Court Opinion

ID: 9384412
Source: CourtListenerOpinion
Date Created: 2023-04-03 19:01:25.643464+00
Date Added: 2024-06-11T17:17:53.334511
License: Public Domain

United States Tax Court

                        T.C. Summary Opinion 2023-12

        ROBERT L. DROCELLA AND PAMELA M. DROCELLA,
                         Petitioners

                                           v.

               COMMISSIONER OF INTERNAL REVENUE,
                           Respondent

                                     —————

Docket No. 6538-21S.                                            Filed April 3, 2023.

                                     —————

Robert L. Drocella and Pamela M. Drocella, pro sese.

David A. Indek, Nancy M. Gilmore, and Jared J. Jones, for respondent.

                              SUMMARY OPINION

       LEYDEN, Special Trial Judge: This case was submitted pursuant
to the provisions of section 7463 of the Internal Revenue Code in effect
when the Petition was filed. 1 Pursuant to section 7463(b), the decision
to be entered is not reviewable by any other court, and this Opinion shall
not be treated as precedent for any other case.

       After a concession, 2 the sole issue for decision is whether under
the passive loss rules in section 469 petitioners cannot deduct certain
losses with respect to their rental real estate for 2018.

        1 Unless otherwise indicated, all statutory references are to the Internal
Revenue Code, Title 26 U.S.C., in effect at all relevant times, all regulation references
are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant
times, and all Rule references are to the Tax Court Rules of Practice and Procedure.
       2 Respondent concedes that petitioners are not liable for the section 6662(a)

accuracy-related penalty.

                                 Served 04/03/23
                                           2

                                    Background

       The parties submitted this case fully stipulated pursuant to Rule
122. Petitioners resided in Maryland when they timely filed their
Petition.

        During 2018 petitioner husband was employed full time by
Northrup Grumman Systems Corp., and petitioner wife was employed
full time by the U.S. Department of Defense. Petitioners did not provide
the exact number of hours they worked as employees in 2018 but rather
stipulated that they worked for their respective employers full time. In
addition to their employment petitioners owned and managed six rental
real estate properties during 2018. They worked renting, renovating the
properties, and handling issues with guests and tenants. The parties
stipulated handwritten logs containing dates, times, and notations as to
whether petitioner husband, petitioner wife, or both performed work as
to a property. The parties did not stipulate as to the truth or falsity of
those logs. The logs list hours attributable to petitioner husband,
petitioner wife, or both from January 14 through November 13, 2018.
The total listed hours equal 1,501.27. The hours listed on the logs that
bear petitioner husband’s first name initial exceed 750, but the total
hours listed on the logs that bear petitioner wife’s first name initial do
not equal or exceed 750.

       Petitioners timely filed a joint federal income tax return reporting
an adjusted gross income (AGI) of $160,627. Their tax return included
a Schedule E, Supplemental Income and Loss, on which petitioners
reported expenses related to their six rental properties. On that return
petitioners claimed a rental real estate loss deduction of $62,983.

       On February 9, 2021, the Internal Revenue Service (IRS) 3 sent
petitioners a notice of deficiency disallowing their claimed rental real
estate loss deduction because the IRS did not receive a response to its
request for supporting information to demonstrate the loss.

                                     Discussion

       Petitioners assert that their activity log supports their position
that they are entitled to deduct their rental real estate loss. Respondent

        3 The Court uses the term “IRS” to refer to administrative actions taken outside

of these proceedings. The Court uses the term “respondent” to refer to the
Commissioner of Internal Revenue, who is the head of the IRS and is respondent in
this case, and to refer to actions taken in connection with this case.
                                    3

contends that petitioners are not entitled to deduct the loss because
petitioners do not qualify as real estate professionals under the passive
activity loss rules. See I.R.C. § 469(c)(7). The Court agrees with
respondent that petitioners do not qualify as real estate professionals;
therefore, they may not deduct the rental real estate loss.

I.    Burden of Proof

       While the parties submitted this case for decision under Rule
122(a), such a submission “does not alter the burden of proof, or the
requirements otherwise applicable with respect to adducing proof, or the
effect of failure of proof.” Rule 122(b).

       In general, the Commissioner’s determination set forth in a notice
of deficiency is presumed correct, and the taxpayer bears the burden of
proving that the determination is in error. Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933). Deductions are a matter of
legislative grace, and taxpayers bear the burden of proving that they are
entitled to any deduction claimed. See Rule 142(a); INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering,
292 U.S. 435, 440 (1934). Under section 7491(a), the burden of proof
may shift to the Commissioner if the taxpayers produce credible
evidence with respect to any relevant factual issue and meet other
requirements. Petitioners have not argued that section 7491(a) applies,
and therefore the burden of proof remains with them.

II.   Petitioners’ Rental Real Estate Loss

       Sections 162 and 212 generally allow a taxpayer to deduct
ordinary and necessary expenses paid or incurred in carrying on a trade
or business or for the production of income. Taxpayers must maintain
adequate records to substantiate the amounts of any deductions. See
I.R.C. § 6001; Higbee v. Commissioner, 116 T.C. 438, 440 (2001); Treas.
Reg. § 1.6001-1(a).

       In the case of an individual, section 469 generally disallows any
current deduction for a passive activity loss. I.R.C. § 469(a)(1), (b). The
effect of the passive activity loss disallowance rule is that deductions
related to passive activities are allowed against income from the passive
activities, and the excess (i.e., the amount by which the deductions
related to the passive activities exceed the income from passive
activities) cannot be deducted from income from activities other than
passive activities. See Krukowski v. Commissioner, 279 F.3d 547, 549
(7th Cir. 2002), aff’g 114 T.C. 366 (2000). Generally, a passive activity
                                    4

is any trade or business in which the taxpayer does not materially
participate. See I.R.C. § 469(a)(1), (c)(1). Rental activity is passive
unless the taxpayer qualifies as a real estate professional as defined in
section 469(c)(7)(B). I.R.C. § 469(c)(2).

       If the taxpayer meets the definition of a real estate professional,
then section 469(c)(2) does not apply, and the taxpayer’s rental real
estate activity, if conducted as a trade or business or for the production
of income, is not treated as a passive activity if the taxpayer materially
participates in the activity. I.R.C. § 469(c)(1); Fowler v. Commissioner,
T.C. Memo. 2002-223, slip op. at 10–11; Treas. Reg. § 1.469-9(e).

       The Court concludes that neither petitioner has met the
requirements for being a real estate professional under section
469(c)(7)(B) and thus does not address the definition of “material
participation” in section 469(h).

      Section 469(c)(7)(B) provides two conjunctive tests that a
taxpayer must satisfy to be described as a real estate professional. A
taxpayer qualifies as a real estate professional if:

              (i) more than one-half of the personal services
       performed in trades and businesses by the taxpayer during
       such taxable year are performed in real property trades or
       businesses in which the taxpayer materially participates,
       and
              (ii) 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.

I.R.C. § 469(c)(7)(B).

       In the case of a joint return the above requirements are satisfied
if either spouse separately satisfies these requirements.          I.R.C.
§ 469(c)(7)(B). A trade or business includes a taxpayer’s status as an
employee. See Ostrom v. Commissioner, T.C. Memo. 2017-118, at *5;
Fowler v. Commissioner, T.C. Memo. 2002-223.

       Both petitioners were full-time employees. However, neither
petitioner has provided the number of hours he or she performed as an
employee. Assuming without finding that petitioners also performed
                                            5

personal services with respect to their rental real estate activities,4
petitioners cannot prove that more than one-half of either petitioner’s
total personal services performed in trades and businesses were
performed on their rental real estate activities during that year. See
I.R.C. § 469(c)(7)(B). Consequently, petitioners have failed to sustain
their burden to prove either petitioner meets the description of a real
estate professional under section 469(c)(7)(B).

       Thus, failing the first prong of the section 469(c)(7)(B) test,
petitioners are not entitled to deduct the rental real estate loss for 2018,
and the Court need not address the reasonableness of the logs and
whether either petitioner performed more than 750 hours of services
during the taxable year in real property trades or businesses in which
he or she materially participated.

        To reflect the foregoing,

       Decision will be entered for respondent as to the deficiency and for
petitioners as to the accuracy-related penalty under section 6662(a).

        4 Another exception to the general rule that rental real estate activities are

per se passive is found in section 469(i), which provides that a taxpayer who actively
participates in rental real estate activities may deduct up to $25,000 per year for
related passive activity losses. I.R.C. § 469(i)(1) and (2). The deduction is phased out
completely if a taxpayer’s adjusted gross income exceeds $150,000. I.R.C. § 469(i)(3).
Generally, spouses filing a joint return for a taxable year shall be treated for that year
as one taxpayer for purposes of section 469, including the AGI dollar limitation of this
phaseout. See Sharma v. Commissioner, T.C. Memo. 2020-147, at *5; Temp. Treas.
Reg. § 1.469-1T(j). Neither petitioners nor respondent raised this exception. Further,
the Court notes that the parties have stipulated that petitioners’ AGI for 2018 was
$160,627.