TAX COURT OPINION

Case: Avedis F. Balekian & Lauren B. Balekian
Docket Number: 27817-15
Judge: Gustafson
Opinion Type: bench
Filed: 12/16/2016
Pages: 13

UNITED STATES TAX COURT WASHINGTON, DC 20217 AVEDIS F. BALEKIAN & LAUREN B. BALEKIAN, Petitioners, v. ) ) ) ) cz ) Docket No. 27817-15. COMMISSIONER OF INTERNAL REVENUE, Respondent ) ) ) ORDER Pursuant Rule 152(b) of the Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit herewith to petitioners and to respondent a copy of the pages of the transcript of the proceedings in the above case before the undersigned judge at Los Angeles, California, on December 7, 2016, containing his oral findings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral findings of fact and opinion, decision will be entered for respondent. (Signed) David Gustafson Judge Dated: Washington, D.C. December 16, 2016 SERVED Dec 16 2016 Capital Reporting Company 3 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Bench Opinion by Judge David Gustafson December 7, 2016 Avedis F. Balekian and Lauren B. Balekian v. Commissioner Docket No. 27817-15 The Court has decided to render the following as its oral Findings of Fact and Opinion in this case. This Bench Opinion is made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code (26 U.S.C.), and Rule 152 of the Tax Court Rules of Practice and Procedure; and it shall not be relied on as precedent in any other case. By notice of deficiency dated August 3, 2015 (Ex. 1-J), the Internal Revenue Service ("IRS") determined deficiencies in the Federal income tax of petitioners Avedis and Laura Balekian for the year 2012, along with an accuracy-related penalty under section 6662(a). The. principal issue for decision is 19 whether real estate losses claimed by the Balekians 20 are limited by section 469--an issue that depends 21 22 23 24 25 largely on whether Mrs. Balekian qualifies as a "real estate professional" under the demanding standard of section 469(c)(7). For the reasons explained hereafter, we hold that petitioners did not prove that Mrs. Balekian meets that standard, and we 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 4 sustain the IRS's determinations. . Trial of this case was conducted on December 6, 2016, in Los Angeles, California. The Balekians represented themselves; and Steven Roth represented respondent, the Commissioner. Employing the burden- of-proof principles set out below, we find the following facts: FINDINGS OF FACT The Balekians' properties The Balekians have been acquiring rental real estate properties over several decades. By 2012 they owned nine such properties--one single family home (and their former residence) in their home town, 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Camarillo; a single-family home in Lancaster, 90 15 minutes away by car; five single-family homes and a 16 17 18 commercial property in Fresno, 3-1/2 hours away; and a four-unit dwelling in Clovis, near Fresno. (Stip. 6.) 19 Mrs. Balekian's work 20 21 22 23 24 25 In 2012 Mrs. Balekian had a part-time job as a pharmacist, for which she was paid by the hour, reported her time, and worked for an average of about 9 hours per week, for a total of about 460 hours per year. (Exs. 3-J, 4-J.) Mrs. Balekian also worked in connection with the Balekians' rental properties, 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 5 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 performing (though not necessarily in 2012) such tasks as: inspecting properties after the eviction of or vacating by a tenant, and hiring repairmen and other contractors to do necessary repairs and cleaning; selecting and ordering carpets, flooring, tile, fixtures, and appliances for installations performed by contractors; retaining a firm that assisted with evictions; hiring contractors to conduct renovations; interviewing and ordering background checks of prospective tenants; and contacting State officials about Section 8 tenants. Mrs. Balekian admits she did not keep track of her hours for her real-estate-related tasks, nor any records reflecting her time spent. Although she made a broad estimate that in 2012 she "put in the necessary time to qualify" as a real estate professional (i.e., 750 hours), she made no attempt to allocate that total among tasks, or even among properties and dates, except in the most general and imprecise terms. (See Ex. 24-P.) She repeatedly stressed that she could not state how many hours she spent on given tasks. Consequently, we are unable to quantify the time she spent on those tasks, and it seems much more likely than not that her time spent was substantially less than 750 hours. We are not 866.488.DEPO www.CapitalReportingCompany.com. Capital Reporting Company 6 1 2 persuaded that in 2012 she worked on real estate more than the 460 hours she worked in her pharmacist job. 3 Work by contractors 4 The Balekians hired others to conduct repairs, 5 maintenance, and improvements on those properties; 6 7 8 9 10 11 12 13 14 15 and the Balekians did not do any of these manual tasks themselves. They hired Sierra Maintenance in Fresno to perform such tasks on their six properties in or near Fresno, used Sierra to hire subcontractors to perform some projects, and also used Sierra to set up "For Rent" signs, show the properties to prospective tenants, make up rental agreements and have the tenants sign them, and check in on new tenants. (Ex. 9-P at 13.) They hired other contractors for the lesser amount of work needed in 16 Camarillo and Lancaster. Given the substantial work 17 18 19 of these contractors, we are not persuaded that Mrs. Balekian worked on any of these properties more than any other individual did. It seems likely that 20 Sierra Maintenance's hours exceeded hers. 21 22 23 24 25 The Balekians' tax return The Balekians timely filed their Federal income tax return for 2012. (Ex. 2-J.) They prepared the return themselves, and they do not allege that they relied on professional advice in taking the positions 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 1 reflected on their return. The return included 2 multiple Schedules E, "Supplemental Income and Loss" 7 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 (Ex. 2-J at 14-37), for their real estate activities. The Balekians allege, and we assume, that they intended to aggregate all their real estate properties in a single activity; but there is no evidence that the Belakians ever included with any tax return a statement electing to treat.all their interests in rental real estate as one activity, and they do not allege that they did. Their Schedules E show $3,307 on line 24 as "Income" and show $41,865 on line 25 as "Losses"; and they carried the net of those two figures--$38,558--and reported it as rental loss on line 17 in the "Income" section of the return, thus reducing the amount of taxable income they had otherwise received as wages and other income. IRS examination The IRS examined the Balekians' 2012 tax return. 20 After the conclusion of the examination, the IRS 21 disallowed the net loss claimed from the real estate 22 activity reported on Schedules E. The IRS issued the 23 24 25 .statutory notice of deficiency ("NOD") on August 3, 2015. In that NOD the IRS determined a deficiency of tax and an accuracy-related penalty under section 866.488.DEPO www.Capita1ReportingCompany.com Capital Reporting Company 8 1 2 3 4 6662 (a) . On November 4, 2015, the Balekians timely filed their petition in this Court challenging the IRS's determinations. At that time they resided in 5 California. (Stip. 1.) 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 I. Burden of proof OPINION The IRS's determination is presumed correct, and the taxpayer generally bears the burden to prove his entitlement to any deductions he claims. Rule 142(a). Taxpayers must satisfy the specific requirements for any deduction claimed. See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Furthermore, taxpayers are required to maintain records sufficient to substantiate their claimed deductions. See sec. 6001; 26 C.F.R. sec. 1. 6001-1 ( a) ; see also id. sec. -1 ( e) ("The books or records * * * shall be retained so long as the contents thereof may become material in the administration of any internal revenue law") . II. Real estate losses Taxpayers are allowed deductions for certain business and investment expenses under sections 162 and 212. Section 469, however, generally disallows any "passive activity loss" being used as a deduction 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 9 1 2 against non-passive income. A passive activity is any trade or business in which the taxpayer does not 3 materially participate. Sec. 469(c)(1). Material 4 5 6 7 8 9 10 11 12 participation is defined as involvement in the operations of the activity that is regular, continuous, and substantial. Sec. 469(h)(1). However, rental activity is generally treated as a per se passive activity regardless of whether the taxpayer materially participates. Sec. 469(c)(2), (4). An exception to the rule that a rental activity is per se passive is found in section 469(c)(7), 13 which provides that if the taxpayer qualifies as a 14 15 16 17 real estate professional, then her rental activities in real property trades or businesses are not per se passive activities under section 469(c)(2) but are treated as a trade or business subject to the 18 material participation requirements of section 19 20 21 22 23 469(c)(1). The taxpayer will qualify as a real estate professional if: (1) more than one-half of the personal services performed in trades or businesses by the taxpayer during the taxable year are performed in real property trades or businesses in which she 24 materially participates, and (2) the taxpayer 25 performs more than 750 hours of services during the 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 10 1 taxable year in real property trades or businesses in 2 which the taxpayer materially participates. Sec. 3 4 5 6 7 8 469(c)(7)(B)(i) and (ii). With respect to the evidence that may be used to establish hours of participation, 26 C.F.R. section 1.469-5T(f)(4) provides: "The extent of an individual's participation in an activity may be established by any reasonable 9 means. Contemporaneous daily time reports, logs, or 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 similar documents are not required if the extent of such participation may be established by other reasonable means. Reasonable means for purposes of this paragraph may include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries." The regulation quoted above does not allow a party to rely on a post-event "ballpark guesstimate" or unverified, undocumented testimony, see Moss v. Commissioner, 135 T.C. 365, 369 (2010). Mrs. Balekian admits she did not maintain contemporaneous, detailed logs that verify her hours spent, and we are not persuaded by her testimony. The "Summary" that the Balekians did proffer for 2012 866.488.DEPO www.Capita1ReportingCompany.com Capital Reporting Company 11 1 2 3 4 5 6 7 8 9 10 11 (Ex. 24-P) was not prepared contemporaneously in 2012 but later--and by Mr. Balekian, not the spouse who allegedly did the work. Mr. Balekian allegedly made his summary by reviewing receipts of real-estate- related expenditures that supposedly enabled him to estimate the time spent by Mrs. Balekian in her activity. However, this summary does not state any amounts of time spent on any specific tasks, but only total hours spent in multiple-month periods for clusters of the properties. And after cross- examination Mr. Balekian was forced to admit that he 12 mistakenly included in his review receipts that did 13 not in fact relate to the real estate activity. 14 Similarly, Mrs. Baekian gave explicit and detailed A 15 16 17 18 19 20 21 22 testimony about an exhibit (Ex. 5-P at 5-11) that supposedly reflected notes made during a walk-through of a property in Fresno but in fact, she later admitted, were a record of a subcontractor's work performed at a different property in Camarillo. These are just the sorts of errors that one would expect in attempted reconstruction of tasks performed and time spent, years after the events. The 23 Balekians' carele.ss estimates are not persuasive 24 evidence of Mrs. Balekian's hours spent on the 25 activity. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 12 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Because we are not persuaded that Mrs. Balekian spent more time on her real estate activities in 2012 than she spent on her other work, nor that she spent at least 750 hours on her real estate work, she has not established that she is a "real estate professional" within the meaning of section 469(c)(7). Her real estate activities are therefore per se passive, and her ability to offset the losses against the Balekians' other income is limited by section 469. In the foregoing analysis, we assume, in the Balekians' favor, that all their properties are properly aggregated to form a single real estate business. In fact, the general rule is that section 469 "shall be applied as if each interest of the taxpayer in rental real estate were a separate 17 activity". Sec. 469(c)(7)(A) (ii). "A taxpayer may 18 19 20 21 22 23 24 25 elect to treat all interests in rental real estate as one activity", sec. 469(c) (7) (A); but 26 C.F.R. sec. 1.469-9(g) (3) requires: "A qualifying taxpayer makes the election to treat all interests in rental real estate as a single rental real estate activ,ity by filing a statement with the taxpayer's original income tax return for the taxable year. This statement must contain a declaration that the 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 13 taxpayer is a qualifying taxpayer for the taxable year and is making the election pursuant to section 469(c) (7) (A)." The Balekians allege that they had the intention to treat all their properties as a single real estate business; but they do not allege that they ever included such a statement in their tax return, and the two returns that are in evidence (Ex. 2-J (for 2012) and Ex. 27-J (for 2011)) lack such a statement. III. Accuracy-related penalty Section 6662 1mposes an "accuracy-related penalty" of 20 percent of the portion of the underpayment of tax that is attributable to the taxpayer's negligence or disregard of rules or regulations or that is attributable to any substantial understatement of income tax. The amount of the 2012 understatement that results from the adjustments that we now sustain (i.e., $8,960) is "substantial" under section 6662(d)--i.e., it exceeds both $5,000 and 10% of the tax that should have been reported (i.e., 10% of $16,291, or $1,629). We therefore need not reach the issue of negligence. The Balekians cannot successfully invoke any of the defenses that a taxpayer might assert against an accuracy-related penalty: They had no "substantial 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 14 authority" for their position (see sec. 6662(d) (2) (B)); they did not disclose on their return (see sec. 6662(d)(2) (B)) that they were unable to show the quantum of Mrs. Balekian's time spent on the real estate activities; and they did not show reasonable cause and good faith for their erroneous reporting (see sec. 6664(c)(1)). Their proof was altogether lacking; their "summary" was patently defective. Even if we assume they had subjective "good faith" in making their allegations, it is quite clear that there is no objective "reasonable cause" for their claim. We therefore hold that the Balekians are liable for the accuracy-related penalty for 2012. This concludes the Court's oral Findings of Fact and Opinion in this case. (Whereupon, at 1:20 p.m., the above- entitled matter was concluded.) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com