T.C. Summary Opinion 2004-62
UNITED STATES TAX COURT
ANDRE AND VENA NELSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10229-03S. Filed May 14, 2004.
Andre and Vena Nelson, pro sese.
Thomas D. Yang, for respondent.
WOLFE, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in
effect when the petition was filed. Unless otherwise indicated,
all subsequent section references are to the Internal Revenue
Code in effect at relevant times, and all Rule references are to
the Tax Court Rules of Practice and Procedure. The decision to
be entered is not reviewable by any other court, and this opinion
should not be cited as authority.
- 2 -
Respondent determined a deficiency in petitioners’ Federal
income tax of $3,472 for 2001. The sole issue for decision is
whether the passive activity rules of section 469 preclude
petitioners from deducting the full amount of their losses from
their rental real estate activities.
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. When they filed their
petition, petitioners resided in Oak Brook, Illinois.
Commencing in January 2001, petitioner Andre Nelson
(petitioner) was employed full time as a Technical Support Team
Manager for the Dial Corporation. He received a $2,500 sign-on
bonus for accepting this position. During 2001, petitioner not
only worked full time for Dial Corporation but also worked
sufficient overtime to earn $5,337 plus $656.30 of “.5 Overtime
Premium” and $545.23 of “Double Time Premium”. He also received
an $850 “Shift Premium”. Petitioner Vena Nelson (Ms. Nelson) is
a certified public accountant employed full time as the chief
financial officer for the Rock of Ages Baptist Church in 2001.
During 2001 petitioners owned three apartment buildings in
Illinois that they operated as rental real properties (rental
properties). These rental properties were: (1) An apartment
building located at 1626 North Luna in Chicago, acquired in 1994
- 3 -
(North Luna property); (2) an apartment building located at 2109
South 5th Avenue in Maywood, acquired in November 2001 (2109
Maywood property); and (3) an apartment building located at 2112
South 5th Avenue in Maywood, acquired in 1992 (2112 Maywood
property). A total of 14 tenants resided at the three apartment
buildings.
Petitioner personally attended to the management and
maintenance of each of his rental properties without assistance
from a management company. Petitioner collected monthly rents,
delivered late warning notices, and took care of eviction
proceedings when necessary. When vacancies arose, petitioner
showed the vacant unit to prospective applicants, conducted
applicant interviews, checked credit reports and references, and
attended to lease signings. Petitioner responded to requests for
routine repairs and was responsible for general maintenance
activities such as caring for the lawns, shoveling snow in the
winter, and waste management. In addition, petitioner was
involved in major renovation projects at two of the three rental
properties in 2001, including the modernizing of outdated
kitchens, bathrooms, and furnaces.
Ms. Nelson was not actively involved with the rental
properties.
Petitioner claims that he devoted more time to his rental
property activities in 2001 than to his full-time job with the
- 4 -
Dial Corporation. In a letter addressed to this Court on June
19, 2003, and incorporated in the stipulation of facts,
petitioner described his typical day in the following manner:
• Although I have a full-time job, I work an off-shift
which allows me time to manage the apartment
buildings on a daily basis.
• My typical schedule is: 8:00am - 3:00 pm apartment
management; 4:00 pm - 12:00 midnight full-time
employee at Dial Corporation; 1:00am - 8:00am sleep.
My weekends are also heavily dedicated toward
apartment management.
* * * * * * *
Yes, this is a lot of work, but my job provides health
insurance and other benefits for my family. I would
not have this safety net without my full-time job at
Dial Corporation.
In connection with the rental properties, petitioners
reported rental real estate losses for 2001 on a Schedule E,
Supplemental Income and Loss, as follows:
Property Rents received Total expenses Losses
North Luna $15,600 $22,479 ($6,879)
2109 Maywood 2,150 10,729 (8,579)
2112 Maywood 29,814 32,840 (3,026)
Total $47,564 ($66,048) ($18,484)
By notice of deficiency dated March 21, 2003, respondent
determined that petitioners’ rental real estate losses were
passive activity losses within the meaning of section 469 and
disallowed $12,248 of the $18,484 in rental real estate losses
claimed by petitioners. As a result of this adjustment,
respondent determined a deficiency in petitioners’ 2001 tax of
$3,472.
- 5 -
Discussion
The taxpayer generally bears the burden of proving that the
Commissioner’s determinations are incorrect. Rule 142(a). Since
petitioners did not meet the substantiation and recordkeeping
requirements of section 7491(a), the burden of proof remains on
petitioners.
Section 162 permits deductions for all the ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on a trade or business. Section 212 permits deductions
for all the ordinary and necessary expenses paid or incurred
during the taxable year for the production of income. The
amounts deductible pursuant to these provisions are not in
dispute here. However, section 469 generally disallows passive
activity losses for individual taxpayers. Sec. 469(a)(1)(A). A
passive activity loss is the amount by which the aggregate losses
from all passive activities for the taxable year exceed the
aggregate income from all passive activities for that year. Sec.
469(d)(1). A passive activity is any trade or business activity
in which the taxpayer does not materially participate. Sec.
469(c)(1).
Rental activities generally are treated as passive
activities without regard to the extent that the taxpayer
materially participates in the activity. Sec. 469(c)(2). Rental
activities involving real estate are not necessarily passive
- 6 -
activities if the taxpayer is a qualifying taxpayer under section
469(c)(7). See sec. 1.469-9(e)(1), Income Tax Regs. Instead,
the rental real estate activity of a qualifying taxpayer who
materially participates in the activity is not subject to the
passive activity rules of section 469. Sec. 469(c)(7); sec.
1.469-9(e)(1), Income Tax Regs. A qualifying taxpayer must meet
the following requirements under section 469(c)(7)(B):
(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
services during the taxable year in real property
trades or businesses in which the taxpayer
materially participates.
A taxpayer is considered to materially participate in a
trade or business if his activities are regular, continuous, and
substantial. Sec. 469(h)(1). In establishing whether a
taxpayer's real property activities result in passive activity
losses, each interest in rental real estate is treated as a
separate rental real estate activity unless the qualifying
taxpayer makes an election to treat all interests in rental real
estate as a single rental real estate activity. Sec.
469(c)(7)(A); sec. 1.469-9(e)(1), Income Tax Regs. Petitioners
did not make such a timely election, so petitioner's activities
must be regular, continuous, and substantial with regard to each
individual rental property.
- 7 -
With respect to the evidence that may be used to establish
material participation, temporary Treasury regulations
promulgated under section 469 provide:
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.
Sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg.
5727 (Feb. 25, 1988); see also sec. 1.469-9(b)(5), Income Tax
Regs. This Court has acknowledged that these temporary
regulations are somewhat ambivalent concerning the records to be
maintained by taxpayers, but we have held that the regulations do
not allow a post-event “ballpark guesstimate”. Fowler v.
Commissioner, T.C. Memo. 2002-223; Goshorn v. Commissioner, T.C.
Memo. 1993-578.
In support of their argument that petitioner was a
qualifying taxpayer under section 469(c)(7)(B) for 2001,
petitioners failed to substantiate the amount of time petitioner
spent on his rental real estate activities relative to his full-
time job at the Dial Corporation. Deductions are a matter of
legislative grace, and petitioners bear the burden of proving
that they are entitled to any of the deductions claimed. Rule
- 8 -
142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). A
taxpayer is required to maintain records sufficient to
substantiate deductions claimed on his tax return. Sec. 6001;
sec. 1.6001-1(a), Income Tax Regs. Moreover, a taxpayer who
claims a deduction bears the burden of substantiating the amount
and purpose of the item claimed. Hradesky v. Commissioner, 65
T.C. 87, 90 (1975), affd. per curiam 540 F.2d 821 (5th Cir.
1976); sec. 1.6001-1(a), Income Tax Regs.
To establish the amount of time petitioner spent on his
rental real estate activities, petitioners introduced a
spreadsheet summarizing the work activities he performed on a
daily basis for each of his three rental properties (daily work
log). The daily work log was not prepared contemporaneously as
petitioner performed each activity but was composed by
petitioners, purportedly from various receipts and documents, in
preparation for trial. Petitioners claim that they have the
underlying receipts and documents from which the spreadsheet was
prepared, but they did not think it was necessary to bring them
to Court for trial or to introduce them into evidence. In the
absence of any corroborative evidence, we do not consider the
daily work log persuasive.
Furthermore, the daily work log merely identifies tasks and
services performed by petitioner on a particular day. It does
not give any indication or approximation of how much time
- 9 -
petitioner actually spent servicing his rental properties.
Consequently, even if we were to give weight to the daily work
log, that document by its own terms would not have established
that petitioner spent more than one-half of his time engaged in
rental real estate activities or that the time petitioner spent
on such rental real estate activities amounts to more than 750
hours of service for purposes of section 469(c)(7)(B).
Other evidence introduced by petitioners at trial was
petitioner's letter to the Court, dated June 13, 2003, in which
petitioner described his typical work schedule and petitioners’
oral testimony at trial. It is well established that the Court
is not bound to accept at face value such uncorroborated and
self-serving testimony from a taxpayer. Shea v. Commissioner,
112 T.C. 183, 189 (1999); Tokarski v. Commissioner, 87 T.C. 74,
77 (1986). Petitioners did not provide appointment books,
calendars, or narrative summaries describing in a detailed and
convincing manner the hours that petitioner actually spent
engaged in his real property activity and did not call any
corroborating witnesses to substantiate their own testimony. In
light of his full work schedule at the Dial Corporation,
petitioner would have to provide substantial and detailed
evidence to convince us that he managed to spend more than one-
half of his time on rental real estate activities or that he even
spent more than 750 hours on them during the year in issue. We
- 10 -
do not doubt that petitioner worked hard during the year in
issue, but he simply failed to present convincing evidence about
the amount of his work in his real property activities. We hold
that petitioner was not a qualifying taxpayer in 2001 for
purposes of section 469(c)(7), and therefore his rental real
estate activity during 2001 is classified as passive activity.
Although petitioners are not entitled to deduct the full
amount of their passive rental real estate losses, section 469(i)
allows a taxpayer to claim up to $25,000 per year in passive
activity losses from rental real estate activities (the $25,000
exemption), subject to a phaseout once the taxpayer’s adjusted
gross income exceeds $100,000. To qualify for the $25,000
exemption, the taxpayer must have “actively participated” in the
rental real estate activity. The active participation
requirement can be satisfied without regular, continuous, and
substantial involvement in an activity. See Madler v.
Commissioner, T.C. Memo. 1998-112; S. Rept. 99-313, 737-738
(1986), 1986-3 C.B. (Vol. 3) 1, 737-738. The active
participation standard should be met as long as the taxpayer
participates in a significant and bona fide sense in making
management decisions or arranging for others to provide services
such as repairs. Madler v. Commissioner, supra. The $25,000
exemption is phased out by 50 percent of the amount by which the
adjusted gross income of the taxpayer for the taxable year
- 11 -
exceeds $100,000. Sec. 469(i)(3). For this purpose, the
taxpayer’s adjusted gross income is determined without regard to
any passive activity loss. Sec. 469(i)(3)(F)(iv).
Respondent agrees that petitioner actively participated in
rental real estate activities and that petitioners are entitled
to the $25,000 exemption, subject to the phaseout provision. On
their 2001 tax return, petitioners reported $135,627 in wages,
$498 in taxable interest, $793 in taxable refunds or credits, and
$611 in unemployment compensation for an adjusted gross income
(without the passive activity loss) of $137,529. Petitioners’
adjusted gross income exceeds $100,000 by $37,529. Fifty percent
of $37,529 is $18,764 (rounded). Petitioners’ maximum offset
amount of $25,000 is reduced by $18,765 to $6,236. Thus, we find
that petitioners are entitled to rental real estate losses of
$6,236 under section 469(i), as determined by respondent in the
notice of deficiency.
Reviewed and adopted as the report of the Small Tax Case
Division.
To reflect the foregoing,
Decision will be entered for
respondent.