T.C. Summary Opinion 2001-135
UNITED STATES TAX COURT
RICHARD S. HOLBROOK, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 17423-99S. Filed September 4, 2001.
Richard S. Holbrook, pro se.
William Henck and Dustin M. Starbuck, for respondent.
POWELL, Special Trial Judge: This case was heard pursuant
to the provisions of section 74631 of the Internal Revenue Code
in effect at the time the petition was filed. The decision to be
entered is not reviewable by any other court, and this opinion
should not be cited as authority.
1
Unless otherwise indicated, subsequent section references are
to the Internal Revenue Code in effect for the year in issue.
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Respondent determined a deficiency of $2,079 in petitioner’s
1996 Federal income tax.2 The issue is whether petitioner’s real
estate rental income constitutes “disqualified income” under
section 32, and, as such, exceeds the 1996 allowable maximum
disqualified income of $2,200 for earned income tax credit
eligibility. Petitioner resided in Danville, Virginia, at the
time the petition was filed.
Background
The applicable facts may be summarized as follows.
Petitioner is a self-employed general contractor for custom-built
single family homes. In 1996, petitioner operated a home
construction business on a full-time basis and a real estate
rental property activity. Petitioner reported a net profit of
$7,260 from the construction business in 1996. Petitioner owns a
condominium and three commercial buildings. Petitioner reported
gross rentals of $25,425 and a net income of $8,095 from his real
estate rental property activity in 1996.
Petitioner personally handled the renting, maintenance, and
collections for the real estate rental property activity. He
employed no agents to assist him in these endeavors, other than
as required for the upkeep of the condominium under the terms of
2
Petitioner filed a joint 1996 Federal income tax return with
his wife. The notice of deficiency was issued to petitioner and
his wife; however, petitioner’s wife did not petition this Court
and is not a party to this proceeding.
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the condominium association. Petitioner, however, performed no
personal services for his tenants in connection with his real
estate rental property activity. Petitioner was not a real
estate dealer. Respondent conceded that petitioner’s real estate
rental property activity was not passive as defined in section
469.
Petitioner explained his long-term objective for his real
estate rental property activity as a “401(k) or * * *
profitsharing or something to retire on, because I don’t have any
other thing besides that. * * * Basically if I can get enough of
this going on and it could be viable, then I could actually quit
the construction business and live on this.”
In 1996, petitioner claimed an earned income credit (EIC or
EITC) of $2,079. Respondent disallowed the credit on the ground
that petitioner’s real estate rental income was “disqualified
income” and prohibited him from claiming the EIC.
Discussion
Section 32(a) provides a credit in “an amount equal to the
credit percentage of so much of the taxpayer’s earned income
* * * as does not exceed the earned income amount.” Section
32(i), however, provides in pertinent part as follows:
(1) In general.-–No credit shall be allowed under
subsection (a) for the taxable year if the aggregate amount
of disqualified income of the taxpayer for the taxable year
exceeds $2,200.
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(2) Disqualified income.-–For purposes of paragraph
(1), the term “disqualified income” means-–
* * * * * * *
(C) * * *
(i) * * * [net] income from rents * * * not
derived in the ordinary course of a trade or
business * * *. [Emphasis supplied.]
In arguing that section 32(i) does not apply, petitioner
focused his argument on whether his real estate rental property
activity constituted a trade or business. We believe, however,
that the inquiry is broader and that the correct focus should be
on the phrase “not derived in the ordinary course of a trade or
business”. In considering the effect of this language we assume,
but do not decide, that petitioner’s real estate rental property
activity constituted a trade or business.
The relevant part of section 32(i) was added by section 4(a)
of Act of April 11, 1995, Pub. L. 104-7, 109 Stat. 93, 95. The
legislative history of section 32(i) states that “The Committee
believes that the EITC should be targeted to families with the
greatest need. Therefore, the Committee believes that it is
inappropriate to allow an EITC to taxpayers with significant
unearned income.” S. Rept. 104-16, at 21 (1995). In using the
phrase “not derived in the ordinary course of a trade or
business”, the congressional focus, therefore, was on whether the
taxpayer had unearned income that exceeded the threshold amount.
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In defining the concept of earned income for purposes of
section 32, section 32(c)(2)(A)(ii) provides that earned income
means, inter alia, “the amount of the taxpayer’s net earnings
from self-employment for the taxable year (within the meaning of
section 1402(a))”. Section 1402(a), in turn, provides in
pertinent part:
SEC. 1402(a). Net Earnings From Self-Employment.--The
term “net earnings from self-employment” means the gross
income derived by an individual from any trade or business
carried on by such individual * * * except * * *
(1) * * * rentals from real estate * * *
unless such rentals are received in the course of a
trade or business as a real estate dealer * * *.
Section 1.1402(a)-4(c)(2), Income Tax Regs., provides:
(2) Services rendered for occupants. Payments for the
use or occupancy of rooms or other space where services are
also rendered to the occupant, such as for the use or
occupancy of rooms or other quarters in hotels, boarding
houses, or apartment houses furnishing hotel services, or in
tourist camps or tourist homes, or payments for the use or
occupancy of space in parking lots, warehouses, or storage
garages, do not constitute rentals from real estate;
consequently, such payments are included in determining net
earnings from self-employment. * * *
Petitioner is not a dealer in real estate, nor does he
provide the type of services to tenants enumerated in the
regulations. We note in this regard that petitioner did not
report his real estate rental income for purposes of computing
self-employment tax. For purposes of sections 1402(a) and
32(c)(2), we conclude that petitioner’s real estate rental income
was not earned income. That income ($8,095) falls within the
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ambit of “disqualified income” under section 32(i) and exceeds
the threshold amount ($2,200).3 Accordingly, petitioner is not
entitled to claim an EIC.
Reviewed and adopted as the report of the Small Tax Case
Division.
Decision will be entered
for respondent.
3
We note that the phrase “not derived in the ordinary course”
also appears in sec. 469(e), which deals with portfolio income in
the context of the passive loss rules. These types of portfolio
income include income that would be disqualified income. See
sec. 1.469-2T(c)(3)(ii), Temporary Income Tax Regs., 53 Fed. Reg.
5713 (Feb. 25, 1988).