TAX COURT OPINION

Case: William A. & Susan E. Gruener
Docket Number: 24950-09S
Judge: Carluzzo
Opinion Type: bench
Filed: 11/30/2011
Pages: 13

UNITED STATES TAX COURT 20217 Washington, D.C. WILLIAM A. & SUSAN E. GRUENER, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. ) ) ) ) ) ) ) ) ) Docket No. 24950-09S 23626-10S Pursuant to Rule 152 (b) , Tax Court Rules of Practice and Procedure, it is O R D E R ORDERED that the Clerk of the Court shall transmit the the transcript of the trial of herewith to petitioners and to respondent a copy of pages of Special Trial Judge Lewis R. Carluzzo at Los Angeles, California, on October 25, 2011, containing his oral opinion rendered at the conclusion of trial. the above case before findings of fact and In accordance with the oral findings of fact and opinion a decision will be entered for respondent with respect deficiencies and for petitioners with respect 6662(a) accuracy-related penalties in docket number 24950-09S, and a decision will be entered for respondent in docket number 23626-10S. to the section to the (Signed) Lewis R. Carluzzo Special Trial Judge Dated: Washington, D.C. November 30, 2011 SERVED NOV 3 0 2011 . 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 SPECIAL TRIAL JUDGE LEWIS R. CARLUZZO WILLIAM A. & SUSAN E. GRUENER V. COMMISSIONER DOCKET NOS.: 24950-09S and 23626-10S OCTOBER 25, 2011 THE COURT: The Court has decided to render oral findings of fact and opinion in these consolidated cases, and the following represents the Court ' s oral f indings o f f act and opinion . Each proceeding wasí conducted as a Small Tax Case pursuant to the provisi ns of section 7463 of the Internal Revenue Code of 1986, as amended, and Rules 170 through 175 of the Tax Court Rules of Practice and Procedure. 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 Rules of Practice and Procedure. Unless otherwise noted, subsequent section references contained in this bench opinion are to the Internal Revenue Code of 1986, as amended, in effect for the relevant periods. William A Gruener and Susan E. Gruener (petitioner) appeared pro sese. Sebastian Voth appeared on behalf of respondent. In a notice of def fciency dated July 28, 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 2009, respondent determined leficiencies in, and imposed section 6662 (a) penalties with respect to petitioners ' Federal income t axes as follows: (1) For 2005, a $5,691 deficiency and a $1,138.20 penalty; (2) for 2006, a $10,431 deficiency and a $2,086.20 penalty. The penalties imposed for 2005 and 2006 have now been conceded by respondent . In a notice of deficiency dated August 18, 010, respondent determined an $11,050 deficiency in petitioners' 2007 Federal income tax. The issue for decision for each of the above-referenced years is whether petitioners are entitled to a deduction for a loss incurred in a rental real estate activity. The resolution of the issue for each year depends pon whether petitioner qualif ies as a taxpayer engaged in a "real property trade or business" within the meaning of section 469 (c) (7) for any of those years . According to petitioners' Motion to Shift Burden of Proof, filed October 17, 2011, respondent ears the burden of proof on the issue for each year. See section 7491(a). Because we resolve the issue on the preponderance of evidence, rather than upon a failure of proof, petitioners' motion is moot, and need not be addressed further. FRCG v. Commissionèr, 89 Fed. Appx. 656 (9th 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 Cir. 2004); Knudsen v. Commissioner, 131 T.C. 185, 189 (2008). Some of the facts have been stipulated and are so found. At the time the petition was filed petitioners resided in California. Petitioners own, att all times relevant here owned, a single-family house located at 636 N. Muro Circle, Placentia, California (the rental property) . Prior to the years in issue they used the rental property as their residence . They intended to sell the rental property when the moved to their new residence, but a depressed real estate market influenced . their decision to rent it out instead, which they did for all years in issue. As between the two. petitioners, it appears that petitioner, otherwise employed as an elementary school teacher during each year in issue, was responsible for routine "landlording" responsibilities with respect to the rental property. She kept a daily calendar on which she record.ëd the many different services she performed in connection with the rental property, and the time that she spent in doing so (pet it ioner ' s log) . For example , ent rie s in petitioner's log show the ti e that she spent to (1) collect and account for rents, (2) pay the mortgage 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 and other bills, (3) participate in phone calls to and from tenants, (4) meet and have discussions with architects and contractors regarding major renovations to the rental property, (5) personally make minor repairs and perform other maintenance services, and (6) shop for materials, supplies and fixtures used at the rental property. Petitioner's logs also show many entries and much time spent on activities generally connected to potential real estate investments, but unrelated to the rental prop rty. For example, there are many entries showing that petitioner (1) attended many open houses, (2) reviewed many real estate listings published in newspapers and otherwise, (3) searched the Internet for real estate listings, and (4) read various periodicals llooking for ideas and trends in the real estate market. All told, and after rounding up, petitioner's logs show that she spent 1,373 hours, 1,371 hours, and 1,348 hours, respectively, in 2005, 2006,,and 2007, performing services not only in connection with the rental property, but in other activities involving real estate not otherwise connected to the rental property. Petitioner's teaching position with the Fullerton School District required that she spend 7 and ½ hours per day, for 186|days, or 1395 hours each 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 year. Deducting her lunch pekiod each school day, and subtracting time for hours and days off, petitioners calculate that petitioner spent (amounts rounded) 1251 hours, 1236 hours, and 1256 hours, respectively in '2005, 2006 and 2007 performing personal services as a teacher. Petitioners filed a joint Federal income tax return for each year in issue. Each return includes a Schedule E, Supplemental Income and Loss, showing the income and deductions attributable to the rental property. For each year a net loss is reported on the Schedule E (the rental property loss or losses) and the rental property loss is deducted in computing the adjusted gross income shown dn each return. Although each return shows a deduction for "teacher supplies", petitioner's profession on each return is shown as "real estate". Without taking the rental property loss into account, the adjusted gross income reported on petitioners' return for each year exceeds, by a wide margin, $150,000. In the notice of deficiency for each year (the notices), the rental loss deduction is disallowed. According to the notices, the rental property losses are passive losses that may be deducted only as provided in section 469. Other 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 8 adjustments made in the notices are computational and need not be discussed. In his recent article published in the October 24, 2011, edition of Tax Notes, Professor George S. Jackson notes that section 469 contains "almost 4,500 words" (we didn't count) and "exemplifies why federal tax law is incomprehensible for most citizens". "Passive Activity Limitations: Time for a New Paradigm?", 133 Tax Notes 447 (Oct . 24, 2011). The dispute between the parties in this case, however, allows us to avoid a discussion of many of the complexities of section 469, and a summarization of the relevant provisions of that section is sufficient. In general and as relevant here, an individual is not entitled to a deduction for a passive activity loss incurréd during the taxable year. Sec. 469 (a) . A passive activity is any activity which involves the conduct of any. trade or business and in which the taApayer does not materially participate. Sec. 469(c) (1) In general, a rental activity is treated as a passive activity regardless of whether the taxpayer materially participates. Sec. 469(c) (2), (4). There are two exceptions to this general rule, each subject tò a variety of limitations 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 9 and conditions, however, if the taxpayer's rental activity is a real estate rental activity. One of those exceptions, which allows a limited deduction if a taxpayer actively participates in the rental real estate activity, is not relevant here. This is so because petitioners' adjusted gross income, as that term is defined in section 469(i) (3) (F), exceeds $150,000 for each year in issue. See section 469(i) (2) and (3) (A). The relevant exception is found in section 469(c) (7). If a taxpayer is identified in that section (sometimes that taxpayer is referred to as a "real estate professional") section 469(c) (2) does not apply, and the taxpayer's rental real estate activity, if conducted as a trade or b siness or for the production of income, is not treated as a passive activity if the taxpayer materially participates in the activity. Sec. 469(c) (1); Fowler v. Commissioner, T.C. Memo. 2002-223; sec. 1.469-9(e), Income Tax Regs. We need not get iñto the complicated definition of the term "material participation" as set forth in section 469(h) and its corresponding regulation. Keeping that definition in mind, we are satisfied that petitioner's logs demonstrate that she materially participated in the.rental property Heritage Reporting Corporation (202) 628-4888 10 activity during each year in |issue, and respondent does not seem to suggest otherwise. Instead, the disagreement between the parties focuses on whether she is a taxpayer described in section 469(c) (7). According to petitioners, she is; according to respondent, she is not. . Section 469(c) (7) contains two tests that a taxpayer must satisfy to be described in that section. One requires that the taxpayer spend more than 750 hours of services during a taxable year in real property trades or businesses. See section 469(c) (7) (B) (ii). The other requires that "more than one-half of the personal ser ices performed.in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates". See 469(c) (7) (B) (I). We turn our attention to this second · test (the real estate profes,sional test). The real estate professional test requires a comparison of the time spenfiby the taxpayer performing personal services in the taxpayer's real property trades or businesses against the time the taxpayer spent in providing ersonal services in all other trades or businesses. In this case, the "other trades or businesses" is a reference to petitioner's 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 11 teaching job, and the referen e to "real property trades or businesses" is a reference to the rental property. Relying on the activities recorded in petitioner's logs, and based upon the manner that petitioner computed the time petitioner spent performing personal services as at teacher during each year, petitioners argue that she is a taxpayer described in section 469(c) (7) because she spent more time providing personal services in connection with real property trades or businesses than she did performing services as a teacher. We cannot help but to note that petitioner's me hod of computing time spent performing personal se vices in each activity is not entirely consistent. For example, her logs include hours spent traveling between.petitioners' residence and various locatiöns, but her calculation of hours.spent in teaching does not include commuting time. Furthermore, petitioner subtracts lunch time from hours spent teaching each day, but no allowance for meals is provided in.her logs on those days showing long hours that would suggest a break for meals would have been appropriate. Lastly, petitioner's logs record much time shopping for items related to the rental properny, but petitioner's 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 12 computation of the time spent as a teacher includes no time that must have been spent shopping for the supplies, the costs of which are deducted on each return. Ignoring these inconsistencies, we proceed by accepting the method petitioners used to compute the time petitioner spent in performing personal services as a teacher, without finding that their method is the appropriate way to have done so. For each year, we compare the hours petitioner spent performing services as a teacher, as computed by petitioners, with the hours shown in petitioner's logs for hours spent in connection with real estate activities. Because petitioners did not elect to aggregate their interests in real estate activities during the years in issue, their interest in each property is treated as a separate activity. See sec. 469(c) (7) (A) (ii); see also sec. 1.469-9(h) (2), Income Tax Regs; sec. 1.469-9(g) (3). Here, that means that only the time petitioner spent providing personal services directly related toithe rental property count in the comparison because it is clear to the extent that any other real property trade or business is identifiable from her logs, petitioner did not have an "interest" in the property or petitioner did not materially participate in that activity. This means 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 13 that time spent attending open houses looking for other rental or investment properties, or the time she spent reading newspapers, reviewing real estate listings, et c . does not count . Eliminating these types of hours from her logs reduces her time each year by at least 200 hours . Counting only the hours petitioner spent in performing services directly related to the rental property shows that she spent more time performing services as a teacher during each year in issue. That being so it follows that petitioner is not a taxpayer described in section 469(c) (7) even if she performed "more than 750 hours of personal services in real property trades or businesses in which the taxpayer materially participates " . Sec . 469 (c) (7) (B) (ii) . Because petitioner is not a taxpayer described in section 469(c) (7) for any year in issue, respondent's disallowance of the real estate loss for each year is sustained. To reflect the forègoing, decision will be entered for respondent with respect to the deficiencies and for petitioners with respect to the penalties. This concludes the Court ' s oral f indings of 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 fact and opinion in this case. (Whereupon, at 12:10 p.m., the bench opinion in the above-entitled matter.) 14 // // // // // // // // , // // // // // // // // // // // // // // Heritage Reporting Corporation (202) 628-4888