T.C. Memo. 1999-258
UNITED STATES TAX COURT
WALTER A. BARNISKIS AND MARY SUE BARNISKIS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18029-97. Filed August 4, 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 $2,675,
$2,842, and $2,366, 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 New Hope,
Minnesota, on the date the petition was filed in this case.
Petitioner husband works as an engineering manager for
Honeywell Corporation at its sensor guidance products division in
Minneapolis, Minnesota. His formal education consists of a
bachelor's degree in electrical engineering from the University
of Notre Dame and some graduate courses in the electrical
engineering program at the University of Minnesota. Petitioner
wife works as a librarian.
In October 1987, petitioners purchased condominium unit
number 40 (the unit) at Bluefin Bay, a condominium complex
1
(...continued)
issue. All Rule references are to the Tax Court Rules of
Practice and Procedure.
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located in Tofte, Minnesota. Tofte is located on the shore of
Lake Superior in Superior National Forest, approximately 250
miles northeast of petitioners' residence in New Hope.
Bluefin Bay consists of six buildings, each having a
different layout. The six buildings contain a total of 54
condominium units. Petitioners' unit is located in a building
which has three floors and consists of 20 condominium units,
including 10 one-story units on the first floor and 10 two-story
units on the second and third floors. Petitioners' unit is a
two-story unit. Since there are exterior doors on both floors,
the unit may be rented in its entirety or by individual floor by
simply unlocking or locking an interior, adjoining door.
Petitioners were members of the Bluefin Bay Condominium
Association (BBCA), the common interest owner of Bluefin Bay.
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. Prior to
1991, BBCA had member committees who would collectively decide
the nature and extent of the services to be performed by TMC.
Other member committees were responsible for establishing minimum
standards for the individual units. In response to increasing
difficulties in making decisions through the committee process,
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BBCA and TMC decided to simplify the relationships between the
unit owners and TMC by negotiating for individual written
management contracts between each unit owner and TMC. The
contracts were modeled after the policies that BBCA's committees
had developed in preceding years. With the exception of a few
unit owners who lived at Bluefin Bay all year, most of the unit
owners entered into management contracts with TMC.
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
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
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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.
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
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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
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 5 or 6 times during each
of the taxable years. In most cases, petitioners would stay at
Bluefin Bay in their unit for a long weekend. They also spent 1
full week each summer in their unit. Petitioners' trips to
Bluefin Bay usually combined family vacations with owner
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activities such as attending board meetings and/or making some
repairs to their unit. Petitioner husband also attended several
BBCA meetings in St. Paul, Minnesota, during the taxable years in
issue. Petitioners sold their unit on or about October 31, 1997.
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 $36,554 $40,202 $38,029
Total Expenses (46,096) (50,360) (46,454)
Net Loss (9,542) (10,158) (8,425)
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 losses were sustained in
connection with an 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).
2
The term "passive activity" also includes any "rental
activity", regardless of whether the taxpayer materially
(continued...)
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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. See 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
be treated as materially participating in an activity for the
taxable year 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
2
(...continued)
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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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.
Petitioners argue that they satisfy the requirements of
section 1.469-5T(a)(3), Temporary Income Tax Regs., 53 Fed. Reg.
5726 (Feb. 25, 1988). Respondent argues that petitioners have
not satisfied this material participation test.
Petitioners' Participation
We must first 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
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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:
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.
In their brief, petitioners characterized their personal
time records as detailed records of their participation. We have
carefully reviewed these personal time records and find that the
exhibit which purports to summarize petitioners' total hours of
participation is not accurate. The summary exhibit lists
petitioners' total hours of participation as 174 hours for 1991,
239 hours for 1992, and 154.5 hours for 1993. We compute the
total hours of participation as listed in the underlying records
to be 149.50 hours for 1991, 146.25 hours for 1992, and 108.25
hours for 1993.
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Furthermore, section 1.469-5T(f)(2)(ii)(A), Temporary Income
Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988), provides that work
performed by an individual in the individual's capacity as an
investor in an activity shall not be treated as participation of
the individual in the activity unless the individual is involved
in the day-to-day management or operations of the activity. We
find that petitioners were not involved in the day-to-day
management or operations of their unit because TMC managed and
operated the entire Bluefin Bay complex on a daily basis.
Section 1.469-5T(f)(2)(ii)(B), Temporary Income Tax Regs.,
53 Fed. Reg. 5727 (Feb. 25, 1988), provides that investor
activities include:
(1) Studying and reviewing financial statements or
reports on operations of the activity;
(2) Preparing or compiling summaries or analyses of the
finances or operations of the activity for the individual's
own use; and
(3) Monitoring the finances or operations of the
activity in a non-managerial capacity.
We find that several of the activities described in
petitioners' personal time records constitute investor
activities. In particular, petitioners' activities of organizing
their personal records, preparing their taxes, paying bills, and
reviewing their monthly statements of the rentals of their unit
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all constitute investor activities.3 Petitioners have failed to
establish that they materially participated in the rental
activity. Even if we were to assume that petitioners expended
100 hours in their rental activity during the years in issue,
they have not proved that their participation was greater than
the management company's participation.
Other Individuals' Participation
The second requirement of the section 1.469-5T(a)(3),
Temporary Income Tax Regs., supra, material participation test is
that petitioners' participation in the activity of renting their
unit must not have been less than the participation in such
activity of any other individuals. Petitioners must establish
that no other individuals participated in the activity of renting
their unit for more time than they did during the years in issue.
Dennis Rysdahl, the founder, president, secretary, and
general manager of TMC, was involved in the construction of
Bluefin Bay in 1984 and, more recently, an adjacent development
called Tofte Cove. Mr. Rysdahl currently oversees the management
and operation of Bluefin Bay and did so during the taxable years
in issue.
In a letter dated June 30, 1997, to the Bluefin Bay and
Tofte Cove owners, Mr. Rysdahl solicited contributions to a fund
3
We find that the listed hours of participation include
38.5 hours, 25.25 hours, and 27.25 hours of investor activities
for 1991, 1992, and 1993, respectively.
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which some of the owners had created to challenge respondent's
position in cases such as this one. Mr. Rysdahl stated in the
letter that he was personally contributing on behalf of the unit
that he owned and explained his motivation as follows:
[I] do so mainly based on the concern that, since
tax benefits are useful to at least some of our owners,
a victory in this case would make ownership of a unit
more desirable for some prospective buyers, and
therefore help retain the re-sale value of our units.
Immediately prior to the submission of this June 30, 1997,
letter as evidence, Mr. Rysdahl had testified as follows:
Q: Mr. Rysdahl, you, in fact, own a unit at Bluefin
Bay, don't you?
A: I am a 50 percent owner in one unit at Bluefin
Bay. Actually I'm a 50 percent owner in a unit at
Tofte Cove Townhomes, which is a more recent and
adjacent development. I no longer own any part of a
unit at Bluefin Bay.
Q: But it -- and it's your opinion or belief that the
outcome of this case will affect the resale value of
your unit?
A: No. It won't affect the resale value of my unit.
Mr. Rysdahl later testified about the type and extent of
TMC's employees' participation in the management and operation of
Bluefin Bay. In light of his personal and business interests in
the outcome of this case, we discredit Mr. Rysdahl's testimony
concerning the number of hours spent by TMC's employees in the
activity of renting petitioners' unit. We rely on his testimony
only to the extent it is corroborated by other reliable evidence.
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The monthly statements generated by TMC during 1991 and 1992
reveal that both or one of the floors of petitioners' unit were
used by 238 different guests during 1991 and by 227 different
guests during 1992. TMC's maintenance records for petitioners'
unit show that petitioners were separately charged for 18 hours
of labor during 1991 and 41 hours of labor during 1992. These
charges were in addition to the 45-percent gross rental fee paid
by petitioners under the management contract. The maintenance
records do not reflect the maintenance staff's work on the
facilities and grounds outside of petitioners' unit.
Based on the record, we find that petitioners have failed to
prove that they participated in the activity of renting their
unit more than TMC's employees during the years in issue. The
record contains only Mr. Rysdahl's biased testimony about the
number of hours TMC's employees devoted to petitioners' unit,
which we do not rely upon without corroboration.4 It is clear,
however, that the front desk staff checked in and out over 200 of
petitioners' guests each year. In addition, the housekeeping
staff inspected and cleaned petitioners' unit after each of their
guests checked out. The frequency with which these services were
required convinces us that TMC's employees devoted a substantial
amount of time to petitioners' unit. We are unable to conclude
4
Although available to Mr. Rysdahl, TMC's business
records of its employees' work hours and assignments were not
made part of the record in this case.
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from this record that petitioners' participation during the years
in issue was greater than the participation of TMC's employees.
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. Cf. Oberle v. Commissioner, T.C. Memo. 1998-156; Chapin v.
Commissioner, T.C. Memo. 1996-56.
To reflect the foregoing,
Decision will be entered
for respondent.