Court Opinion

ID: 4339416
Source: CourtListenerOpinion
Date Created: 2018-11-14 04:24:47.367336+00
Date Added: 2024-06-11T10:10:07.974915
License: Public Domain

FRANCIS J. DIRICO AND JENNIFER DIRICO, PETITIONERS v.
                                             COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
                                                    Docket No. 16202–09.                  Filed November 13, 2012.

                                                 P–H leased land and telecommunication towers to S, his
                                               wholly owned S corporation, in exchange for a percentage of
                                               S’s revenues from its leases of tower access to third parties.
                                               P–H also leased three parcels of land to S that were without
                                               towers. S also sold and serviced radios and provided special-
                                               ized mobile radio (SMR) services to customers for a monthly
                                               subscriber fee. Four of the towers leased to S housed antennas
                                               in free (unused) space for the rent-free use of S’s SMR cus-
                                               tomers. P–H reported the net income from his leases to S as
                                               passive activity rental income pursuant to I.R.C. sec.
                                               469(c)(2). R alleges that (1) P–H’s rental income from his
                                               tower and land rentals to S constituted income from property
                                               used in a trade or business in which P–H materially partici-
                                               pated and, therefore, constituted non-passive-activity income
                                               pursuant to sec. 1.469–2(f)(6), Income Tax Regs., (2) that
                                               regulation applies only to P–H’s profitable tower and land
                                               leases to S so that P–H’s losses from unprofitable tower and
                                               land leases to S remain passive activity losses, and (3) P–H’s
                                               income from the three land-only leases to S constituted non-
                                               passive-activity income pursuant to sec. 1.469–2T(f)(3), Tem-
                                               porary Income Tax Regs., 53 Fed. Reg. 5721 (Feb. 25, 1988),
                                               because less than 30% of the leased property’s unadjusted
                                               basis was subject to depreciation.
                                                 1. Held: S used the towers and associated land leased from
                                               P–H in a rental (not a trade or business) activity with the
                                               result that P–H’s income from those leases constituted passive
                                               activity income (or loss) pursuant to I.R.C. sec. 469(c)(2),
                                               regardless of P–H’s material participation in that activity. See
                                               I.R.C. sec. 469(c)(4).
                                                 2. Held, further, the prior holding renders moot Ps’ objection
                                               to treating P–H’s losses from unprofitable tower and land
                                               leases to S as passive activity losses.
                                                 3. Held, further, because the land included in the land-only
                                               leases was not ‘‘provided in connection with’’ any of the towers
                                               P–H leased to S, those leases may not be grouped with P–H’s
                                               tower and land leases to S, see sec. 1.469–4(d)(2), Income Tax
                                               Regs., and, therefore, because less than 30% of the property

                                     396

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                                     (396)                           DIRICO v. COMMISSIONER                                         397

                                               covered by those leases was depreciable, P–H’s income there-
                                               from constituted non-passive-activity income pursuant to sec.
                                               1.469–2T(f)(3), Temporary Income Tax Regs., supra.

                                       Donald-Bruce Abrams, Daniel A. Nelson, and Lawrence I.
                                     Silverstein, for petitioners.
                                       Nina P. Ching, for respondent.
                                        HALPERN, Judge: By notice of deficiency respondent deter-
                                     mined deficiencies in petitioners’ Federal income tax liabil-
                                     ities of $69,910 and $216,845 for their 2004 and 2005 tax-
                                     able, calendar, years (years in issue), respectively.
                                        Unless otherwise indicated, all section references are to the
                                     Internal Revenue Code in effect for the years in issue. All
                                     dollar amounts have been rounded to the nearest dollar.
                                        The issues for decision are (1) whether rental income paid
                                     to Francis J. Dirico (petitioner), or to one of his wholly owned
                                     grantor or nominee trusts, by his wholly owned subchapter
                                     S corporation for the use of telecommunication towers and
                                     land constituted income from a passive activity (passive
                                     activity income) pursuant to section 469(c)(2) or income from
                                     a nonpassive activity (non-passive-activity income) pursuant
                                     to section 1.469–2(f)(6), Income Tax Regs., (2) whether the
                                     rental income involved in deciding the first issue is the net
                                     income derived from all of the property leased to petitioner’s
                                     wholly owned subchapter S corporation or that derived from
                                     the profitable rentals only, (3) whether, in deciding the first
                                     issue, we should exclude from consideration petitioner’s
                                     income from rentals of land without a tower and treat that
                                     income as non-passive-activity income pursuant to section
                                     1.469–2T(f)(3), Temporary Income Tax Regs., 53 Fed. Reg.
                                     5721 (Feb. 25, 1988). 1

                                        1 The notice of deficiency also reflects reductions in petitioners’ itemized deductions for the

                                     years in issue, which derive from the principal adjustment and are not directly disputed by peti-
                                     tioners. Additionally, in their petition, petitioners argue that they are entitled to treat the por-
                                     tion of petitioner’s income from his wholly owned subchapter S corporation that was attributable
                                     to that corporation’s tower rental income as passive activity income even though the corporation
                                     reported his entire 100% distributive share of its income for the years in issue as ‘‘ordinary busi-
                                     ness income’’, a characterization that carried over to petitioners’ individual joint returns for
                                     those years. On brief, however, petitioners abandon that argument, apparently because the
                                     record does not include a breakdown between the corporation’s tower rental and other income
                                     for the years in issue. Therefore, we do not address that issue.

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                                     398                 139 UNITED STATES TAX COURT REPORTS                                    (396)

                                                                         FINDINGS OF FACT

                                     Residence
                                      At the time the petition was filed, petitioners resided in
                                     Key Largo, Florida.
                                     Background
                                       Petitioner attended high school, college, and graduate
                                     school in Massachusetts. He earned an undergraduate degree
                                     in public health and epidemiology and did graduate-level
                                     courses in various technical areas. After completing his
                                     schooling, he worked in Boston as a staff engineer in his
                                     father’s manufacturing business.
                                       In the early 1970s, he formed what became Industrial
                                     Communications & Electronics, Inc. (ICE). ICE’s business,
                                     which petitioner initially conducted out of his home in Pem-
                                     broke, Massachusetts, was electrical contracting, servicing
                                     two-way radios, and, later, performing specialized services
                                     for cellular carriers. ICE moved, first to Kingston and then to
                                     Marshfield, Massachusetts, where, at the time of the trial, its
                                     corporate headquarters had been for the preceding 10 years.
                                     ICE also maintains small offices in Miami and Naples,
                                     Florida.
                                       Before and during the years in issue, ICE was engaged in
                                     a variety of radio-related activities, including construction of
                                     and leasing access to telecommunications towers (towers),
                                     sales and servicing of Motorola radios, and providing special-
                                     ized mobile radio services (SMR) for a monthly subscriber fee.
                                     It constructed towers both for unrelated parties and for its
                                     own use, the latter for rental to customers, including
                                     Verizon, T-Mobile, AT&T, paging companies, and government
                                     entities.
                                       SMR was a pre-cellular-telephone-technology, push-to-talk
                                     radio system with some telephone capabilities. Before the cel-
                                     lular telephone industry matured, SMR was an attractive
                                     technology, offering party-line or intercom-like services to
                                     such users as security companies, plumbers, electricians,
                                     construction companies, and tow-truck and rubbish compa-
                                     nies.
                                       By 1997 or 1998, ICE and Nextel each owned half of the
                                     SMR frequencies in Boston. ICE used its frequencies in its SMR
                                     business, but, by then, Nextel’s use of digital technology on

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                                     (396)                           DIRICO v. COMMISSIONER                                       399

                                     its frequencies resulted in interference that caused ICE’s cus-
                                     tomers to have difficulty in using their SMR radios. The fre-
                                     quencies involved in the SMR business were both 800 and 900
                                     megacycles (megs), and it was Nextel’s use of the former that
                                     hurt ICE’s customers and led to ICE’s loss of some 90% of
                                     those customers. As a result, in 1997 or 1998 ICE disposed to
                                     Nextel all of its 800 megs frequencies in exchange for cash
                                     and Nextel’s 900 megs frequencies. Thereafter, ICE rebuilt its
                                     SMR business as a 900 megs business, which continued
                                     during the years in issue. ICE mounted the SMR antennas on
                                     a small number (perhaps four) of the towers that it leased
                                     from petitioner during the years in issue. ICE placed the SMR
                                     antennas on what was otherwise free space, i.e., space not
                                     already used by lessee antennas.
                                        During the years in issue, ICE was an S corporation (within
                                     the meaning of section 1361(a)(1)), and petitioner owned
                                     100% (in 2004, indirectly, through another wholly owned S
                                     corporation, and, in 2005, directly) of its stock.
                                     Petitioner’s Ownership and Leasing of Telecommunications
                                     Towers and Land to ICE
                                       During the years in issue, either individually or through
                                     grantor or nominee trusts, petitioner owned towers and land
                                     that he leased to ICE. In all, petitioner leased to ICE 19 prop-
                                     erties in 2004 (10 consisting of both a tower and land owned
                                     by a nominee trust, 6 consisting of land owned by a nominee
                                     trust on which was situated a tower owned by ICE, and 3 con-
                                     sisting of land owned by petitioner with no tower) and 21
                                     properties in 2005 (1 consisting of both a tower and land
                                     owned by petitioner, 10 consisting of both a tower and land
                                     owned by a nominee trust, 7 consisting of land owned by a
                                     nominee trust on which was situated a tower owned by ICE,
                                     and 3 consisting of land owned by petitioner with no tower).
                                     Those properties were in Massachusetts, Rhode Island, New
                                     Hampshire, and Florida. During both years, petitioner
                                     incurred net losses with respect to four of the properties
                                     leased to ICE, each consisting of tower and land.
                                       Under the typical lease from either petitioner or one of the
                                     nominee trusts to ICE, the lessor leased the land, towers, and
                                     other property at a specified address to ICE for a five-year
                                     initial term with provision for indefinite five-year renewals in

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                                     400                 139 UNITED STATES TAX COURT REPORTS                                        (396)

                                     consideration of ‘‘base rent of 25% of the gross tower rent
                                     revenue.’’ ICE was responsible for payment of utilities and for
                                     maintenance of the leased property.
                                        With respect to both the towers it leased from petitioner or
                                     a nominee trust and the towers it owned (on land it leased
                                     from a nominee trust), ICE leased tower access to unrelated
                                     third parties, including mobile telecommunication service
                                     providers such as Verizon and Nextel. ICE leased tower
                                     access to 3 to 20 tenants per tower, and each of those tenants
                                     would install up to 30 antennas on a tower. Under the typ-
                                     ical tower access lease (entitled ‘‘License Agreement for
                                     Antenna Site’’), the ‘‘licensee’’ is allowed to ‘‘install, operate,
                                     and maintain’’ at its ‘‘sole expense and risk’’ specified items
                                     of equipment (typically, antennas and transmission lines) in
                                     consideration of a ‘‘monthly license fee.’’ The ‘‘licensor’’ is
                                     liable for repairs except those ‘‘required because of the fault
                                     or negligence of * * * [the licensee] or its designated mainte-
                                     nance company’’, in which event the ‘‘licensee’’ becomes
                                     responsible for the repairs. ICE, as lessor or ‘‘licensor’’, gen-
                                     erally maintained each tower, made sure that it was painted
                                     and that the lights were working, picked up papers and other
                                     debris, plowed snow, etc.
                                     Petitioner’s Involvement With ICE
                                        Petitioner was immersed in ICE’s business operations,
                                     working long hours 51⁄2 to 6 days every week, at least until
                                     the sale of the 800 megs SMR frequencies to Nextel in 1997
                                     or 1998. Shortly after that sale, he and his family moved
                                     from Massachusetts to Key Largo, Florida. Thereafter, peti-
                                     tioner’s involvement with the day-to-day activities of ICE less-
                                     ened. 2
                                        2 The trial testimony, certain of the exhibits, and the parties’ briefs address the extent of peti-

                                     tioner’s involvement with ICE during the years in issue. Assuming ICE used the towers and
                                     land leased from petitioner or a nominee trust in a ‘‘trade or business activity’’ as defined in
                                     sec. 1.469–4(b)(1), Income Tax Regs., the question is whether petitioner’s involvement in that
                                     activity rose to the level of material participation therein, as defined in sec. 1.469–5T, Tem-
                                     porary Income Tax Regs., 53 Fed. Reg. 5725 (Feb. 25, 1988), thereby triggering the application
                                     of sec. 1.469–2(f)(6), Income Tax Regs., to convert petitioner’s tower and land rental income from
                                     passive activity to non-passive-activity income. For the reasons discussed below, we find that
                                     ICE did not use the towers and land leased from petitioner or a nominee trust in a trade or
                                     business activity, which renders moot the issue of whether petitioner materially participated in
                                     ICE’s tower access leasing activity during the years in issue. Therefore, we do not address or
                                     attempt to resolve the conflicting evidence in the record regarding petitioner’s involvement in
                                     the day-to-day operations of ICE during those two years.

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                                     (396)                           DIRICO v. COMMISSIONER                                       401

                                     Petitioners’ and ICE’s Tax Returns
                                        Petitioners’ returns for the years in issue reported the
                                     income and loss from the leasing of towers and land to ICE
                                     as passive activity income and loss for purposes of section
                                     469. Those returns listed each of the individual land and
                                     tower rentals as a separate activity.
                                        ICE’s returns for the years in issue did not separately
                                     report the income or loss from its various activities. Rather,
                                     ICE reported its total net income as ‘‘ordinary business
                                     income’’. Moreover, on the Form 1120S Schedule K–1, Share-
                                     holder’s Share of Income, Deductions, Credits, etc., it issued
                                     to petitioner for each of the years in issue, ICE included peti-
                                     tioner’s entire 100% distributive share of its income for the
                                     year in Box 1, ‘‘Ordinary business income (loss)’’. Consistent
                                     with those Schedules K–1, petitioner reported his distribu-
                                     tive share of ICE’s income for the years in issue as ordinary,
                                     non-passive-activity income on Schedule E, Supplemental
                                     Income and Loss.
                                     Respondent’s Adjustments at Issue
                                       For each of the years in issue, respondent recharacterized
                                     petitioner’s income from profitable rentals of towers and/or
                                     land from passive activity income to non-passive-activity
                                     income for purposes of section 469. He did not, however, so
                                     recharacterize petitioner’s losses from unprofitable tower and
                                     land rentals. On that basis, respondent recharacterized
                                     $428,128 and $590,054 for 2004 and 2005, respectively, from
                                     passive activity income to non-passive-activity income, attrib-
                                     utable to profitable rental properties, but he did not so re-
                                     characterize $143,829 and $157,824 for 2004 and 2005,
                                     respectively, of losses attributable to unprofitable rental
                                     properties.
                                       As noted supra note 1, for each of the years in issue,
                                     respondent also made correlative adjustments that are not in
                                     dispute.

                                                                                  OPINION

                                     I. Burden of Proof
                                       Each party argues that the other should bear the burden
                                     of proof. We have found many facts without the need to

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                                     402                      139 UNITED STATES TAX COURT REPORTS                                      (396)

                                     determine who bears the burden of proof. With respect to one
                                     possible material fact, i.e., whether petitioner materially
                                     participated in ICE’s tower access leasing activity, the parties
                                     propose conflicting findings. Because our disposition of the
                                     case makes it unnecessary to find whether petitioner materi-
                                     ally so participated, see supra note 2, there are no facts left
                                     to be found, only issues of law as applied to undisputed facts.
                                     Therefore, it is unnecessary to assign burden of proof.
                                     II. Applicable Law
                                            A. General Principles
                                        Section 469(a) disallows the passive activity loss of an indi-
                                     vidual taxpayer. The term ‘‘passive activity loss’’ means the
                                     amount, if any, by which the aggregate losses from all pas-
                                     sive activities for the taxable year exceed the aggregate
                                     income from all passive activities for such year. Sec.
                                     469(d)(1). A ‘‘passive activity’’ is any activity involving the
                                     conduct of a trade or business in which the taxpayer does not
                                     materially participate. 3 Sec. 469(c)(1). In addition, with an
                                     exception that is inapplicable herein, see sec. 469(c)(7), the
                                     term ‘‘passive activity’’ includes any rental activity (defined
                                     in section 469(j)(8) as ‘‘any activity where payments are prin-
                                     cipally for the use of tangible property’’), regardless of the
                                     taxpayer’s material participation therein, sec. 469(c)(2), (4);
                                     see Carlos v. Commissioner, 123 T.C. 275, 278 (2004). A tax-
                                     payer’s ‘‘activities’’ include those conducted through an S cor-
                                     poration. Sec. 1.469–4(a), Income Tax Regs.
                                        Section 1.469–1T(e)(3)(i), Temporary Income Tax Regs., 53
                                     Fed. Reg. 5702 (Feb. 25, 1988), states that an activity is a
                                     ‘‘rental activity’’ for the taxable year if ‘‘(A) [d]uring such
                                     * * * year, tangible property held in connection with the
                                     activity is used * * * or held for use by customers’’ and
                                     (B) The gross income attributable to the conduct of the activity during
                                     such taxable year represents (or, in the case of an activity in which prop-
                                     erty is held for use by customers, the expected gross income from the con-
                                     duct of the activity will represent) amounts paid or to be paid principally
                                     for the use of such tangible property (without regard to whether the use
                                     of the property by customers is pursuant to a lease or pursuant to a
                                     service contract or other arrangement that is not denominated a lease).

                                           3 See   sec. 469(h) for the definition of ‘‘material participation’’.

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                                     (396)                           DIRICO v. COMMISSIONER                                       403

                                        Section 1.469–1T(e)(3)(ii)(A)–(F), Temporary Income Tax
                                     Regs., 53 Fed. Reg. 5702 (Feb. 25, 1988), lists six exceptions
                                     or instances in which an activity involving the use of tangible
                                     property is not a ‘‘rental activity’’ for the taxable year, none
                                     of which is alleged by respondent to be applicable herein.
                                           B. Recharacterization of Passive Activity Rental Income
                                        Section 469(l), in relevant part, directs the Secretary to
                                     issue ‘‘such regulations as may be necessary or appropriate
                                     to carry out provisions of * * * [section 469] including regu-
                                     lations * * * (3) requiring net income or gain from a * * *
                                     passive activity to be treated as not from a passive activity’’. 4
                                     Pursuant to that legislative directive, the Commissioner
                                     promulgated section 1.469–2T(f), Temporary Income Tax
                                     Regs., supra, which incorporates by reference section 1.469–
                                     2(f)(5) and (6), Income Tax Regs., and is entitled ‘‘Re-
                                     characterization of passive income in certain situations.’’
                                     Only section 1.469–2T(f)(3), Temporary Income Tax Regs.,
                                     supra, and section 1.469–2(f)(6), Income Tax Regs., are
                                     alleged by respondent to be applicable herein; both apply to
                                     rental activities. The former provides, in relevant part, that,
                                     if less than 30% of the unadjusted basis of rental property
                                     is subject to the allowance for depreciation under section 167,
                                     the taxpayer’s net passive activity income from the property
                                     shall be treated as non-passive-activity income (sometimes,
                                     the 30% test). The latter provides, in relevant part, as fol-
                                     lows:
                                     (6) Property rented to a nonpassive activity.—An amount of the taxpayer’s
                                     gross rental activity income for the taxable year from an item of property
                                     equal to the net rental activity income for the year from that item of prop-
                                     erty is treated as not from a passive activity if the property—
                                       (i) Is rented for use in a trade or business activity * * * in which the
                                     taxpayer materially participates (within the meaning of sec.1.469–5T) for
                                     the taxable year * * *

                                     In general, ‘‘trade or business activities’’ constitute ‘‘activi-
                                     ties, other than rental activities’’. Sec. 1.469–4(b)(1), Income
                                     Tax Regs.
                                       4 The conference report accompanying the enactment of sec. 469 cites, as an example of pas-

                                     sive activity income to be converted into non-passive-activity income, income from ‘‘related party
                                     leases or sub-leases, with respect to property used in a business activity, that have the effect
                                     of reducing active business income and creating passive income’’. H.R. Conf. Rept. No. 99–841
                                     (Vol. II), at II–147 (1986), 1986–3 C.B. (Vol. 4) 1, 147.

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                                     404                 139 UNITED STATES TAX COURT REPORTS                                    (396)

                                       Thus, application of section 1.469–2(f)(6), Income Tax Regs.
                                     (sometimes, the self-rental rule), requires the satisfaction of
                                     two conditions: (1) property must be rented for use in a trade
                                     or business and (2) the lessor-taxpayer must materially
                                     participate in the trade or business. 5
                                       The fact that section 1.469–2(f)(6), Income Tax Regs., re-
                                     characterizes the net rental activity income from ‘‘an item of
                                     property’’ rather than the net income from the taxpayer’s
                                     entire rental activity means that the passive losses generated
                                     by unprofitable rental properties remain passive activity
                                     losses. Therefore, those losses do not offset the recharacter-
                                     ized (from passive activity to non-passive-activity) income
                                     from the taxpayer’s profitable rental properties. Veriha v.
                                     Commissioner, 139 T.C. 45, 49 (2012); Carlos v. Commis-
                                     sioner, 123 T.C. at 280–282.
                                           C. Rules for Grouping Activities
                                       Section 1.469–4(c), Income Tax Regs., entitled ‘‘General
                                     rules for grouping activities’’, provides: ‘‘(1) Appropriate eco-
                                     nomic unit. One or more trade or business activities or rental
                                     activities may be treated as a single activity if the activities
                                     constitute an appropriate economic unit for the measurement
                                     of gain or loss for purposes of section 469.’’ Section 1.469–
                                     4(c)(2), Income Tax Regs., applies a facts and circumstances
                                     test for determining whether activities constitute ‘‘an appro-
                                     priate economic unit’’.
                                       Section 1.469–4(d), Income Tax Regs., provides limitations
                                     on the grouping of activities. In that regard, section 1.469–
                                     4(d)(1)(i), Income Tax Regs., provides that ‘‘[a] rental activity
                                     may not be grouped with a trade or business activity unless
                                     the activities * * * constitute an appropriate economic unit’’
                                     and
                                        (A) The rental activity is insubstantial in relation to the trade or busi-
                                     ness activity;
                                        (B) The trade or business activity is insubstantial in relation to the
                                     rental activity; or
                                        (C) Each owner of the trade or business activity has the same propor-
                                     tionate ownership interest in the rental activity, in which case the portion
                                        5 Although sec. 1.469–2(f)(6), Income Tax Regs., has been challenged as invalid, its validity

                                     has been upheld repeatedly. See, e.g., Krukowski v. Commissioner, 279 F.3d 547, 552 (7th Cir.
                                     2002), aff ’g 114 T.C. 366 (2000); Sidell v. Commissioner, 225 F.3d 103, 107–108 (1st Cir. 2000),
                                     aff ’g T.C. Memo. 1999–301; Fransen v. United States, 191 F.3d 599, 601 (5th Cir. 1999); Shaw
                                     v. Commissioner, T.C. Memo. 2002–35.

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                                     (396)                           DIRICO v. COMMISSIONER                                         405

                                     of the rental activity that involves the rental of items of property for use
                                     in the trade or business activity may be grouped with the trade or business
                                     activity.

                                        Pursuant to section 1.469–4(d)(2), Income Tax Regs., real
                                     and personal property rental activities (other than where one
                                     type of property is provided in connection with the other)
                                     may not be grouped and treated as a single activity.
                                        A shareholder in a section 469 entity such as an S corpora-
                                     tion ‘‘may not treat activities grouped together by * * * [the
                                     S corporation] as separate activities.’’ Sec. 1.469–4(d)(5)(i),
                                     Income Tax Regs. (last sentence).
                                        Pursuant to section 1.469–4(e)(1), Income Tax Regs., ‘‘once
                                     a taxpayer has grouped activities * * *, the taxpayer may
                                     not regroup those activities in subsequent taxable years.’’
                                     However: ‘‘If it is determined that a taxpayer’s original
                                     grouping was clearly inappropriate * * *, the taxpayer must
                                     regroup the activities’’. Sec. 1.469–4(e)(2), Income Tax Regs.
                                     III. Summary of the Parties’ Arguments
                                           A. Respondent’s Arguments
                                        Respondent argues that, during the years in issue, peti-
                                     tioner (either individually or through a nominee trust) rented
                                     to ICE for use in its trade or business activities (1) tele-
                                     communications towers and land and (2) land on which ICE-
                                     owned towers were situated (together, tower and land
                                     rentals). Respondent further argues that, within the meaning
                                     of section 1.469–5T, Temporary Income Tax Regs., 53 Fed.
                                     Reg. 5725 (Feb. 25, 1988), petitioner materially participated
                                     in those ICE activities. Therefore, respondent concludes, peti-
                                     tioner’s income from those rentals must be recharacterized
                                     from passive activity income to non-passive-activity income
                                     pursuant to the self-rental rule of section 1.469–2(f)(6),
                                     Income Tax Regs. 6
                                        6 The parties appear to agree that petitioner’s tower and land rentals to ICE constituted a

                                     single activity. Presumably, both parties accept (and we agree) that those rentals represent the
                                     rental of personal property ‘‘provided in connection with’’ real property, or vice versa. Therefore,
                                     they come within the exception to the general prohibition against grouping real and personal
                                     property rentals. See sec. 1.469–4(d)(2), Income Tax Regs. Moreover, because petitioner’s activi-
                                     ties include those he conducted through ICE, see sec. 1.469–4(a), Income Tax Regs., his rentals
                                     of land with ICE-owned towers situated thereon are properly includable within that grouping
                                     as rentals of real property ‘‘provided in connection with’’ personal property indirectly provided
                                     by petitioner through ICE.

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                                     406                 139 UNITED STATES TAX COURT REPORTS                                    (396)

                                        Respondent’s argument that ICE’s leasing of tower access to
                                     unrelated third parties constituted a trade or business is
                                     based, in part, on his view that (1) ‘‘ICE was in the trade or
                                     business of leasing and managing tower access to unrelated
                                     parties’’ and (2) that ‘‘business’’ and ICE’s other business
                                     activities complemented one another with the overall result
                                     that they should be considered a single trade or business.
                                     Respondent also refers to ICE’s maintenance of the towers, its
                                     payment of the electrical bills, and its providing of technical
                                     specifications to the lessees regarding how they should
                                     install their antennas. Respondent’s argument that ICE’s
                                     tower access rental activity must be considered a part of and
                                     included within its overall trade or business activity is based
                                     principally on the fact that ICE, on its returns and on the
                                     Schedules K–1 issued to petitioner for the years in issue,
                                     grouped all of its activities and reported the income there-
                                     from as ‘‘ordinary business income’’. Respondent argues that,
                                     pursuant to section 1.469–4(d)(5)(i) (last sentence) and (e)(1),
                                     Income Tax Regs., petitioners are bound by ICE’s grouping of
                                     its activities and may not treat any of them as separate
                                     activities. Respondent further argues that ICE’s grouping was
                                     correct on the ground that its activities constituted ‘‘an
                                     appropriate economic unit’’ and petitioner had the same
                                     proportionate interest (100%) in both his rental activity and
                                     ICE’s trade or business activities. See sec. 1.469–4(d)(1)(C),
                                     Income Tax Regs.
                                        Respondent also argues that, pursuant to section 1.469–
                                     2(f)(6), Income Tax Regs., he properly recharacterized, from
                                     passive activity income to non-passive-activity income, only
                                     petitioner’s income from profitable tower and land rentals. In
                                     support of that argument, respondent cites Carlos v.
                                     Commissioner, 123 T.C. 275, and, in particular, our observa-
                                     tion in Carlos that section 1.469–2(f)(6), Income Tax Regs.,
                                     ‘‘explicitly recharacterizes net rental activity income from an
                                     ‘item of property’ rather than net income from the entire
                                     rental ‘activity’ ’’. Id. at 280–281.
                                        Lastly, respondent argues that petitioner’s rental income
                                     for the years in issue from the three parcels of land without
                                     a tower that he leased to ICE (land-only rentals) must be re-
                                     characterized as non-passive-activity income pursuant to the
                                     30% test of section 1.469–2T(f)(3), Temporary Income Tax
                                     Regs., supra, which requires such recharacterization with

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                                     (396)                           DIRICO v. COMMISSIONER                                       407

                                     respect to income from rental property less than 30% of the
                                     unadjusted basis of which is subject to the allowance for
                                     depreciation under section 167.
                                           B. Petitioners’ Arguments
                                        Petitioners argue that, because ICE’s leasing of tower
                                     access to third parties was a rental activity under section
                                     469(j)(8), which, by definition, cannot be a trade or business
                                     activity, see sec. 1.469–4(b)(1), Income Tax Regs., petitioner
                                     (either individually or through a nominee trust) did not lease
                                     any properties to ICE for use in a trade or business. There-
                                     fore, the self-rental rule of section 1.469–2(f)(6), Income Tax
                                     Regs., does not apply to petitioners’ rental income from those
                                     leases, which remains passive activity income, regardless of
                                     whether petitioner materially participated in the rental (or
                                     other) activities of ICE.
                                        Petitioner argues alternatively that, even if ICE’s leasing of
                                     tower access were treated as a trade or business (i.e., non-
                                     passive) activity, petitioners’ rental income would still be
                                     passive activity income because petitioner did not, within the
                                     meaning of the regulations, materially participate in the
                                     activity.
                                        Petitioner also objects to respondent’s failure to net his
                                     profitable and unprofitable property rentals to ICE in deter-
                                     mining the amount of income subject to recharacterization as
                                     non-passive-activity income under section 1.469–2(f)(6),
                                     Income Tax Regs. Petitioners argue that both the profitable
                                     and unprofitable rentals arose out of the same rental activity
                                     so that if the profits are to be treated as nonpassive so must
                                     the losses. Thus, petitioners reject as ‘‘excessive’’ respond-
                                     ent’s treatment of the profits from profitable rentals as non-
                                     passive while allowing the losses from nonprofitable rentals
                                     to remain passive and, therefore, unavailable to offset the
                                     non-passive-activity rental income.
                                        Petitioners make a similar argument in opposition to
                                     respondent’s citation of section 1.469–2T(f)(3), Temporary
                                     Income Tax Regs., supra, as grounds for recharacterizing,
                                     from passive activity income to non-passive-activity income,
                                     his income from land-only rentals. Petitioners argue that, in
                                     determining whether less than 30% of the unadjusted basis
                                     of petitioners’ property leased to ICE was depreciable,
                                     respondent should have included in the computation all of

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                                     408                 139 UNITED STATES TAX COURT REPORTS                                    (396)

                                     the property leased to ICE, not just the real property included
                                     in the land-only rentals. Petitioner also argues that respond-
                                     ent’s position with respect to the land-only rentals was first
                                     raised on brief and, for that reason, should be rejected as
                                     untimely.
                                     IV. Analysis and Conclusions
                                           A. Application of the Self-Rental Rule: Section 1.469–2(f)(6),
                                              Income Tax Regs.
                                           1. Introduction
                                       Application of section 1.469–2(f)(6), Income Tax Regs., to
                                     petitioner’s tower and land rentals to ICE during the years in
                                     issue depends upon our finding that two conditions existed
                                     with respect to those rentals: (1) ICE used those properties in
                                     a trade or business activity (which, for purposes of section
                                     469, is an activity other than a rental activity, see sec. 1.469–
                                     4(b)(1), Income Tax Regs.), and (2) petitioner materially
                                     participated in that trade or business activity. Because, for
                                     the reasons set forth below, we find that ICE did not use
                                     those properties in a trade or business activity, we do not
                                     address the issue of whether petitioner materially partici-
                                     pated in ICE’s tower access rental activities, and we hold that
                                     section 1.469–2(f)(6), Income Tax Regs., is inapplicable to
                                     petitioner’s income from tower and land rentals to ICE.
                                           2. Analysis
                                        The fact that the typical tower lease between ICE and its
                                     tower access customers was denominated a ‘‘License Agree-
                                     ment for Antenna Site’’ is of no consequence. If the customer
                                     is paying for the use of tangible property, the activity is a
                                     rental activity ‘‘without regard to whether the use of the
                                     property * * * is pursuant to a lease * * * a service contract
                                     or other arrangement that is not denominated a lease.’’ Sec.
                                     1.469–1T(e)(3)(i)(B), Temporary Income Tax Regs., 53 Fed.
                                     Reg. 5702 (Feb. 25, 1988).
                                        Also, the fact that ICE’s various activities may have com-
                                     plemented one another does not alter the fundamental fact
                                     that ICE’s leasing of towers and land to unrelated third par-
                                     ties was a rental activity within the meaning of section
                                     469(j)(8) and section 1.469–1T(e)(3)(i), Temporary Income

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                                     (396)                           DIRICO v. COMMISSIONER                                       409

                                     Tax Regs., supra. 7 The few services that ICE provided in
                                     connection with its rentals (e.g., painting the towers, making
                                     sure the lights worked, plowing the snow around the towers)
                                     were equivalent to the services routinely provided by any
                                     lessor or landlord in order to make premises habitable by a
                                     lessee. They were no more than supportive of ICE’s rental
                                     activities and did not turn those activities into trade or busi-
                                     ness activities as defined in section 1.469–4(b)(1), Income Tax
                                     Regs. More importantly, ICE’s performance of those services
                                     did not bring its tower leasing activities within any of the
                                     exceptions to the definition of a rental activity that are
                                     described in section 1.469–1T(e)(3)(ii)(A)–(F), Temporary
                                     Income Tax Regs., supra. Those exceptions, none of which is
                                     alleged by respondent to be applicable herein, describe cir-
                                     cumstances under which ‘‘an activity involving the use of
                                     tangible property’’ will not be considered a rental activity for
                                     the taxable year. They include rentals of ‘‘seven days or less’’
                                     (subdivision (A)); rentals of 30 days or less accompanied by
                                     ‘‘significant’’ lessor-provided services (subdivision (B) and sec.
                                     1.469–1T(e)(3)(iv), Temporary Income Tax Regs., 53 Fed.
                                     Reg. 5702 (Feb. 25, 1988)); rentals accompanied by ‘‘extraor-
                                     dinary personal services’’ (i.e., the use of the property is
                                     ‘‘incidental’’ to the receipt of the services) (subdivision (C)
                                     and sec. 1.469–1T(e)(3)(v), Temporary Income Tax Regs., 53
                                     Fed. Reg. 5702 (Feb. 25, 1988)); rentals ‘‘incidental to a non-
                                     rental activity of the taxpayer’’ (subdivision (D) and sec.
                                     1.469–1T(e)(3)(vi), Temporary Income Tax Regs., 53 Fed.
                                     Reg. 5702 (Feb. 25, 1988)); rentals where the property is
                                     made available ‘‘during defined business hours for nonexclu-
                                     sive use by various customers’’ (subdivision (E)); rentals to a
                                     passthrough entity (e.g., an S corporation) where the tax-
                                     payer has made property available to the entity ‘‘in the tax-
                                     payer’s capacity as an owner of an interest in’’ the entity
                                     (e.g., by way of capital contribution) for use in a nonrental
                                     activity (subdivision (F) and sec. 1.469–1T(e)(3)(vii), Tem-
                                     porary Income Tax Regs., 53 Fed. Reg. 5702 (Feb. 25, 1988)).
                                     Four of those exceptions (section 1.469–1T(e)(3)(ii)(A), (B),
                                        7 That ICE’s activities may have complemented one another is an indication that those activi-

                                     ties may have constituted an ‘‘appropriate economic unit’’ within the meaning of sec. 1.469–
                                     4(c)(1), Income Tax Regs. But, as discussed infra, that fact alone, even if proven, would not jus-
                                     tify the grouping of ICE’s rental and nonrental activities. See sec. 1.469–4(d)(1), Income Tax
                                     Regs.

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                                     410                 139 UNITED STATES TAX COURT REPORTS                                    (396)

                                     (E), and (F), Temporary Income Tax Regs., supra), are inap-
                                     plicable by their terms, and respondent does not seek to
                                     apply the other two exceptions (section 1.469–1T(e)(3)(ii)(C)
                                     and (D), Temporary Income Tax Regs., supra), presumably
                                     because the facts herein overwhelmingly demonstrate their
                                     inapplicability, i.e., there is no basis for concluding that ICE’s
                                     peripheral services afforded to tower lessees were ‘‘extraor-
                                     dinary personal services’’ as defined in section 1.469–
                                     1T(e)(3)(v), Temporary Income Tax Regs., supra, or that ICE’s
                                     rental activity was ‘‘incidental’’ to its nonrental activities
                                     within the meaning of section 1.469–1T(e)(3)(vi), Temporary
                                     Income Tax Regs., supra. 8
                                        Respondent relies heavily on the fact that, for the years in
                                     issue, ICE reported (both on its own returns and on the
                                     Schedules K–1 issued to petitioner) all of its income as a
                                     single, undifferentiated amount denominated as ‘‘ordinary
                                     business income’’. He further notes: ‘‘There is no evidence in
                                     the records [sic] showing what income and expenses are
                                     attributable to each of ICE’s business operations.’’ Respondent
                                     argues that ICE’s grouping of its activities as a single activity
                                     producing ‘‘ordinary business income’’ was proper under sec-
                                     tion 1.469–4(c) and (d), Income Tax Regs., and that, (1) under
                                     section 1.469–4(e)(1), Income Tax Regs., ICE may not
                                     ‘‘regroup’’ those activities and (2) under section 1.469–
                                     4(d)(5)(i), Income Tax Regs. (last sentence), petitioner may
                                     not treat those activities as separate activities for the years
                                     in issue.
                                        Petitioners respond that, even if ICE’s tower rental activity
                                     was to be combined with its other activities as part of ‘‘an
                                     appropriate economic unit’’ within the meaning of section
                                     1.469–4(c)(1), Income Tax Regs., the actual disconnect
                                     between that activity and ICE’s other activities, save for ‘‘the
                                     limited and rent-free use in the SMR business of antennas
                                     mounted in ‘free space’ * * * [atop] some of the towers’’,
                                     mandates its treatment as a passive activity thereby ren-
                                        8 ICE’s only trade or business activity to which its tower rentals conceivably could have been

                                     considered ‘‘incidental’’ was its SMR business for which it provided ‘‘free space’’ for SMR anten-
                                     nas atop no more than four of those towers. The record indicates that ICE received no rent for
                                     providing that space. Under those circumstances, it is beyond dispute that the towers in ques-
                                     tion were not ‘‘predominantly used in * * * [the SMR business] during the taxable year or dur-
                                     ing at least two of the five taxable years * * * [immediately preceding] the taxable year’’ as
                                     required by sec. 1.469–1T(e)(3)(vi)(C)(2), Temporary Income Tax Regs., 53 Fed. Reg. 5703 (Feb.
                                     25, 1988).

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                                     (396)                           DIRICO v. COMMISSIONER                                       411

                                     dering the self-rental rule of section 1.469–2(f)(6), Income
                                     Tax Regs., inapplicable to petitioner’s tower and land rentals
                                     to ICE during the years in issue. We agree with petitioner.
                                        ICE’s grouping of its activities and its reporting of those
                                     activities on its returns for the years in issue and on the
                                     Schedules K–1 issued to petitioner as a single business
                                     activity generating ‘‘ordinary business income’’ was improper.
                                     Section 1.469–4(d)(1), Income Tax Regs., prohibits the
                                     grouping of a rental activity and a trade or business activity
                                     unless those activities constitute an ‘‘appropriate economic
                                     unit’’ (as defined in paragraph (c) of the regulation) and one
                                     of three additional conditions is satisfied. Respondent does
                                     not argue that either ICE’s tower rental activity or its non-
                                     rental activities is ‘‘insubstantial’’ in relation to the other,
                                     i.e., he agrees that neither of the first two conditions applies
                                     herein. See sec. 1.469–4(d)(1)(i)(A) and (B), Income Tax Regs.
                                     Respondent does argue, however, that the third condition, set
                                     forth in section 1.469–4(d)(1)(i)(C), Income Tax Regs., applies
                                     because ‘‘petitioner had the same proportionate ownership
                                     interest in each of ICE’s activities (including the rental
                                     activity)’’ and that, therefore, ‘‘the grouping of ICE’s non-
                                     rental and rental activities was proper.’’
                                        Section 1.469–4(d)(1)(i)(C), Income Tax Regs., permits the
                                     grouping of a taxpayer’s rental and trade or business activi-
                                     ties, which form an ‘‘appropriate economic unit’’, and ‘‘[e]ach
                                     owner of the trade or business activity has the same propor-
                                     tionate ownership interest in the rental activity, in which
                                     case the portion of the rental activity that involves the rental
                                     of items of property for use in the trade or business activity
                                     may be grouped with the trade or business activity.’’
                                     (Emphasis added.)
                                        As petitioner points out, respondent’s argument does not
                                     take into account the emphasized language. Pursuant to that
                                     language, only the portion of ICE’s tower rental activity that
                                     involves the rental of petitioner’s towers for use in an ICE
                                     trade or business activity may be grouped with that trade or
                                     business activity. ICE’s only use of petitioner’s towers in a
                                     trade or business activity was its use of perhaps four of peti-
                                     tioner’s towers to house antennas used in ICE’s SMR business.
                                     But the SMR customers’ use of those towers was on a rent-
                                     free basis, and that use was de minimis as compared to the
                                     use of the towers by ICE’s tower rental customers. Thus, no

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                                     412                 139 UNITED STATES TAX COURT REPORTS                                    (396)

                                     portion of the income from ICE’s rental activity involved ‘‘the
                                     rental of ’’ petitioner-owned towers for use in ICE’s SMR busi-
                                     ness. 9 Therefore, we conclude that section 1.469–4(d)(1)(i)(C),
                                     Income Tax Regs., does not support respondent’s application
                                     of the self-rental rule to recharacterize, from passive activity
                                     to non-passive-activity income, any portion of petitioner’s
                                     income from his tower and land rentals to ICE.
                                        The question, then, is whether ICE’s erroneous grouping of
                                     its rental and other activities and its treatment of those
                                     activities as a single ‘‘ordinary business’’ activity is, by virtue
                                     of the last sentence of section 1.469–4(d)(5)(i), Income Tax
                                     Regs., and section 1.469–4(e)(1), Income Tax Regs., binding
                                     on petitioner with respect to his tower and land rentals to
                                     ICE with the result that the self-rental rule of section 1.469–
                                     2(f)(6), Income Tax Regs., is applicable to his income there-
                                     from (assuming that petitioner materially participated in
                                     that ‘‘ordinary business’’ activity).
                                        Pursuant to the last sentence of section 1.469–4(d)(5)(i),
                                     Income Tax Regs., petitioner, in his capacity as ICE’s sole
                                     shareholder, may not treat any of ICE’s activities as separate
                                     activities (‘‘A shareholder * * * may not treat activities
                                     grouped together by a section 469 entity as separate activi-
                                     ties.’’). 10 That provision might serve as the basis for denying
                                     to petitioner the right to treat his 100% distributive share of
                                     the income from ICE’s tower rentals to third parties as
                                     income from a separate activity generating passive activity
                                     income, even if he were able to determine the amount of that
                                     income. 11 It is not, however, authority for the application of
                                     the self-rental rule to petitioner’s income from his tower and
                                     land rentals to ICE. Petitioner derived that income as a lessor
                                     of property to ICE, not as a shareholder. Because petitioner
                                     wore his lessor hat (and not his shareholder hat), the last
                                       9 Respondent does not claim, nor is there any evidence to support a conclusion, that we should

                                     treat a portion of the monthly subscriber fee paid by ICE’s SMR customers as payment for the
                                     use of tower space, i.e., as a tower rental payment. Therefore, we consider ICE’s installation
                                     of SMR antennas on a few of its towers to be a gratuitous accommodation to its SMR customers.
                                       10 The consistency requirement of the last sentence of sec. 1.469–4(d)(5)(i), Income Tax Regs.,

                                     parallels that of sec. 6037(c)(1), which requires a shareholder of an S corporation to ‘‘treat a
                                     subchapter S item in a manner which is consistent with the treatment of such item on the cor-
                                     porate return.’’ By reporting his 100% distributive share of ICE’s income as ordinary income,
                                     petitioner acted in accordance with both provisions.
                                       11 Whether such separate activity treatment would be proper is, as stated supra note 1, an

                                     issue we need not address because petitioner has conceded it.

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                                     (396)                           DIRICO v. COMMISSIONER                                       413

                                     sentence of section 1.469–4(d)(5)(i), Income Tax Regs., is
                                     inapplicable to him.
                                       Section 1.469–4(e)(1), Income Tax Regs., prohibits only the
                                     regrouping of activities by ‘‘the taxpayer’’ (in this case, ICE)
                                     and, therefore, constitutes a limitation on the manner in
                                     which the taxpayer (i.e., ICE) reports its income for purposes
                                     of section 469. It does not affect petitioner’s reporting of ICE’s
                                     rental payments to him.
                                           3. Conclusion
                                        We find that petitioner’s tower and land rentals con-
                                     stituted the rental of property to ICE for use in a rental
                                     activity, which, by definition, see sec. 1.469–4(b)(1), Income
                                     Tax Regs., is not a trade or business activity. As a result,
                                     section 1.469–2(f)(6), Income Tax Regs., is inapplicable to
                                     petitioner’s income from those rentals for the years in issue,
                                     and respondent may not treat that income as non-passive-
                                     activity income pursuant to that regulation.
                                        We recognize that, because ICE erroneously reported all of
                                     its income as ordinary business (non-passive-activity) income,
                                     nonapplication of the self-rental rule of section 1.469–2(f)(6),
                                     Income Tax Regs., to ICE’s rental payments to petitioner, in
                                     effect, results in the reduction of what was reported as
                                     ‘‘active business income’’ and the offsetting creation of ‘‘pas-
                                     sive income’’ in seeming contravention of the congressional
                                     conferees’ directive to issue regulations preventing that
                                     result. See H.R. Conf. Rept. No. 99–841 (Vol. II), at II–147
                                     (1986), 1986–3 C.B. (Vol. 4) 1, 147. We do not believe, how-
                                     ever, that ICE’s tax return mischaracterization of its tower
                                     access rental income from third parties should control the
                                     application of the self-rental rule where, as here, it is, by its
                                     terms, inapplicable, i.e., where petitioner’s towers were not,
                                     in fact, used in a trade or business. Moreover, we are not
                                     persuaded that the result we reach herein violates the con-
                                     ferees’ directive as it does not, in fact, permit ‘‘passive
                                     income’’ to offset ‘‘active business income’’.

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                                     414                 139 UNITED STATES TAX COURT REPORTS                                    (396)

                                           B. Separate Treatment of Tower Rentals Producing Net
                                              Losses
                                           1. Analysis
                                        Petitioner objects to what he refers to as the ‘‘selective’’ re-
                                     characterizing of the income from his profitable tower and
                                     land rentals to ICE but not the losses from the unprofitable
                                     rentals. On his returns for the years in issue, he character-
                                     ized all of his property rentals to ICE as passive activities
                                     generating either passive activity income or loss. In effect,
                                     petitioner grouped all of his property rentals to ICE and
                                     treated them as a ‘‘single activity’’ pursuant to section 1.469–
                                     4(c)(1), Income Tax Regs. He argues that the ‘‘losses were
                                     generated from the same type of activity as the profits * * *
                                     and if the profits from the profitable Towers and Underlying
                                     Land are active, then the net losses from the unprofitable
                                     Towers must be treated as active as well.’’ In short, peti-
                                     tioner argues for consistency of treatment. Therefore, we
                                     assume that, because we reject respondent’s treatment of
                                     petitioner’s profitable tower and land rentals to ICE as gener-
                                     ating non-passive-activity income, petitioner would be willing
                                     to adhere to his return position whereby he treated all of his
                                     property rentals to ICE as passive activities generating either
                                     passive activity income or passive activity loss. Moreover,
                                     that is the treatment required by section 469(c)(2), which
                                     generally requires ‘‘any rental activity’’ to be treated as a
                                     passive activity. Thus, the issue regarding the proper
                                     characterization of petitioner’s rentals producing net losses is
                                     now moot.
                                           2. Conclusion
                                       There is no change to petitioner’s reporting of his losses
                                     from unprofitable tower and land rentals to ICE as passive
                                     activity losses.
                                           C. Separate Treatment of the Land-Only Rentals
                                           1. Introduction
                                       During each of the years in issue, petitioner made three
                                     land-only rentals to ICE. Each of those leases generated net
                                     rental income to petitioner, which he reported as passive
                                     activity income on his returns for the years in issue.

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                                     (396)                           DIRICO v. COMMISSIONER                                       415

                                       Respondent argues that the rental income from those land-
                                     only rentals was properly recharacterized as non-passive-
                                     activity income pursuant to section 1.469–2T(f)(3), Tem-
                                     porary Income Tax Regs., supra, which requires such re-
                                     characterization with respect to income from a rental activity
                                     where ‘‘less than 30 percent of the unadjusted basis of the
                                     property used * * * by customers in * * * [that] activity
                                     * * * during the taxable year is subject to the allowance for
                                     depreciation under section 167’’.
                                       Petitioners reject respondent’s argument on two grounds:
                                     (1) respondent improperly separated (‘‘ungrouped’’) the land-
                                     only rentals from petitioners’ other rentals of towers and
                                     land to ICE in applying the 30% test of section 1.469–2T(f)(3),
                                     Temporary Income Tax Regs., supra, and (2) respondent’s
                                     argument was first raised on brief and, for that reason alone,
                                     should be rejected as untimely.
                                           2. Analysis and Conclusions
                                           a. Timeliness
                                       Petitioners cite the following language set forth in respond-
                                     ent’s pretrial memorandum as demonstrating respondent’s
                                     intent to apply the 30% test on an aggregate basis to all of
                                     the properties (towers and land) leased to ICE:
                                       Alternatively, under Treas. Reg. section 1.469–2T(f)(3), the income
                                     earned by petitioner from leasing the telecommunications towers and the
                                     land upon which they sit, is non-passive income since less than 30 percent
                                     of the unadjusted basis of the property is subject to the allowance for
                                     depreciation under section 167. Simply stated, income from leased land is
                                     nonpassive. Land has an indefinite useful life and is not depreciable.
                                     Accordingly, under Treas. Reg. section 1.469–2T(f)(3), unless petitioner
                                     produces documentation that more than 30% of the unadjusted basis of the
                                     property is depreciable, then the rental activity is nonpassive.

                                        Petitioners allege that, consistent with that language, they
                                     ‘‘presented evidence at trial that ‘more than 30 percent of the
                                     unadjusted basis of [all of] the [leased] property’ * * * is
                                     depreciable.’’ They further allege: ‘‘Had the Commissioner
                                     asserted that there was a further question as to whether the
                                     rentals of the Underlying Land and the rentals of the Towers
                                     (or any of them) were separate activities, evidence on that
                                     point could have been introduced as well.’’ Thus, petitioners
                                     claim both surprise and prejudice with respect to respond-

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                                     416                 139 UNITED STATES TAX COURT REPORTS                                    (396)

                                     ent’s application of the 30% test exclusively to the land-only
                                     rentals, and, in support of their argument, they cite our deci-
                                     sion in Seligman v. Commissioner, 84 T.C. 191, 197–199
                                     (1985), aff ’d, 796 F.2d 116 (5th Cir. 1986), which involved
                                     surprise and prejudice to the taxpayer in regard to the
                                     Commissioner’s initial assertion in his opening brief of ‘‘addi-
                                     tional bases for his disallowance of specific items’’. Under
                                     those circumstances we declined to consider the newly raised
                                     issues.
                                        In this case, petitioners may have been surprised by
                                     respondent’s argument, but they were not prejudiced. The
                                     issue respondent raises (application of the 30% test to the
                                     land-only rentals) presents an issue of law. The fact that
                                     there were three land-only rentals in each of the years in
                                     issue is not in dispute. Therefore, we fail to see what addi-
                                     tional evidence petitioners were prevented from introducing
                                     in refutation of respondent’s argument (i.e., it is beyond dis-
                                     pute that 100% of each of those rentals consisted of non-
                                     depreciable land). Moreover, any surprise to petitioners was
                                     mitigated by their ability to address the merits of respond-
                                     ent’s argument in their reply brief, which, in fact, they did.
                                     The element of surprise was further mitigated by the above-
                                     quoted portion of respondent’s pretrial memorandum, which,
                                     although ambiguous regarding respondent’s intent to sepa-
                                     rately apply the 30% test to the land-only rentals, at least
                                     suggests that possibility by observing that ‘‘income from
                                     leased land is nonpassive.’’ Under those circumstances, we
                                     find Seligman distinguishable and, therefore, not controlling.
                                     Rather, we are guided in this matter by our analysis in Ware
                                     v. Commissioner, 92 T.C. 1267, 1268 (1989), aff ’d, 906 F.2d
                                     62 (2d Cir. 1990), wherein we stated:
                                       The rule that a party may not raise a new issue on brief is not absolute.
                                     Rather, it is founded upon the exercise of judicial discretion in determining
                                     whether considerations of surprise and prejudice require that a party be
                                     protected from having to face a belated confrontation which precludes or
                                     limits that party’s opportunity to present pertinent evidence. * * *

                                     As discussed above, we do not believe that the circumstances
                                     herein warrant our rejection of respondent’s argument on the
                                     ground that it was not timely raised. Moreover, it is always
                                     open to this Court to apply the correct law to the facts before
                                     it. See, e.g., Concord Consumers Hous. Coop. v. Commis-

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                                     (396)                           DIRICO v. COMMISSIONER                                       417

                                     sioner, 89 T.C. 105, 126 (1987) (Ko¨rner, J. concurring) (‘‘Nei-
                                     ther party can avoid the application of the correct law to the
                                     facts of the case by failing to plead or argue it. That is the
                                     province of the Court.’’).
                                       We shall consider the issue of whether it is proper to sepa-
                                     rately apply the 30% test to petitioners’ land-only rentals.
                                           b. Application of Section 1.469–2T(f)(3), Temporary Income
                                              Tax Regs., to Petitioners’ Land-Only Rentals
                                        Petitioners argue that, because all of the property rentals
                                     to ICE ‘‘involved the same landlord (or grantor trusts owned
                                     by the same landlord), the same tenant, and the same gen-
                                     eral types of property used for the same purpose’’, there is
                                     no basis for applying the 30% test separately to the land-only
                                     rentals. Thus, petitioners make the same argument with
                                     respect to the application of the 30% test that they did with
                                     respect to the application of the self-rental rule: Both should
                                     be applied to the aggregate of the properties he leased to ICE
                                     on the ground that all of those rentals constituted a ‘‘single
                                     activity’’ pursuant to section 1.469–4(c), Income Tax Regs.
                                     We disagree.
                                        Respondent’s separate application of the 30% test to peti-
                                     tioners’ land-only rentals to ICE is supported by section
                                     1.469–4(d)(2), Income Tax Regs., which provides as follows:
                                        (2) Grouping real property rentals and personal property rentals prohib-
                                     ited.—An activity involving the rental of real property and an activity
                                     involving the rental of personal property (other than personal property
                                     provided in connection with the real property or real property provided in
                                     connection with the personal property) may not be treated as a single
                                     activity.

                                        The section 469 regulations do not furnish illustrative
                                     examples of the foregoing provision’s parenthetical exception.
                                     Nonetheless, we find no basis for concluding that it applies
                                     to petitioners’ land-only rentals. The land is not ‘‘provided in
                                     connection with’’ any personal property situated thereon, and
                                     it is not ‘‘provided in connection with’’ the towers situated on
                                     other parcels of land where petitioner provides both a tower
                                     and land, one ‘‘in connection with’’ the other.
                                        Therefore, we find that respondent correctly applied the
                                     30% test of section 1.469–2T(f)(3), Temporary Income Tax
                                     Regs., supra, to the land-only rentals to ICE, and that, pursu-

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                                     418                 139 UNITED STATES TAX COURT REPORTS                                    (396)

                                     ant to that provision, petitioners’ income from those leases
                                     constituted non-passive-activity income.
                                                                         Decision will be entered under Rule 155.

                                                                               f

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