T.C. Summary Opinion 2009-29

UNITED STATES TAX COURT

SHRI G. AND SUDHA AGARWAL, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 12670-07S. Filed March 2, 2009.

Shri G. and Sudha Agarwal, pro sese.

Kris H. An, for respondent.

DEAN, Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code

(Code) in effect when the petition was filed. Pursuant to

section 7463(b), the decision to be entered is not reviewable by

any other court, and this opinion shall not be treated as

precedent for any other case. Unless otherwise indicated,

subsequent section references are to the Code in effect for the
- 2 -

1In a “Stipulation of Settled Issues” the parties agree

that: (1) Petitioners are entitled to a net capital loss of $856

(rather than $5,988.16) for 2001; (2) they are not entitled to a

self-employed health insurance deduction of $2,332 for 2001; (3)

they are not entitled to additional exemptions of $9,048 and

$1,920 for 2001 and 2002, respectively; and (4) itemized

deductions adjustments for 2001 and 2002 are computational.

years in issue, and all Rule references are to the Tax Court

Rules of Practice and Procedure. 

Respondent determined deficiencies of $15,066 and $6,649 in

petitioners’ 2001 and 2002 Federal income taxes, respectively. 

Respondent also determined accuracy-related penalties under

section 6662(a) of $3,013.20 and $1,329.80 for 2001 and 2002,

respectively.

After concessions by the parties,1 the issues remaining for

decision are whether petitioners are: (1) Entitled to deduct on

Schedule E, Supplemental Income and Loss, losses of $40,104 and

$19,656 for 2001 and 2002, respectively, as qualifying taxpayers

in real property trades or businesses; and (2) liable for the

accuracy-related penalty for each year.

Background

Some of the facts have been stipulated and are so found.

The stipulation of facts and the exhibits received into evidence

are incorporated herein by reference. When the petition was

filed, petitioners resided in California.
- 3 -

2The brokerage firm is a licensed broker under California

law. The brokerage firm is franchised by a broker, Albert

Foulad. 

3Mrs. Agarwal became a licensed broker in December 2007.

During 2001 and 2002 Shri Agarwal (Mr. Agarwal) worked full

time as an engineer. During 2001 and 2002 Sudha Agarwal (Mrs.

Agarwal) worked full time as a real estate agent at “Century 21

Albert Foulad Realty” (brokerage firm).2 During 2001 and 2002

Mrs. Agarwal was licensed as a real estate agent under California

law; she was not a licensed as a broker.3 She worked for a

brokerage firm pursuant to an “Independent Contractor Agreement

(Between Broker and Associate Licensee)”. The contract provided

that she was an independent contractor, not an employee of the

brokerage firm. Consistent with Mrs. Agarwal’s independent

contractor status, the brokerage firm issued a Form 1099 to her

for each year, and it did not pay her a salary; rather, she

received commissions. The contract also required Mrs. Agarwal to

sell, exchange, lease, or rent properties and solicit additional

listings, clients, and customers diligently and with her best

efforts. 

During 2001 and 2002 petitioners owned two rental

properties. Together they spent approximately 170 hours managing

the “Wanda Property” and approximately 170 hours managing the

“Mohave Property” during 2001 and 2002. They were the only

persons who managed their rental properties. Mrs. Agarwal spent
- 4 -

a total of 1,400 and 1,600 hours managing petitioners’ rental

properties and selling real estate in 2001 and 2002,

respectively.

For 2001 Mrs. Agarwal reported commissions of $13,912 as

gross receipts on Schedule C, Profit or Loss From Business. She

also reported total expenses of $14,084 for a $172 loss with

respect to her Schedule C real estate business. For 2002 she

reported commissions of $14,119 as gross receipts on Schedule C

and total expenses of $13,401 for a profit of $718. 

For 2001 petitioners reported total rents of $36,367 on

Schedule E. They also reported total expenses of $76,471.78 for

a $40,104.78 loss (which they rounded down to $40,104). For 2002

they reported total rents of $45,521 on Schedule E and total

expenses of $65,177 for a $19,656 loss.

In the notice of deficiency issued to petitioners,

respondent disallowed their Schedule E losses for each year

because: (1) Passive losses are allowed only to the extent that

they qualify for the special allowance for rental real estate and

the transitional phase-in rule; and (2) petitioners’ losses were

in excess of their passive income, the special allowance, and the

phase-in rule.
- 5 -

Discussion

I. Burden of Proof

The Commissioner’s determinations in a notice of deficiency

are presumed correct, and the taxpayer bears the burden to prove

that the determinations are in error. See Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933). But the burden of proof on

factual issues that affect the taxpayer’s tax liability may be

shifted to the Commissioner where the “taxpayer introduces

credible evidence with respect to * * * such issue.” See sec.

7491(a)(1). Petitioners have not alleged that section 7491(a)

applies; however, the Court need not decide whether the burden

shifted to respondent since there is no dispute as to any factual

issue. Accordingly, the case is decided by the application of

law to the undisputed facts, and section 7491(a) is inapplicable.

II. Petitioners’ Losses and Application of Section 469

Section 469(a) generally disallows any passive activity

loss. A passive activity loss is defined as the excess of the

aggregate losses over the aggregate income from all passive

activities. Sec. 469(d)(1). A passive activity is any trade or

business or an activity engaged in for the production of income

in which the taxpayer does not materially participate. Sec.

469(c)(1), (6). Material participation means that the taxpayer

is involved in the activity’s operations on a regular,

continuous, and substantial basis. Sec. 469(h); see also sec.
- 6 -

1.469-5T(a), Temporary Income Tax Regs., 53 Fed. Reg. 5725 (Feb.

25, 1988) (an individual is treated as materially participating

if the individual satisfies any one of the seven enumerated

tests). 

The general rule is that a rental activity is treated as a

per se passive activity regardless of whether the taxpayer

materially participates. Sec. 469(c)(2), (4). But under section

469(c)(7), rental activities of a qualifying taxpayer in a real

property trade or business are not a per se passive activity

under section 469(c)(2). Kosonen v. Commissioner, T.C. Memo.

2000-107. Rather, the qualifying taxpayer’s rental activities

are treated as a trade or business--subject to the material

participation requirements of section 469(c)(1). Fowler v.

Commissioner, T.C. Memo. 2002-223; sec. 1.469-9(e)(1), Income Tax

Regs. And in determining whether a taxpayer materially

participates, the participation of the taxpayer’s spouse is taken

into account. Sec. 469(h)(5). 

A taxpayer may qualify for the real property trade or

business exception if: (1) More than one-half of the personal

services performed in trades or businesses by the taxpayer during

the taxable year are performed in real property trades or

businesses in which the taxpayer materially participates; and 

(2) the taxpayer performs more than 750 hours of services during

the taxable year in real property trades or businesses in which
- 7 -

the taxpayer materially participates. Sec. 469(c)(7)(B)(i) and

(ii). In the case of a joint return, either spouse must satisfy

both requirements. Sec. 469(c)(7)(B). 

Section 469(c)(7)(C) defines the term “real property trade

or business” as “any real property development, redevelopment,

construction, reconstruction, acquisition, conversion, rental,

operation, management, leasing, or brokerage trade or business.” 

[Emphasis added.]

A. The Parties’ Arguments

Petitioners argue that real estate agents should be

considered real estate professionals because real estate agents

are engaged in a real property brokerage business in that real

estate agents “bring together buyers and sellers”.

In reply, respondent argues that Mrs. Agarwal was a licensed

real estate agent, not a licensed real estate broker. Thus,

under California law, according to respondent, Mrs. Agarwal could

not be engaged in a brokerage trade or business, and therefore,

she was not engaged in a real property trade or business as

defined by section 469(c)(7)(C). 

B. Brokerage Defined

The term “brokerage” is not defined in section 469, within

the legislative history of section 469, or by any court decision. 

Thus, the Court turns to principles of statutory construction to

determine its meaning. See Baker v. Wash. Group Intl., Inc., No.
- 8 -

1:06-CV-1874 (M.D. Pa. Mar. 14, 2008); Sierra Club v. Leavitt,

355 F. Supp. 2d 544, 555 (D.D.C. 2005); Weber v. Heitkamp (In re

Hopson), 324 Bankr. 284, 287 (S.D. Tex. 2005).

“Statutory words are uniformly presumed, unless the contrary

appears, to be used in their ordinary and usual sense, and with

the meaning commonly attributed to them.” Caminetti v. United

States, 242 U.S. 470, 485-486 (1917). In addition, a statutory

term is construed “in its context and in light of the terms

surrounding it.” Leocal v. Ashcroft, 543 U.S. 1, 9 (2004); see

also Jarecki v. G. D. Searle & Co., 367 U.S. 303, 307 (1961) (“a

word is known by the company it keeps”). Legislatures are

presumed to have intended that a statute’s terms “‘be given a

reasonable construction’”. Hazlett v. Evans, 943 F. Supp. 785,

788 (E.D. Ky. 1996) (quoting D.L.C. v. Walsh, 908 S.W.2d 791 (Mo.

Ct. App. 1995)); see also Beck v. N. Natural Gas Co., 170 F.3d

1018, 1024 (10th Cir. 1999); In re Nofziger, 925 F.2d 428, 435

(D.C. Cir. 1991). 

A term’s common or approved usage may be established by a

dictionary. Rousey v. Jacoway, 544 U.S. 320 (2005); Smith v.

United States, 508 U.S. 223, 228-229 (1993). Webster’s Third New

International Dictionary 282 (2002) defines the term “brokerage”

as “the business of a broker” or “the fee or commission for

transacting business as a broker.” [Emphasis added.] 
- 9 -

The Court concludes that Congress is presumed to have

defined the term “brokerage” in its common or ordinary meaning. 

The Court further concludes that for purposes of section 469, the

“business” of a real estate broker includes, but is not limited

to: (1) Selling, exchanging, purchasing, renting, or leasing

real property; (2) offering to do those activities; (3)

negotiating the terms of a real estate contract; (4) listing of

real property for sale, lease, or exchange; or (5) procuring

prospective sellers, purchasers, lessors, or lessees. See Hooper

v. California, 155 U.S. 648, 657 (1895); Lawrence Gas Co. v.

Hawkeye Oil Co., 165 N.W. 445, 447 (Iowa 1917); Schmidt v.

Maples, 289 N.W. 140, 143 (Mich. 1939); Commonwealth v. Jones &

Robins, Inc., 41 S.E.2d 720, 727 (Va. 1947); In re Pipes, 748

A.2d 118, 121 (N.J. Super. Ct. App. Div. 2000); Commonwealth v.

Fahnestock, 15 Pa. C. 598 (Pa. Quar. Sess. 1895); see also Ky.

Rev. Stat. Ann. sec. 324.010(1) (LexisNexis 2007) (defining “Real

estate brokerage”); Md. Code Ann. Bus. Occ. & Prof. sec.

17-101(l) (LexisNexis 2004 & Supp. 2008) (defining “Provide real

estate brokerage services”); Wis. Stat. Ann. sec. 452.01(3e)

(West 2006) (defining “Brokerage service”).

C. Application of the Definition to Mrs. Agarwal’s

 Activities

As is relevant here, California law defines the term “real

estate broker” as a person who does, or negotiates to do, any one

of the enumerated activities for compensation. Cal. Bus. & Prof.
- 10 -

Code sec. 10131 (West 2008). Similarly, California law also

defines the term “real estate salesman” as a person who is

employed by a broker and who does any one of the enumerated

activities. Cal. Bus. & Prof. Code sec. 10132 (West 2008). But

whether Mrs. Agarwal is characterized as a broker or a

salesperson for State law purposes is irrelevant for Federal

income tax purposes–-the test is whether she was engaged in

“brokerage” within the meaning of section 469, as defined supra. 

Consistent with her real estate salesman’s license and pursuant

to her contract with the brokerage firm, Mrs. Agarwal was engaged

in “brokerage”; i.e., she sold, exchanged, leased, or rented real

property and solicited listings. Therefore, Mrs. Agarwal was

engaged in a “brokerage” trade or business within the meaning of

section 469(c)(7)(C). 

Because Mrs. Agarwal owned an interest in a rental property,

performed more than one-half of her personal services in real

property trades or businesses in which she materially

participated, and performed more than 750 hours of services in

real property trades or businesses in which she materially

participated, she is a qualifying taxpayer. See sec. 469(c)(7);

sec. 1.469-9(b)(6), (c)(1), Income Tax Regs. Because Mrs.

Agarwal is a qualifying taxpayer and she materially participated
- 11 -

4If the taxpayer is a qualifying taxpayer, then each

interest in rental real estate is treated as a separate activity

unless the taxpayer elects to treat all interests in rental real

estate as one activity. Sec. 469(c)(7)(A); Fowler v.

Commissioner, T.C. Memo. 2002-223. And the determination of

whether the qualifying taxpayer materially participated pursuant

to sec. 469(c)(1) must be met with respect to each rental

activity, unless the taxpayer elected to treat all of the

taxpayer’s rental activities as a single activity. Sec.

469(c)(7)(A); Fowler v. Commissioner, supra; Shaw v.

Commissioner, T.C. Memo. 2002-35; sec. 1.469-9(e)(1), (4) Example

(i), Income Tax Regs. 

with respect to each property,4 petitioners are entitled to

deduct their 2001 and 2002 Schedule E losses. See sec.

469(c)(7); sec. 1.469-9(e)(1), (3), (4) Example (i), Income Tax

Regs.; sec. 1.469-5T(a), Temporary Income Tax Regs., supra

(defining material participation); see also Fowler v.

Commissioner, T.C. Memo. 2002-223; Shaw v. Commissioner, T.C.

Memo. 2002-35.

III. Accuracy-Related Penalty

Initially, the Commissioner has the burden of production

with respect to any penalty, addition to tax, or additional

amount. Sec. 7491(c). The Commissioner satisfies this burden of

production by coming forward with sufficient evidence that

indicates that it is appropriate to impose the penalty. See

Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once the

Commissioner satisfies this burden of production, the taxpayer

must persuade the Court that the Commissioner’s determination is
- 12 -

5Because the Court finds that petitioners were negligent or

disregarded rules or regulations, the Court need not discuss

whether there is a substantial understatement of income tax. See

sec. 6662(b); Fields v. Commissioner, T.C. Memo. 2008-207.

in error by supplying sufficient evidence of reasonable cause,

substantial authority, or a similar provision. Id.

In pertinent part, section 6662(a) and (b)(1) and (2)

imposes an accuracy-related penalty equal to 20 percent of the

underpayment that is attributable to: (1) Negligence or

disregard of rules or regulations; or (2) a substantial

understatement of income tax.5 Section 6662(c) defines the term

“negligence” to include “any failure to make a reasonable attempt

to comply with the provisions of this title,” and the term

“disregard” to include “any careless, reckless, or intentional

disregard.” Negligence also includes any failure by the taxpayer

to keep adequate books and records or to substantiate items

properly. Sec. 1.6662-3(b)(1), Income Tax Regs.

Section 6664(c)(1) provides an exception to the section

6662(a) penalty: no penalty is imposed with respect to any

portion of an underpayment if it is shown that there was

reasonable cause therefor and the taxpayer acted in good faith. 

Section 1.6664-4(b)(1), Income Tax Regs., incorporates a facts

and circumstances test to determine whether the taxpayer acted

with reasonable cause and in good faith. The most important

factor is the extent of the taxpayer’s effort to assess his
- 13 -

proper tax liability. Id. “Circumstances that may indicate

reasonable cause and good faith include an honest

misunderstanding of fact or law that is reasonable in light of 

* * * the experience, knowledge, and education of the taxpayer.” 

Id.

Because petitioners concede that they are not entitled to

certain deductions, see supra note 1, the Court finds that

respondent has met his burden of production and that petitioners

were negligent. Petitioners did not establish a defense for

their noncompliance with the Code’s requirements. See sec. 6001

(requiring taxpayers to keep records sufficient to establish the

amounts of the items required to be shown on their Federal income

tax returns). Respondent’s determination is sustained. 

To reflect the foregoing,

Decision will be entered

under Rule 155.