T.C. Memo. 2000-386
UNITED STATES TAX COURT
KENNETH M. AND DELORES J. HAIRSTON, Petitioners
v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12452-98. Filed December 20, 2000.
Wylie Joseph Neal, for petitioners.
C. Glenn McLauglin, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
THORNTON, Judge: For taxable years 1995 and 1996,
respondent determined deficiencies of $11,620 and $5,994,
respectively, in petitioners’ Federal income taxes.
The primary issue for decision is whether petitioners’
equipment rental activity constitutes a passive activity under
section 469(c)(2).
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Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years in
issue.
FINDINGS OF FACT
The parties have stipulated some of the facts, which are so
found. When they filed their petition, petitioners resided in
Tulsa, Oklahoma.
Since 1985, petitioners have owned and operated Hairston,
Inc. (Hairston), a subchapter C corporation engaged in the
business of leasing heavy construction equipment to third
parties. During 1995 and 1996, petitioners were employed full
time by Hairston.
During 1993 through 1996, petitioners purchased in their
names eight pieces of heavy construction equipment (petitioners’
equipment). They leased this equipment to Hairston, which
subleased petitioners’ equipment to its customers (end users).
Petitioners entered into a written lease agreement with
Hairston reflecting the lease of petitioners’ equipment to
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Hairston (the lease agreement).1 Petitioners’ equipment was
essentially the same type of heavy construction equipment that
also was owned directly and leased by Hairston to its end users.
Throughout 1995 and 1996, petitioners’ equipment was stored in
and subleased from Hairston’s rental equipment storage yard,
where petitioners’ equipment was commingled with Hairston’s
equipment.
As consideration for leasing their equipment to Hairston,
the lease agreement states that petitioners “may be” paid by
Hairston up to 40 percent of Hairston’s basic end-user lease
1
The entire lease agreement between petitioners and
Hairston, Inc., provided as follows:
EQUIPMENT LEASE AGREEMENT
Ken and Delores Hairston may from time to time
purchase equipment by check or personal bank loan and
may lease that equipment to Hairston, Inc. dba A.I.M.
Equipment Rental.
A.I.M. Rental will assume all responsibility for
the leased equipment, providing insurance, collecting
and paying appropriate taxes, etc.
Ken and Delores may be paid up to 40% of the basic
rental rate only (excludes tax, fuel, delivery and p.u.
charges). Repairs to maintain the equipment may be
charged against the amount paid to Ken and Delores
Hairston.
Payments may be paid each quarter or when
sufficient revenues have been collected.
Ken and Delores will calculate and maintain
records and will be responsible for loan re-payments
and personal income taxes.
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charge. Consequently, as compensation for subleasing
petitioners’ equipment to end users, Hairston was entitled to
retain at least 60 percent of the basic rental charge to the end
users. In addition, Hairston retained 100 percent of additional
end-user fees such as taxes and charges for delivery and fuel.
Pursuant to the lease agreement, Hairston assumed “all
responsibility” for petitioners’ equipment. Hairston was
required to service and maintain the equipment, to provide
insurance, and to collect and pay any taxes on the equipment.
Hairston was to make or arrange for all repairs and to charge
petitioners for the repair costs by subtracting them from the
40-percent portion of the end-user lease payments Hairston might
otherwise pay to petitioners. During 1995 and 1996, Hairston
charged petitioners only minimal amounts for repairs on
petitioners’ equipment.
The officers and employees of Hairston, including
petitioners, were responsible for supervising and performing
maintenance and repairs on petitioners’ equipment and on the
equipment owned by Hairston, for dealing with the end users, and
for billing and collecting lease payments from end users of the
equipment. Occasionally, after hours or on weekends, petitioners
would check on the status of the equipment they personally owned.
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The sublease agreements between Hairston and the end users
typically had terms of 7.93 days in 1995 and 11.63 days in 1996.
All of petitioners’ equipment was leased to end users in the name
of and under lease agreements with Hairston, not with
petitioners.
On their 1995 and 1996 joint Federal income tax returns,
with regard to the lease of their equipment, petitioners claimed
Schedule C ordinary deductions under section 162, reported rental
income from Hairston, and claimed net losses after depreciation
as follows:
Sec. 162
Year Expenses Rental Income Net Losses
1
1995 $1,371 $15,000 $58,899
1996 350 37,500 38,499
1
On audit for 1995, respondent charged petitioners with
an additional $22,800 in unreported income from the lease of
their equipment, to which additional income petitioners agree.
OPINION
Section 469(a)(1) limits the deductibility of losses from
certain passive activities of individual taxpayers. Generally, a
passive activity includes the conduct of a trade or business in
which the taxpayer does not materially participate. In addition,
rental activity (except certain rental activity involving real
estate) is generally treated as a passive activity without regard
to whether the taxpayer materially participates. See sec.
469(c)(1), (2), (4), (7).
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Rental activity is defined as any activity where payments
are principally for the use of tangible property. See sec.
469(j)(8); sec. 1.469-1T(e)(3)(i), Temporary Income Tax Regs., 53
Fed. Reg. 5702 (Feb. 25, 1988).
Petitioners contend that under the applicable temporary
regulations, their equipment rental activity qualifies for two
exceptions from the above definition of rental activity.
First, rental activity will not be treated as such for
purposes of section 469 where the average period of customer use
of the property is 30 days or less and where significant personal
services are provided by or on behalf of the owner of the
property in connection with making the property available for use
by customers. See sec. 1.469-1T(e)(3)(ii)(B), Temporary Income
Tax Regs., 53 Fed. Reg. 5702 (Feb. 25, 1988).2
Second, otherwise passive rental activity will not be
treated as such for purposes of section 469 where extraordinary
personal services are provided by or on behalf of the owner of
the property in connection with renting the property to customers
(without regard to the average period of customer use). See
sec. 1.469-1T(e)(3)(ii)(C), Temporary Income Tax Regs., 53 Fed.
2
The temporary regulations provide additional exceptions
to the definition of rental activity, but petitioners do not
claim that their equipment rental activity qualifies for any of
the additional exceptions. See sec. 1.469-1T(e)(3)(ii)(D), (E),
and (F), Temporary Income Tax Regs., 53 Fed. Reg. 5702 (Feb. 25,
1988).
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Reg. 5702 (Feb. 25, 1988). For this purpose, extraordinary
personal services are provided only if performed by individuals
and the customers’ use of the property is incidental to their
receipt of the services. See sec. 1.469-1T(e)(3)(v), Temporary
Income Tax Regs., 53 Fed. Reg. 5702 (Feb. 25, 1988).
The lease agreement had an indefinite term and extended over
a number of years. Petitioners’ equipment was maintained in the
equipment yard of Hairston and was available for use and sublease
by Hairston at all times throughout each year. Under section
1.469-1(e)(3)(iii)(A) and (D), Income Tax Regs., Hairston’s right
to use petitioners’ equipment is properly treated as one period
of customer use extending for the entirety of each taxable year.
Petitioners contend that they had an agency, not a lease,
relationship with Hairston and that they individually should be
regarded as the lessors of their equipment to end users for
average periods of customer use of less than 30 days.
Petitioners’ contention is contrary to the evidence and is
rejected. In light of the form of the lease agreement and the
course of conduct between petitioners and Hairston, under
Oklahoma law, the arrangement with regard to petitioners’
equipment constituted a lease from petitioners to Hairston (i.e.,
a transfer of the right of possession and use of property for a
term in return for consideration). See Okla. Stat. tit. 12A,
sec. 2A-103(j) and (k) (1991).
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Accordingly, we conclude that the average period of use by
Hairston of petitioners’ equipment exceeded 30 days. On this
score alone, petitioners fail to satisfy the requirements of the
first exception described above.
Moreover, the evidence does not establish that petitioners
in their individual capacities provided either significant or
extraordinary personal services in connection with making their
equipment available for use either by petitioners’ customer
(namely, Hairston) or for use by Hairston’s customers under the
subleases. Under the terms of the lease agreement between
petitioners and Hairston, petitioners individually had little or
no responsibility for upkeep and maintenance of the equipment.
Rather, Hairston assumed “all responsibility” for the equipment.
The services of petitioners as officers and employees of
Hairston in maintaining all of the equipment and in handling
subleases of the equipment to end users do not qualify as
services of petitioners (or as services rendered on behalf of
petitioners) as owners of the equipment. Under the lease
agreement with Hairston, petitioners were not obligated as owners
of the equipment to provide any services to Hairston or end
users. Any services that petitioners might have performed as
Hairston officers or employees were unrelated to petitioners’
obligations as owners of the equipment.
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In any event, no credible evidence supports petitioners’
contention that significant or extraordinary services were
performed either by them or on their behalf as owners of the
equipment. Personal services were not a dominant or significant
aspect of either the equipment rental relationship between
petitioners and Hairston or of the relationship between Hairston
and end users. See Frank v. Commissioner, T.C. Memo. 1996-177.
The evidence does not establish that the type, frequency, and
value of the services that were provided to end users by
petitioners, as owners of the equipment or as officers and
employees of Hairston, were significant in comparison to the
value of the use of the equipment by end users. See sec. 1.469-
1T(e)(3)(iv) and (v), Temporary Income Tax Regs., 53 Fed. Reg.
5702 (Feb. 25, 1988).
Petitioners cite a portion of the legislative history of
section 469 which describes a short-term rental of automobiles as
not constituting a rental activity under section 469 where the
lessor furnishes significant services. See S. Rept. 99-313, at
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742 (1986), 1986-3 C.B. (Vol. 3) 1, 742.3 This legislative
history provides petitioners little support. As previously
discussed, petitioners provided no significant services in their
capacities as lessors to Hairston or as owners of the equipment.
Moreover, their property rentals were not short term, since their
lease of their heavy construction equipment to Hairston was for
an indefinite term.
Petitioners’ equipment rental activity constitutes a passive
rental activity subject to the loss limitations of section 469.
Decision will be entered for
respondent.
3
The Senate report states in pertinent part:
For example, an activity consisting of the short-
term leasing of motor vehicles, where the lessor
furnishes services including maintenance of gas and
oil, oil changing and lubrication and engine and body
repair, is not treated as a rental activity. By
contrast, furnishing a boat under a bare boat charter,
or a plane under a dry lease (i.e., without pilot,
fuel, or oil), constitutes a rental activity under the
passive loss rule, because no significant services are
performed in connection with providing the property.
[S. Rept. 99-313, at 742 (1986), 1986-3 C.B. (Vol. 3)
1, 742.]