TAX COURT OPINION

Case: Shrikant U. & Vaishali U. Janolkar
Docket Number: 18664-11
Judge: Holmes
Opinion Type: bench
Filed: 07/30/2012
Pages: 9

UNITED STATES TAX COURT WASHINGTON, DC 20217 SHRIKANT U. & VAISHALI U. JANOLKAR, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent . ) ) ) ) ) Docket No. 18664-11. ) ) ) ) ) ) ) ) ) Order of Service of Transcript Pursuant to Rule 152(b), Rules of Practice of Procedure of this Court, there is transmitted herewith to petitioner and to respondent a copy of the pages of the transcript of the trial of the above case before Judge Mark V. Holmes, at San Francisco, California, on June 27, 2012, containing his oral findings of fact and opinion rendered at the conclusion of the trial. In accordance with the oral findings of fact and opinion, decision will be entered for respondent. (Signed) Mark V. Holmes Judge Dated: Washington, D.C. July 30, 2012 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 Bench Opinion by Judge Mark V. Holmes July 27, 2012 Shrikant U. & Vaishali U. Janolkar v. Commissioner 3 Docket No. 18664-11 THE COURT: In the case of Janolkar v. Commissioner, 18664-11, the Court has decided to render oral findings of fact and opinion, and the following represents the Court's oral findings of fact and opinion. This bench opinion is made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code of 1986, as amended, and Rule 152 of the Tax Court's Rules of Practice & Procedure. The Janolkars were California residents when they filed their petition, and the dispute concerns their 2007 through 2009 tax years. There were just ·two issues. The first is whether the Janolkars are entitled to deduct real estate rental losses after applying the Code's passive limitation rules set out in code section 469, and whether, if they are not, penalties should be applied under section 6662. I'll begin with some background. In each of the 2007, 2008, and 2009 tax years, the Janolkars claimed rental real estate losses in excess of their rental real estate income. Shrikant Janolkar claimed to qualify as a real estate professional in each of the years at issue. On their Heritage Reporting Corporation (202) 628-4888 1 2 3 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 2007 form 1040, the Janolkars reported the following expenses from three rental properties on Schedule E, all of which are locaded outside of California: $122,455 for a house in Sorrento, Louisiana; $1602 in losses on a home in Ellijay, Georgia; and $1867 for a home in Tooele, Utah. On thg 2008 form 1040, the Janolkars reported the following income and expenses from four rental properties on Schedule E, three of which were still located outside the state of California. On their home in Sorrento, they reported slightly more than $10,000 in income but total deductions of $28,060; on their home in Ellijay, no rents, but $31,994 in expenses; În their home in Tooele, $7648 in rents, but $23,214 in expenses. And n their fourth home in Mountain View, California, $21,480 in rents, but $38,666 in deductions. A similar pattern applied in 2009 as well. On that form, the Janolkars reported income from their Sorrento home of $15,172, but deductions of 30,048; at their home in Ellijay, rents of $18,886, but expenses of 38,084; their home in Tooele, $14,400 in rent, but $25,324 in deductions; and the home in Mountain View, $37,800 in rent, but $80,753 in deductions. Despite these extensive losses and the receipt of some rents, most of the Janolkars' income came from the husband, Mr. Janolkar, Shrikant Janolkar, who listed himself Heritage Reporting Corporation (202) 628-4888 as an engineer and who had substantial wage income from more 5 than one employer in each of the three years in question. The law here is very well defined. Internal Revenue Code section 469 disallows deductions for losses incurred with respect to passive activities . A passive activity is defined as any activity involving the conduct of any trade or business in which the taxpayer does not materially participate . See section 469 (c) (1) . Rental activities are per se passive activities under section 469 (c) (2) . However, under IRC section 469 (c) (7) (B) , the rental activities of a taxpayer in the real property business, in other words, a real estate professional, are not per se passive activities, but are treated as a trade or business and subject to the material participation requirement of section 469 (c) (1) . So the goal is to see if Mr. Janolkar qualifies as a real estate professional. Section 469(c) (7) (B) (ii), which Mr. Janolkar claims, provides that a taxpayer is a real estate professional if 'such taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates . ' These requirements must be met as if each interest of the taxpayer in rental real estate was a separate activity. See section 469 (c) (7) (A) (ii) . A taxpayer, 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 Heritage Reporting Corporation (202) 628-4888 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 however, may elect to treat all his interests in real estate as one activity under section 469(c) (7) (A). To do so, however, a taxpayer has to comply with the relevant regulation, which in this case is 26 CFR section 1.469-9(g) (3), which states, 'a qualifying taxpayer makes the election to treat all interests in rental real estate as a single rental real estate activity by filing a statement with the taxpayer's ORIGINAL income tax return for the taxable year,' This means that even if Mr. Janolkar, who is relying in this case on an election he claimed to make in an amended return, which he didn't even introduce, would not have counted. There are no fewer than three reasons to disallow Mr. Janolkar's claim to be a real estate professional. The first is that he had no proof that he ever spent 750 hours on any one property in any one year. Because his election to group them all was ineffective, that alone would suffice to eliminate his right to the deduction. But a second and more disturbing problem is that the log he introduced was simply incredible. A taxpayer may use any reasonable means to establish that he is participating in a real estate activity. See 26 CFR section 1.469-5T(f) (4). In this case, however, Mr. Janolkar did not satisfy the requirement. Well, he prepared several Heritage Reporting Corporation (202) 628-4888 7 reconstructed logs of the hours he supposedly engaged in real estate activity; those logs exaggerated and contain d extremely unreliable information. In an exceptionally good cross-examination, the Commissioner's attorney showed several examples where Mr. Janolkar claimed obviously exaggerated hours. For example, 276 hours during a month-long trip to India, his native country, with his family during the end of the year in 2008. Or 22 hours a day in Los Angeles at his Mountain View property (sic) in 2007, described as visiting and preparing it. And especially another 276 hours in India at the same time, according to his logs, that he was spending 240 hours at the property in Georgia. My conclusion, of course, is that Mr. Janolkar's real estate activity log is completely without credibility, and that would be a second reason why he is not a real estate professional. But the third reason is that, even if I believed his improbable number of hours and allowed him to retroactively make an election which he can make only on his original return, many of the hours he records were not of the sort that count as real estate activity. For instance, the time spent commuting between his residence and the properties doesn't count. See, for instance, Mowafi v. Commissioner, TC Memo 2001-111; or Toups v. Commissioner, TC 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 Heritage Reporting Corporation (202) 628-4888 8 Memo 1993-359. In addition, such activities as studying and revlew1ng financial statements or reports of the operations of the real estate business or preparing or compiling summaries or analyses of the finances or operations of the activities for his own use, or monitoring the finances or operations of his properties in a non-managerial capacity, or even merely his participation as an investor, all operations he listed on his log, don't count towards the 750-hour requirement. See 26 CFR section 1.469-5T(f). My conclusion is that the Janolkars have failed utterly to qualify as real estate professionals. The Commissioner's determination on that issue is sustained. The second issue in the Janolkar case is their liability for an accuracy-related penalty. The Code imposes a 20 percent penalty on any underpayment of tax attributable to, among other things, negligence or the substantial understatement of tax. See code section 6662(a) and (b). An understatement is the excess of the amount of tax required to be shown on the return over the amount of tax actually shown on the return. An understatement is substantial if it exceeds the greater of 20 percent of the amount of tax required to be shown on the return, or $5000. Code section 6662(d) (1) (A). The tax required to be shown on the Janolkars' 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 Heritage Reporting Corporation (202) 628-4888 2007 return was $13,241, leading to an understatement of $15,241. For this year there was a substantial understatement of tax because the understatement for 2007 is 9 greater than $5000. For 2008, the tax required to be on the return was $22,625, and the understatement, $19,029. Again, there was a substantial understatement for tax year 2008 because the understatement exceeded $5000. And for 2009, the tax required to be shown on the return was $6841 and the understatement was $8841. Here there is a substantial understatement again because it exceeded $5000. Respondent thus met his burden of production under IRC section 7491(c). He also met his burden of production to show negligence. Negligence means 'any failure to make a reasonable attempt to comply with the provisions of this title.' It includes any failure to keep adequate books or records or to substantiate items properly. Manufacturing exceptionally implausible logs to avoid the restrictions that Mr. Janolkar knew existed on the deductions he claims is, I find, negligence in this case. There is a defense to penalties under 6662. Petitioners, however, did not present sufficient evidence that they had reasonable cause for the underpayment of their tax, and they provided no evidence that they reasonably 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 Heritage Reporting Corporation (202) 628-4888 . 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 10 relied upon professional advice in the preparation of their returns. Therefore, I sustain the Commissioner's determination in its entirety, and find that for tax year 2007 there is a deficiency owed by the Janolkars of $15,241 and a penalty under section 6662(a) of $3048; for the tax year 2008, a deficiency of $19,029 and a penalty under section 6662 (a) of $3805; and for tax year 2009, a deficiency of $8841 and a penalty under section 6662 of $1768. This concludes the Court's oral findings of fact and opinion, in this case. (Whereupon, at 5:02 p.m., the bench opinion in the above-entitled matter was concluded.) // // // // // // // ff // // // Heritage Reporting Corporation (202) 628-4888