T.C. Memo. 2009-79

UNITED STATES TAX COURT

CARLOS A. AND ANA MARIA SENRA, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 10540-06. Filed April 15, 2009.

P-H owned 86.75 percent of Keys Granite, a C

corporation, and 100 percent of Keys Holdings, a

limited liability company that was treated as a

disregarded entity for tax purposes. Keys Holdings

rented property to Keys Granite. On their 2001 and

2002 tax returns, Ps reported losses from Keys

Holdings’ rental activity and offset those losses

against wages they received from Keys Granite. R

disallowed the losses pursuant to sec. 469, I.R.C.

1986.

Ps contend their activities in Keys Granite and PH’s activity in Keys Holdings constitute an appropriate

economic unit that may be treated as a single activity

for purposes of measuring gain and loss under sec. 469,

I.R.C. 1986.

Held: Because Keys Granite is “a C corporation

subject to section 469”, Ps may group their activities

in Keys Granite with P-H’s activities in Keys Holdings
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1Unless indicated otherwise, all section references are to

sections of the Internal Revenue Code of 1986 as in effect for

the years in issue.

(continued...)

“but only for purposes of determining whether the

taxpayer [P-H] materially or significantly participates

in” P-H’s activities in Keys Holdings. Sec. 1.469-

4(d)(5)(ii), Income Tax Regs. (emphasis added). 

Because in this case P-H’s activities in Keys Holdings

are passive even if he materially participated in them,

the regulation precludes grouping these activities with

Ps’ activities in Keys Granite for purposes of

offsetting the passive losses from Keys Holdings

against Ps’ nonpassive wage income from Keys Granite. 

Sec. 469, I.R.C. 1986.

Robert L. Trescott and Joshua E. Schoen, for petitioners.

Justin L. Campolieta, for respondent.

MEMORANDUM OPINION

CHABOT, Judge: Respondent determined deficiencies in

Federal individual income taxes against petitioners as follows:

 Year Deficiency

 2001 $34,917

 2002 43,087

The issue for decision is whether petitioners are permitted

to group their activities in a C corporation with petitioner

husband’s activities in a disregarded entity to form an

appropriate economic unit that may be treated as a single

activity for purposes of measuring gain and loss under section

469.1 
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1(...continued)

Petitioners do not dispute the correctness of the deficiency

amounts if we hold for respondent on the issue for decision.

2The instant case was filed as a small tax case under sec.

7463. Before the case was submitted, petitioners filed a motion

to remove the case from small tax case status, respondent stated

no objection, and the Court granted the motion. Accordingly, the

instant case was submitted and has been treated as a “regular”

case.

3The record does not show who owned the remaining 13.25

percent of Keys Granite; this does not appear to affect the

results or analyses.

Background

The instant case was submitted fully stipulated; the

stipulations and the stipulated exhibits are incorporated herein

by this reference.2

When the petition was filed in the instant case, petitioners

resided in Florida.

During 2001 and 2002 petitioner Carlos Senra (hereinafter

sometimes referred to as Carlos) was an 86.75-percent shareholder

of Keys Granite, Inc. (hereinafter sometimes referred to as Keys

Granite), a C corporation.3 Carlos also served as president of

Keys Granite in 2001 and 2002. During these years Carlos and

petitioner Ana Maria Senra (hereinafter sometimes referred to as

Ana Maria) were employees of Keys Granite; they received, and

reported on their tax returns, wages from Keys Granite as shown

in table 1.
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Table 1

 Amounts 

 Year Carlos Ana Maria

 2001 $494,485 $86,977

 2002 329,471 65,141

During these years Keys Granite was solely in the business of the

retail sale of granite and marble.

Also during 2001 and 2002 Carlos owned 100 percent of Keys

Holdings and Investments Co., LC (hereinafter sometimes referred

to as Keys Holdings), a single-member limited liability company,

a disregarded entity for Federal income tax purposes. 

Petitioners reported all of Keys Holdings’ income and expenses on

Schedule C, Profit or Loss From Business, of their 2001 and 2002

tax returns. During these years Keys Holdings’ only tangible

business asset was a warehouse in Miami, Florida, and a tract of

land on which the warehouse was situated (hereinafter sometimes

collectively referred to as the Miami property). During these

years Keys Holdings rented the Miami property solely to Keys

Granite; this rental activity was Keys Holdings’ only business

activity, and Keys Granite used the Miami property solely as a

place to store its inventory and as a showroom where its

potential customers could view that inventory. During these

years Keys Granite paid rent to Keys Holdings for the use of the

Miami property; Keys Holdings was engaged in a rental activity

within the meaning of section 469(j)(8). See infra note 5.
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4Sec. 7491, relating to burden of proof, was not drawn into

issue by either side; accordingly, the burden of proof remains on

petitioners. See Rule 142(a). Also, the parties’ presentation

of the instant case fully stipulated does not change the burden

of proof or the effect of a failure of proof. See Rule 122(b);

Borchers v. Commissioner, 95 T.C. 82, 91 (1990), affd. 943 F.2d

22 (8th Cir. 1991).

Unless indicated otherwise, all Rule references are to the

Tax Court Rules of Practice and Procedure.

Table 2 shows the Keys Holdings income, expenses, and net

losses petitioners reported on the Schedule C of their 2001 and

2002 tax returns.

Table 2

 2001 2002

 Income $324,000 $432,000

 Expenses 410,701 544,328

 Net (Loss) ( 86,701) ( 112,328)

All of the income shown in table 2 for both years was rental

income paid by Keys Granite to Keys Holdings with respect to Keys

Granite’s rental of the Miami property.

Discussion4

1. Parties’ Contentions

Respondent does not dispute the correctness of the numbers

on petitioners’ Schedules C, nor Keys Holdings’ status as a

disregarded entity. See supra table 2. Petitioners do not

contend Keys Holdings’ losses are deductible against any income

other than petitioners’ compensation income from Keys Granite. 

See supra table 1. Both sides deal only with the application of
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section 469 to the instant case, and so will we. See Estate of

Fusz v. Commissioner, 46 T.C. 214, 215 n.2 (1966).

Petitioners contend (1) the activities conducted by Keys

Granite and the activities conducted by Keys Holdings are related

activities; (2) these activities constitute an appropriate

economic unit and therefore a single activity; and (3) Carlos’s

ownership of both of these activities results in Carlos’s being

permitted to net his Keys Holdings losses against his and Ana

Maria’s Keys Granite wages.

Respondent contends (1) the losses of Keys Holdings result

from a rental activity, which is a passive activity, and so these

losses can be deducted only against passive income; (2)

petitioners did not have any passive income (other than the

rental receipts of Keys Holdings); and so (3) petitioners are not

permitted to net the Keys Holdings losses against Carlos’s wages

or any other income of petitioners.

Both sides direct our attention to section 1.469-4, Income

Tax Regs. Respondent contends section 1.469-4(d)(5)(ii), Income

Tax Regs., permits the grouping of a C corporation’s activities

with another activity of the taxpayer, but only for purposes of

determining whether the taxpayers materially or significantly

participates in the other activity. Respondent contends that,

because Keys Holdings is a rental activity, which is per se a

passive activity regardless of the extent of Carlos’s
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5Sec. 469 provides, in pertinent part, as follows:

SEC. 469. PASSIVE ACTIVITY LOSSES AND CREDITS LIMITED.

(a) Disallowance.--

(1) In general.--If for any taxable year the

taxpayer is described in paragraph (2), neither--

(A) the passive activity loss, nor

(B) the passive activity credit,

for the taxable year shall be allowed.

(2) Persons described.--The following are

described in this paragraph:

(continued...)

participation, it follows that the regulation’s limited material

participation exception does not apply, and so all that remains

is the regulation’s prohibition on the grouping of Keys Granite’s

activities with the activities of Keys Holdings for any other

purpose under section 469. Petitioners contend that the

prohibitions of section 1.469-4(d)(5)(ii), Income Tax Regs.,

apply only to the grouping of unrelated activities, and that

related activities that constitute an appropriate economic unit

may be grouped so as to consider such grouped activities as a

single activity under section 1.469-4(c)(2), Income Tax Regs.

We agree with respondent’s conclusion and much of

respondent’s analysis.

2. The Statutory Framework

In general, section 4695 provides that losses from passive 
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5(...continued)

(A) any individual, estate, or trust,

(B) any closely held C corporation, and

(C) any personal service corporation.

* * * * * * *

(c) Passive Activity Defined.--For purposes of

this section--

(1) In general.--The term “passive activity”

means any activity--

(A) which involves the conduct of any

trade or business, and

(B) in which the taxpayer does not

materially participate.

(2) Passive activity includes any rental

activity.--Except as provided in paragraph (7),

the term “passive activity” includes any rental

activity.

* * * * * * *

(4) Material participation not required for

paragraphs (2) and (3).--Paragraphs (2) and (3)

shall be applied without regard to whether or not

the taxpayer materially participates in the

activity.

* * * * * * *

(d) Passive Activity Loss and Credit Defined.--For

purposes of this section--

(1) Passive activity loss.--The term

“passive activity loss” means the amount (if

any) by which--

(A) the aggregate losses from all

passive activities for the taxable year,

exceed

(continued...)
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5(...continued)

(B) the aggregate income from all

passive activities for such year.

* * * * * * *

(j) Other Definitions and Special Rules.--For

purposes of this section--

* * * * * * *

(8) Rental activity.--The term “rental

activity” means any activity where payments are

principally for the use of tangible property.

* * * * * * *

(l) Regulations.--The Secretary shall prescribe

such regulations as may be necessary or appropriate to

carry out provisions of this section, including

regulations--

(1) which specify what constitutes an

activity, material participation, or active

participation for purposes of this section,

(2) which provide that certain items of

gross income will not be taken into account

in determining income or loss from any

activity (and the treatment of expenses

allocable to such income),

(3) requiring net income or gain from a

limited partnership or other passive activity

to be treated as not from a passive activity,

(4) which provide for the determination

of the allocation of interest expense for

purposes of this section, and

(5) which deal with changes in marital

status and changes between joint returns and

separate returns.

activities for a year may offset only income from passive

activities for that year; losses so disallowed may be carried
- 10 -

over to later years. The term “passive activity” is broadly

defined in section 469(c)(1) as any activity involving the

conduct of a trade or business and in which the taxpayer does not

“materially participate.” But rental activities are passive

regardless of whether the taxpayer materially participates. Sec.

469(c)(2), (4).

Section 469(j)(8) provides that, for purposes of section

469, any activity where payments are principally for the use of

tangible property is a rental activity. The parties have

stipulated--and we have found--that during 2001 and 2002 Keys

Holdings was engaged in a rental activity within the meaning of

section 469(j)(8). It is clear from the record herein (and

neither side suggests the contrary) that all of Keys Holdings’

losses in 2001 and 2002 were from a rental activity and thus, by

operation of the statute, were losses from passive activities.

3. The Treasury Regulations

The statute (section 469(l)) requires the Secretary (see

section 7701(a)(11)(B)) to prescribe regulations dealing with

certain matters (presumably in addition to the general

authorization granted in section 7805(a)). In the instant case,

both sides rely on the relevant Treasury regulations; no question

is raised as to the extent to which deference is due to these 
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6Sec. 1.469-4, Income Tax Regs., provides, in pertinent

part, as follows:

§ 1.469-4. Definition of activity.--(a) Scope and

purpose.--This section sets forth the rules for

grouping a taxpayer’s trade or business activities and

rental activities for purposes of applying the passive

activity loss and credit limitation rules of section

469. A taxpayer’s activities include those conducted

through C corporations that are subject to section 469,

S corporations, and partnerships.

* * * * * * *

(c) General rules for grouping activities.--(1)

Appropriate economic unit.--One or more trade or

business activities or rental activities may be treated

as a single activity if the activities constitute an

appropriate economic unit for the measurement of gain

or loss for purposes of section 469.

(2) Facts and circumstances test.--Except as

otherwise provided in this section, whether activities

constitute an appropriate economic unit and, therefore,

may be treated as a single activity depends upon all

the relevant facts and circumstances. * * *

* * * * * * *

(d) Limitation on grouping certain activities.--

The grouping of activities under this section is

subject to the following limitations:

(1) Grouping rental activities with other

(continued...)

regulations or as to whether these regulations are authorized by

section 7805(a) or by section 469(l). See T.D. 8565, 1994-2 C.B.

81, 83.

Section 1.469-4, Income Tax Regs., provides rules for

grouping a taxpayer’s activities for purposes of applying section

469.6 Under paragraph (c)(1) of this regulation, activities may 
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6(...continued)

trade or business activities.--(i) Rule.--A rental

activity may not be grouped with a trade or business

activity unless the activities being grouped together

constitute an appropriate economic unit under paragraph

(c) of this section and--

(A) The rental activity is

insubstantial in relation to the trade or business

activity;

(B) The trade or business activity

is insubstantial in relation to the rental activity; or

(C) Each owner of the trade or

business activity has the same proportionate ownership

interest in the rental activity, in which case the

portion of the rental activity that involves the rental

of items of property for use in the trade or business

activity may be grouped with the trade or business

activity.

(ii) Examples.--The following examples

illustrate the application of paragraph (d)(1)(i) of

this section:

Example 1. (i) H and W are married and

file a joint return. H is the sole shareholder of an S

corporation that conducts a grocery store trade or

business activity. W is the sole shareholder of an S

corporation that owns and rents out a building. Part

of the building is rented to H’s grocery store trade or

business activity (the grocery store rental). The

grocery store rental and the grocery store trade or

business are not insubstantial in relation to each

other.

(ii) Because they file a joint return, H

and W are treated as one taxpayer for purposes of

section 469. See § 1.469-1T(j). Therefore, the sole

owner of the trade or business activity (taxpayer H-W)

is also the sole owner of the rental activity. 

Consequently, each owner of the trade or business

activity has the same proportionate ownership interest

in the rental activity. Accordingly, the grocery store

(continued...)
- 13 -

6(...continued)

rental and the grocery store trade or business activity

may be grouped together (under paragraph (d)(1)(i) of

this section) into a single trade or business activity,

if the grouping is appropriate under paragraph (c) of

this section.

* * * * * * *

(5) Activities conducted through section 469

entities.--(i) In general.--A C corporation subject to

section 469, an S corporation, or a partnership (a

section 469 entity) must group its activities under the

rules of this section. Once the section 469 entity

groups its activities, a shareholder or partner may

group those activities with each other, with activities

conducted directly by the shareholder or partner, and

with activities conducted through other section 469

entities, in accordance with the rules of this section. 

A shareholder or partner may not treat activities

grouped together by a section 469 entity as separate

activities.

(ii) Cross reference.--An activity that

a taxpayer conducts through a C corporation subject to

section 469 may be grouped with another activity of the

taxpayer, but only for purposes of determining whether

the taxpayer materially or significantly participates

in the other activity. * * * 

be treated as a single activity “if the activities constitute an

appropriate economic unit for the measurement of gain or loss for

purposes of section 469.” The remainder of paragraph (c)

provides rules for determining whether activities constitute an

appropriate economic unit. Paragraph (d) of this regulation

provides “limitations” on the grouping of activities under this

section of the regulations. One of these limitations, specified

in paragraph (d)(5)(ii) of this regulation, is--
- 14 -

7Sec. 469 applies to “any closely held C corporation”. Sec.

469(a)(2)(B). Sec. 469(j)(1) defines “closely held C

corporation” by directing us to sec. 465(a)(1)(B), which in turn

directs us to “the stock ownership requirement of paragraph (2)

of section 542(a)”. That requirement is met as to a corporation

if “At any time during the last half of the taxable year more

than 50 percent in value of its [the corporation’s] outstanding

stock is owned, directly or indirectly by or for not more than 5

individuals.” The parties stipulated, and we have found, that

during the years in issue, Carlos was an 86.75-percent

shareholder of Keys Granite. Consequently, the stock ownership

requirement of sec. 542(a)(2) has been met as to Keys Granite for

the years in issue. Thus, for these years, Keys Granite was

subject to sec. 469. This analysis may seem like a minicruise

with many ports of call, but the result of the cruise is clear

and the reason for the result of the cruise becomes apparent when

we apply the regulations, infra.

For discussions of the advantages and disadvantages of such

statutory drafting devices, see, e.g., Dickerson, The

Fundamentals of Legal Drafting 130-134 (1986); Hirsch, Drafting

Federal Law, sec. 5.17 (3d ed. 1992).

An activity that a taxpayer conducts through a C

corporation subject to section 469 may be grouped with

another activity of the taxpayer, but only for purposes

of determining whether the taxpayer materially or

significantly participates in the other activity. * * *

[Emphasis added.]

4. Application to the Instant Case

During the years in issue, Keys Granite, a C corporation

subject to section 469,7 was solely in the business of the retail

sale of granite and marble.

The parties stipulated, and we have found, that during the

years in issue, Keys Holdings (1) was owned 100 percent by Carlos

and (2) was engaged in a rental activity within the meaning of

section 469(j)(8).
- 15 -

To determine whether section 469 limits a taxpayer’s

deductions in real-world settings, one generally must consider

the parameters of the “activities” that the taxpayer has engaged

in. The “ground rules” for setting parameters are found in

section 1.469-4, Income Tax Regs., paragraph (c) of which focuses

on “appropriate economic unit”. Petitioners make an appealing

argument that Keys Granite and Keys Holdings constitute an

appropriate economic unit within these ground rules.

But in the instant case we need not, and we do not, decide

whether the two Keys fit into one lock under paragraph (c). This 

is because paragraph (d)(5)(ii) of this regulation presents an

impassible barrier to petitioners’ paragraph (c) contention.

Because Keys Granite is “a C corporation subject to section

469” (see the detailed analysis supra note 7), petitioners’

activities conducted through Keys Granite may be grouped with

Carlos’s activities conducted through Keys Holdings, but only for

the purpose of determining whether Carlos materially or

significantly participated in the Keys Holdings activities.

Section 469(c)(2) provides that any rental activity (the

parties stipulated that Keys Holdings was engaged in a rental

activity) is a passive activity “Except as provided in paragraph

(7)”. Under section 469(c)(7) it would be relevant to determine

whether Carlos materially or significantly participated in the

Keys Holdings activities. But petitioners do not contend that
- 16 -

section 469(c)(7) applies. Petitioners have not directed our

attention to, and we have not found, any other provision

(relevant to the instant case) to which the material or

significant participation provision could apply. Consequently,

it appears that the restriction of section 1.469-4(d)(5)(ii),

Income Tax Regs., precludes petitioners from grouping the Keys

Holdings activities with the Keys Granite activities for purposes

of section 469 in the instant case.

We are then left with section 469 mandating that Keys

Holdings’ passive losses are not deductible against petitioners’

income from nonpassive sources. This requires us to hold for

respondent. See supra note 1.

5. Petitioners’ Arguments

a. Petitioners’ Interpretation of the Regulations Section

Petitioners contend that because their activities satisfy

the facts and circumstances test of section 1.469-4(c)(2), Income

Tax Regs., their activities in Keys Granite and Carlos’s

activities in Keys Holdings constitute an appropriate economic

unit and thus are entitled to treatment as a single activity for

purposes of measuring gain and loss under section 469. 

Petitioners further contend that the “but only for” restriction 

in section 1.469-4(d)(5)(ii), Income Tax Regs., “applies only to 
- 17 -

8In the instant case we have not been directed to, and we

have not found, any legislative history--or regulatory

equivalent--suggesting that we should give other than a plain

meaning effect to the “but only for” language of par. (d)(5)(ii).

For completeness, we present the only history we have found

on this matter, the preamble to T.D. 8565, 1994-2 C.B. 81, 82,

which states as follows:

A commentator requested clarification on whether

activities conducted through a C corporation may be

grouped with activities not conducted through the C

corporation. The final regulations clarify that in

determining whether a taxpayer materially or

significantly participates in an activity, a taxpayer

may group that activity with activities conducted

through C corporations that are subject to section 469

(that is, personal service and closely held C

corporations).

(continued...)

the grouping of unrelated activities not to activities that

constitute an appropriate economic unit and are thus treated as a

single activity.”

Paragraph (d) of the regulation is not so limited. 

Paragraph (c) of the regulation provides the authority for

grouping activities. The opening language of paragraph (d) of

the regulation states: “The grouping of activities under this

section [i.e., all of section 1.469-4, Income Tax Regs.,

including, of course, paragraph (c) thereof] is subject to the

following limitations”. The limitation of paragraph (d)(5)(ii)

of the regulation by its terms applies to all groupings under

paragraph (c). We have no reason to believe the regulation does

not mean what it plainly states.8
- 18 -

8(...continued)

This explanation is consistent with our reading of the

regulation. 

Accordingly, we reject petitioners’ contention that

paragraph (d)(5)(ii) does not apply “to activities that

constitute an appropriate economic unit”.

b. Petitioners’ Hypothetical

Petitioners also argue that “Even though the parties have

stipulated the losses were from a rental activity, that would not

cause them to be disallowed had [the Miami property] been owned

directly by Keys Granite instead of being owned by a disregarded

single member LLC”. They assert that “Holdings’ legal existence

(vs. Keys Granite owning the warehouse directly) is for asset

protection and not for any tax motivation purposes”.

Petitioners base their argument on a hypothetical scenario

involving an ownership structure that is meaningfully different

from the facts in the instant case: Keys Granite did not own the

Miami property. Moreover, Carlos had substantial control over

his business affairs. Carlos owned 86.75 percent of Keys Granite

and served as its president at the same time as his wholly owned

limited liability company rented the Miami property to Keys

Granite. In essence, Carlos sat on both sides of the table in

the rental agreement between Keys Granite and Keys Holdings,

substantially controlling the terms of the lease and the amount

of the rent.
- 19 -

Absent proof that the form of the transaction does not

properly represent its substance, we will not relieve a party

from the tax consequences of the form in which he or she appears

to have molded a transaction. Don E. Williams Co. v.

Commissioner, 429 U.S. 569, 579-580 (1977); Commissioner v. Nat.

Alfalfa Dehydrating, 417 U.S. 134, 149 (1974) (“while a taxpayer

is free to organize his affairs as he chooses, nevertheless, once

having done so, he must accept the tax consequences of his

choice, whether contemplated or not * * * and may not enjoy the

benefit of some other route he might have chosen to follow but

did not.”); Yamamoto v. Commissioner, 73 T.C. 946, 954 (1980),

affd. without published opinion 672 F.2d 924 (9th Cir. 1982).

Petitioners’ hypothetical does not apply to the instant case, and

their argument in this regard is without merit.

c. Petitioners’ Argument Regarding Their Wages From Keys

 Granite

Petitioners maintain that, if we were to agree with their

economic unit analysis, then the Keys Holdings losses should be

netted against their Keys Granite wages because those wages were

really the income of Keys Granite. When asked to explain that

point, petitioners stated:

Had the Taxpayers’ two entities been

parent/subsidiary C corporations the losses of Keys

Holdings would have been netted against the income of

Keys Granite by filing a consolidated income tax return

(I.R.C. § 1502). The Taxpayers’ wages reported on
- 20 -

9We note that the amounts set forth supra table 1 are

reported on the “Wages, salaries, tips, etc.” lines of

petitioners’ tax returns, and not on the “dividends” lines. 

Petitioners do not seek to recharacterize the status of these

amounts on their tax returns. The record in the instant case

does not indicate any dispute between respondent and Keys Granite

as to whether these amounts are deductible compensation or

nondeductible distributions of profits. See Estate of Fusz v.

Commissioner, 46 T.C. 214, 215 n.2 (1966).

their Form W2 would have been reduced.[9] The fact that

Keys Holdings is a disregarded entity should not change

the result.

Again, petitioners seek a tax treatment that is inconsistent

with the structure that Carlos created for his business dealings. 

Petitioners received wages from Keys Granite, and according to

section 469(e)(3), wages are not passive income. As we

previously discussed, (1) petitioners are bound by the structure

Carlos created (b. Petitioners’ Hypothetical), and (2)

petitioners’ losses from Keys Holdings constituted a passive

activity loss (a. Petitioners’ Interpretation of the Regulations

Section). Under section 469, petitioners may not offset their

passive losses against their nonpassive income.

d. Caselaw

Both sides direct our attention to Kessler v. Commissioner,

T.C. Memo. 2003-185. Respondent tells us: “The facts in this

case are similar to those presented in Kessler”; petitioners

counter that the small factual differences between the two cases

are sufficient to cause “Kessler to lack the precedent setting

the Respondent draws.” In Kessler we held that the activity we
- 21 -

were examining was not excepted from the definition of a rental

activity, and so the taxpayer could not offset the income and

losses. In our Kessler opinion, we stated that, because of the

“but only for” language in section 1.469-4(d)(5)(ii), Income Tax

Regs., the attribution rule (i.e., the rule under which the

corporation’s activities could be attributable to the

corporation’s owner) could not apply so as to permit the

corporation’s owner to offset the income and losses. See Kessler

v. Commissioner, T.C. Memo. 2003-185, 85 TCM (CCH) 1543, 1547,

2003 RIA T.C. Memo. par. 2003-185, 988, 992.

Our focus in the instant case on the effect of the “but only

for” language in section 1.469-4(d)(5)(ii), Income Tax Regs., is

consistent with what we did in Kessler.

Petitioners contend that Gregg v. United States, 186 F.

Supp. 2d 1123 (D. Or. 2000), supports their position because in

Gregg the District Court allowed a--

grouping (a C corporation with a limited liability

company) for material participation purposes even when

the two activities existed entirely independently of

each other and the activities did not occur

simultaneously. In Gregg the activities were not an

appropriate economic unit and did not constitute a

single activity.

Respondent rejoins as follows:

In their brief, petitioners attempt to distinguish

Gregg on the grounds that the activities in Gregg “were

not an appropriate economic unit and did not constitute

a single activity.” See Petitioners’ Brief at p. 7. 

Petitioners are incorrect. In Gregg, the Court

specifically held that the taxpayer could “group his
- 22 -

activities in [the C corporation] and [the LLC] as a

single activity for determining whether he materially

participated in the activities of [the LLC] in tax year

1994.” Gregg v. United States, 186 F. Supp. 2d at 1133

(emphasis added). Thus, the activities were considered

a “single activity”, but only for a single purpose: 

determining participation.

Gregg involved a taxpayer who created networks of health

care professionals for use by insurance companies. The taxpayer

initially did business through Ethix--a C corporation. He later

sold Ethix and formed Cadaja--a limited liability company that

was in a substantially similar business. To prevail, the

taxpayer in Gregg needed to show that he materially participated

in Cadaja. So the District Court considered whether he was able

to do so under section 1.469-4, Income Tax Regs. Citing section

1.469-4(d)(5)(ii), Income Tax Regs., the District Court allowed

grouping, but “only for purposes of determining whether the

taxpayer materially participates in the other activity.” Gregg

v. United States, 186 F. Supp. 2d at 1132 (emphasis added). The

District Court concluded, on the facts in Gregg, that the

taxpayer should be treated as having materially participated in

Cadaja. As a result, the taxpayer’s activities in Cadaja were

not defined as passive. The District Court concluded that, in

those circumstances, Ethix and Cadaja constituted an appropriate

economic unit for purposes of the rules of section 1.469-4(c),

Income Tax Regs.
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Petitioners contend that they have a stronger “appropriate

economic unit” argument than did the taxpayer in Gregg. But they

overlook the fact that Carlos’s activities in Keys Holdings would

be passive even if Carlos were to have actively participated in

Keys Holdings. Consequently, we are left in the instant case

with a passive activity and a nonpassive activity, and the

regulation’s prohibition on combining the two. Thus the District

Court’s application in Gregg of section 1.469-4(d)(5)(ii), Income

Tax Regs., is consistent with our analysis in the instant case

and does not advance petitioners’ argument. 

6. Holding

We hold for respondent. Petitioners may not group their

activities in Keys Granite with Carlos’s activity in Keys

Holdings to form an appropriate economic unit that may be treated

as a single activity for purposes of measuring gain and loss

under section 469.

In light of the foregoing,

Decision will be

entered for respondent.