FOR PUBLICATION



### UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT

C HAR L E S G R A G G ; D E L O R

E S G R A G G , Plaintiffs-Appellants,

v

.

U NI T E D S TA T E S O F A ME R I C A ; I N T E R N AL REVE

N UE S E R VI C E C O MMI S S I O

NER , Defendants-Appellees. No. 14-16053

D.C. No. 4:12-cv-03813-YGR

OPINION

Appeal from

the United States District Court for the Northern District of California Yvonne Gonzalez Rogers, District Judge, Presiding

Subm itted May 10, 2016 * San Francisco, California

Filed August 4, 2016

B efore: Jerom e Farris, Diarmuid F. O’Scannlain, and Morgan Christen, Circuit Judges.

Opinion by Judge Christen

* The panel unanim ously concludes this ca s e i s suitable for decision without oral argum ent. See Fed. R. App. P. 34(a)(2).G R A G G V

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NI T E D S TA T E S 2

SUMMARY * *

Tax

The panel held that Internal Revenue Code § 469 allows real estate p rofessionals to deduct rental losse s from their taxable incom e, but o nly if they m aterially participate in rental activities.

Under I RC § 469(c)(1), the general rule is that any activity in which a taxpayer does n ot m aterially participate is
p assive. Under § 469(c)(2), rental activity is per se passive, regardless o f whether the taxpayer m aterially participates. Under § 469(c)(7), the per se bar does not apply to real estate professionals.

Taxpayers sought to deduct losses f rom rental properties they owned, contending that Delores Gragg’s status as a real
estate professional rendered the r ea l estate losses per se nonpassive and deductible under IRC § 469, regardless o f

m aterial participation. The p anel explained that the statutory text, regulations, and relevant case law a l l p o i nt in o ne direction: a lthough taxpayers who qualify as real estate professionals are not subject to § 469(c)(2)’s per se rule that rental losses are p ass i ve, they still m ust show m aterial participation in rental activities before deducting rental losses according to the general rule under § 469(c)(1).

** This sum

m ary constitutes no p art o f th e o p i n i on of the court. It h as been prepared by court staff for the convenience of the reader.G R A G G V

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NI T E D S TA T E S 3

C OUNSEL

Robert L. Goldstein, Law Offices of R o bert L

. Goldstein, San Francisco, California, for Plaintiffs-Appellants.

Julie Ciam

porcero Avetta and Tere s a E. McLaughlin, Attorneys; Tam ara W. Ashford, Acting Assistant Attorney General; Tax Division, United States Departm ent of Justice, W ashington, D.C.; for Defendants-Appellees.

David Radm ore, Staff Attorney; Jenny Y. Li, Senior Counsel; June Babiracki Barlow, Vice President and General Counsel; Los Angeles, California; as and for Am icus Curiae California Association of Realtors.

OPINION

CHRISTEN, Circuit Judge:

In the 1 980s and 1990s, Congress substantially am ended the Internal Revenu e C o d e (I.R.C.) to curb widespread abuses of tax loopholes. One newly added provision, I.R.C. § 469,

r e stricted taxpayers’ ability to reduce their taxable inco me using passive rental losses—that is, losses from r e n t al
pro p erties they own but in which they do not m aterially participat e

. This case requires us to d eterm ine the scope o f § 469. Specifically, it requires us to determ ine whether § 469 entitles real estate professionals like petitioner Delores Gragg to deduct rental losses without showing m aterial participation in the rental property. W e hold that it does not. Section 469

a llows real estate professionals to deduct rental losses from their taxable incom e, b ut only if they m aterially participate in rental activities.G R A G G V

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NI T E D S TA T E S 4

I.

In 1986, Congress passed the T ax Reform Act of 1986 to curb taxpayers’ deduction of losses from so-called “passive” investm ents. Tax Reform Act of 1986, Pub. L. No

. 9 9-514, § 501(a), 100 Stat. 2085, 2233 (codified as am ended at I.R.C. § 469). It im

plem ented a sim

ple rule: taxp ay e r s could not reduce the taxable portion of their tru e incom e with investm ent lo s s es unless they m aterially participated in the investm ent. Id. §§ 5 01(c), (h) (defining “m aterial participation” as “regular, c o n tinuous, and substantial” participation). But investm ents in rental properties were treate d d i fferently. The Tax Reform Act of 1986 rendered losses from rental activity per se passive, and therefore per se nondeductible

. I

d

. § 5 01(c)(2). This per se bar applied to

ren t a l property regardless of the extent of a taxpayer’s participation. Id.

In 1993, C ongress decided the T ax Reform A ct of 1986 had gone “too far.” 139 Cong. Rec. H6134-01, H6157 (daily ed. Aug. 5, 1993). The Comm ittee on the Budget deem ed it “unfair that a person who perform s p ersonal services in a real
estate trade or business in which h e m aterially parti c i p a tes

m ay not offset losses from rental real estate activities against incom e from n onrental real estate activities.” H.R. Rep. No. 103-111, at 613 (1993), reprinted in 1993 U.S.C.C.A.N. 378, 844. C o ngress subsequently enacted § 469(c)(7) to create an exception to the per se bar o n de ducting rental losses: for taxpayers who qualify as real estate professionals, 1 the per se

1 T he statute d oes not use the t erm “real estate p rofessionals,” but rather refers t o “taxpayers in r eal property business.” I.R.C. § 469(c)(7). W e

use the industry shorthand “real estate p r o f essionals” for ease of reference. Both parties agree that Delores qualified as a r eal estate professional forG R A G G V

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rental bar “shall n ot apply.” Omnibus Budget Reconciliation Act o f 1 9 9 3
, Pub. L. No. 103-66, § 13143(a), 1 07 Stat. 312, 440 (codified at I.R.C. § 469).

This case is about the scope o f that exception. Delores and Charles Gragg sought to dedu ct from their taxable incom e rental losses they incurred in 2006 and 2007. Delores is a licensed real estate agent who worked for a real estate brokerage during both y ears. On their 2006 joint tax return, the Graggs d educted $ 38,153 in losses from rental properties they owned. O n their 2007 return, they d educted $40,390 in rental losses. T he Graggs’ joint returns were audited in 2009, and they subm itted docum ents establishing that Delores was

a real estate professional under § 469(c)(7). The Int ernal Revenue Service (IRS) requested “a written log o f a l l

. . . ren t a l related activities that w[ould] support the deduction claim ed.” In response, the Graggs subm itted two undated one-page notes estim ating the hours Delores spent working on the Graggs’ rental properties in 2006.

The IRS disallowed the rental losses because it concluded th a t the Graggs were required to show they m aterially participated in the rental p roperties, and h ad not done so. The Graggs paid the deficiencies for both years and tim ely filed adm inistrative refund claim s wi th the IRS for both years. They argued that Delores’s status as a real estate professional rendered thei r rental losses p er se nonpassive and “re quest[ed] that the[] claim s be imm ediately d enied so that [the Graggs could] initiate a District Court action.” The IRS disallowed the Graggs’ claim s, and the Graggs tim ely filed suit for a refund in the district court under I.R.C. § 7422. The Graggs’ com

plaint renewed their argum ent that b y vi rtue o f

the relevant tim e period.G R A G G V

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NI T E D S TA T E S 6

Delores’s status as a real estate p rofessional, their rental losses were autom atically nonpassive and they did n ot n e ed
to prove m aterial participation. The g o vernm ent and the Graggs filed cross m otions for summ ary judgm ent. Th e d is tr ict court granted summ ary judgm ent in favor of th e governm ent, and the Graggs tim ely appealed. W e h a ve jurisdiction under 28 U.S.C. § 1291.

II.

The issue on appeal is whethe r I.R.C. § 469(c)(7)
autom atically renders a real estate professional’s rental losses nonpassive and d eductib l e , o r whether it m erely rem oves § 469(c)(2)’s p er se bar on tr e ating rental losses as passive. The Graggs advocate for the form er interpretation, and the governm ent argues for the latter.

The text of the statute favors the governm ent ’s interpretation. Se ction 469(c)(1), which was part of the
statute as o riginally enacted in 1986, provides the general rule that any activity in wh ich a taxpayer does not m aterially participate is passive:

(c)(1): The term “passive activity” m eans any activity (A) which involves the conduct of any trade or b usiness, and (B) in which the taxpayer does not m aterially participate.

The n ext section, 469(c)(2), is the per se rental bar

. Th is section w as also p art of the original 1986 legislation. It establishes that rental activity is per se passive, regardless o f whether the taxpayer m aterially participates:G R A G G V

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(c)(2): Passive activity includes any rental activity. Except as p rovided in paragraph (7), the term “passive activity” includes any rental activity.

Section 469(c)(7), added in the 1993 am endm ents, p rovides the exception; if the taxpayer is a real estate professional, the per se bar does not apply:

(c)(7)(A): If this paragraph ap p lies to any taxpayer f

or a taxable y ear

. . . paragraph (2) shall not apply to any renta l r ea l estate activity of such taxpayer for such taxable year

. . . .

The Gra g gs contend these provisions, taken together, establish that after a taxpayer qualifies as a real estate professional under § 469(c)(7), all r e n t al losses are autom atically rendered nonpassive an d d ed u ctib le, reg ardless of m aterial participati o n

. The text of the statute does not support this interpretation. The effect of the (c)(7) exception is m erely that “paragraph (2)”—the p er s e b ar—“shall not apply.” If the per se rental bar does not apply, th e g eneral (c)(1) rule d oes, and the activity is p assive unless the taxpayer

m aterially participates.

Th e IRS Treasury Regulations im plem enting § 469 reinforce this interpretation. Treasury Regulation § 1.469- 9(e)(1) states that a taxpay e r wh o qualifies as a real estate professional can treat rental losses as nonpassive, b ut only so long as she m aterially participates:

Section 469(c)(2) [(the per se rental bar)] does
not apply to any rental real estate activity of aG R A G G V

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NI T E D S TA T E S 8

taxpayer for a taxable y ear in wh i c h the taxpayer is a q

ualifying t a xp ayer under paragraph (c) of this section [i.e., a real estate professional]. Instead, a rental real estate activity of a [ real estate professiona l ] is a passive activity under se ct i o n 469 for the taxable year unless the tax pa yer materially participates in the activity

.

Treas. Reg. § 1.469-9(e)(1) (em phasis added). A subsequent provision confirm s that even taxpayers who establish real
estate professional status m ust sep ar a tely show m aterial participation in rental activitie s ( a s opposed to other real
estate activities) before claim in g any rental losses as nonpassive:

[I]f a qualifying taxpayer d evelops real property, constructs buildings, and owns an i nterest in rental real estate, the taxpaye r’ s interest in rental real e state m ay n ot be grouped with the taxpayer’s d e velopm ent activity or construction activity. Thus, o n ly the participation of the taxpayer with respect to th e rental real estate may be used to de t e r m i n e i

f th e t ax

p a y e r m a t e r i a l l

y participates in the rental real estate ac t ivity under [the material participation safe harbor provisions in] § 1.469-5T

.

Id. § 1.469-9(e)( 3 ) (i) (em phasis added). These regulations
cannot be reconciled with the Graggs’ understanding that the (c)(7 ) e xception excuses real estate professionals from the

m aterial participation requirem ent.G R A G G V

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NI T E D S TA T E S 9

Our court has not previously addressed the Graggs’ interpretation of § 469, but their argum ent has been squarely rejected by the Tax Court, and w e view Tax Co urt o p inions

as persuasive authority. See Dobson v. C .I.R.
, 320 U.S. 489, 502 (1943) (“The Tax Court is inform ed by experie n c e and kept current with tax evolution and needs by the volum e and variety of its w ork

. . . [and] uniform adm inistration would be
prom oted b y conform ing to [its decisions] when p o ssible.”). In Perez v. C.I.R.
, the taxpayer argued, as the Graggs do here, that “because she [was] a qualifying real estate p rofessional pursuant to section 469(c)(7)(B), all her real estate activities, including rental activ it i e s, [ were] not passive and therefore she [was] n ot subject to the passive activity loss lim itations.” 100 T.C.M. (CCH) 3 5 1, at *1 (2010). The T ax Court disagreed, ruling that “[c]aselaw clearly requires that a taxpayer claim ing deductio n s f o r r ent al real estate losses m eet the ‘m aterial participation’ requirem ent[].” Id. at *2.

The Graggs do n ot seriously g rapple with Perez

. Instead, they contend that Agarwal v. C.I.R.
, another Tax C ourt case, supports their cause. It does not. The issue in Agarwal was whether a rea l e s ta te agent could qualify as a real estate p ro f essio n al un d er § 469(c)(7)(C), notwithstanding th e text o f the statute, which specified that it applied to broke rages

. T.C. Summ

. Op. 2009-29, 2009 W L 5 1 3391 at *3 (U.S. Tax Ct. 2009). The Graggs contend that Agarwal perm its m aterial participation t o be calculated as a function of a taxpayer’s

com bined real estate activities, effectively rem oving the requirem ent that the taxpayer independently show m aterial participation wi th regard to rental activities. The court in Agarwal d id not specify h ow it de term ined m aterial parti cipation, but it recognized that “the determ ination o f whether the qualifying taxpayer m aterially participated

. . . m ust be m et with respect to each rental activity,” suggestingG R A G G V

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NI T E D S TA T E S 10

that it would not perm it a taxpayer to com bine rental and nonrental activities for purposes of calc u l a t ing m aterial participation. Id. at *4 & n.4

. Aga rwal provides no

com pelling reason to depart from the Tax Court’s decision in Perez , nor have we found one.

The Graggs argue on appeal that even if they m ust show

m aterial p articipation before d educting rental losses, they “could potentially satisfy” this requirem ent by m eeting o ne o r

m or e of the m aterial participation safe harbor provisions in the Treasury Regulations. But the Graggs did not m ake this argum ent before the d istrict court. There, they conceded that “Plaintiff Delores Gragg does not contend that she m eets the

m aterial participation requir em ents

. . . for each rental real
estate activity” and f

o cused instead on the argum ent that “[t]hese tests are irreleva nt” to them by virtue of Delores’s

s tatus as a real estate professional. W e decline to a d dre s s their new argum ent that lim ited evidence in the record—two undated notes estim at in g the total hours spent on rental properties in 2007—satisfies the Graggs’ burden o f dem onstrating m aterial participation in rental activities for 200 6 an d 2 0 07. 2 In the district court, the Graggs did not

a t tem p t to dem onstrate m aterial participation in their 2006 and 2007 rental activities, and those losses are therefore nondeductible.

Section 469’s text, regulations, and relevant case law all poi n t in one direction: though taxpayers who q u alify as real
estate p rofessionals are not subject to § 469(c)(2)’s per se rule

2 T he Treasury Regulations provide t hat m aterial participation “m ay be established by any reasonable m eans,” and “[c]ontem poran eo u s d ai l y ti m e reports

. . . are not required if the extent of such participation m ay be established by other reasonable m eans.” Treas. Reg § 1.469-5T(f)(4).G R A G G V

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that rental losses are p assive, they still m ust show m a te r i al participation in rental activities before deducting rental losses. Congress endeavored to narro w the scope o f perm issible deductions f or passive losses in real estate investm ents, in part by requiring m aterial participation before losses m ay be deducted. R eal estate profes s i o nals w ere not

exem p ted from this requirem ent.

AFFIRMED.