Summary Opinion 2011-43

T.C.

Summary Opinion 2011-43

UNITED STATES TAX COURT

¢

JOSE B. MAGNO AND SUSAN A. O'CONNELL, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No.

4600-10S.

Filed April 6,

2011.

John E. Ellsworth, for petitioners.

Brett A. Saltzman, for respondent.

LARO, Judge:

This case was heard pursuant to the provisions

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

petition was filed.1

Pursuant to section 7463(b), the decision

Subsequent section references are. to the applicable

versions of the Internal Revenue Code, and Rule references are to~

the Tax Court Rules of Practice and Procedure.

Some dollar

amounts are rounded.

ERVED APR - 6 2011

- 2 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 deficiencies in petitioners' Federal

income taxes of $23,847, $36,684, and $30,145, and accuracyrelated penalties of $4,769, $7,337, and $6,029, for 2005, 2006,

and 2007 (subject years), respectively.

must decide whether:

After concessions,2 se

(1) Losses related to rental prop'erties

owned by petitioners and claimed on their Federal income tax

returns for the subject years are subject to the passive activity

limitations of section 469; and (2) petitioners are liable for

section 6662(a) accuracy-related penalties for the subject years.

We hold for respondent as to both issues.

Background

Some of the facts have been stipulated and are so found.

The stipulated facts and the exhibits submitted therewith are

incorporated by this reference.

2In addition to the concessions explicitly agreed to by the

parties, we consider petitioners to have conceded respondent's

determination that for 2006 they may not deduct $17,141 of

mortgage interest claimed on Schedule E, Supplemental Income and

Loss, by virtue of the fact that petitioners did not address that

issue at trial or on brief. We hold without further comment that

petitioners may not deduct $17,141 of Schedule E mortgage

interest for 2006 because they have failed to introduce any

evidence with respect to the payment of that interest. See

Vanicek v. Commissioner, 85 T.C. 731, 742-743

(1985); Masloff v.

Commissioner, T.C. Memo. 1998-257; see also Mendes v.

Commissioner,

121 T.C.

308,

316

(2003).

- 3 Petitioners Jose B. Magno (Mr.:Magno) and' Susan A. O'Connell

(Ms. O'Connell) resided in Illinois when- their- petition was

filed.

During the subject years Mr.' Magno worked as a financial

planner.

From 1998 until July 2003 petitioners lived in Michigan

(first residence).

3

In early 2003 petitioners began constructing a second house

in Michigan (second residence) and thereaft~er tried multiple

times to sell the first residence but without success.

When

-

their sales efforts failed, petitioners often rented that

property.

Tenants occupied the first residence'without

interruption from July 2003 until the lease expired in August

2005.

Petitioners tried to sell the first residence from August

2005 until March 2006.

During that time Mr. Magno performed

general maintenance on the property, prepared it for sale, and

marketed it to prospective buyers.2 Despite Mr.. Magno's efforts',

however, the first residence did not' sell, and petitioners again

rented that property.

e -

In March 2006 petitionersaleased the first residence' to

tenants who broke the lease after 2 months.

Petitioners

commenced an action against those tenants for breach of contract,

and Mr. Magno assisted the prosecution of that ááse.

The lawsuit

settled, and.petitioners again sought to sell the first residenc'e

without success.

Petitioners instead chose to lease the property

from November 2006 until November 2007.

In connection with that

- 4 -

rental, Mr. Magno prepared the lease, verified the tenant's

employment, and.showed the property.

In 2006 Ms. O'Connell was offered a job promotion which

would require petitioners to move from Michigan to Illinois.

Ms.

O'Connell accepted the promotion, and petitioners tried to sell

or lease the second residence.

Petitioners secured tenants, and

they leased the second residence from October 2006 through the

end of 2007.

During that time Mr. Magno performed maintenance on

the second residence, which required him to travel 370 miles from

Illinois to Michigan.

These trips typically required Mr. Magno :

to spend 2 days in Michigan, during which time he stayed with

family or at a hotel.

Mr.. Magno paid for these hotel stays with

cash or a credit card.

During each of these trips,.Mr. Magno -repaired or supervised

the repair of the second residence.

The tasks which Mr. Magno or

his contractors performed included, among others, fixing a tub,

installing a sump pump, fixing an icemaker, removing a bone from

a garbage disposal, replacing heads on a sprinkler system,

winterizing.that sprinkler system, and removing lint from aclothes dryer and vent.

When the repairs required.Mr. Magno to

purchase parts, she paid with cash or a credit card- and received

receipts.

When he was unable to.complete the repairs himself,

-<5

-

Mr. Magno hired repairmen to do so, though he could not recall

the names of the individuals he.hired.

Petitioners timely filed their Federal income ta'x return for

each of the subject years and reported on Schedules E total

rental real estate losses (of $30,117,- $57,275,: and $86,321,

respectively.

On each of those returns petitioners reported Mr.

Magno's occupation as a provider of financial planning services.

Petitioners also reported on Schedules C,' Profit ,or Loss From

Business, that Mr. Magno operated a financial.services or

planning business during -the subject- years.

Respondent issued to

petitioners a notice of-deficiency dated-November 20, 2009,

disallowing the Schedule E losses because respondent had

determined that section 469.prohibited recognition of the losses.

Petitioners petitioned the Court,e and on September 27, 2010, a

trial was held ins Chicago, Illinois.«

Discussion

I.

. * E

Burden of.Proof

The-Commissioner's determinationsrin a notice of deficiency

are presumed correct, and the taxpayer-bears the burden of

proving that those determinations are incorrect.

Welch ar. Helvering, 290 -U.S. 111, 115 (1933).

Rule 142(a) (1);

Under section

7491(a), the burden of proof as to factual matters may shift to

3Mr. Magno also modified mortgages on the first and second

residences in 2007.

- 6 the Commissioner in certains circumstances.«

Petitioners have not,

alleged that section 7491(a) applies, nor have they established

their compliance with the substantiation and recordkeeping

requirements of the Internal Revenue Code.7491(a) (2) (A) and (B) .

See sec.

Accordingly, petitioners bear the biirden

of proof.

II.

Real Estate Activities

Petitioners argue mainly that Mr. Magno is a qualifying real

estate professional because he meets the requirements of section

469(c) (7) (B) and that the «rental portions of his real estate

-a

activities.are not passive because he materially participated in

those activities.' ,Respondent argues that Mr. Magno's rental

real estate activities are per se passive and that petitioners

may not deduct losses associated with those activities because

Mr. Magno is not a qualifying real estate professional."

We

agree with respondent.

A taxpayer is generally allowed a deduction for all the

ordinary and necessary expenses paid or incurred in connection

with a trade or business or for the production of income.

See

4Petitioners do not contend that they are entitled to the ,

offset under sec. 469(i), nor are they.

sRespondent does not argue in the main that the claimed

rental expenses should be disallowed on the grounds that the

first and second residences were not converted from personal use

property to property held for the production of income. See,

e.g.; Saunders v. Commissioner, T.C. Memo. 2002-143, affd. 75

Fed. Appx. 494 (6th Cir. 2003).

- 7 -

secs. 162, 212.

Section 469(a) (1), however, limits the

deductibility of losses from these activities where those losses

arise from passive activities.

A passive activity is any

activity which involves -the conduct of any trade or business in

which the taxpayer does not materially participates.

469(c) (1).

Sec.

The disallowed passive activity loss equalso the

excess of the aggregate losses from all passive activities for a

taxable year over the aggregate income from all passive

a

activities for that year. ' Sec. 469(d) (1); sec. 1.469-2T(b) (1),

Temporary. Income Tax Regs., 53 Fed. Reg. 5711 (Feb. 25, 1988).

Rental real estate activity is generally treated as a per se

passive activity regardless of whether the taxpayer materially

participates^.

Sec. 469(c) (2)/.(4).

However, a taxpayersmay

avoid having his or her real-estate activity classified as-a per se passive activity if the taxpayer is a qualifying real estate professional.

A taxpayer may qualify as a real estate

a

professional 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

service during the taxable year in real property trades

or businesses in which the taxpayer materially

participates.

Sec. 469(c) (7) (]B).

Where, as here, a joint return has been made,

the foregoing requirements are satisfied if either spouse

- 8 -

separately -satisfies those requirements.

Id.

Thus, if Mr. Magno

meets the foregoing requirements, petitionersi rental activities

are not per se passive and the normal passive activity loss rules

of section 469(c) (1) will apply.

We consider.in turn.

petitioners' ability to meet each of the requirements under

section 469(c)-(7) (B).

t A.

Other Personal Services Mr. Magno Performed

Petitioners argue that the hours Mr. Magno spent on his

rental real-estate activities accounted for more than one-half of

the total hours of personal services he performed in trades or

businesses during the subject years.

We are not persuaded.

See sec. 469(c) (7) (B) (i).

Petitioners did not elect to treat their

interests in the first and second residences as a single rental

activity, and they must therefore prove that Mr. Magno meets the

requirements of section 469(c) (7) (B) as to each property.

sec. 469(c) (7) (A); sec..1.469-9(g),

See

Income Tax Regs.

During the audit stage of this proceeding, Mr. Magno told

respondent's·revenue agent that he worked approximately 25 to 30

hours per week on his financial planning and services business.

That conversation was documented in the revenue agent's notes,

and the revenue agent testified credibly to its contents at

trial.

At trial, however, Mr. Magno testified that he worked

principally as a financial consultant from January through August

2005.

He also testified that he became a full-time manager of

l

the first and second residences in 2006 and 2007 and that he

reduced the number of hours which he devoted to his financial

consulting services business to "about" 500 hours per ~year.

We credit the testimony of respondent's revenue agent and

therefore conclude that Mr. Magno must have worked more than

1,250 hours during each subject year in real property trades or

businesses to qualify as a real estate professional under section

469(c) (7) (B) (i).6

Mr. Magno was not able to corroborate with

written documentation his assertions that more than one-half of

the personal services he performed in trades or businesses during

the subject years were performed in real property trades or

businesses.

Accordingly, we find that Mr. Magno has not proven

that he meets the requirements of section 469(c) (7) (B) (i).

B.

750-Hour Requirement

Assuming arguendo that we were persuaded by petitioners'

claim that more than one-half of Mr. Magno's personal services

performed in trades or businesses during the subject years were

performed in real property trades or businesses, petitioners are

still unable to satisfy the 750-hour requirement of section

469(c) (7) (B) (ii).

Petitioners argue that Mr. Magno spent more

than 750 hours on each of petitioners' rental real estate

activities during each of the subject.years.

The extent of Mr.

'The product of 25 hours per week for 50 weeks per year is

1,250 hours.

- 10 -

Magno's participation in petitioners' real estate activities may

be proven by "any reasonable means."

See sec. 1.469-5T(f) (4),

Temporary Income Tax Regs., 53 Fed.; Reg. 5727 (Feb. 25, 1988).

Reasonablesmeans include the identification of services performed

over a period of time and the approximate number of hours spent

performing those services, based on appointment books, calendars,

or narrative summaries.

Id.

It is well settled that although

the phrase "any reasonable means" is broad, a taxpayer may not

use a postevent "ballpark guesstimate" of the time committed to

the rental activity.

See Hill v. Commissioner, T.C. Memo. 2010-

200; Lee v. Commissioner, T.C. Memo. 2006-193; Goshorn v.

Commissioner, T.C.. Memo. 1993-578; cf. :D'Avanzo v. United States,

67 Fed. Cl. 39, 42

(2005)

(adopting same standard).

Petitioners rely solely on the testimony of Mr. Magno to

prove that they devoted the requisite number of hours to qualify

their rental activities under section 469(c) (7) (B) (ii).

In so

doing, they.present no calendars, narrative summaries, mileage

logs, receipts,.or any other records which would support Mr.

Magno's testimony, even though by Mr. Magno's own admission they

possessed such items.

'The failure of petitioners to introduce

such evidence creates a presumption that such information was not

favorable to them.

See Wichita Terminal Elevator Co. v,.

Commissioner, 6 T.C.

1158, 1165 (1946), affd. 162 F.2d 513

Cir. 1947).

(10th

But here we are concerned with more than just the

- 11 -

lack of corroborating evidence., In certain material respects, we

found the testimony of Mr. Magno to be vague and unpersuasive.

See Mowafi v. Commissioner, T.C. Memo. 2001-111.

For example, Mr. Magno testified that between August 2005

and March 2006 he devoted 250 hours to repairing or supervising

the repair of the first residence.

That testimony does not allow

us to determine hoù much time Mr. Magno personally spent making

such repairs or whether such activity was material under section

469.

See D'Avanzo v. Commissioner, supra at 44-45; cf. Trask v.

Commissioner, T.C. Memo. 2010-78 (crediting a taxpayer for time

spent to repair or supervise the repair of rental properties

where the taxpayer maintained detailed work logs which identified

the properties repaired and the contractors used).

We are also

troubled by the fact that Mr. Magno is unable to recall basic

details about those repairs such as the dates they were performed

or the names of third parties whom he hired.

We also find Mr. Magno's estimates of the time he devoted to

petitioners' rental activities to be excessive in relation to the

tasks performed.

See Hill v. Commissioner, supra.

Mr. Magno

testified that he spent between 8 and 10 hours per day for 2 or 3

days to complete such seemingly simple tasks as removing a bone

from a garbage disposal, removing lint from a clothes dryer and a

dryer vent, and winterizing a sprinkler system.

We do not credit

Mr. Magno's assertion that he would drive approximately 740 miles

- 12 -

over the course of 16 or 20 hours to perform such simple and

routine tasks.

See Rapp v.. Commissioner, T.C. Memo. 1999-249.

Such is especially so given that Mr. Magno did not offer any

records to substantiate these trips or the expenses incurred

during them.7

Given the lack of corroborating evidence, we simply cannot

accept as fact that Mr. Magno worked the requisite number of

hours to qualify as a real estate professional for each of his

rental real estate activities.

T.C. Memo. 1996-554.

See Scheiner v. Commissioner,

We find that Mr. Magno's method for proving

the time he devoted to his rental activities is not reasonable

under section 1.469-5T(f) (4), Temporary Income Tax Regs., supra.

Cf. Trask v. Commissioner, supra (relying on a taxpayer's

testimony as proof that he spent more than 750 hours to resolve

over 80 issues for 11 pieces of property during a 1-year period).

C.

Conclusion

We hold that Mr. Magno is not a qualifying real estate

professional under section 469(c) (7) (]B) and that petitioners'

rental real estate activities are treated as per se passive under

section 469(c) (2).®

See Fowler v. Commissioner, T.C. Memo. 2002-

'Mr. Magno testified that the record included copies of gas

receipts, but we find no such receipts in the record.

"Given that holding, we need not consider whether Mr. Magno

materially participated in petitioners' rental real estate

activities.

- 13 223.

It follows that the losses petitioners sustained in

connection with their real estate activities may not be used to

reduce their nonpassive income.

See sec. 469(a).

III. Accuracy-Related Penalties

Respondent determined that petitioners are liable for

accuracy-related penalties under section 6662(a) for the subject

years.

Section 6662(a) and.(b) (1) imposes an accuracy-related

penalty equal to 20 percent of any portion of an underpayment of

tax required to be shown on the return that is attributable to

negligence or disregard of rules or regulations.

The term "negligence" includes any failure to make a

reasonable attempt to comply with the provisions of the internal

revenue laws and any failure to keep adequate books and records

or to substantiate items properly.

Sec. 6662(c); see also sec.

1.6662-3 (b) (1), Income Tax Regs.

Negligence may also'be defined

as lack of due care or the failure to do what a reasonable and

ordinarily prudent person would do under similar circumstances.

Neely v.

Commissioner,

85 T.C.

934,

947

(1985).

Respondent bears the burden of p'roduction with respect to

petitioners' liability for the accuracy-related penalties

included in the notice of deficiency and must therefore produce

evidence that it is appropriate to impose those penalties.

See

sec. 7491(c); see also Higbee v. Commissioner, 116 T.C. 438, 446

(2001).

Once respondent has met his burden of production,

- 14 -

petitioners must then adduce proof sufficient to persuade the

Court that they were not negligent and that they did not act

carelessly, recklessly, or with an intentional disregard of rules

or regulations.

Higbee v. Commissioner, supra at 446-447; see

also sec. 6662(c).

Alternatively, petitioners may avoid

liability for the accuracy-related penalties by showing that

there was reasonable cause for the underpayment and that they

acted in good faith.

See sec. 6664(c) (1).

,

We find that respondent has met his burden of production

because petitioners offered no documentation to support their

claim that they performed the requisite number of hours to be

engaged in a real property trade or business.

Commissioner, T.C. Memo. 1998-33.

See Smith v.

Petitioners did not address

their liability for the accuracy-related penalties at trial or on

brief, and on the basis of the record at hand, we find that

petitioners were negligent.

They maintained no books and made no

apparent effort to substantiate the hours which Mr. Magno

purportedly spent on petitioners' real estate activities.

Stewart v. Commissioner, T.C. Memo. 2010-184.

See

We believe that an

ordinarily reasonable and prudent person with Mr. Magno's

expertise in financial planning would have sought the advice of a

tax expert before claiming more than $173,000 in losses over a 3year period.

Petitioners made no such effort and in failing to

do so were negligent.

Cf. Fowler v. Commissioner, supra (finding

- 15 -

a taxpayer who relied on the advice of an accountant not liable

for an accuracy-related penalty even though the taxpayer did not

meet the requirements of section 469(c) (7) (]B)).

Nor does reasonable cause exist to excuse petitioners from

the accuracy-related penalties.

We recognize that section 469

and the regulations thereunder cover a highly complex area of the

Internal Revenue Code, but complexity alone does not excuse a

taxpayer from taking reasonable steps to determine the law and

comply with it.

Niedringhaus v. Commissioner, 99 T.C. 202, 222

(1992); see also sec. 1.6664-4(b) (1), Income Tax Regs.

Petitioners made no apparent effort to comply with the tax law or

to seek out the advice of someone who could help them do so.

We

therefore hold petitioners liable for accuracy-related penalties

for the subject years.

We have considered all arguments made by the parties, and to

the extent that we have not specifically addressed them, we

conclude that they are moot, irrelevant, or without merit.

To reflect the foregoing,

Decision will be entered

for respondent.