1 Unless otherwise indicated, subsequent section references are

to the Internal Revenue Code in effect for the year in issue.

T.C. Summary Opinion 2001-135

UNITED STATES TAX COURT

RICHARD S. HOLBROOK, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 17423-99S. Filed September 4, 2001.

Richard S. Holbrook, pro se.

William Henck and Dustin M. Starbuck, for respondent.

POWELL, Special Trial Judge: This case was heard pursuant

to the provisions of section 74631 of the Internal Revenue Code

in effect at the time the petition was filed. The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority.
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2 Petitioner filed a joint 1996 Federal income tax return with

his wife. The notice of deficiency was issued to petitioner and

his wife; however, petitioner’s wife did not petition this Court

and is not a party to this proceeding.

Respondent determined a deficiency of $2,079 in petitioner’s

1996 Federal income tax.2 The issue is whether petitioner’s real

estate rental income constitutes “disqualified income” under

section 32, and, as such, exceeds the 1996 allowable maximum

disqualified income of $2,200 for earned income tax credit

eligibility. Petitioner resided in Danville, Virginia, at the

time the petition was filed.

Background

The applicable facts may be summarized as follows. 

Petitioner is a self-employed general contractor for custom-built

single family homes. In 1996, petitioner operated a home

construction business on a full-time basis and a real estate

rental property activity. Petitioner reported a net profit of

$7,260 from the construction business in 1996. Petitioner owns a

condominium and three commercial buildings. Petitioner reported

gross rentals of $25,425 and a net income of $8,095 from his real

estate rental property activity in 1996.

Petitioner personally handled the renting, maintenance, and

collections for the real estate rental property activity. He

employed no agents to assist him in these endeavors, other than

as required for the upkeep of the condominium under the terms of
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the condominium association. Petitioner, however, performed no

personal services for his tenants in connection with his real

estate rental property activity. Petitioner was not a real

estate dealer. Respondent conceded that petitioner’s real estate

rental property activity was not passive as defined in section

469. 

Petitioner explained his long-term objective for his real

estate rental property activity as a “401(k) or * * *

profitsharing or something to retire on, because I don’t have any

other thing besides that. * * * Basically if I can get enough of

this going on and it could be viable, then I could actually quit

the construction business and live on this.”

In 1996, petitioner claimed an earned income credit (EIC or

EITC) of $2,079. Respondent disallowed the credit on the ground

that petitioner’s real estate rental income was “disqualified

income” and prohibited him from claiming the EIC.

Discussion

Section 32(a) provides a credit in “an amount equal to the

credit percentage of so much of the taxpayer’s earned income 

* * * as does not exceed the earned income amount.” Section

32(i), however, provides in pertinent part as follows:

(1) In general.-–No credit shall be allowed under

subsection (a) for the taxable year if the aggregate amount

of disqualified income of the taxpayer for the taxable year

exceeds $2,200.
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(2) Disqualified income.-–For purposes of paragraph

(1), the term “disqualified income” means-– 

****** *

(C) * * *

(i) * * * [net] income from rents * * * not

derived in the ordinary course of a trade or

business * * *. [Emphasis supplied.]

In arguing that section 32(i) does not apply, petitioner

focused his argument on whether his real estate rental property

activity constituted a trade or business. We believe, however,

that the inquiry is broader and that the correct focus should be

on the phrase “not derived in the ordinary course of a trade or

business”. In considering the effect of this language we assume,

but do not decide, that petitioner’s real estate rental property

activity constituted a trade or business.

The relevant part of section 32(i) was added by section 4(a)

of Act of April 11, 1995, Pub. L. 104-7, 109 Stat. 93, 95. The

legislative history of section 32(i) states that “The Committee

believes that the EITC should be targeted to families with the

greatest need. Therefore, the Committee believes that it is

inappropriate to allow an EITC to taxpayers with significant

unearned income.” S. Rept. 104-16, at 21 (1995). In using the

phrase “not derived in the ordinary course of a trade or

business”, the congressional focus, therefore, was on whether the

taxpayer had unearned income that exceeded the threshold amount. 
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In defining the concept of earned income for purposes of

section 32, section 32(c)(2)(A)(ii) provides that earned income

means, inter alia, “the amount of the taxpayer’s net earnings

from self-employment for the taxable year (within the meaning of

section 1402(a))”. Section 1402(a), in turn, provides in

pertinent part:

SEC. 1402(a). Net Earnings From Self-Employment.--The

term “net earnings from self-employment” means the gross

income derived by an individual from any trade or business

carried on by such individual * * * except * * *

(1) * * * rentals from real estate * * * 

unless such rentals are received in the course of a

trade or business as a real estate dealer * * *.

Section 1.1402(a)-4(c)(2), Income Tax Regs., provides:

(2) Services rendered for occupants. Payments for the

use or occupancy of rooms or other space where services are

also rendered to the occupant, such as for the use or

occupancy of rooms or other quarters in hotels, boarding

houses, or apartment houses furnishing hotel services, or in

tourist camps or tourist homes, or payments for the use or

occupancy of space in parking lots, warehouses, or storage

garages, do not constitute rentals from real estate;

consequently, such payments are included in determining net

earnings from self-employment. * * *

Petitioner is not a dealer in real estate, nor does he

provide the type of services to tenants enumerated in the

regulations. We note in this regard that petitioner did not

report his real estate rental income for purposes of computing

self-employment tax. For purposes of sections 1402(a) and

32(c)(2), we conclude that petitioner’s real estate rental income

was not earned income. That income ($8,095) falls within the
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3 We note that the phrase “not derived in the ordinary course”

also appears in sec. 469(e), which deals with portfolio income in

the context of the passive loss rules. These types of portfolio

income include income that would be disqualified income. See

sec. 1.469-2T(c)(3)(ii), Temporary Income Tax Regs., 53 Fed. Reg.

5713 (Feb. 25, 1988).

ambit of “disqualified income” under section 32(i) and exceeds

the threshold amount ($2,200).3 Accordingly, petitioner is not

entitled to claim an EIC.

Reviewed and adopted as the report of the Small Tax Case

Division.

Decision will be entered

for respondent.