T.C. Summary Opinion 2013-43

T.C. Summary Opinion 2013-43

UNITED STATES TAX COURT

PETER H. HOFINGA AND MARGARET M. WONG, Petitioners v.

COMMISSIONER OF INTERNAL REÝENUE, Ilespondent

Docket No. 21704-09S.

Filed June 3, 2013.

Shannon Gallagher, for petitioner

Sebastian Voth, for respondent.

SUMMAI Y ÓPINION

CARLUZZO, Special Trial Judge: This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code in effect when the

SERVÉD JUN 3 2013

-2petition was filed.' Pursuant to section 7463(b), the decision o be entered is not

reviewable by any other court, and this opinion shall not be tr ated as precedent

for any other case.

In a notice of deficiency dated August 21, 2009, respo dent determined

deficiencies of $23,706 and $27,653 in petitioners' 2006 and 007 Federal income

tax, respectively. The issue for decision for each year is whe er petitioners are

entitled to a deduction for a rental real estate loss. The resol ion of the'issue

depends upon whether Peter H. Hofinga (petitioner) is a taxp yer described in

section 469(c)(7) for either year in issue.

Background

Some of the facts have been stipulated and are so foun . At the time the

petition was filed, petitioners resided in California.

Over the years after they married in 1982, petitioners urchased, and as

necessary renovated and remodeled, residential real estate pr perties that they held

for rent. As of the close of 2006, petitioners owned eight ren al properties; as of

the close of 2007, petitioners owned nine rental proÊerties (c llectively, rental

properties). Because of an election they made for Federal ingome tax purposes,

1Unless otherwise indicated, section references are to the Internal Revenue

Code of 1986, as amended, in effect for the year in issue. R le references are to

the Tax Court Rules of Practice and Procedure.

3petitioners' interests in the rental proper ies are treated as one activity.. See sec.

469(c)(7)(A).

042 Before retiring in 1993 petitioner Was employed as a soccer coach and

professor of physical education by the University of California Irvine (UCI). .He

was not employed in any capacity during either year in issue. At all times

relevant, Märgaret M. Wong (Mrs. Won ) was also émployed by UCI. '

. 042

As between the two of them, petitioner was more re:sponsible for the .

management of the rental properties. For the most part he did so from his ,

den/office iii petitioners' residence. Rodtinely and regularly he reviewed and paid

various bills, considered and made arrangements for repairs, arranged for the

purchase of suiiplies, reviewed,rental applications, from time to time inspected a

rentál þròperty for various reasons, and upervised and/or made the arrangements

fòr renovatiñg and remodeling a rental propertyavhen necessary. Neither

petitioner, howeye , kept any sort of,coritemporaneous log or record that shows the

amount of time either spent, or specific 541ervices

either provided, with respect to

any specific·rental property on any specific date.

Petitioners also employed propertysmanagers for some of the rental

properties. Routinely, the property managers were responsible for collecting rent,

responding to inquiries or complaints from tenants, and making/supervising

repairs, the costs of which did not exceed a designated amount set by petitioners.

In addition to the fees paid to the property managers, a review of petitioners'

. .

Federal ine'ome tax returns for the years in issue shows deduc ions for expenses

attributable to the rental properties for cleaning, maintenance, gardening, pest

control, plumbers, electricians, and commissions.

On their 2006 and 2007 Federal income tax returns, pe itioners deducted

losses of $111,042 and $141,133, respectively, attributable to the rental properties

(rental property losses). If the rental property losses are not t ken into account,

then petitioners' adjústed gross income as reported on each o those returns would

exceed $150,000.

The rental property losses are disallowed in the notice f deficiency.

According to respondent's explanation, "[r]ental activities of any kind, regardless

of material participation, are considered passive activities un ess the.requirements

of section 469(c)(7) of the Internal Revenue Code are met in tax years beginning

after December 31, 1993". According to respondent, those "requirements", which

will be more fully discussed below, havé not been "met".. Ot er adjustments made

in the notice of deficiency are computational and will not be discussed.

5Discussion

The explanation for the disallowances of the rental property losses provided

in the notice of deficiency includes terms of art, such as "material participation"

and "passive activities", which are used and defined in section 469 and its

corresponding regulations.. In an article published in the October 24, 2011, edition

of Tax Notes, Professor George S. Jacksbn states that section 469 contains "almost

4,500 words" (we did not count) and "exemplifies why federal.tax law is

incomprehensible for most citizens." George S. Jackson, "Passive Activity

Limitations: Time for a New Paradigm?'', 133 Tax Notes 447,. 459 (2011).

Describing section 469 as "incomprehensible" is probably an overstatement; that

section, however, is hardly uncomplicated.2 The dispute between the parties in

this case,·however, allows us to avoid a discussion of many of the complexities of

section 469, and a summarization.ofthe relevant provisions of that section is

sufficient.

2Sec. 469 was enacted as part of the Tax Reform. Act of 1986, Pub. L. No.

99-514, sec. 501, 100 Stat. at 2233, to prevent affected taxpayers from using

deductions from a passive,activity to shelter wages or other active income. See

generally Staff of J. Comm. on Taxation, General Explanation of the Tax Reform

Âct of 1986, at 209-215 (J. Comm. Print 1987). .

-6In general and as relevant here, an individual is not enti led to a deduction

for a passive activity loss incurred during the taxable year. Me sec. 469(a). A

passive activity is any activity which involves the conduct of ny trade or business

in which the taxpayer does not materially participate. _S_ee sec 469(c)(1).

"Material participation" is defined generally in the statute and more specifically in

the regulations. See sec. 469(h); sec. 1.469-5T, Temporary I come Tax Regs., 53

Fed. Reg. 5725 (Feb. 25, 1988).

In general, a rental activity is treated as a passive activi y regardless of

whether the taxpayer materially participates. See sec. 469(c)(2), (4).. There are

two exceptions to this general rule, each subject to a variety f limitations and

conditions if the taxpayer's rental activity is a real estate rent 1 activity. One of

those exceptions, which allows a limited deduction if a taxpayer actively

participates in the rental real estate activity, is not relevant h re because

petitioners' adjusted gross income, as that term is defined in ection 469(i)(3)(F),

exceeds $150,000 for each year in issue. See sec. 469(i)(2) a d (3)(A).

The relevant exception is found in section 469(c)(7). If a taxpayer is

described in that section (sometimes that taxpayer is referred to as a "real estate

professional"), then section 469(c)(2) does not apply and the taxpayer's rental real

estate activity, if conducted as a trade or business or for the roduction'of income,

7is not treated as a passive activity if the axpayer materially-participates in the

activity. Sec. 469(c)(1); Fowler v. Com nissioner, T.C...Memo. 2002-223; sec.

1.469-9(e), Income Tax Regs.

We need not get into the complicdted definition of the term "material

participation" set forth in section 469(h) and:its corresponding regulations.

Keeping that definition in mind, and because petitioners elected to treat the rental

properties as a single actiyity, we are satisfied that.they materially participated in

the rental property activity during each ear in. issue, and respondent does not

541eem

to suggest otherwise. Instead, the disagreement between the parties focuses

on whether petitioner is a taxpayer desc ibed in section 469(c)(7). According to ,

petitioners, he is; according to respondent, he is not.

Section 469(c)(7) contains two tests that,a2taxpayer must satisfy to be

described in that section. One requires hat the taxpayer perform more than 750

hours of services during the taxable yea in real property trades or businesses in

which the taxpayer materially participates..See sec. 469(c)(7)(B)(ii)..The other

requires that "more than one-hal£of the ersonal 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". Sm sec.

3Mrs. Wong does not claim to be a taxpayer so described.

-8469(c)(7)(B)(i). Because petitioner was not otherwise emplo ed during either year

in issue, we need turn our attention only to the first test (the 750-hour test).

Ideally, a taxpayer who claims to be described in sectioh 469(c)(7) would

maintain a contemporaneous log or record showing.with parti ularity the amount

of time devoted to the rental real estate activity on an event-b -event basis. See

sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25,

1988). Ideally, the log would>be detailed enough to allow for someone who

reviewed it to make an informed judgment as to the accuracy of the information .

reported. The creation and availability of a detailed log is im ortant, especially if

||

that reviewing "someone" is an Internal Revenue Service em bloyee considering.

!I

the log in connection with an examination of the taxpayer's return on which rental

real estáte losses are deducted. Apparently, petitioners were ot aware of the

impórtance of keeping such a log and, as noted, neither kept à log during either

year in issue.

.

Recognizing that many taxpayers might not be aware f the importance of

keeping a contemporaneous log of time devoted to the taxpa er's.rental real estate

activity, the Commissioner's regulations provide a second-b st alternative.

Section 1.469-5T(f)(4), Temporary'Income Tax Regs., supra, provides: . 2 .

-9(4) Methods of proof. The extent of an individual's

participation in an activity may be established by any reasonable

means. Contemporaneous daily time reports, logs, or siinilar

documents are not required if the extent of such participation may be

established by other reasonable means. Reasonable means for

purposes of this paragraph may include but are not limited to the

identification of services performed over a period of time and the

approximate number of hours spent performing such services during

such period, based on appointment books, calendars, or narrative

summaries.

·. n

Although petitioners did not maintain contemporaneous logs of the time

devoted to their rental real estate activity, they tried-to establish petitioner's

participation by other reasonable means (e.g., noncontemporaneous logs based on

petitioners' records) in compliance with section 1.469-5T(f)(4), Temporary

Income Tax Regs., supra. During the examination of the years here in dispute, and

in response to a request by the examining agent, Mrs. Wong prepared several sets

of logs showing estimates of time spent on various events. According to Mrs.

Wong, she used calendars, bank statements, credit card records, property trip files,

bills, receipts, and other records to construct the logs. According to petitioners,

these logs establish thát petitioiier has sátisfieil the 750-hoùr test. . According to

respondent, they do not. For the follow ng reàsons, we agree with respondent.

The estimates of time shown for some entries oñ the first set of logs Mrs.

Wong prepared include a combination of time spent by both petitioners. For

-10purposes of the 750-hour test, however, only the hours petitioner spent are taken

into account. See sec. 469(c)(7)(B). Having had this problem pointed out to her

during the examination, she prepared a second set of logs usi g a generalized

allocation of time spent by each of them. For the most part, she supported the

allocation of time on the basis of the amount of time petitioner spent in his

den/office at their residence.4 The logs contain generalized e tries such as:

Address ,

Week of

Hours

(Petitioner)

Hours

(Mrs. Wona)

All properties

2/6/2006

8

---

Description

Payment f bills, filing of bills,

paperworl , monthly statement

reviews, e oss-checking, keeping in

touch witl property management

compames

All properties

2/13/2007

9

1

Payment òf bills, filing of bills,

paperwork, monthly statement

reviews, e oss-checking, keeping in

touch witl7 property management

compames

.

4Petitioner's health prevented his appearance at trial. The trial was

continued twice to allow for the possibility that his health wduld improve so that

he could be called as a witness. But petitioner's health did n t improve and, as it

turned out, only Mrs. Wong testified on petitioners' behalf when the matter was

tried. Her testimony as to what he was doing while in his de /office and out of her

presence might very well have been objectionable under Fed R. Evid. 602 and

802, see sec. 7453, but for petitioners' sec. 7463 election. B cause this case is

subject to that election, "evidence deemed by the Court to h e probative value

shall be admissible." See Rule 174(b). Probative value, ho ever, does not

necessarily equate to persuasive effect.

-11All properties

1/1/2007

.

9

1

Payment of bills, filing of bills,

-

paperwork, monthly statement

. reviews, cross-checking, keeping in

touch with property manägement

compames

All properties

1/8/2007

7

1

..

Payment of bills, filing of bills,

paperwork, monthly statement

reviews, cross-checking, keeping in

touch,with property management

companies

On thé other hand, some of the ei ries in the logs referencé specific

properties and provide a distinct description: such as.

Address

RPT-25 Park City

Week of

1/2/2006

Hours

Hours

(Petitioner) ( Irs. Wona)

4

Description

---

Discuss winter rentals, hot tub

repair, roof repair

Miraflores

4/3/2006

3

---

Walk-through inspection, assess

patio cover, painting needs

82401 Odlum

4/23/2007

6

--

. Work with handyman to identify

repairs, window coverings,

installation

Although we expect petitioners, ir their role of landlords, expended

significant time during each year in issu providing services in connection with

the rental properties, we are unable, froi what has been submitted, to quantify the

total time that petitioner spent domg so, and we cann

igno e the deductions

attributable to others' providing management and maintenance services m

connection with the rental properties. S mply put, the logs do-not.allow for a

-12review of activity related to the rental properties on an event-by-event basis to the

extent necessary to establish that the 750-hour test has been satisfied.5

Petitioners have failed to establish that petitioner satisfied the 750-hour test

for either year in issue; consequently, petitioner is not a taxpayer described in

section 469(c)(7) for either of those years. That being so, petitioners' rental real

estate activity is treated as a passive activity for both of those years. It follows

that respondent's disallowances of the rental property losses áttributable to that

activity are sustained.

To reflect the foregoing,

Decision will be entered

for respondent.

5Giving petitioners the benefit of the doubt, and keeping in mind the

infirmities of time logs prepared after the fact, see Moss v. Commissioner, 135 042

T.C. 365, 369 (2010) (we are not required to accept a postevþnt "ballpark

guesstimate"); Bailey v. Commissioner, T.C. Memo. 2001-296 (the regulations do

not allow a postevent "ballpark guesstimate"), to the extent 1;hat the logs reference

specific properties or events, at best they show that petitioner spent 379.5 hours

during 2006 and 526 hours during 2007 performing services in connection with

the rental properties.