The opinion
T.C. Summary Opinion 2010-115
UNITED STATES TAX COURT
GREGORY JOHN BAHAS AND LINDA A. BAHAS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 29381-09S. Filed August 16, 2010.
Gregory John Bahas and Linda A. Bahas, pro sese.
Emly B. Berndt, for respondent.
JACOBS, Judge: This case was heard pursuant to the
provisions of section 7463 of the Internal Revenue Code in effect
when the petition was filed. 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.
Respondent determined: (1) A deficiency in petitioners’
Federal income tax of $9,560 and a section 6662(a) penalty of
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$1,912 for 2006, and (2) a deficiency of $2,408 for 2007. After
concessions,1 the sole issue for decision is whether petitioners
are entitled to claimed losses of $36,617 for 2006 and $10,874
for 2007 from rental real estate property. Resolution of this
issue depends upon whether section 469(c)(7) applies to the
rental real estate activities of Linda Bahas (Mrs. Bahas).
All section references are to the Internal Revenue Code in
effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. Petitioners resided in
Ohio when they filed the petition.
During 2006 and 2007 Mrs. Bahas was a licensed real estate
agent, and Mr. Bahas designed computer networks as a technical
applications manager. Mrs. Bahas worked full time for Snyder &
Snyder Real Estate, Inc. (Snyder & Snyder), an Ohio corporation
which for tax purposes elected to be treated as an S corporation.
Barbara Snyder (Ms. Snyder) owned all the stock of Snyder &
Snyder.
1
Petitioners did not challenge other determinations
respondent made; hence, in accordance with Rule 34(b)(4),
petitioners are deemed to have conceded these determinations.
Respondent conceded the sec. 6662(a) penalty of $1,912 for 2006.
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On December 22, 2004, Mrs. Bahas and Ms. Snyder entered into
an employment agreement. At the time Mrs. Bahas did not have a
real estate license. Pursuant to that agreement, Mrs. Bahas was
hired to be the office manager of Snyder & Snyder and Ms.
Snyder’s assistant. She received an hourly wage ($7.50 per hour)
for her duties as Snyder & Snyder’s office manager. As the
assistant to Ms. Snyder, Mrs. Bahas received the same $7.50
hourly wage “during normal business hours” but no hourly wage
“outside of normal business hours”. Rather, she was entitled to
receive “10% of the gross sales of Barbara Snyder on a bi-weekly
basis.” Starting January 1, 2006, by which date it was assumed
Mrs. Bahas would be a licensed real estate agent, Mrs. Bahas
would receive (as a licensed real estate agent assistant to Ms.
Snyder) “6 percent of the net profits of Snyder & Snyder to be
paid once a year upon completion of the [company’s] tax return.”
According to pay stubs she received from Snyder & Snyder, Mrs.
Bahas worked there during 2006 for 1,759.5 hours and during 2007
for 1,869.5 hours.
During 2006 and 2007 petitioners jointly owned and managed
three rental properties in Akron, Ohio. Their ownership of these
properties was not related to Mrs. Bahas’s employment at Snyder &
Snyder. Petitioners spent less than 750 hours managing these
properties during each of 2006 and 2007.
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Petitioners timely filed Forms 1040, U.S. Individual Income
Tax Return, for 2006 and 2007. They attached a Schedule E,
Supplemental Income and Loss (From rental real estate, royalties,
partnerships, S corporations, estates, trusts, REMICs, etc.),
to each of the returns and reported a loss of $39,154 for 2006
and a loss of $12,195 for 2007 in connection with their rental
properties.
Respondent determined that: (1) The losses petitioners
claimed from their rental properties were passive activity
losses, (2) petitioners had no passive activity income against
which these rental losses could be offset, (3) petitioners did
not meet the requirements of section 469(c)(7), and (4) $2,537 of
the rental loss claimed for 2006 (and none for 2007) was
allowable.
Discussion
Burden of Proof
In general, the Commissioner’s determinations set forth in a
notice of deficiency are presumed correct, and the taxpayer bears
the burden of proving that the determinations are incorrect. See
Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Deductions are a matter of legislative grace, and the taxpayer
bears the burden of proving that he is entitled to any deduction
claimed. Rule 142(a); New Colonial Ice Co. v. Helvering, 292
U.S. 435, 440 (1934).
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Section 7491(a) provides that under certain circumstances,
the burden of proof with respect to factual matters shifts to the
Commissioner. Petitioners neither alleged nor proved that this
section is herein applicable. Hence, petitioners bear the burden
of proof.
Petitioners’ Rental Losses
Generally, the deduction of passive activity losses is
suspended. Sec. 469(a). A passive activity is defined as “any
activity--(A) which involves the conduct of any trade or
business, and (B) in which the taxpayer does not materially
participate.” Sec. 469(c)(1). A passive activity loss is
defined as “the amount (if any) by which--(A) the aggregate
losses from all passive activities for the taxable year, exceed
(B) the aggregate income from all passive activities for such
year.” Sec. 469(d)(1). A rental real estate activity is
generally treated as a passive activity without regard to whether
the taxpayer materially participates in the activity. Sec.
469(c)(2), (4).
There are exceptions to the general rule suspending the
deduction of passive activity losses with respect to taxpayers
engaged in a rental real estate activity. One such exception is
found in section 469(i), where the taxpayer is an individual and
actively participates in rental real estate activities. In such
a case, the individual may deduct up to $25,000 (subject to a
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phaseout if the individual’s adjusted gross income exceeds
$100,000) of his/her losses. See sec. 469(i).2
Another exception is where the taxpayer materially
participates in a real property trade or business. A taxpayer
qualifies for this exception if:
(i) more than one-half of the personal services
performed in trades or businesses by the taxpayer during
such taxable year are performed in real property trades or
businesses in which the taxpayer materially participates,
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.
Sec. 469(c)(7)(B).
In the case of a joint return, as in the matter at hand, the
“materially participates” exception set forth in section
469(c)(7) applies if either spouse separately satisfies both
requirements set forth in section 469(c)(7)(B). And a taxpayer
is treated as materially participating in a real property
activity only if the taxpayer is involved in the operations of
the activity on a basis which is regular, continuous, and
substantial. Sec. 469(h)(1).
In establishing whether a taxpayer’s real property
activities result in passive activity losses, each interest of
2
As noted supra p. 4, respondent allowed petitioners a
$2,537 rental loss deduction for 2006 pursuant to sec. 469(i).
Petitioners’ gross income exceeded the gross income limitation
provided in sec. 469(i)(3) for 2007.
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the taxpayer in multiple rental properties is treated as a
separate rental real estate activity, unless the qualifying
taxpayer makes an election to treat all interests in the rental
properties as a single rental real estate activity. Sec.
469(c)(7)(A). The taxpayer must clearly notify the Commissioner
of his/her intent to make an election to treat multiple real
estate activities as a single activity. See Estate of Higgins v.
Commissioner, 897 F.2d 856, 860 (6th Cir. 1990), affg. 91 T.C. 61
(1988); Knight-Ridder Newspapers, Inc. v. United States, 743 F.2d
781, 795 (11th Cir. 1984). The statement of election must be
filed with the taxpayer’s original return declaring that the
election is under section 469(c)(7)(A). Sec. 1.469-9(g)(3),
Income Tax Regs. Merely listing the rental properties and
aggregating their losses on Schedule E is not sufficient to
constitute an election to aggregate petitioners’ rental
properties. See Trask v. Commissioner, T.C. Memo. 2010-78
(citing Kosonen v. Commissioner, T.C. Memo. 2000-107 (aggregation
of real estate rental losses was not clear notice of election
pursuant to section 469(c)(7))). Petitioners did not file a
statement of election with either their 2006 or their 2007 tax
return.
Mrs. Bahas maintains that she was engaged in a real property
business in 2006 and 2007 because she worked more than 750 hours
per annum as a licensed real estate agent assistant for Ms.
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Snyder. She asserts that in that capacity she actively showed
and sold houses to home buyers as an agent for Ms. Snyder
and/or Snyder & Snyder and therefore should be able to “use my
hours from Snyder and Snyder to make my 750 hours”.
Mrs. Bahas misconstrues section 469. Because petitioners
did not elect to aggregate their real estate rental activities,
pursuant to section 469(c)(7)(A) petitioners must treat each of
these interests in the rental real estate as if it were a
separate activity. See sec. 469(c)(7)(A)(ii). Thus, Mrs. Bahas
is required to establish that she worked for more than 750 hours
each year with respect to each of the three rental properties.
But, petitioners presented no documents or other evidence with
respect to the number of hours Mrs. Bahas worked managing the
three rental properties in question. Indeed, the parties
stipulated that “petitioners spent less than 750 hours managing
the rental properties” in question.3
Moreover, the hours Mrs. Bahas worked at Snyder & Snyder do
not qualify as hours worked in a real property trade or business
for purposes of section 469(c)(7)(B)(ii). In this regard,
section 469(c)(7)(D)(ii) provides:
3
We note that Mrs. Bahas did not establish that more than
one-half of the personal services she performed in 2006 and 2007
were with respect to any of the three rental properties. Thus,
she also failed to establish that she met the requirement set
forth in sec. 469(c)(7)(B)(i).
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Personal services as an employee.--For purposes of
subparagraph (B), personal services performed as an employee
shall not be treated as performed in real property trades or
businesses. The preceding sentence shall not apply if such
employee is a 5-percent owner (as defined in section
416(i)(1)(B)) in the employer.
Relying on Internal Revenue Service (IRS) Publication 925,
Passive Activity and At-Risk Rules, published in 2006, Mrs. Bahas
argues that because she was entitled to receive 6 percent of
Snyder & Snyder’s net profits as compensation for her efforts as
a licensed real estate assistant, she owned more than a 5-percent
profits interest in Snyder & Snyder. Mrs. Bahas claims her
position is supported by a passage on page 5 of IRS Publication
925 which states:
Do not count personal services you performed as an
employee in real property trades or businesses unless you
were a 5% owner of your employer. You were a 5% owner if
you owned (or are considered to have owned) more than 5% of
your employer’s outstanding stock, outstanding voting stock,
or capital or profits interest.
Mrs. Bahas’s position is flawed. Snyder & Snyder is an Ohio
corporation, owned entirely by Ms. Snyder. A 5-percent owner for
purposes of section 469(c)(7)(D)(ii) is defined in section
416(i)(1)(B)(i), which provides:
(I) if the employer is a corporation, any person who
owns (or is considered as owning within the meaning of
section 318) more than 5 percent of the outstanding stock of
the corporation or stock possessing more than 5 percent of
the total combined voting power of all stock of the
corporation, or
(II) if the employer is not a corporation, any person
who owns more than 5 percent of the capital or profits
interest in the employer.
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Mrs. Bahas’s employment agreement does not provide for the
transfer of any stock to her. Moreover, Mrs. Bahas candidly
admitted at trial that her right to 6 percent of the net profits
of Snyder & Snyder would terminate should her employment with
Snyder & Snyder cease. Thus, Mrs. Bahas’s employment agreement
with Snyder & Snyder only defined how Mrs. Bahas would be
compensated for services rendered; i.e., her compensation would
be based, in part, on the profits of the company. Therefore, we
conclude that Mrs. Bahas did not meet the 5-percent ownership
requirement of section 469(c)(7)(D)(ii).
To summarize, Mrs. Bahas did not qualify for the exception
to the passive activity loss rules for taxpayers in a real
property business as provided in section 469(c)(7). Hence,
petitioners are not entitled to the disallowed passive activity
deductions during the years at issue.
To reflect the foregoing and the parties’ concessions,
Decision will be entered
for respondent with respect to
the deficiencies in income
taxes for 2006 and 2007, and
for petitioners with respect
to the section 6662(a) penalty
for 2006.