TAX COURT OPINION

Case: William J. Dunn
Docket Number: 17290-06
Judge: Thornton
Opinion Type: memo
Filed: 09/13/2010
Pages: 48

T .C . Memo . 2010-19 8 UNITED STATES TAX COUR T WILLIAM J . DUNN, Petitioner v . OMMISSIONER OF INTERNAL REVENUE, Responden t Docket No . 17290-06 . Filed September 13, 2010 . Frank J . Yong and J . Ellsworth Summers , Jr . , fo r petitioner . I Jeffrejr S . Luechtefeld , for respondent . 'Petitioner was represented by Elizabeth Opalka when he filed his petition . On Jan . 3, 2007, Donald W . Wallis was substituted for Ms . Opalka as counsel for petitioner . On Sept . 21, 2009, Frank J . Yong was substituted for Mr . Wallis as counsel for petitioner . SERVED EP 1 2U1 MEMORANDUM FINDINGS OF FACT AND OPINION THORNTON, Judge : Respondent determined the following deficiencies in and penalties on petitioner's Federal income taxes : Year Deficiency Sec . 6662(a) . Accuracy-Related Penalt y 2002' 2003 2004 $177,658 140,820 192,463 $35,53 2 28,16 4 38,49 3 The issues for decision are : (1) Whether petitioner i s entitled to deduct expenses , mostly relating to airplane rentals, use, and maintenance , incurred by his wholly owned S corporation , Dunn Property Management, Inc .. (DPM) ; (2) whether petitioner' s pass-through . losses from DPM and his single- member limite d liability company, Dunn Equipment Leasing, L . L .C . (DEL), ar e subject to the passive activity loss restrictionsrof section 469 ;,; and (3) whether petitioner is liable for a ,section 6662(a ) accuracy-related penalty for each year at issue . 2 FINDINGS .OF FAC T The parties have stipulated some facts, which we so find . When he petitioned the Court, petitioner resided in Florida . 2All section references are to the Internal Revenue Code (Code) in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure . A . Petiti ner's Background = - 3 Petiti ner is a 1976 graduate of the U .S . Air Force Academy and a 1980 raduate of Georgetown University Medical School . After servi g some years as an Air Force flight surgeon, in 198 8 he left ac t live duty for the private practice of-ophthalmology i n Bangor, Ma i ie . While working and living there with his family, he commuted in his private plane to Cleveland, Ohio, for a fellowship'program in retina and vitreous surgery . Since 1991 he has been em~loyed as a retinologist by the Florida Retina Institute, ~ .A . (FRI), a Florida professional corporation o f which he is a vice .president and shareholder . FRI has a number of offices throughout northeast Florida and Georgia . Petitioner's medical practice is concentrated primarily in FRI's Daytona Beach office, which is in the general vicinity of his resilence, and in Palm Coast, a short distance away . Petitioner ypically works at FRI about 4-1/2 days each week and takes 6 to weeks of vacation each year . In addition to practicing medicine with,FRI, petitioner participate in drug treatment studies for two major drug companies a d serves on their advisory boards . Sometimes he travels to Miami or Atlanta to participate in these advisory boards . Th se companies pay petitioner consultant's fees and reimburse h ;s travel expenses, typically on the basis of airline As described more fully below, during the years at issu e petitioner. also pursued aviation interests and real estat e activities . B . Petitioner's Aviation Interest s _ . Petitioner,has been an aviation enthusiast since childhood . At age, 14 he took his first flying lesson, and at ageY17--th e youngest age permitted by the Federal Aviation Administratio n (FAA), :--he obtained his private pilot' s-license . At the,Air Forc e Academy he frequently flew military aircraft, and he completed a pilot .., indoctrination course . In 1986 petitioner purchased-<his first airplane, a 1969 Aero,, Commander-, which he flew for training and attending medica l meetings .s In 1990 he traded upto a 1968 Mooney M20F, which he used for, among other things, attending medical meetings , commuting between Bangor, Maine, and Cleveland, Ohio, and taking , his family(cid:127)on trips . Because the Mooney was only a .four-seater , he decided he needed a larger aircraft that .would~allow him t "take' .everybody onra .trip" with greater safety , range , and speed . , Consequently, '.in 1996 he traded up to a - Cessna .414 :, ,which hey use d for,-among other things, "flying my children around and business . associates" and,for trips from his Florida home to his Air Force , reserve duty stat-ion,in Washington, D .C . 5 _ petitioner and his wife divorced . She got the Petitioner decided to replace it with a Mitsubish i C . Dunn Equipment Leasing, LL C The Mitsubishi dealer referred petitioner to Louis M . Meiners, Jr . (Meiners), for advice about placing the new airplan e in a holding company for asset and liability protection and to minimize State taxes . Meiners was a certified public accountant (C .P .A .) an attorney with his on CPA firm in Indianapolis, Indiana (the Meiners firm), that specialized in tax-plannin g services . Meiners was also president of Advocate Aircraf t Taxation Co sulting Co . (Advocate), an aviation consulting business wi h about 35 employees including CPAs, attorneys , paralegals , and support staff . Advocate assists its clients in complying w 'th Treasury regulations, FAA regulations, and State aviation-re ated regulations . In 200 petitioner engaged Advocate for advice about ., income taxes and a out acquiring an aircraft in such a manner as t o reduce sale or use taxes . Following Advocate's advice, petitioner formed DEL, a limited liability company organized under India a law . During the years .at issue, petitioner wa s DEL's only ember and employee . DEL paid petitioner no salary . _ . .b DEL's Purchase and Lease of the Mitsubishi to Petitioner On or about July 1, 2000, DEL purchased a Mitsubishi MU-2, ° aircraft (the Mitsubishi) for about $630,000 . The purchase was financed by a loan that petitioner personally guaranteed . -On July 20,' 2000, DEL, as owner, and petitioner, as operator,, enteredinto(cid:127)an aircraft lease . Pursuant to the lease, . . petitioner . agreed to lease the Mitsubishi from DEL,-for a term ending December 31, 2004, and to,-make the following fixed°renta-l payments :,,. $5,000 on July 20, 2000 ; $225,000 by August 19,2000 ; and $5,000 at . yearend 2000, 2001, 2002, and 2003 .3 In addition, petitioner .was responsible for all .maintenance, service,,and insurance on the Mitsubishi . Petitioner's Florida residence is in a "fly-in/fly-out"' community ;~i .e ., one-with a private airport for use by its residents .. An airplane-hangar adjoins petitioner's residence . The Mitsubishi was stored in this hangar . E . Dunn Property Managemen t In .September 2001 petitioner incorporated DPM under the laws . .of Nevada . The articles of incorporation list DPM's,purpose a s "PROPERTY MANAGEMENT" . Petitioner was DPM's sole officer .3Petitioner testified that the $225,000 payment was made to "maximize state tax savings by doing'a large prepayment of the lease payment" . Other than this testimony, there is no evidence . that petitioner actually made any of the scheduled lease payments to DEL . e - 7 - director, a nd shareholder . DPM elected for Federal income ta x purposes to be treated as an S corporation . F . DEL's Lease of the Cessna Citation to Petitioner and DP M In Jul 2002, in a 'reverse like-kind exchange facilitated by Advocate, DEL sold the Mitsubishi for about $545,000 and purchased a Cessna Citation aircraft (the Citation) for about $810,000 . The purchase was financed with a loan that petitioner personally guaranteed . The Citation, like the Mitsubishi before it, was kept at petitioner's home in Florida . " The parties amended the preexisting aircraft lease between DEL and petitioner to substitute the Citation for the Mitsubishi . .Also, on July 3, 2002, DEL, as-owner, and DPM, as operator , entered into aircraft rental agreement, whereby DEL rented to DPM the nonexcl sive right to use and operate the Citation . The DPM rental agre ment stated that DPM-was renting the Citation in furtherance of its "primary, non-transportation business and its employee benefits ." DPM agreed to pay DEL rent of $175 per hour of flight titme . In 2002, 2003, and 2004, DPM paid DEL aggregate rents of $51,400, $26,968, and $26,058, respectively . DPM also paid costs f using and maintaining the aircraft . , On Nov mber 1, 2004, DEL, as owner, and petitioner, a s operator, e tered into another rental agreement whereby DEL 8 - granted petitioner nonexclusive rights to use and operate the, .- . Citation for a rental rate of $700-per hour of flight time . ' G . Real Estate Owned by Petitioner Directl y During the .years at issue petitioner owned . in his own name, in addition to .his Florida residence, interests in .the following three real properties . b s 1 . Mountain ...Air Country Club Residenc e In 1996 . pet-itioner :and, his ; wife purchased this residential- unit for about $380,000 . It-is near Burnsville, North Carolina, in,Mountain Air Country Club, an exclusive <"fly-in/fly-out " community. with its own landing strip and amenities .such as .golf, swimming , and tennis . Pursuant to his divorce agreement-in 2000 , . typically used ;: the propertyabout six to eight times each year,, . with family . and friends . Generally , he and _ his family or friends would fly there in'the Mitsubishi or,-later, in the Citation . , 2.. Mountain, Air Country Club Building Lo t , . .. .In 2001 petitioner purchased this unimproved lot ., also in Mountain Air Country .Club, for $319,000 . 3 .. Miami Beach Condominium . In 2004 petitioner and-his girlfriend purchased this property for.$539,50 0 . She lived in the condominium whil e 4Apart from petitioner ' s testimony , there is no evidence that petitioner paid DEL such rents in 2004 . attending s chool in Miami . Petitioner would visit using th e - 9 - Citation . H . Property Management Agreement Between,DPM and Petitioner On January 1, 2003, DPM and petitioner entered into an asset management agreement, which stated that petitioner retained DPM to manage designated assets for annual compensation . calculated as the sum of 1 percent of the asset value of non-income-producing properties and 10 percent of the income on income-producing properties . The annual payment was due no later than June 30 of the year following the year in which the management services were rendered .5 The asset management agreement indicates that it covers petitioner's two North Carolina country club properties . I . Real Property Owned by DPM During the years at issue, DPM purchased ownership interests in the foll wing four real properties, all of which it still possessed a the end of 2004 . 1 . Ormond Beach, Florida, Apartmen t In May 2002 DPM purchased this property for $72,500 . For an undisclosed period during the years at issue, DPM leased thi s apartment t tenants for $875 per month under a monthly rental agreement . DPM employed a property management company to collec t 'The record indicates that in May 2004 petitioner wrote DPM a $15,000 check for 2003 management fees . The record does not indicate whether petitioner paid DPM any management fees for 2004 . 10 - rent .and handle day-to-day management duties and routine maintenance . DPM paid the property management company 10 .-.percen t of the rental income generated, by the . property . Petitioner drov e .to the,, Ormond Beach property about once a month in his Lexu s automobile, which DPM leased,from him . . 2 . . Key Largo, Florida, Condominium In August-2002 DPM purchased this condominium for $749,900 . The property includes amenities such .as.-a pool, a spa, tenni s courts-, and a deepwater marina . DPM employed property management companies, which marketed the property for rent,-collected .the rent for the property, and enforced the rental agreements with tenants .. The property managers were authorized to handle minor repairs, but DPM handled major repairs :- The property manager s 1 were also responsible for day-to-day duties such as changing linens, booking reservations, and handling the arrival and departure of guests . For its services DPM paid the„property_ management companies 30 to 40 percent of'total rental revenues . Petitioner flew to the Key Largo property four to six times, each year in the-° Citation .' .According tohis testimony, he would engage in "global oversight" .of the property to make sure it was being, maintained and marketed according to . the management . agreements . On these visits, which typically lasted from Frida y night through Sunday night, he would stay in DPM's condominium if it was vaca t . Otherwise he would stay in another unit on the - 11 - property for a discounted rate . 3 . La e Mary, Florida, Pro er t In Jun e 2003 DPM and one of petitioner's professional colleagues purchased, as 50-50 coowners, an unimproved parcel of land in Lak e Mary, Florida, adjacent to one of FRI's properties . Petitioner visited the property four to six times each year in his Lexus a .itomobile, which DPM leased from him . 4 . Telluride, Colorado, Condominium In Ju n 0 2004 DPM purchased this unit in a resort hotel wit h amenities s such as ski-in/ski-out access, a spa, restaurants, a swimming pool, and a gym . DPM engaged a property managemen t company which handled day-to-day duties such as changing the linens, hou ekeeping, marketing the property for rent, booking reservation 3, and collecting rent . As payment for its services DPM paid th property management company 50 percent of total rental revenues . DPM's responsibilities for the propert y included making decisions regarding the marketing, occasionally inspecting he property, and staying apprised of the current real estate markt . In 2004 petitioner flew to this property twice i n the Citati o J . Tax Re ortin I The Meners firm prepared DPM's Form 11205, U .S . Income Tax Return for an S Corporation, for each year at issue . On these 12 - returns DPM reported net losses .from rental real estate activities (hereinafter sometimes referred to as rental losses) and, separately, net losses from nonrental activities, which it labeled "ordinary income losses (hereinafter sometimes-referred to as nonrental losses), as follows : Year Nonrental Losses ' Rental Losses 2 2002 $173,912 $36,123 2003 150,478 65,393 2004 160,502 . 141,87 2 'In calculating these nonrental losses, DPM reported no gross receipts for 2002 or 2003 . For 2004 DPM reported gross receipts of $15,000, representing "management fees" that petitioner paid to DPM . In calculating its nonrental losses, DPM reported deductions as shown in appendix A . Most of these deductions appear to be aviation related . 21n calculating these rental losses, DPM claimed deductions shown in appendix B . On Schedules K-1, Shareholder's Share of Income, Credits, Deductions, etc ., DPM reported these losses as passing through to petitioner . CPA firms other than the Meiners firm prepared petitioner' s Forms .1040, U .S . Individual Income Tax Return, for the years at issue, although the Meiners firm helped prepare certain schedules relating to airplane expenses and also prepared grouping elections . For 2002, on Schedule E, Supplemental Income and Loss, of his Form 1040 petitioner claimed the aggregate $210,035 of DPM pass-through losses (i .e ., $173,912 of nonrental losses plus $36,123 of rental losses) as nonpassive losses which he - 13 - offset against other income, principally wages, to repor t adjusted gross income of $897,451 . . For 2003 and 2004 o n Schedules E petitioner claimed the DPM pass -through nonrenta l losses as nonpassive losses, which he offset against other income, principally wages, to report adjusted gross income of $793,448 for 2003 and $702,654 for 2004 . For 2003 and 2004 he treated the DPM rental losses as passive losses and deducted them only to the extent of other real estate rental income that he received frm-FRI ($5,808 in 2003 and $3,995 in 2004) . On Schedules C, Profit-or Loss From Business, attached t o his Forms 1 40, petitioner also claimed net losses from DEL a s follows : 2002 2003 200 4 :S . ciation Expen s Depr Insu ~ance Inte est Hangar Taxe Lega l and professional and licenses $174,701 36,600 17,114 1,100 -- -- se vice s otal expenses eceipts Gross Net lo ss 229,515 54,400 175 ,115 203 , 942 26 , 968 176,974 $167, 313 $286,86 3 -- 31,601 -- 28 5,000 - - -- 28,05 1 ' 60 3 5,00 0 320,51 7 26,05 8 294,45 9 The Meiners firm provided petitioner's tax return preparer the information used to prepare the Schedules C relating to DEL's leasing activities . Petitioner, on his 2003 Form 1040, and DPM, on its 2003 and 2004 Forms 1205, elected to group the activities of DPM and DEL for purposes of the section 469 passive activity loss limitations and for purposes of section 183 .6 The Meiners firm prepared - 14 - these grouping elections for petitioner . K . .Notice of Deficienc y In the notice .of deficiency, respondent disallowed the .DPM pass-through losses and petitioner's DEL Schedule C losses on : grounds that it had not been-established-that any amounts were incurred and paid for,ordinary and necessary business purposes or in an activity entered into for profit or with respect to . property held for the production .of income . Alternatively, respondent determined that DPM's pass-through losses and the DEL Schedule C losses : were attributable to passive activities and .subject to the section 469 limitations . More particularly ., respondent made separate adjustments for DPM's rental and Fnonrental,pass-through losses and for the DEL Schedule C-losses, as more fully described below . - 1 . DPM Rental Pass-Through Losse s Respondent disallowed in their entirety the DPM rental losses that petitioner claimed ($36,123 for 2002, $5,808 for 2003, and $3,995 for 2004) and determined that petitioner should have reported pass-through rental income equal to DPM's gros s rents ($4,361 for 2002, $28,752 for 2003, and $29,269 for 2004) . 6As related to the sec . 469-grouping, the elections on these various returns stated identically : "Taxpayer hereby elects to group equipment rental activity identified as Dunn Equipment Leasing, Inc . , with Dunn Property Management, Inc . , its lessee in the original grouping as an appropriate economic unit pursuant to Regulation § 1 .469-4(d) (1) (C) ." - 1 5 As a result of these adjustments, respondent determined tha t petitioner' s taxable income should be increased $40,484 for 2002, $34,560 fo r 2003, and $33,264 for 2004 ;_i .e ., . the sum of the disallowed losses and the unreported gross rents . For 2002 - respondent urther determined that the DPM pass-through rental . losses," whi h petitioner had claimed as nonpassive losses on hi s 2002 Form 1 40 should be recharacterized as,passive losses fo r purposes of section 469 . For 2003. and 2004 respondent determined that no suc recharacterization was required, becaus e petitioner' 2003 and 2004 Forms 1040 properly showed the DP M pass-throug rental losses as passive . 2 . DP Nonrental Losse s Respon ent disallowed in their entirety the DPM nonrental pass-througi-i losses ($173,912 for-2002, $150,478 for 2003, and $160,502 fo 2004) and-determined that petitioner should have reported as income the gross amount of DPM's nonrental income (zero for 2)02 and 2003, and $15,000 for 2004) . As a result of these adjustments, respondent determined that petitioner's taxable income should be increased by $173,912 for .2002, $150,478 for 2003, aid $175,502 for 2004 ; i .e ., the sum of the disallowe d losses and he unreported gross income . Respondent .furthe r determined that all the DPM nonrental pass -through losses wer e subject to the section 469 passive activity loss limitations . 1 . DEL Schedule C .Losse s On grounds that petitioner had failed to establish that any amounts were paid for ordinary and necessary business purposeso r in an'activity entered into for profit or with respect'to property held for the production ,of income, „respondent disallowed in their,, entirety the Schedule C business-expense deductions-tha t petitioner claimed with respect to his DEL activity, resulting . i corresponding increases to his taxable income .-($229,51'5 for 2002 , $203,9.42 for 2003,' and $320,517(cid:127)for 2004) . Respondent furthe r determined that any profits or losses allowable with respect(cid:127)t o his DEL activity were attributable to apassive activity . 4 . Section 6662(a) Penalty (cid:127) Respondent determined that for each year at issue,petitione r was-liable for a section 6662~(a) accuracy-related penalty fo r substantial understatement of income-tax . OPINION I . Introduction Petitioner, a retinologist and a licensed'pilot,,claim s substantial losses attributable to airplanes that DEL, hi s single-member LLC, owned and that he flew, allegedly on behalf o f DPM, his wholly owned S corporation . . More particularly, , petitioner claims Schedule C losses from DEL's activity o f leasing the airplanes to DPM and-petitioner . Petitioner also claims substantial pass-through losses from DPM . They comprise : 17 - (1) Rental losses, attributable to DPM' s expenses of renting real estate that it owned, and (2) nonrental losses, attributable mainly to DPM' s leasing , using, and maintaining at least one of the airplanes . As pre viously described, in the notice of deficienc y respondent disallowed all the Schedule C deductions for DE L business expenses and DPM pass-through losses on variou s alternativ e grounds . In this proceeding, respondent has modified his positio s . Respondent now concedes that DEL and DPM paid the disputed ex~enses . Respondent continues to maintain, however, a s he did in t he notice of deficiency, that the aviation-relate d expenses gi ing rise to the DPM nonrental losses were not ordinary-ano necessary expenses incurred in a ,trade or business . He no longe presses this contention, however, with regard to the DPM rental ctivity or with regard to DEL's activity . Responden t continues t assert that DEL was not engaged in an activity for profit, but he no longer presses this argument with regard to DPM . As in the notice of deficiency, respondent maintains tha t any allowable losses from either petitioner's DEL activity or his . DPM activities are subject to the passive activity loss restriction of section 469 . But respondent now concedes the adjustments of $34,560 and $33,264 for 2003 and 2004 , respectivel , with respect to the DPM pass-through losses attributabl . to its rental activities, noting that petitioner correctly reported these pass-through losses as passive for 200 3 - 18 - . ' II . Burden-of ;Proo f .and 2004 The taxpayer generally bears the burden of proving th e Commissioner's determinations erroneous . Rule 142(a) . particular, the taxpayer bears the burden of substantiating,the, amount and purpose of each item claimed as a deduction . See Higbee v . Commissioner, 116 T .C . 438, 440 (2001) ; Hradesky V . Commissioner , 65 T .C . 87, 90 (1975), affd . per curiam 540 F .2d 821 (5th Cir . .197.6 ) Section 7491(a)(1) provides that if, in any court proceeding, a taxpayer introduces credible evidence .with respect to any factual issue relevant to ascertaining the taxpayer's proper tax liability, the Commissioner shall have the burden of prbof .with respect to that issue . Credible evidence is evidence 'the Court would find sufficient upon which to base a decision-on the issue in the taxpayer's favor,, absent any contrary evidence . See Higbee v . Commissioner , supra at 442 . Section 7491(a)(1), . applies, however, only if. .the taxpayer complies with al l 7The notice of deficiency similarly determined that, petitioner had correctly reported the 2003 and 2004 DPM rental losses as passive but nevertheless determined an increase in petitioner's tax liabilities resulting from the disallowance of the DPM rental losses for failure to establish that they represented ordinary and necessary business or investment expenses .' In conceding this issue, respondent has waived any issue as to whether the DPM rental expenses should be disallowed entirely . 19 - substantiat ion and recordkeeping requirements under the Code and cooperates with the Commissioner's reasonable requests for witnesses, information documents, meetings, and interviews . Sec . 7491( a )(2)(A) and (B) . As dis cussed infra , our decision turns primarily on two issues : (1 Whether DPM's airplane expenses were ordinary and necessary ; and (2) whether petitioner's DPM and DEL pass-through losses are subject to the passive activity loss restrictions o f section 469 As to the firstissue, respondent concedes tha t petitioner" as substantiated the amounts of the disputed expense s but contends, and we agree , that petitioner has failed t o substantiate business purposes independen t )f substantia l personal p Whether petitioner's failur e in this reg rd be viewed as failure to satisfy the substantiatio n prerequisit f section 7491( a)(2)(A) or as failure to presen t credible ev dence sufficient for the Court to render a decisio n in his favo the result is the same--the burden of proof remain s with petit i ner . The pa sive loss issue involves mixed questions of law an d fact . With to the numb r of hours petitioner might have engaged in his DPM and DEL act,vities, petitioner has, again, failed to substantiat e these mattes or to present credible evidence sufficient for the - 2 0 Court to render a decision in his favor . . The burden ofrproof as, to this issue also remains with petitioner . .Respondent bears the burden of production with respect to penalties . See sec . 7491(c) . We discuss this matter infra . III . Deductibility of DPM's Airplane Expense s A . . .The Parties' Contention s Respondent contends that the DPM nonrental losses (i .e ., the losses-attributable to DPM's activities other than renting its real estate properties) are nondeductible under section 162(a), because they .are not attributable to the conduct of any trade or, business . Alternatively, ..respondent contends that the : DPM nonrentallosses are nondeductible under either section 162-(a) or section 212 because they do(cid:127)not .represent ordinary and necessary business . expenses but rather primarily personal expenses . 8 Characterizing respondent's discussion of the trade, or business requirement of section 162(a) as "inapposite" and thereby implicitly conceding that the DPM nonrental activity wa s not a,trade or business, petitioner contends on brief that DPM's deduction of the .disputed expenses was based not upon section 162(a) butupon section 212(2) .9 Petitioner contends that DPM' s 'Respondent argues alternatively that even if DPM's aircraft-related expenses were ordinary and necessary business expenses, petitioner's deduction of these expenses would be limited by the sec . 469 passive activity loss limitations . We address these arguments in pt . IV, infra . 9Petitioner's contentions are inconsistent with the manner (continued . . .) - 2 1 main activity was holding real estate for appreciation . He contends that the disputed expenses represent ordinary and necessary travel expenses that were integral to DPM's managing , conserving , and maintaining properties that it owned during the years at i s sue and were also necessary for DPM's investigatin g prospective investment properties . He contends that his need to travel on D M's behalf by private plane was "obvious" because otherwise would have-been inefficient or infeasible for him t o pursue hi s ar-flung real estate investment activities while a t the same t i one conducting his full-time medical practice . Thus , he contends the disputed expenses are deductible under sectio n 212 (2) as D G'M's ordinary and necessary expenses . B . General Legal Principle s An eligible small business corporation that elects S corporation status is generally exempt from corporate income tax . See sec . 13 3(a) . Instead, the S corporation's shareholders mus t 9 ( . . . continued ) in which he treated the disputed expenses on his tax returns for the years at issue . On his . returns petitioner treated thes e items not a as reductio pursuant to argument th miscellaneo not), colla under sec . and under s likely redu deductions Because we conclude, for reasons discussed . infra , that the disputed ex~enses are not ordinary and necessary, we need not consider these issues further . miscellaneous itemized deductions under sec . 212 but s in arriving at adjusted gross income, presumably sec . 162(a) . If we were to agree with petitioner' s t the disputed expenses are deductible a s s itemized deductions under sec . 212 (which we do eral computational effects (i .e ., subjecting them 7(a) to the 2-percent floor of adjusted gross income c . 68 to reduction for high-income individuals) would e the value of these miscellaneous itemize d o petitioner . See infra text accompanying note 11 . 22 - report pro rata shares of the S corporation's taxable income , losses,, deductions, and credits . Sec . 1366(a)(1)(A) ; sec . 1 .1366-1(a), Income Tax Regs .10 An S corporation item generally.. retains its character for the shareholder . Sec . 1366(b) . With . ,certain exceptions, an Scorporation's taxable income is,computed, in the same manner as an individual',s . .-Sec . .11363,(b) .Unless expressly provided in the Code,(cid:127)no deduction . is allowed for .personal expenses . Sec . 262(a) . . Section 162(a), allows a deduction for "all the ordinary and necessary expenses, paid or incurred during the taxable year in carrying on any trade or-business" .- Section 212 .(1) and (2) provides,that an individual may deduct ordinary and necessary expenses paid or incurred for the production or collection of income or for the management,, conservation, or maintenance of property held .,,for, .the production of 'income . Generally, sections .162 .(a) .and 212 provide, with respect to,, the respective classes of activities to which they pertain, "coextensive" deductions . Trust of Bingham v . Commissioner , 32 5 ,U .S . 365, 374 (1945) .(discussing statutory predecessors .of sections- .162(a) and 212(1) and (2)) . In some circumstances, . however, a section 212 deduction : might be,less beneficial than a- 10The shareholder may not take into account S corporation, .. losses and deductions for any taxable year in excess of .the~ shareholder's adjusted basis in theS corporation's, stock and . debt . Sec .1366(d)(1) . Respondent . does not contend tha t ,petitioner's basis in .DPM .was insufficient to support the pass through losses in question . . - 23 - section 162 (a) deduction . For instance, as miscellaneou s itemized deductions, section 212 deductions, unlike section 162(a) deductions, are deductible only to the extent they exceed 2 percent o the taxpayer's adjusted gross income and for high- income indi iduals are subject to reduction ." Secs . 67(a), 68 ; see 1 Bittk r & Lokken, Federal Taxation of Income, Estates and Gifts, par . 20 .5 .1, at 20-115 through 20-117 (3d ed . 1999) (discussing various other circumstances in .which deductibility under section 212 may be less beneficial than under sectio n 162 (a) To be eductible under either section 162(a) or 212, expenses mu t be ordinary and necessary . Under the section 212 regulations this means that the expenses must be "reasonable in amount and must bear a reasonable and proximate relation to the production r collection of taxable income or to the management, conservation, or maintenance of property held for the productio n of income ." Sec . 1 .212-1(d), Income Tax Regs . ; see Trust of "For r asons such as-these, to effect flowthrough of deductions rom an S corporation to a shareholder, itemized deductions under sec . 212,-unlike deductions under sec . 162(a), must be separately stated rather than aggregated with the S corporation's other items of income, deductions, losses, and credits . See secs . 1363(b)(2) (disallowing in the computation of an S corpor tion's taxable income deductions referred to in sec . 703(a)(2) which includes, in subpar . (E) thereof, itemized deductions inder sec . 212), 1366(a)(1) ; sec . 1 .1366-1(a)(2)(vi), Income Tax egs . The character of such separately stated items is determin d in the hands of the shareholder as if they were "incurred in the same manner as incurred by the corporation ." Sec . 1366(b) - ..24 Bingham v Commissioner , supra =at 373 (articulating a substantially identical standard with respect to the statutory predecessor of section 212) . If substantial business and personal motives exist for owning and maintaining property, it is . necessary to allocate the expenditures .12 Internatl . Artists , Ltd . v . Commissioner , 55 T .C . 94, 105 (1970) ; Richardson v . Commissioner , T .C . Memo . 1996-368 . C . Analysi s During 2002 and 2003, of the three real properties in which DPM held ownership interests, only one--the Key Largo condominium--was a destination to which petitioner : flew : himself in .one of .the airplanes in question . He made these trips, he„ testified, four to six times a year on DPM's .behalf, staying weekends . In .2004 DPM also acquired a resort property in Telluride, Colorado ; in 2004 petitioner flewthere twice and 12 Pursuant to sec .-274(d)(4),, 'stringent substantiation is required for deductions with respect to "listed property", which includes passenger automobiles and "any other property used as a means of transportation" ; e .g ., airplanes . Sec . ' 280F(d) (4)'(A) (i) and (ii) .. These rules require the-taxpayer to maintain adequate records or sufficient corroborating evidence to establish each, element of an expenditure, .including .business purpose . . See sec . 274(d) ; sec . 1 .274-5T(b) (6) , (c)-(2) (i) .,' Temporary Income Tax Regs ., 50 Fed . Reg .,46016 ., . 46017 (Nov . 6,,1985) . If the listed property is used for both personal and business purposes, no deduction is allowed unless the taxpayer,establishes the, business purpose . 1 .274-5T-(b) (6) (i) (B) , Temporary Income Tax Regs ., 50 Fed . Reg . 46016 (Nov . 6, 1985) . Although these rules would seem germane to'- the deductibility of DPM's airplane expenses, respondent has not cited or relied upon the sec : 274(d) substantiation rules . Accordingly, we likewise do not rely upon them in our analysis . Kinney v . Commissioner , T .C . Memo . 2008-287 ; sec . - 25 - stayed for eriods undisclosed in the record . For the years at issue DPM claimed airplane expenditures ranging from $150,478 to $175,502 .1 3 - Clearl , these large airplane expenditures were not wholly attributable to the approximately 20 flights that petitioner made during the rears at issue to DPM's :Key Largo and Telluride properties . In fact, according to .petitioner's flight logs, which are i evidence, during the years at issue petitioner made over 350 flights in the airplanes .14 He has offered into evidence a edacted version of his flight logs that, according to his testimony, omits "personal trips" and includes only "busines s trips" . Th ese redacted flight logs show about 250 flights tha t 13Respondent characterizes these expenses as being "predominatly related to petitioner's aircraft" . Appearing to agree with his characterization, petitioner states that "the bulk" of these expenses are expenses related to airplane travel . The dispute expenses appear to include some relatively small nonaviation items ; e .g ., "Auto and truck expense" . See app . A . On the basis of petitioner's testimony and in the absence of other evidence, we infer that "Auto and truck expense" includes the expense of DPM's purportedly leasing . petitioner's Lexus from him, so that he could drive it, allegedly on DPM's behalf, to the Ormond Bead and Lake Mary, Fla ., properties . Petitioner has not advanced independent arguments with respect to such nonaviation items but, dike respondent, has contented himself with treating all the dis~uted expenses as being aviation related . 14DPM reported as "Rent expense" $54,400,,$27,607, and $32,058, for 2002, 2003, and .2004, respectively . See app . A . Although the record is not explicit on this point, it would appear that these are the amounts that DPM paid DEL as rent for the airplans . The record does not establish the reasonableness of such ren s between these related entities . As discussed infra , it a pears that a substantial portion of the rents represents petitioner's personal use of the airplanes . 26 - he took in'the airplanes . According'-to"petitioner's own reckoning, then, at least 100 of his flights were for personal purposes . 'Insofar as we can tell from the record, however'(an d petitioner does not contend otherwise), all 'the flights, including those that petitioner concedes to have been personal, are included in the aviation expense deductions that DPM claimed for the years'at issue . The record" does "not reflect that, petitioner reimbursed DPM for any of these flights . Another problem brought to light by these flight logs i s that petitioner is claiming as part of 'DPM's airplan e expenditures the cost of 22 flights that he made between January land June 16, 2002, in the Mitsubishi, before DEL acquired the Citation in July 2002 . DEL and DPM entered into the leas e agreement for the Citation on July 3, 2002 . Insofar as the record shows, DEL never leased the Mitsubishi to DPM . Petitioner has not explained why any of the Mitsubishi expenses represent expenses of DPM rather than of petitioner . Furthermore, it appears that petitioner . has counted as "business flights" numerous flights, both in the Mitsubishi and .;. in the Citation, that he made to the North Carolina country calub in which he owned a vacation home and a building lot . In the 11, flight logs'the purpose of these flights is generally,described, without elaboration, as "Inspect'Property" or as , "Training/Inspect Property" .' Apparently, petitioner . - 27 - characteriz s these as business flights partly because of the. asset management agreement whereby DPM purportedly agreed to manage then properties on petitioner 's behalf . The asse t management agreement ; however, was executed on January 1, 2003, and so has Lo bearing on flights petitioner made before then . More fundam ntally, we do not perceive any significant purpose, apart from oped-for tax benefits, in petitioner's purportedly arranging f Dr DPM to manage his properties . Because petitioner was the sole officer, director, and shareholder of DPM, which had no employee , this agreement was tantamount to petitioner's agreeing, for a fee, to "manage" his properties for himself . Nor are we impressed with petitioner's suggestion that he should be allowed to deduct the expenses of .flying to his vacation home because he ioped someday to sell it at a profit . " In the redacted flight logs the purpose of many of the so- called business trips is listed simply as "Training" . For many years befor forming DPM and DEL, petitioner had regularly taken training flights to acquire flying licenses and to satisf y insurance s andards . We are unconvinced that the "Training " flights wero not primarily for personal purposes .16 See Noyce v . 15 Similarly, we see no DPM=related purpose to a July 30, 2004, flight, included in petitioner's redacted flight logs, in which petitioner flew with his girlfriend and his daughter to make an off r on the Miami Beach condominium that he .and his girlfriend ould eventually coown in their own names . . 16In some instances, the flight logs manifest persona l (continued . . .) 28 - Commissioner , 97. T .C . 670, 693 (1991) (treating training flights as personal) . Indeed, we do not believe that even the 20 or so flights that petitioner made to two of the properties that DPM owned were devoid of substantial personal motivations . After all, ,these were resort-properties managed by, professional management companies . : Although petitioner testified that he performed, "global oversight" at these properties, his description,of this activity ("looking at the big picture, taking care of maintenance items,~et cetera, that type of thing") does not persuade us that any such activity would have much interfered with his personal .(cid:127) motives for his frequent weekends at the Key Largo :condominium or for-his two tripsto the Telluride, Colorado, condominium during 2004 . Petitioner suggests that in evaluating whether- .the disputed expenses were'ordinary .and necessary, we should take,into accoun t not only the airplane trips he made to the°two properties tha t DPM owned but also the more numerous airplane . . trips .he .claimsrto have made to investigate other prospective real estat e 16( . .continued ) purposes for the " Training " flights . For instance , a "Training" trip to Miami, Fla ., on Aug . 14 ,- 2002 , is described in the unredacted .version of the-flight logs as having the purpose of "pick up daughter " Sept . 27, 2002, is described in the unredacted version of the flight logs as having the purpose of "visit Lisa " . instances where a personal . purpose is not made manifest , however, we are not convinced that personal motives were absent . A "Training " trip ;to Chapel Hill, N .C ., on . Even in - 29 - investments, allegedly . on DPM's behalf . . He has failed to substantiate, however, that any such investigatory expenses relating to new investment opportunities rather than to the maintenance of existing investments qualify for deduction unde r section 212 . See Bick v . Commissioner , T .C . Memo . 1978-390 (and cases cited therein) . In No ce v . Commissioner, supra , this Court held that Intel Corp .'s vic chairman, a licensed pilot, was entitled to deduct unreimbursed expenses of using his private airplane in the course of his empl yment with Intel. The . Court held that these were ordinary an necessary expenses incurred in the taxpayer's trade or business as a corporate official, finding that he had not voluntarily assumed the travel expenses, that his official duties required extensive and frequent travel, that his access to the airplane enabled him to significantly reduce his travel time, that he traveled by aircraft only when there was business advantage in doing so, and that the cost of replicating his travel sche ule and time savings via commercial charter carrie r would have xceed the costs of operating his airplane . Id . 685-688 ; see also Richardson v . Commissioner , T .C . Memo . 1996-36 8 (holding thi t the .taxpayer was-entitled to deduct airplane expenses incurred by his S corporation as ordinary and necessary expenses thI~t contributed to the efficiency and productivity o f the corporation's trade or business) . - 3 0 Unlike the taxpayers in . Noyce and Richardson , petitione r .does not . contend thatithe disputed expenses were incurred in the conduct of any trade or business ." More fundamentally, unlik e the taxpayers in Noyce -and Richardson , petitioner has failed-to , identify business purposes independent of substantial persona l purposes for any of the flights in question .18 Rather, : th e evidence convinces us that for all the flights in question . petitioner had substantial personal motives emanating from hi s lifelong interest in flying airplanes . From this perspective , this casebears some similarity,to Henry v . Commissioner , 36 T ..C . 879'(1961) . In that case, a lawyer sought to deduct, as ordinary and necessary business expenses , the costs of acquiring-an d maintaining . his yacht . He claimed that he used the yacht t o t . 17moreover, petitioner has not claimed, and the evidence does'not suggest, that he incurred the disputed expenses in the conduct of his trade or business of being an employee of'FRI . The evidence does not-show-that petitioner-used the airplane as" part of his FRI employment or that any such use would not have represented-his voluntary assumption of FRI', s expenses , rendering them nondeductible to him . Cf . Noyce v . Commissioner , 97 T .C . 670, 683-685 (1991) (concluding that the taxpayer personally incurred airplane expenses pursuant to Intel's written travel reimbursement policy requiring its officers°to incur certain , expenses for Intel's benefit without reimbursement) . "In Noyce v . Commissioner , supra at 681-682, the taxpayer's personal use of the airplane was 45 .6 hours out of a total 147 .4 hours, and the taxpayer claimed no deduction for this personal use . . The Court in Noyce also disallowed expenses for flight ,hours attributable to maintenance, training, and delivery on the grounds that these flight hours did not represent business use . Id . at 693 .. Similarly, in Richardson v . Commissioner , T .C . Memo .' 1996-368, the taxpayer's use of the airplane is described,as "minor", and the taxpayer paid the actual cost associated with this personal use . - 31 - promote his business . In disallowing the expenses the Court noted the taxpayer's strong personal interest in yachting and stated : In determining that which is "necessary" to a taxpayer's trade or business, the taxpayer is ordinarily the best judge on the matter, and we woul d hesitate to substitute our own discretion for his with regard to whether an expenditure is "appropriate and helpfu , in those cases in which he has decided to make the expenditure solely to serve the purposes of his business . * * * But where, as in this case, the expenditures may well have been made to further ends which are primarily personal, this ordinary constraint does not prevail ; petitioner must show affirmatively that his expenses were "necessary" to the conduct of his prDfessions . * * * We do not think petitioner has shown That the expenses of acquiring and maintaining a yacht we're "necessary" to the conduct of his professions . ( Id . at 884 . 1 Petitioner has failed to show that the disputed expense s were ordinary and necessary expenses of DPM rather than hi s personal ex enses . Accordingly, petitioner is not entitled t o deduct the claimed DPM nonrental pass -through losses pursuant to section 212 or otherwise . " "on reply brief, petitioner appears to concede that some of the'flights for which he claimed deductions were personal and states that "these expenses, at a minimum, would have to be allocated based on the use" . He also acknowledges that "if it were true" (and we find that it-is true) that DPM deducted the total airplane expenses without allocating any portions to petitioner's personal use, this "oversight or error should be corrected ." Petitioner suggests that this "oversight or error" should be cLrected "as part of the computations that will be made under Rule 155(b) .* *'* in accordance with the findings and conclusions of this Court ." We disagree . In accordance with our findings and conclusions supra , no allocation of the disputed . expenses is warranted . - 32 - IV . Passive Activity Limitation s A . The Parties ' Contentions Respondent contends that during the years at issue DPM' s only activity-was renting real estate and that DEL's only activity was leasing airplanes . Accordingly, respondent, . contends that under section 469(c)(2) petitioner's activities with . respect to DEL and the,., ;DPM rental activity were per se passive activities and his claimed losses therefrom are subject to the sectio n 469(a) passive activity loss restrictions .20 Respondent furthe r argues that whether or not these rental activities are deemed per se passive, all petitioner's DPM and DEL activities were . in fact passive because' petitioner failed to materially participate in them . Petitioner contends that all his activities--including his medical professional activities, his medical research activities, his real estate investment activities, and the ownership and use, of airplanes--should be regarded as a "single activity" for purposes of(cid:127)section 469 . From this perspective, he suggests, DPM's rental activities were merely "incidental" to its investment activities, and DEL's airplane rental activities should-be disregarded altogether, since "no one other than Petitioner ever used the aircraft in connection with an y 20As previously .noted, respondent concedes the adjustments with respect to the 2003 and 2004 DPM rental losses, on the . ground-that petitioner correctly treated these losses as-passive on his 2003 and 2004 returns . See supra note 7 . - 3 3 activity ." Accordingly, he contends , neither DEL's nor DPM' s activities should be treated as per se passive rental activities . He further contends that he meets the material participation tes t for these various activities, whether viewed separately or as a group, and :hat accordingly the disputed losses are not subjec t to the section 469 restrictions . B . General Legal Principle s Section 469(a)(1) disallows any deduction for a "passiv e " defined generally .,as the-amount each year b y which the aggregate losses from all passive activities exceed aggregate income from all passive activities .21 Sec . 469(d) (1) Generally, a passive activity is one involving the conduct .of a trade or business in which the taxpayer'does not materiall y participat e Sec . 469(c)(1) . Subject to certain exceptions, a "rental act vity" is treated as a per se . passive activity withou t regard to whether the taxpayer materially participates . Sec . 469(c)(2), (4) . A "rental activity" is one in which payments are principally for the use of tangible property . Sec . 469(j)(8) . Gener lly, one or more trade or business activities or rental activities may be treated as a single activity if the 21By it s terms, sec . 469 applies to individuals and various specified entities but not to conduits such as partnerships and S See sec . 469 (a)(2) . For purposes of sec . 469, the corporations . character of each item of gross income and deduction allocated to a taxpayer from a partnership or S corporation is determined by reference to the taxpayer's participation in the activity . Sec . 1 .469-2T(e)(1), Income Tax Regs ., 53 Fed . .Reg . 5718 (Feb . 25, 1988) . - 34 - activities constitute an appropriate economic unit for the measurement of gain or loss for purposes of section 469 . Sec . 1 .469-4(c)(1), Income Tax Regs . As an-exception to this-general rule, however, an activity involving the rental of real property and an activity involving the rental of personal property generally may not be treated as a single activity . Sec . 1 .469- 4(d) (2), Income Tax Regs . C . Analysi s 1 . Petitioner's Grouping Argument s On their 2003 returns petitioner and DPM elected .-to group,, . DPM's and"DEL's activities for purposes of section 469 . Insofar as the record shows, no grouping election was made before 2003 . . And contrary to petitioner's assertions on brief,, no election was evermade, for any year, to group these activities with hi s medical practice employment or his medical research, activities . Indeed, such an election would have been inappropriate for a variety of reasons . In the first instance, petitioner does not contend, and the record does not show that during the years at issue his medical research activities constituted a "trade or business" sons to be eligible for grouping with his other activities under the regulations .22 See sec . 1 .469-4(c)(1), Income Tax Regs . A s 22Although petitioner-.testified that he reported consultant' s fees from his-medical research activities as additional income on his . tax returns, we find no such additiona l . .) (continued . - 35 - previously discussed , we have also concluded that petitioner, by insisting that DPM has claimed its nonrental expenses unde r section 212 and by characterizing as "inapposite" respondent' s complaint that DPM did not meet the trade or business requirement of section 62(a), has effectively conceded that DPM's nonrental activities did not constitute a trade or business during th e years at issue . Accordingly, petitioner's medical research activities and DPM's nonrental activities are ineligible for grouping wi~h petitioner's other activities . But ev~n if we were to assume, for the sake of argument, that all th~ activities which petitioner seeks to group constituted either trades or businesses or rental activities, we would never heless conclude that these activities do not constitute an "appropriate economic unit" within the meaning of the regulat'ons . Id . The regulations provide that whether activities constitute an appropriate economic unit for groupin g depends upo all the relevant facts and circumstances , with thes e five factors receiving the greatest weight : ('') Similarities and differences in types of trades or businesses ; zz ( . . . cl ntinued ) income repo~ted on his returns for the years at issue . Petitioner's generalized testimony about his medical research activities leaves us in doubt as to the exact periods during which he might have been involved in these activities . But eve n if we were to assume, for the sake of argument, that he was involved in these activities during the years at issue, the record does not establish that they would have constituted a trade or business . =(ii) The extent,of common .control ; (iii) The extent of common ownership ; (iv) Geographical location an d (v) Interdependencies between or among th e activities (for example, the extent to which th e activities purchase or sell goods between or among themselves, involve products or services that ar e normally provided together, have the same customers , have the same employees, or are accounted for with a single set of books and records) . [Sec . 1 .469-4(c)(2),, . Income Tax Regs . ] Petitioner conducted his medical practice as an employee o f FRI . . Being an employee may be a trade or business . Putoma Corp . v . Commissioner , 66 T .C . 652, 673 (1976), affd . 601 F .2d 734 (5t h Cir . 1979) . Petitioner has made no showing, however, that hi s trade or business-of being an employee of FRI or any putative trade or business involving his medical research satisfies an y these grouping factors, with the possible exception of the geographical factor . It is not apparent to us that petitione r used the airplanes to any significant degree in his medical practice, based a short distance from his residence , or to what extent he might have used the airplanes in any medical researc h activities during the years at issue . His central, argument, as we understand it, is that using the airplanes was helpful to his medical employment and his medical research . because it minimi :zedIN the time he-would lose from these activities while pursuing other activities, such as real estate activities (and,,we infer, : vacations) : But any such connection does , not . suffice to makeuhis various act ivities an "appropriate economic . unit" . We rejec t petitioner' s suggestion that all his activities should be grouped 37 - for purpos e s of section 469 .2 3 2 DEL's Rental Activit y Apart from his grouping argument, which we have rejected, petitioner as advanced no reason for us to conclude that DEL's activity wa s not in fact, as petitioner and DPM expressly characteriz ed it in their grouping elections, an "equipmen t rental activity" . Petitioner has not shown that respondent erred in treating DEL's rental activity as per se passive under section 469(c)(2) a pd (4) . Consequently , we hold that the Schedule C losses pet i tioner claimed with respect to DEL's activities are subject to the passive activity loss limitations .2 4 23 Consequently, we also reject as without legal or factual basis petitioner's argument that "as a result of the grouping pursuant to the elections, it is appropriate to merge together, and to ignore the separateness of, the aircraft rental income received an the aircraft rental expense paid ." Taken to its logical conclusion, petitioner's argument might suggest that the transactions or entities in question should be collapsed or disregarded and viewed, in substance, as signifying nothing more than petitioner's attempt to garner tax deductions by renting his airplanes to himself . But because respondent has not pursued this precise argument, neither do we . 24We note that this holding will result in a smaller increase to petitioner's taxable income with respect to this item than respondent determined in the notice of deficiency,- which disallowed petitioner's Schedule C DEL deductions entirely for failure to (establish that any amounts had been paid or incurred for ordinary and necessary expenses . In this proceeding, respondent concedes that the DEL expenses were paid or incurred and has not argued that the DEL expenses were not ordinary and necessary . Rather, respondent has sought only to limit the DEL . . .) (continued . 3 . DPM's .Rental Activit y For 2003 and,2004 petitioner reported the DPM rental losse s as passive, and respondent has conceded any adjustment wit h respect to these items for these years . Respondent continues t o challenge,,however, petitioner' .s .treating the 2002 DPM renta l losses as nonpassive . Respondent contends that the 2002 DP M rental activity was per se passive under section 469 (c)(2) an d (4) . Petitioner disagrees , contending that, at. least for 200 2 (the only year for'which petiti.oner .reported .the DPM rental activity as nonpassive ), DPM's rental activity was incidental t o its primary activity of holding investment properties for futur e appreciation .25 We need not decide whether DPM's rental activit y 24( . . .continued ) deductions on the grounds that they represent passive activity losses under sec . 469 and , alternatively,,that the DEL activit y was an "activity' not engaged in for profit " within the meaning . o f sec .- 183(c) . If respondent's alternative sec . 183 contentio n were sustained, the result-would be to limit petitioner's DE L deductions to DEL' s gross income for each year at issue . Se e sec . 183 (a) and (b) . petitioner's circumstances, this result is, functionally equivalen t to applying-the sec . 469 restrictions to petitioner's DEL losses . Consequently, we need not and do not address respondent's . alternative sec . 183 contentions . .As discussed in more detail infra , in 25Under temporary regulations , an activity involving the us e of tangible property is not treated as a rental activity for a taxable year if rental of the property is treated as incidenta l to a nonrental activity . Sec . 1 .469-1T(e)(3)(ii)(D), Temporar y Income Tax Regs ., 53 Fed . Reg .,5702 (Feb . 25, 1988) . Rental o f property is treated as incidental to an activity of holding th e property for investment only if the principal purpose-of holdin g the property-is to realize gain from the ; appreciation of th e property and the gross rental income from the property is les s than , 2. percent of the lesser of (i) the unadjusted., basis of .the (continued . .. ) - 39 - was "incidental", because even if it were, to avoid the sectio n 469 restric :ions petitioner would still need to show that h materially participated in this activity . As discussed below , petitioner has not shown that he materially participated in an y of the DPM f activities (or for that matter, the DEL activities) for any yea ; r, whether they be considered singly or together . 4 Lack of Material Participatio n Mater i al participation is defined generally as regular , continuous, and substantial involvement in the busines s operations . Sec . 469(h)(1) . The regulations identify thes e seven situa ;ions in which an individual will be treated a s materially participating in an activity : (L) The individual participates in the activity for more than 500 hours during such year ; ( :) The individual's participation in the activity for the taxable year constitutes substantially all of the pa ticipation in such activity of all individuals (inclu ing individuals who are not owners of interests in the activity) for such year ; (3) The individual participates in the activity for more tan 100 hours during the taxable .year, and such individual's participation in the activity for the taxable year is not less than the participation in the activity of any otier individual (including individuals who are not owners of interests in the activity) for such year ; (1) The activity is a significant participation activi y (within-the meaning of paragraph (c) of this section) for the taxable year, and the individual' s 25 continued ) property, or (ii) the fair market value of the property . Sec . 1 .469-1T ( e)(3)(vi )( B)(2), Temporary Income Tax Regs ., 53 Fed . Reg . 5703 (Feb . 25, 1988) . - 40 - aggregate participation in all significant participation activities during such year exceeds .500 hours ; (5) The individual materially participated in the activity (determined .without regard to this paragraph (a)(5)) for any five taxable years (whether or no t consecutive) during the ten taxable years that immediately precede the taxable year ; (6) The activity is a personal service activity (within . the meaning of paragraph (d) of-this section), and the individual materially participated in the activity for any three taxable years (whether or not consecutive) preceding the taxable year ; o r (7) Based on all of the facts and circumstances (taking into account the rules in paragraph-(b) of, this section), the individual participates in the activity on a regular, continuous, and substantial basis during such year . :[Sec . 1 .469-5T(a), Temporary Income Tax Regs ., 53 Fed . Reg . 5725-5726 (Feb . 25, 1988) . ] The regulations also provide that the last-described "facts an d 4 circumstances" test requires that the individual's participation in the activity exceed 100 hours during the taxable year .26 Sec . 1 .469-5T(b)(2) .(iii), Temporary Income Tax Regs .,53 Fed . . Reg . 5726 (Feb . 25, 1988) . On brief petitioner claims that he meets the third, fourth , sixth,, and seventh of these tests . He has directed-us, however, to no evidence or proposed findings to .show that. he meets th e 26Although the . regulations permit a taxpayer to establish"„ the extent of his participation by "any reasonable means",,sec . 1 .469-5T(f)(4), Temporary Income Tax Regs ., 53 Fed . Reg . 5727 (Feb . 25, 1988), a postevent "ballpark guesstimate" does not suffice, see Lee v . Commissioner , T .C . Memo . 2006-193 ; Bailey v_ Commissioner, T .C . Memo . 2001-296 ; Carlstedt'v . Commissioner , T .C . Memo . 1997-331 ; Speer v . Commissioner , . T .C . Memo . 1996-323 ; Goshorn v . Commissioner , T .C . Memo . 1993-578 . 41 - quantitative requirements for the third, fourth, or seventh test, as applied to his activities separately . Petitioner's reliance on all four tests appears to be partly or (in the case of the sixth test) wholly premised on the notion that all his activities should be g ouped together so as to constitute, in the aggregate, a personal service activity . For the reasons discussed above, w e reject this premise . D . Summary of Conclusion s We conclude and hold that petitioner's DEL and DPM activities were passive . Consequently, pursuant to section 469 (d) , fo r each year at issue he may not deduct losses fro m these passi e activities to the extent that his aggregate losse s from all hits passive activities exceed his aggregate income fro m these activities . Application of this rule in calculating petitioner ' s tax liability requires some consideration of the interplay a ong . petitioner ' s various activities in the light of our holdings . For each year at issue , petitioner engaged in three passive activities : ( 1) The DPM nonrental activity ; ( 2) the DPM rental activity ; and (3 ) the DEL activity . We have disallowed the DPM nonrental l sses for failure to show that the disputed expenses were ordinary and necessary . Consequently , petitioner is allowed sive or otherwise, with respect to the DPM nonrenta l activity . For 2002 and 2003 petitioner reported no income from - 42 - the DPM nonrental activity . For 2004, however , petitioner reported, $ 15,000 of income from the DPM nonrental activity ; pursuant to our earlier holding , petitioner is allowed no' deductions against this income . . For 2004 , then, the result of our holding DPM's nonrental activity to .be passive is partly t o "free up" $15,000 of passive income to be added to petitioner's aggregate income from all passive activities and .thereby to , increase by $15,000 the aggregate losses petitioner is allowed to claim with respect to all his passive activities for 2004 .2 7 V . Accuracy-Related Penaltie s Respondent determined that for each year at issue petitioner is-liable for an accuracy-related penalty pursuant to section 6662(a) . an.d .(b) (2) for substantial understatement of income tax . Respondent bears the burden of production with respect thi s 27As previously noted, we have declined to address respondent's alternative argument under sec . 183 that petitioner's DEL activity was not engaged in for profit . Our reason for declining to address this alternative argument was that, even if it were sustained, it would not affect petitioner's tax liabilities in any way different from our holding that the DEL losses . were subject to the sec . 469 restrictions . In the light of the discussion supra , that conclusion requires some further elaboration . If we had held that the DEL losses were subject to the sec . 183 limitation, those losses would have been allowable only. to the extent of DEL's gross income for each year and consequently would not have been available to absorb the .$15,000 of "freed up" passive income from the DPM nonrental activity in 2004 . But because the DPM rental activity generated more than $15,000 of losses in excess of income from that activity, those losses are available to offset the $15,000 of " .freed up" passive income from the DPM nonrental activity, independent of any effect that our treatment of the DEL losses,-' as being limited by either sec . 183 or 469, might have . upon the calculation . - 43 - penalty . Sec . 7491(c) . To meet this burden, respondent must produce' evidence establishing that it is appropriate to impose this penalty . Once respondent has done so, the burden of proof is upon petitioner . See Higbee v . Commissioner , 116 T .C . at 449 . Section 6662(a) and (b)(2) imposes a 20-percen t accuracy-re lated penalty on any portion of a tax underpaymen t that is attributable to any substantial understatement of incom e tax, defined in section 6662(d)(1)(A) as an understatement tha t exceeds the greater-of 10 percent of the tax required to be show n on the return or $5,000 . The exact amount of petitioner's understatement will depend upon the Rule 155 computation, taking into account respondent's concessions and in accordance with our findings an conclusions . To the extent that-those computations establish, as seems almost certain, that petitioner has a substantial understatement of income tax, respondent has met his burden of p oduction . See Prince v . Commissioner , T .C .- Memo . 2003-247 . The accuracy-related penalty does not apply with respect to any portion of the underpayment if it is shown that the taxpayer had reasona le cause and acted in good faith . Sec . 6664(c)(1) . Petitioner contends that he had reasonable cause and acted i n good faith because in reporting his taxes for the years at issu e he relied in good faith on advice from the Meiners firm, whic h prepared DPM's Forms,1120S and numerous schedules and tables that were incorporated into petitioner's . Forms 1040 . . He also contends that he relied upon Advocate, which advised him in forming DEL and DPM and in preparing necessary documents . , .Reliance on a professional tax adviser's advice-ma y demonstrate reasonable cause and good faith if, taking into account all .the facts and . circumstances, the reliance wa s reasonable and the taxpayer acted in good faith . Sec . 1 .6664- 4(b) (1), (c)(1) ; Income Tax Regs . 'Reliance on a tax adviser may be reasonable and in good faith if the taxpayer establishes : (1 ) The adviser was a competent professional with sufficient expertise to .justify reliance ; (2),the taxpayer provide d necessary and accurate information;,and .(3 ) .; the taxpayer actually relied . .in good faith-on the adviser's judgment ., Neonatology Associates, P .A . v . Commissioner ,,115 T .C . 43, 99 ( 2000 )(cid:127), affd . 299 F .3d 221,(3d Cir . 2002) . The advice must not be based on , unreasonable factual or legal assumptions and must no t unreasonably rely on representations, statements, findings, o r agreements of the taxpayer or any other,person . Sec . .1 .16664- 4(c)(1)(ii) Income Tax Regs . Our determinations regarding petitioner' s tax deficiencies . turn on two key issues : (1.)'Whether DPM's nonrental expense s were ordinary and necessary expenses ; and (2) whether his DPM an d DEL activities were passive activities . Petitioner has not shown that he provided his tax advisers, necessary and accurate . rA - 45 - information as to certain critical matters regarding these issues . . Moreover, it appears that his advisers unreasonabl y relied' on c ertain of his-representations . More particularly, the disputed airplane expenses , reporte d as ordinary and necessary expenses of DPM,-emanate from th e flight logs that petitioner maintained . >,Meiners testified that these flight logs were a "logbook format that we provide to our clients as an example of what they can use to meet th e documentati n requirements ." It appears, however, that the Meiners firm accepted at face value petitioner's characterizatio n of all . his lights as business related . Similarly, the evidence indicates that it was petitioner , not his tax advisers, who decided whether to characterize hi s activities as-passive or nonpassive . Meiners testified : "The clientiwoul tell us whether or not it was passive'or nonpassive . * * * We wo ld have to ask the client . We would have no way of knowing without . * * * If the client told us it was passive , s passive . If the client tells us -- you know, w e don't know .unless the client tells us ." Judging from thi s testimony, t appears that on this critical issue the tax advisers re ied upon petitioner, rather than the other way around . As pet tioner acknowledges on brief, he is "highly educate d and sophist cated and possesses extensive business experience ." - 46 - Accordingly, , as, petitioner concedes, "the standard-of care tha t must have been exercised by(cid:127)the .;Petitioner is a high one . are not convinced that petitioner met that high standard of,,,care . We hold that :for each year at issue petitioner is liable for a section 6662(a) penalty insofar-as the Rule 155 calculations, sho w a substantial, understatement of income tax . To reflect the foregoing and respondent 's concessions , under Rule 155 . 47 - APPENDIX A DPM Nonrental Loss Deduction s 2002 2003 . 200 4 Repairs & m intenance -- $22,506 $54',591 Rent expens $54,400 27,607 32,058 600 1. 25 125 Taxes & licenses Depreciation -- 1,056 1,35 3 Other deductions : .3,075 -3,075 Auto' & truck expense 2,038 Avionics 2,630 -- -- Fuel 57,567 55,210 53,143 Landing f es permits 3,092 -- -- Maintenance Aircraft 30,575 -- Real esta e fees 160 -- -- Training 22,850 1,724 1,794 Charts & maps -- 279 81 Dues,& supscriptions -- 1,045 -- Flight planning fees 162 -- Hanger rent -- 6,00 0 Insurance -- 24,310 20,91 0 Legal & professional -- 375 1,300 Management fees -- 1,800 1,800 Meals & entertainment -- 526 261 Miscellaneous -- 488 430 Oil -- 58 -- Other rent -- 213 -- Ramp & landing fees - 179 106 Postage -- -- 339 Supplies -- 46 1,307 Telephone -- 788 725 Tie down arking -- 543 770 Transportation -- 200 . 200 -- 2,263 1,13 4 Travel Total 173,912 150,478 175,502 48 - APPENDIX B DPM .Rental Loss-Deduction s 2002 2003 200 4 Advertising $196 -- Auto & travel 1,414 $319 Cleaning & maintenance 692 Commissions 261 4,858 Insurance 4,027 1,773 $1,965 Interest 4,578 21,837 66,883 Repairs -- 1,118 6,082 Taxes 1,382 14,863 13,529 Utilities 503 1,183 2,087 Depreciation 20,829 33,685 67,228 6,602 14,509 13,36 7 Other deductions Total 40,484 94,145 171,141 --