T.C. Memo. 1999-249
UNITED STATES TAX COURT
STEVEN D. RAPP AND JUDITH A. RAPP, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18039-97. Filed July 28, 1999.
Scott M. Nelson and Robert B. Patterson, for petitioners.
Blaine C. Holiday, for respondent.
MEMORANDUM OPINION
DINAN, Special Trial Judge: This case was heard pursuant
to the provisions of section 7443A(b)(3) and Rules 180, 181, and
182.1
1
Unless otherwise indicated, all section references are
to the Internal Revenue Code in effect for the taxable years in
(continued...)
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Respondent determined deficiencies in petitioners' Federal
income taxes for 1991, 1992, and 1993 in the amounts of $2,548,
$2,772, and $2,774, respectively.
The issue for decision is whether petitioners' claimed
Schedule C losses for 1991, 1992, and 1993 constitute passive
activity losses under section 469. The resolution of this issue
turns on whether petitioners materially participated in the
activity of renting their condominium unit during the taxable
years in issue.
Some of the facts have been stipulated and are so found.
The stipulations of fact and attached exhibits are incorporated
herein by this reference. Petitioners resided in Roseville,
Minnesota, on the date the petition was filed in this case.
Petitioner husband works as a manager of a commercial unit
for Norwest Banks. His formal education includes a bachelor's
degree from the University of Minnesota and a master's degree
from Mankato University.
In 1988, petitioners purchased condominium unit number 6
(the unit) at Bluefin Bay, a condominium complex located in
Tofte, Minnesota. Tofte is located on the shore of Lake Superior
in Superior National Forest, approximately 225 miles northeast of
petitioners' residence.
1
(...continued)
issue. All Rule references are to the Tax Court Rules of
Practice and Procedure.
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Bluefin Bay consists of six buildings, each having a
different layout. The six buildings contain a total of 54
condominium units. Petitioners' unit is a three-bedroom unit.
As unit owners, petitioners were members of the Bluefin Bay
Condominium Association (BBCA), the common interest owner of
Bluefin Bay. Petitioner husband was one of BBCA's officers, at
one time serving as its president. BBCA owns all of Bluefin
Bay's common property, including an indoor swimming pool, tennis
courts, a conference room, a parking area, water and waste
treatment facilities, and communication and cable equipment.
BBCA arranged for the Tofte Management Company (TMC) to manage
and operate the Bluefin Bay complex. BBCA's members, the unit
owners, entered into individual management contracts with TMC.
The terms of the management contracts were the result of the
joint effort of numerous BBCA members, including petitioner
husband.
Petitioners' management contract with TMC was effective
January 1, 1991, through the taxable years in issue. Under the
management contract, TMC was appointed as the exclusive rental
agent for petitioners' unit. Petitioners were required to
specifically reserve their unit in writing for the days which
they intended to personally use it. In the event petitioners
failed to properly notify TMC of their intended use, rental
arrangements previously made by TMC with other guests would hold
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priority over petitioners' personal use, unless the guests could
be assigned to another, comparable unit.
The management contract provided for TMC to receive 45
percent of the gross rental proceeds from petitioners' unit in
exchange for its services. Under the management contract, TMC's
duties included, but were not limited to, managing reservations,
checking in and out guests, providing housekeeping services,
collecting rents, generating financial reports, conducting damage
inspections, and making any necessary maintenance calls and
repairs.
TMC owns and operates a restaurant located adjacent to the
condominium complex. During the taxable years in issue, TMC's
employees staffed a reception desk near the restaurant entrance
for guests staying at Bluefin Bay. TMC also employed managers,
activity directors, bookkeepers, a housekeeping staff, and a
maintenance staff, all of whom participated in the activity of
renting petitioners' unit.
TMC's employees developed, drafted, and printed marketing
and promotional materials for Bluefin Bay. TMC maintained a
toll-free telephone number for promotional and reservation
purposes. TMC's employees answered this telephone line, booked
reservations for owners and guests, and mailed promotional and
marketing materials to interested parties.
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TMC's employees checked in guests, received deposits, and
issued keys. They responded to maintenance calls and made any
necessary repairs. TMC's employees opened, closed, and cleaned
the pool, hot tub, and pool house on a daily basis. They also
maintained Bluefin Bay's tennis courts and exercise room. In the
winters, TMC's employees plowed the parking lots and shoveled,
salted, and sanded the walkways.
TMC's employees collected payments from guests and checked
them out of the unit. They cleaned and inspected the unit after
guests departed. The cleaning activity included cleaning the
interior of the unit and laundering the linens and towels.
TMC's employees maintained daily books and records
reflecting the collected rents and fees owed by petitioners.
They issued monthly and annual reports to petitioners reflecting
the rental activity, owner charges, and TMC's share of the gross
rentals.
Petitioners' duties under the management contract included
providing TMC with a schedule of their intended personal use,
maintaining adequate insurance on their unit, and complying with
certain "Interior Quality Standards".
TMC made detailed inspections of petitioners' unit at least
annually and compiled lists of mandatory repairs and items which
needed to be replaced in order to satisfy the Interior Quality
Standards. Petitioners were given the choice to personally make
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these repairs and improvements or to authorize TMC to make them.
If they failed to comply by certain dates, TMC would arrange for
the work to be performed by its employees or subcontractors and
charge petitioners accordingly.
Petitioners traveled to Bluefin Bay 4 to 6 times during each
of the taxable years in issue. In most cases, petitioners would
stay at Bluefin Bay in their unit for a long weekend. They also
spent one full week each year in their unit. Petitioners' trips
to Bluefin Bay usually combined family vacations with owner
activities such as attending board meetings and/or making some
repairs to their unit. Petitioner husband also participated in
BBCA meetings at locations close to petitioners' residence during
the taxable years in issue.
On Schedules C attached to their 1991, 1992, and 1993
returns, petitioners reported the following amounts with respect
to the rental of their unit:
1991 1992 1993
Gross Income $32,380.34 $31,281.31 $37,174.23
Total Expenses (41,463.72) (40,864.03) (43,834.35)
Net Loss ( 9,083.38) ( 9,582.72) ( 6,660.12)
Petitioners claimed business loss deductions on their 1991,
1992, and 1993 returns in amounts equal to the amounts of their
net losses reported on the Schedules C. In the statutory notice
of deficiency, respondent disallowed the claimed business loss
deductions on the ground that the claimed losses were sustained
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in connection with a passive activity in which petitioners did
not materially participate.
Section 469 generally disallows for the taxable year any
passive activity loss that exceeds passive activity income. See
sec. 469(a), (d)(1). A passive activity is any activity which
involves the conduct of any trade or business in which the
taxpayer does not materially participate.2 See sec. 469(c)(1).
In general, section 469(h)(1) provides that a taxpayer shall
be treated as materially participating in an activity only if the
taxpayer is involved in the operations of the activity on a basis
which is regular, continuous, and substantial. Section 469(l)
authorizes the Secretary to prescribe regulations as may be
necessary or appropriate to carry out the provisions of section
469, including regulations which specify what constitutes
material participation. Sec. 469(l)(1).
Section 1.469-5T(a), Temporary Income Tax Regs., 53 Fed.
Reg. 5725-5726 (Feb. 25, 1988), provides that an individual will
2
The term "passive activity" also includes any "rental
activity", regardless of whether the taxpayer materially
participates in the activity. Sec. 469(c)(2), (4). A rental
activity is any activity where payments are principally for the
use of tangible property. See sec. 469(j)(8). However,
petitioners' activity does not constitute a rental activity
within the meaning of sec. 469(j)(8) because the average customer
stay at their unit was less than 7 days. See sec. 1.469-
1T(e)(3)(ii)(A), Temporary Income Tax Regs., 53 Fed. Reg. 5702
(Feb. 25, 1988).
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be treated as materially participating in an activity for the
taxable year if and only if:
(1) The individual participates in the activity
for more than 500 hours during such year;
(2) The individual's participation in the
activity for the taxable year constitutes substantially
all of the participation in such activity of all
individuals (including individuals who are not owners
of interests in the activity) for such year;
(3) The individual participates in the activity
for more than 100 hours during the taxable year, and
such individual's participation in the activity for the
taxable year is not less than the participation in the
activity of any other individual (including individuals
who are not owners of interests in the activity) for
such year;
(4) The activity is a significant participation
activity * * * for the taxable year, and the
individual's aggregate participation in all significant
participation activities during such year exceeds 500
hours;
(5) The individual materially participated in the
activity * * * for any five taxable years (whether or
not consecutive) during the ten taxable years that
immediately precede the taxable year;
(6) The activity is a personal service activity
* * * and the individual materially participated in the
activity for any three taxable years (whether or not
consecutive) preceding the taxable year; or
(7) Based on all of the facts and circumstances
* * * the individual participates in the activity on a
regular, continuous, and substantial basis during such year.
These regulations provide for taxpayers to be treated as
materially participating in an activity if they satisfy one of
the seven enumerated tests. Petitioners argue that they satisfy
the requirements of section 1.469-5T(a)(3), Temporary Income Tax
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Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988). Respondent argues that
petitioners have not satisfied this material participation test.
We must initially decide whether petitioners participated in
the rental of their unit for more than 100 hours during each of
the taxable years in issue. Section 1.469-5(f)(1), Income Tax
Regs., generally provides that any work done by an individual in
connection with an activity in which the individual owns an
interest at the time the work is done shall be treated as
participation of the individual in the activity. We consider
petitioners' combined hours of participation in deciding whether
this material participation test is satisfied. See sec.
469(h)(5); sec. 1.469-5T(f)(3), Temporary Income Tax Regs., 53
Fed. Reg. 5727 (Feb. 25, 1988).
With respect to the evidence which may be used to establish
hours of participation, section 1.469-5T(f)(4), Temporary Income
Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988), provides:
(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 similar 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.
Petitioners submitted copies of their monthly calendars from
1991, 1992, and 1993, two documents which purport to summarize
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their hours of participation in the activity of renting their
unit, and petitioner husband's testimony. Neither of the summary
documents was prepared contemporaneously. Petitioner husband
testified that the detailed summary document (joint exhibit 6-F)
was prepared in 1994. The other summary document was prepared at
some time after 1994 in preparation for this case and we do not
rely upon it. We also have serious doubts about the accuracy of
the detailed summary document. The monthly calendars corroborate
little more than the dates of petitioners' trips to Bluefin Bay
and petitioner husband's local BBCA meetings. Petitioner
husband's testimony establishes that he spent some hours working
out the details of the individual management contracts and
serving as BBCA's president. However, his testimony with respect
to petitioners' participation in renting the unit and performing
repairs to the unit was unpersuasive. The maintenance records
show that petitioners filled out work orders for TMC's employees
to perform such simple repairs as replacing light bulbs. In
addition, Dennis Rysdahl, who oversees the management and
operation of Bluefin Bay and did so during the taxable years in
issue, testified that petitioner wife's participation in making
repairs and improvements to the unit was greater than petitioner
husband's. Mr. Rysdahl testified that petitioner wife was
involved in decorating the unit, but the maintenance records show
that petitioners left the actual work of decorating their unit to
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TMC or its subcontractors. Petitioner wife's involvement appears
to have been limited to making decisions concerning how the unit
should be decorated. Petitioner wife did not testify about her
alleged hours of participation.
After carefully reviewing the record, we find that
petitioners have not proved that they participated in the
activity of renting their unit for more than 100 hours during any
of the taxable years in issue. We therefore need not decide
whether petitioners satisfy the section 1.469-5T(a)(3), Temporary
Income Tax Regs., 53 Fed. Reg. 5726 (Feb. 25, 1988), second
requirement of participating in the activity of renting their
unit more than any other individual. See Serenbetz v.
Commissioner, T.C. Memo. 1996-510.
We conclude that petitioners did not materially participate
in the activity of renting their unit during 1991, 1992, and
1993. Accordingly, we hold that petitioners' claimed losses from
such activity constitute passive activity losses which are not
deductible in the taxable years in issue by reason of section
469.
To reflect the foregoing,
Decision will be entered
for respondent.