

carry th es e p as si ve lo ss es forwardto tax ab le y ear 2 01 0. Pet it io ne rs furth er co nc ed e th atth ey are n oten ti tl edto th e fo ll owi ng de du ct io ns : (1 ) ot he r lo ss es of $ 89 3,3 94 rep orte d o n F orm 47 97 , Sal es of B us in es s Pr op erty , fo r 20 08 ; (2 ) ne t l os se s o f $1 5,8 30 , $1 8,1 40 , and$1 ,98 1 re po rte d o n S ch edul es C, Pro fitor Lo ss Fro m

Bu si ne ss , for20 07 , 20 08 , and20 09 , res pe ct iv el y ; (3 ) rea l es ta te tax es of $ 36 ,56 4 a ndin te res t o f $2 0,4 85 , rep orte d o n S ch edul es A, Item iz ed Deduc ti on s, fo r 20 07 an d 2 00 8, re sp ect iv el y ; an d (4 ) a l os s o f $7 68 ,20 8 i de nt ifi ed as “ Oth er Write inInc om e” fo r 20 09 . The p art ie s ag ree t ha t (1 ) res po nd en t pr op erl y de te rm in edth ata de du ct io n fo r m ortg ag e in te res t o f $2 6,8 71 th at pe ti ti on ers rep orte d o n S ch edul e A fo r 20 07 is di sa ll owe d a ndth atsame ite m is pr op erl y de du ct ib le on pe ti ti on ers ’ Sch edul e E for20 07 , and(2) pe ti ti on ers are al lo wedde du ct io ns fortax es of $ 8,4 18 an d $ 8,2 00 on Sch edul es E for 2 00 7 a nd 20 08 , res pe ct iv el y .- 4 -

[* 4] I. Via Capr i an d Vi a Mu ran o P ro pe rti es InMarc h 2 00 5 p et it io ne rs pu rch as eda co nd om in iu m un itat 2 74 7 Vi a Cap ri, Cl earwa te r, Flo rid a (Vi a Cap ri p ro pe rty), for $ 60 3,0 85 . In Ap ril 20 05 pe ti ti on ers pu rch as eda se co ndco nd om in iu m un it(al so inCle arwat er) a t 2 72 9 Vi a Muran o (ViaMu ran o p ro pe rty) for $ 49 2,2 80 . Peti ti on ers ob ta in edm ortg ag e lo an s fr om Fi fth Thi rdMo rtg ag e Co . (Fif th Thi rd ) to pu rch as e th e two pro pe rti es . The Fi fth Thi rdlo ando cum en ts are n otpa rt o f th e rec or d. II. AJH Re so ur ces , LLC Pet it io ne rs each he lda 49 .5% i nt eres t i n AJ H Res ou rces , LLC (AJH), fro m 20 05 th ro ug h a t l eas t 2 01 0. Zan de r So lu ti on s, In c., he lda 1% i nt eres t i n AJ H. 4 Dur in g 2 00 5 p et it io ne rs tra ns ferr edown ers hi p o f th e ViaCap ri a ndVia M ur an o pr op ert ie s t o AJ H, whi chintu rnact edas l an dl or d a ndlea se d t he two pro pe rti es fro m 20 05 to 20 08
. III. Fo recl os ur e Act io n In20 08 Fif

th Thi rdfil eda la wsu itag ai ns t p et it io ne rs inth e Ci rcu itCo urt fo r th e Si xt h J ud ic ia l Ci rcu itinPin el la s C ou nty , Flo rid a, to for ecl os e th e AJH i s a l im it edli ab il ity

co m pa ny with at l eas t two m em be rs . Becau se 4 AJH d idno t el ectto be tre at edas aco rp or at io n, i t i s treat edas apa rtn ers hi p (aso cal le d p as st hr ou gh en ti ty) for Fe de ral in co m e ta x p ur po se s, an d i ts pro fit s an d lo ss es “pa ss th ro ug h” th e en ti ty to the own ers , cal le d m em be rs . Sec. 3 01 .77 01
- 3( a) an d (b )(1 )(i ), Pro ced . & Adm in . Reg s.- 5 -

[* 5] m ortg ag es on th e ViaCap ri a ndVia M ur an o p ro pe rti es an d t o re co ve r de fic ie nc ie s fr om

th em (fo recl os ur e li ti ga ti on ). Pet it io ne rs fil eda co un te rcl ai m ag ai ns t Fi fth Thi rd
. 5 The cir cu itco urt en te redfin al jud gm en ts of f or ecl os ur e in fav orof F ift h Thi rdinres pe ctof b oth p ro pe rti es , andFif th Thi rdsubs eque nt ly w as th e su cces sf ul bi dd er wh enth e p ro pe rti es were s ol d a t fo recl os ur e sa le s o n Dec em be r 19 , 20 08 . Fift h Th irdlat er fi le d am ot io n fo r en try of d efi ci en cy jud gm en ts ag ai ns t p et it io ne rs inres pe ctof b ot h p ro pe rti es . As di sc us se d b el ow, Fi fthThi rd ’s
m ot io n fo r en try of d efi ci en cy jud gm en ts an d p et it io ne rs ’ co un te rcl ai m rem ai ne d
un res ol ve d u nt il th ey

ag reedto set tl e th e fo recl os ur e li ti ga ti on in20 11
. Inth e in te rim Fi fthThi rdis su edto Mr. Herwi g F orm s 1 09 9- A, Acqu is it io n orAban do nm en t o f Sec ur edPro pe rty, for 2 00 8 re po rti ng th at(1) th e b al an ce due on th e m ortg ag e o n t he Via Capr i p ro pe rty was $ 57 4,1 00 an d the fai r m ark etva lu e of th e p ro pe rty was $ 10 0,0 00 , and(2) th e b al an ce due on th e m ortg ag e o n t he Via Mu ran o p ro pe rty was $ 47 1,1 00 an d t he fai r m ark etva lu e o f th e p ro pe rty was $1 02 ,00 0.

The reco rddo es no t re fle ctth e n atur e o f pe ti ti on ers ’ cau se of a ct io n a ga in st 5 Fi fth Thi rd
.- 6 -

[* 6] IV. AJH’s Tax R eturns 6 The reco rdin cl ud es Fo rm s 1 06 5, U.S. Return o f Part ne rs hi p In co m e, th at AJH fi le d fo r th e ta xabl e y ears 20 08 , 20 09 , and20 10
. AJH rep orte d a n o rd in ary bu si ne ss lo ss of $ 1,8 00 on it s Fo rm 10 65 for20 08
an d a tt ach edto th atreturn (1 ) a Sch edul e D, Cap it al Gain s an d Lo ss es , rep orti ng a sh ort-t erm

cap it al lo ss of $ 7,2 16 an d alo ng -te rm cap it al lo ss of $ 98 ,72 1, (2) a 7 Fo rm 88 25 , Ren ta l Re al Est at e In co m e an d Ex pe ns es of aPartne rs hi p o r anS Co rp or at io n, re po rti ng a ne t re nt al real est at e lo ss of $ 31 ,34 8 att rib ut ab le to th e Via C ap ri a ndVia M ur an o p ro pe rti es , and(3) a Sch edul e L, Bal an ce Sh eet s p er Bo ok s, re po rti ng th atitown edbu il di ng s an d o th er d ep reci ab le ass et s wi th a va lu e of $1 ,04 5,1 00 at the en d o f th e y ear. AJH is su edSch edul es K-1, Partn er’s Sh are 8 of Inc om e, Deduc ti on s, Cr ed it s, et c., to pe ti ti on ers in di cat in g t ha t the y each
co nt rib ut edcap it al of $ 2,2 91 du rin g 2 00 8.
The pa rti es st ip ul at edth atfro m 20 05 to 20 08 AJH cl ai m edde du ct io ns for 6 de pr eci at io n o n t he Via Capr i an d Vi a Mu ran o p ro pe rti es to ta li ng $7 3,9 36 an d $6 0,6 68 , res pe ct iv el y . Inad di ti on to it s re nt al real est at e act iv it y , AJH tr ad edsec ur it ie s dur in g t he 7 y ears inis su e. Und er the cir cu m st an ces , we in fer tha t thi s en try refers to th e ViaCap ri a nd 8 Via M ur an o p ro pe rti es . There is no co rres po nd in g e nt ry on th e Sch edul e L, ho wev er, fo r bu il di ng s an d o th er d ep reci ab le ass et s o wne d a t the be gi nn in g o f 20 08
.- 7 -

[* 7] AJH rep orte d a n o rd in ary bu si ne ss lo ss of $ 2,4 10 on it s Fo rm 10 65 for20 09
an d a tt ach edto th atreturn (1 ) a Sch edul e D rep orti ng a sh ort-t erm cap it al lo ss of $6 ,54 0, an d (2 ) a Sch edul e L rep orti ng th atitown edbu il di ng s an d o th er de pr eci ab le ass et s wi th a va lu e o f $1 ,04 5,1 00 at t he be gi nn in g o f th e y ear. AJH 9 is su edSch edul es K-1 t o p et it io ne rs in di cat in g tha t the y each co nt rib ut edcap it al of $7 0,9 32 du rin g 2 00 9. AJH fi le d aFo rm

10 65 for20 10 an d c he ck eda bo x o n the form in di cat in g th atitwas a“ Fi na l re tu rn ”. AJH rep orte d t ha t i t h adno rece ip ts an d n o e xp en se s du rin g 2 01 0. V. Peti ti on ers ’ Tax Returns Pet it io ne rs fil edjoi ntFo rm s 1 04 0, U.S. In di vi du al Inc om e Tax Return, fo r th e y ears inis su e. Pet it io ne rs att ach edSch edul es E to th ei r returns rep orti ng in rel ev an t p art“ no np as si ve ” lo ss es of $ 97 ,85 1, $ 33 ,60 8, an d $ 2,3 86 for 20 07 , 20 08 , an d 2 00 9, re sp ect iv el y , whi chth ey att rib ut edto th ei r in te res ts inAJH. Pet it io ne rs rep orte d alo ss of $ 89 3,3 94 on Fo rm 47 97 att ach edto th ei r Fo rm 10 40 for20 08 in
co nn ect io n wi th th e ViaCap ri andVia M ur an o p ro pe rty fore cl os ur es . Peti ti on ers carr ie d o ve r $7 68 ,20 8 o f th e lo ss de sc rib edab ov e to th ei r Fo rm 10 40 for20 09
.
The re i s n o c orres po nd in g e nt ry on th e Sch edul e L forbu il di ng s an d o th er 9 de pr eci ab le ass et s o wne d a t the en d o f 20 09
.- 8 -

[* 8] VI. Peti ti on ers ’ Set tl em en t With Fif th Thi rd InJu ly 201 1 p et it io ne rs ex ecu te d aset tl em en t ag reem en t an d re le as e (s et tl em en t ag reem en t) wi th Fif th Thi rdwhi chst at es th at , inco ns id erat io n o f Fi fth Thi rd ’s agr eem en t t o wai ve an y de fic ie nc y

jud gm en ts ari si ng ag ai ns t p et it io ne rs in
res pe ctof t he Via Capr i an d Vi a Mu ran o p ro pe rty fore cl os ur es , pet it io ne rs ag reed to di sm is s wi th pre

jud ic e th e co un te rcl ai m

th atth ey ha d fi le d a ga in stFif

th Thi rd
. VII. Not ic e o f Defi ci en cy Res po nd en t d et erm in edinrel ev an t p artth atde du ct io ns th atpe ti ti on ers cl ai m edforlo ss es att rib ut ab le to th ei r in te res ts inAJH were pa ss iv e act iv ity lo ss es withi n t he m ean in g o f se ct io n 4 69 . Res po nd en t fu rth er d et erm in edth at , bec au se pe ti ti on ers di d n otsh ow tha t the y ha d d is po se d o f th ei r “ en ti re i nt eres t” inAJH withi n t he m ean in g o f se ct io n 4 69 (h ), orth atth ey ha d p as si ve in co m e dur in g t he y ears inis su e, th e su sp en de d l os se s wer e carrie d fo rwardto th e ta xabl e y ear 2 01 0. VIII. Pet it io n Pet it io ne rs fil eda ti m el y

pe ti ti on forred et erm in at io n. Th e p et it io n a ll eg es th atpe ti ti on ers were “ m at eri al ly part ic ip at in g re al est at e p ro fes si on al [s ]” durin g th e y ears inis su e. As m en ti on edab ov e, pe ti ti on ers subs eque nt ly con ced edth at
res po nd en t co rrec tl y

de te rm in edth atpo rti on s o f th e d educ ti on s tha t the y cla im ed- 9 -

[* 9] forlo ss es att rib ut ab le to th ei r in te res ts inAJH were pa ss iv e act iv it y lo ss es withi n t he m ean in g o f se ct io n 4 69
. IX. Deve lo pm en ts at Tri al Pet it io ne rs di d n ottes ti fy at t ria l, n ordi d t he y

cal l an y witne ss es to tes ti fy
. The trans cri ptof t he pro ceed in gs is li m it edto co un se ls ’ op en in g s ta te m en ts an d
or al arg um en t an d t he adm is si on of a n e xh ib itoff eredin to ev id en ce b y

pe ti ti on ers ’
co un se l. Pet it io ne rs ’ co un se l b eg anhi s p res en ta ti on by info rm in g t he Co urt tha t pe ti ti on ers ha d re cen tl y

di sc ov eredth atth ey

ha d n ev er “ de ed ed ” th e ViaCap ri a nd Via M ur an o p ro pe rti es to AJH. He th enm ad e anora l m ot io n t o re sc in d a st at em en t i n t he pa rti es ’ st ip ul at io n o f fact s (e xe cu te d t wo d ay s ea rli er) tha t pe ti ti on ers ha d t ran sf

erre d t he pro pe rti es to AJH dur in g 2 00 5. Th e Co urt d en ie d pe ti ti on ers ’ co un se l’s o ral m ot io n t o re sc in d g iv enth atres po nd en t wo ul d b e un du ly prejud ic edif p et it io ne rs were p erm itte d t o ra is e th atis su e fo r th e fi rs t t im e attri al
. 1 0 Pet it io ne rs di d n otrai se an y is su e rel at edto th e tr an sf er o f th e p ro pe rti es to 1 0 AJH i n t he ir p et it io n o r inanam en de d p le ad in g, n ordi d the y fil e a p retria l m em or an du m

rai si ng th e is su e. W e d o n otco ns id er an is su e th atha s n otbe en pl ead ed . See, e.g ., Fren tz v. Co m m is si on er, 4 4 T.C. 4 85 , 49 1 (1 96 5) , aff’d, 3 75 F.2 d 6 62 (6t h C ir. 1 96 7) . This is pa rti cu la rly tru e in a cas e li ke th is wher e th e is su e can no t b e co ns id eredwitho utsu rp ris e an d p reju di ce t o t he op po si ng pa rty. (co nt in ue d...)- 10 -

[* 10 ] The ex hi bi t ad m it te d i nt o e vi de nc e attri al was aco py of p et it io ne rs ’ Ju ly 20 11 set tl em en t ag reem en t wi thFif thThi rd . In the li gh t o f th e se tt le m en t ag reem en t, the pa rti es ag reedth atpe ti ti on ers ha d c an cel la ti on of i nd eb te dn es s (COD) i nc om e in 20 11 inco nn ect io n wi th th e ViaCap ri a ndVia M ur an o p ro pe rty fo recl os ur es (as op po se d t o 2 00 8 a s s ta te d i n t he pa rti es ’ st ip ul at io n o f fac ts ). Pet it io ne rs ’ co un se l wen t o n t o s ta te th at , in so far a s AJ H hadfil eda Fo rm 10 65 for20 10 , cle arl y

m ark ed“ Fi na l re turn ”, itwas p et it io ne rs ’ po si ti on th atth ey sh ou ldbe de em edto ha ve di sp os edof t he ir e nt ire in te res ts inth e p as si ve act iv ity withi n t he m ean in g o f se ct io n 4 69 (g ) du rin g 2 01 0. OPINION As a g en eral rul e, th e Co m m is si on er’s d et erm in at io n o f a t ax pa y er’s l iabi li ty in a no ti ce o f de fic ie nc y

is pre su m edco rrec t, an d t he tax pay er b ears th e b ur de n o f pr ov in g t ha t the de te rm in at io n i s i nc orrect . Rul e 1 42 (a); W el chv. Hel ve rin g, 2 90 U.S. 11 1, 1 15 (19 33 ). Pet it io ne rs do no t co nt en d tha t the bu rd enof p ro of sh ift s t o res po nd en t und er s ect io n 7 49 1( a). Inan y ev en t, b ecau se we de ci de th e que st io n whe th er p et it io ne rs di sp os edof t he ir e nt ire in te res ts inth e und erl y in g p as si ve act iv ity on th e p rep on de ran ce o f th e ev id en ce, the all oc at io n o f th e b ur de n o f (...co nt in ue d) 1 0 See Es ta te of M an de ls v. Co m m is si on er, 6 4 T.C. 6 1, 7 3 (1 97 5)
.- 11 -

[* 11 ] pro of

as t o t ha t i ss ue is imm at eri al . See Knud se n v . Comm is si on er, 1 31 T.C. 18 5, 1 89 (20 08 ). Deduc ti on s ar e a m at te r of leg is la ti ve gra ce, an d t he tax pa y er g en eral ly be ars th e b ur de n o f pr ov in g e nt it le m en t t o a ny deduc ti on cla im ed . Rul e 1 42 (a); INDOPCO, In c. v. Co m

m is si on er, 5 03 U.S. 79 , 84 (19 92 ); Ne w Col on ia l Ic e Co
. v. Hel ve rin g, 2 92 U.S. 43 5, 4 40 (19 34 ). A tax pa y er cl ai m in g ade du ct io n o n a Fed eral in co m e ta x re tu rnm us t d em on st rat e th atth e d educ ti on is all owabl e pu rs ua ntto a st atut ory

pro vi si on an d m

us t fu rth er s ub st an ti at e th atth e ex pe ns e to whi chth e d educ ti on rel at es ha s b eenpa idor i nc urred . Sec. 6 00 1; see Hrad es ky v. Co m m is si on er, 6 5 T.C. 8 7, 8 9- 90 (19 76 ), aff’d, 5 40 F.2d82 1 (5 th Cir . 19 76 ). I. Pas si ve Acti vi ty L os se s Tax pa y ers are al lo wedde du ct io ns forcert ai n b us in es s an d i nv es tm en t
ex pe ns es un de r se ct io ns 16 2 and21 2. Se ct io n 4 69 (a), h owe ve r, ge ne ral ly di sa ll ows pa ss iv e act iv ity lo ss es an d c red it s. A pa ss iv e act iv it y lo ss is de fin edas th e ex ces s o f th e ag gr eg at e lo ss es fro m all pa ss iv e act iv it ie s fo r a t ax ab le y ear o ve r th e ag gr eg at e in co m e fro m all pa ss iv e act iv it ie s fo r th aty ear. Se c. 46 9( d) (1 ). W it h e xc ep ti on s n otrel ev an t h ere, re nt al act iv it ie s ar e p as si ve act iv it ie s. Sec
. 46 9( c)(2 ).- 12 -

[* 12 ] Inacco rd an ce wi th sec ti on 46 9( b) , a pa ss iv e act iv it y lo ss di sa ll owe d u nd er
se ct io n 4 69 foran y

tax ab le y ear i s ca rri edforwardan d treat edas ade du ct io n al lo cab le to su chact iv ity inth e n ex t t ax ab le y ear. If i t turns ou t tha t the act iv it y res ul ts inad di ti on al pa ss iv e act iv it y lo ss es inth e carry ov er y ear ( an d i n t he ab se nc e o f pa ss iv e in co m e fro m so m e o th er ac ti vi ty), the su sp en de d p as si ve lo ss es are c arri edforwardto th e su ccee di ng tax ab le y ear b y ap pl ic at io n o f se ct io n 46 9( b) . See Lan gi ll e v . Comm is si on er, T.C. Mem o. 2 01 0- 49 , aff’d, 4 47 Fed
. App x. 1 30 (11 th Cir . 20 11 ). Sus pe nd edpa ss iv e lo ss es m ay be carr ie d fo rward in de fin it el y

by thi s p ro ces s u nt il th ey are u se d. Id
. Sect io n 4 69 (g ) pr ov id es th atpa ss iv e lo ss es th atha ve be ensu sp en de d a s de sc rib edab ov e are ge ne ral ly allo wedwhen th e ta xp ay er “ di sp os es of h is en ti re in te res t i n a ny pas si ve act iv ity ”. See B il th ou se v. Un it edSta te s, 5 53 F.3d51 3, 51 5 (7 thCir . 20 09 ). Mo re s pe ci fic al ly, se ct io n 4 69 (g )(1 ) pr ov id es th at , if a ta xp ay er d is po se s o f hi s en ti re i nt eres t i n apa ss iv e act iv it y ina tr an sa ct io n wi th an un rel at edpa rty where all of t he ga in or l os s re al iz edon th e d is po si ti on of t he in te res t i s re co gn iz ed , th e ex ces s o f an y lo ss fro m

su chact iv it y

forth e ta xabl e y ear (in cl ud in g s us pe nd edpa ss iv e lo ss es fro m anearl ie r ta xabl e y ear) , ov er an y ne t in co m e o r ga in forsu chtax ab le y ear f ro m all ot he r pa ss iv e act iv it ie s (d et erm in ed aft er the ap pl ic at io n o f subs ect io n (b )), s ha ll be tre at edas alo ss whi chis no t fr om- 13 -

[* 13 ] a pa ss iv e act iv ity . See Lo we v. Co m m is si on er, T.C. Mem o. 2 00 8- 29 8. Th e
ex ces s l os s, i f an y , no rm al ly offs et s the tax pa y er’s i nc om e fo r th e lo ss y ear, an d
an y rem ai ni ng lo ss es are carri edba ckto th e two pre ced in g years a ndth encarr ie d fo rwardto th e 2 0 years f

ol lo win g t he lo ss y ear i n a cco rd an ce wi th th e p ro vi si on s of sec ti on 17 2. Inth e cas e o f anS co rp or at io n, a p artne rs hi p, o r a g ran to r trus t, the rul es pr es cri be d i n s ect io n 4 69 (g ) li ke wis e ap pl y whenth e en ti ty dis po se s o f it s en ti re in te res t i n apa ss iv e act iv ity . See S. Rep t. No . 99 -3 13 , at 7 25 (19 86 ), 19 86 -3 C.B. (Vo l. 3 ) 1, 7 25 -7 26 . If th e en ti ty carrie s o n m or e th anon e act iv it y , th e en ti ty’ s sa le or e xc hang e o f al l as se ts of apa ss iv e act iv it y is su ffi ci en t t o i nv ok e th e pr ov is io ns of s ect io n 4 69 (g ), ev enif o th er as se ts are re ta in ed . Id. 1 1

Inth is reg ard , sec . 1.4 69 -4 (g ), In co m e Tax Reg s., p ro vi de s as fol lo ws: 1 1 (g ) Treat m en t o f parti al di sp os it io ns .--A ta xp ay er m ay , forth e ta xabl e y ear i n wh ic h t he re i s a d is po si ti on of s ub st an ti al ly all o f an act iv ity , tre atth e p artdi sp os edof a s a s ep arat e act iv ity , bu t o nl y if the ta xp ay er ca n e st ab li sh with re as on ab le cert ai nt y -- (1 ) The am ou ntof d educ ti on s an d c red it s al lo cab le to th atpa rt of th e act iv ity

for th e ta xabl e y ear u nd er § 1.4 69 -1 (f)(4 ) (rel at in g t o carry ov er o f di sa ll owe d d educ ti on s an d c red it s) ; an d (2 ) The am ou ntof g ro ss in co m e an d o f an y ot he r de du ct io ns an d c red it s al lo cab le to th atpa rt o f th e act iv ity forth e ta xabl e y ear.- 14 -

[* 14 ] Sect io n 4 69 (g ) do es no t d efi ne or d es cri be whatco ns ti tu te s a f ul ly tax ab le di sp os it io n, an d t he re ar e n o re gu lati on s el ab or at in g o n t he pri nc ip le . One
co m m en ta to r ha s o bs erv ed : “ Sect io n 4 69 is m ean t t o c ur b arti fic ia l t ax lo ss es , no t
on th e u lt im at e d educ ti bi li ty of eco no m ic lo ss es . Whe n a n i nv es tm en t i n apa ss iv e act iv ity is so ldan d the cum

ul at iv e res ul t o f th e in ve st m en t (i nc lu di ng ga in or l os s on sal e) i s a l os s, the lo ss is aneco no m ic lo ss , no t an art ifi ci al tax lo ss , andou gh t to be all owe d.” Bor is I. Bit tk er & Lawre nc e Lokke n, Fe de ral Taxa ti onof I nc om e, Est at es an d Gi fts , par a. 28 .10 .1, at28 -9 5 t o 2 8- 96 (3ded . 19 99 ). Pet it io ne rs no lo ng er d is pu te th atth e lo ss es th ey cla im edinco nn ect io n wi th AJH’s ren ta l re al est at e act iv it ie s wer e p as si ve lo ss es withi n t he m ean in g o f
se ct io n 4 69 . Peti ti on ers co nt en d, h owe ve r, th atth ey di sp os edof t he ir e nt ire in te res ts inth e p as si ve act iv ity when Fif th Thi rdfor ecl os edon th e p ro pe rti es in Decem be r 20 08 or, i n t he alt ern at iv e, whe n AJ H fil edit s “ Fi na l re tu rn ” in20 10
. 1 2

Altho ug h t he no ti ce o f de fic ie nc y up on whi chth is cas e is ba se d d oe s n ot 1 2 co nc ernth e ta xabl e y ear 2 01 0, s ec. 6 21 4( b) pro vi de s i n re le va ntpa rt t ha t, i n red et erm in in g ade fic ie nc y foran y tax ab le y ear, the Co urt s ha ll co ns id er s uc h fa ct s with re la ti on to th e ta xe s fo r othe r y ears as m ay be ne ces sa ry

co rrec tl y to red et erm in e th e am ou ntof s uc h d efi ci en cy . Con si st en t wi th sec . 62 14 (b ), th e Co urt h as juri sd ic ti on to co ns id er p et it io ne rs ’ cl ai m th atth ey m ay carry ba ck su sp en de d p as si ve lo ss es fro m th e ta xabl e y ear 2 01 0 t o t he tax ab le y ears inis su e (i.e ., 20 08 an d 2 00 9) . See Ca lu m etIndus ., Inc . v. Co m mis si on er, 9 5 T.C. 2 57 , 27 4- 27 6 (1 99 0)
.- 15 -

[* 15 ] W e are no t co nv in ced , onth is reco rd , th atpe ti ti on ers sat is fie d t he requi rem en ts of s ect io n 4 69 (g ) whe n F ift h Th irdfor ecl os edon th e ViaCap ri a nd Via M ur an o p ro pe rti es inDecem be r 20 08 . As pr ev io us ly m en ti on ed , sec ti on 46 9( g) co nt em

pl at es th atth e ta xp ay er m us t d is po se of h is or h er en ti re i nt eres t i n a pa ss iv e act iv ity

ina tr an sa ct io n wi th anun rel at edpa rty un de r whi chall ga in or lo ss real iz edon su chdi sp os it io n i s re co gn iz ed
. Sect io n 1 00 1 s et s fo rth th e ru le s g ov ern in g t he co m pu ta ti on of g ai n o r lo ss real iz edfro m

th e sa le or o th er d is po si ti on of p ro pe rty. Afor ecl os ur e sa le
no rm al ly con st itut es a di sp os it io n o f pr op erty forpurp os es of s ect io n 1 00 1( a). See Helv eri ng v. Hamm el , 31 1 U.S. 5 04 (19 41 ); Ry anv. Co m m is si on er, T.C. Mem o. 19 88 -1 2, af

f’d sub n om . Lam

m v. Co m m is si on er, 8 73 F.2d19 4 (8 th Cir . 19 89 ).

“ A for ecl os ur e act io n t ha t i s b ei ng ap pe al ed[, ho wev er,] is n ot‘ fin al ’ in th e no rm al sen se of tha t wo rd .” See Gre atPla in s Gas ifi cat io n As so cs . v. Co m m is si on er, T.C. Mem o. 2 00 6- 27 6 (quo ti ng Ry anv. Co m mis si on er, T.C. Mem o. 1 99 8- 12 ). Altho ug h F ift h Th irdfor ecl os edon th e p ro pe rti es inDecem be r 20 08 , we no te th atAJH co nt inue d t o l is t the pro pe rti es as a ss et s o n S ch edul es L att ach edto it s Fo rm s 1 06 5 fo r 20 08 an d 2 00 9. Pe ti ti on ers off eredno expl an at io n wh y

th is
was th e cas e if

infactth e fo recl os ur e sa le s wer e fi na l i n 2 00 8. Mo reo ve r, Fif th- 16 -

[* 16 ] Thi rd ’s m ot io n fo r en try of d efi ci en cy jud gm en ts ag ai ns t p et it io ne rs an d pe ti ti on ers ’ co un te rcl ai m ag ai ns t Fi fthThi rdwere p en di ng inth e fo recl os ur e li ti ga ti on un ti l b ot h m at te rs were s et tl edinJu ly 201 1. Th e p art ie s ag reedat tria l th at , inth e li gh t o f th e Fi fth Thi rdset tl em en t ag reem en t, p et it io ne rs real iz edCOD in co m e in20 11 (as op po se d t o 2 00 8 a s the y in it ia ll y ass um ed ). Co ns id eri ng th e un cert ai nt ie s i nh eren t i n t he on go in g l it ig at io n, we co nc lu de th atth e cu m ul at iv e eco no m ic effe ctof p et it io ne rs ’ in ve st m en t i n t he pa ss iv e act iv it y --a fi na l
acco un ti ng of t he ga inor l os s re al iz edon th e d is po si ti on of t he pa ss iv e act iv it y an d re co gn it io n o f an y

ga in or l os s fo r ta x p ur

po se s- -co ul d n otbe de te rm in edin 20 08 . Con se qu en tl y , pet it io ne rs di d n otdi sp os e o f th ei r en ti re i nt eres ts inth e pa ss iv e act iv ity

withi n t he m ean in g o f se ct io n 4 69 (g ) as a res ul t o f th e Fi fth Thi rd fo recl os ur e act io ns inDecem be r 20 08 , andth ei r su sp en de d p as si ve lo ss es were no t el ig ib le to be tre at edas n onpa ss iv e lo ss es forth aty ear. W e li ke wis e ag ree wi th res po nd en t tha t the tax return t ha t AJ H fil edfor 20 10 , m ark ed“ Fi na l re tu rn ”, do es no t d em on st rat e th atpe ti ti on ers di sp os edof th ei r en ti re i nt eres ts inAJH wit hi n t he m ean in g o f se ct io n 4 69 (g ). Co nt rary to pe ti ti on ers ’ po si ti on , a tax return a lo ne is no t p ro of of t he st at em en ts co nt ai ne d th erei n; a ta x re turnm erel y set s fo rth th e ta xp ay er’s cl ai m . See Ro be rts v. Co m m is si on er, 6 2 T.C. 8 34 , 83 7 (1 97 4) ; Se ab oa rdCo m m erci al Co rp . v.- 17 -

[* 17 ] Co m

m is si on er, 2 8 T.C. 1 03 4, 1 05 1 (1 95 7) . Peti ti on ers off eredno tes ti m on y th em se lv es , andth ey

di d n otcal l an y

witne ss es to ad dr es s the accu racy of AJH’s Fo rm 10 65 for20 10 . In the ab se nc e o f an y ob jecti ve ev id en ce tha t AJ H wou ndup it s b us in es s an d was no lo ng er en ga ge d i n p as si ve act iv it ie s dur in g 2 01 0, we ar e un ab le to co nc lu de th atpe ti ti on ers di sp os edof the ir e nt ire in te res ts inth e p as si ve act iv it y inqu es ti on withi n t he m ean in g o f se ct io n 4 69 (g ). II. Accu racy-Rel at edPen al ty Sect io n 6 66 2( a) an d (b )(1 ) im po se s a p en al ty equ al to 20 % of t he am ou ntof
an y un de rp aym en t at tri bu tabl e to ne gl ig en ce o r di sr eg ardof rul es or r eg ul at io ns . The term “ ne gl ig en ce” i nc lu de s an y fai lu re t o m ak e a rea so nabl e at te m ptto
co m pl y with t ax laws , and“ di sr eg ard ” in cl ud es an y care le ss , reck le ss , or in te nt io na l d is reg ardof rul es or r eg ul at io ns . Sec. 6 66 2( c). Neg li ge nc e al so in cl ud es an y

fai lu re t o k eep ad equa te bo ok s an d re co rd s o r to subs ta nt ia te it em s pr op erl y . Sec. 1 .66 62 -3 (b )(1 ), In co m e Tax Reg s.; see Oli ve v. Co m mis si on er, 1 39 T.C. 19 , 43 (20 12 ). Sect io n 6 66 4( c)(1 ) pr ov id es anex cep ti onto th e im po si ti onof t he accu racyrel at edpe na lty

if the tax pa y er es tabl is he s tha t the re was reas on ab le cau se for , and th e ta xp ay er ac te d i n g oo d fa ith wi th res pe ctto , th e und erp aym en t. Sec . 1.6 66 4- 4( a), In co m e Tax Reg s. Th e d et erm in at io n o f whe th er the tax pa y er ac te d wi th- 18 -

[* 18 ] reas on ab le cau se an d i n g oo d fa it h i s m ad e o n acas e-b y -cas e b as is , tak in g in to acco un t the pe rti ne ntfact s an d c irc um st an ces . Sec. 1 .66 64 -4 (b )(1 ), In co m e Tax Reg s. W ith re sp ectto a ta xp ay er’s l iabi li ty for an y pe na lt y , sec ti on 74 91 (c) p la ces on th e Co m

m is si on er the bu rd enof p ro du ct io n, the reb y requi rin g t he Co m m is si on er t o c om e fo rwardwith s uf fic ie ntev id en ce i nd ic at in g t ha t i t i s ap pr op ria te to im

po se th e p en al ty. Once th e Co m m is si on er m eet s h is bu rd enof pr oduc ti on , th e ta xp ay er m us t co m e fo rwardwith p ers ua si ve ev id en ce tha t the Co m m is si on er’s d et erm in at io n i s i nc orrect . Hig be e v . Comm is si on er, 1 16 T.C. 43 8, 4 47 (20 01 ); s ee Ru le 14 2( a); W el chv. Hel ve rin g, 2 90 U.S. at 1 15
. Res po nd en t h as di sc ha rg edhi s b ur de n o f pr oduc ti on un de r se ct io n 7 49 1( c) in as m uc h a s p et it io ne rs ha ve co nc ed edth atth ey were n oten ti tl edto nu m ero us de du ct io ns foreach of t he y ears inis su e. See s ec. 1 .66 62 -3 (b )(1 ), In co m e Tax Reg s. Pet it io ne rs di d n ottes ti fy at t ria l, an d t he y

di d n otoff

er an y othe r ev id en ce in supp ort o f th e p ro po si ti on th atth ey ha d re as on ab le cau se for , andth ey act ed in go odfai th with re sp ectto , th e und erp aym en ts forth e y ears inis su e. See s ec. 1.6 66 4- 4( a), In co m e Tax Reg s. Co ns eque nt ly, we su st ai n re sp on de nt ’s- 19 -

[* 19 ] de te rm in at io n tha t p et it io ne rs are l iabl e fo r acc ur acy-rela te d p en al ti es un de r
se ct io n 6 66 2( a) an d (b )(1 ) fo r th e y ears inis su e. To re fle ctth e fo reg oi ng , Deci si on wil l b e en te red
un de r Ru le 15 5.