T.C. Summary Opinion 2009-29
UNITED STATES TAX COURT
SHRI G. AND SUDHA AGARWAL, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12670-07S. Filed March 2, 2009.
Shri G. and Sudha Agarwal, pro sese.
Kris H. An, for respondent.
DEAN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code
(Code) in effect when the petition was filed. Pursuant to
section 7463(b), the decision to be entered is not reviewable by
any other court, and this opinion shall not be treated as
precedent for any other case. Unless otherwise indicated,
subsequent section references are to the Code in effect for the
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years in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
Respondent determined deficiencies of $15,066 and $6,649 in
petitioners’ 2001 and 2002 Federal income taxes, respectively.
Respondent also determined accuracy-related penalties under
section 6662(a) of $3,013.20 and $1,329.80 for 2001 and 2002,
respectively.
After concessions by the parties,1 the issues remaining for
decision are whether petitioners are: (1) Entitled to deduct on
Schedule E, Supplemental Income and Loss, losses of $40,104 and
$19,656 for 2001 and 2002, respectively, as qualifying taxpayers
in real property trades or businesses; and (2) liable for the
accuracy-related penalty for each year.
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the exhibits received into evidence
are incorporated herein by reference. When the petition was
filed, petitioners resided in California.
1
In a “Stipulation of Settled Issues” the parties agree
that: (1) Petitioners are entitled to a net capital loss of $856
(rather than $5,988.16) for 2001; (2) they are not entitled to a
self-employed health insurance deduction of $2,332 for 2001; (3)
they are not entitled to additional exemptions of $9,048 and
$1,920 for 2001 and 2002, respectively; and (4) itemized
deductions adjustments for 2001 and 2002 are computational.
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During 2001 and 2002 Shri Agarwal (Mr. Agarwal) worked full
time as an engineer. During 2001 and 2002 Sudha Agarwal (Mrs.
Agarwal) worked full time as a real estate agent at “Century 21
Albert Foulad Realty” (brokerage firm).2 During 2001 and 2002
Mrs. Agarwal was licensed as a real estate agent under California
law; she was not a licensed as a broker.3 She worked for a
brokerage firm pursuant to an “Independent Contractor Agreement
(Between Broker and Associate Licensee)”. The contract provided
that she was an independent contractor, not an employee of the
brokerage firm. Consistent with Mrs. Agarwal’s independent
contractor status, the brokerage firm issued a Form 1099 to her
for each year, and it did not pay her a salary; rather, she
received commissions. The contract also required Mrs. Agarwal to
sell, exchange, lease, or rent properties and solicit additional
listings, clients, and customers diligently and with her best
efforts.
During 2001 and 2002 petitioners owned two rental
properties. Together they spent approximately 170 hours managing
the “Wanda Property” and approximately 170 hours managing the
“Mohave Property” during 2001 and 2002. They were the only
persons who managed their rental properties. Mrs. Agarwal spent
2
The brokerage firm is a licensed broker under California
law. The brokerage firm is franchised by a broker, Albert
Foulad.
3
Mrs. Agarwal became a licensed broker in December 2007.
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a total of 1,400 and 1,600 hours managing petitioners’ rental
properties and selling real estate in 2001 and 2002,
respectively.
For 2001 Mrs. Agarwal reported commissions of $13,912 as
gross receipts on Schedule C, Profit or Loss From Business. She
also reported total expenses of $14,084 for a $172 loss with
respect to her Schedule C real estate business. For 2002 she
reported commissions of $14,119 as gross receipts on Schedule C
and total expenses of $13,401 for a profit of $718.
For 2001 petitioners reported total rents of $36,367 on
Schedule E. They also reported total expenses of $76,471.78 for
a $40,104.78 loss (which they rounded down to $40,104). For 2002
they reported total rents of $45,521 on Schedule E and total
expenses of $65,177 for a $19,656 loss.
In the notice of deficiency issued to petitioners,
respondent disallowed their Schedule E losses for each year
because: (1) Passive losses are allowed only to the extent that
they qualify for the special allowance for rental real estate and
the transitional phase-in rule; and (2) petitioners’ losses were
in excess of their passive income, the special allowance, and the
phase-in rule.
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Discussion
I. Burden of Proof
The Commissioner’s determinations in a notice of deficiency
are presumed correct, and the taxpayer bears the burden to prove
that the determinations are in error. See Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933). But the burden of proof on
factual issues that affect the taxpayer’s tax liability may be
shifted to the Commissioner where the “taxpayer introduces
credible evidence with respect to * * * such issue.” See sec.
7491(a)(1). Petitioners have not alleged that section 7491(a)
applies; however, the Court need not decide whether the burden
shifted to respondent since there is no dispute as to any factual
issue. Accordingly, the case is decided by the application of
law to the undisputed facts, and section 7491(a) is inapplicable.
II. Petitioners’ Losses and Application of Section 469
Section 469(a) generally disallows any passive activity
loss. A passive activity loss is defined as the excess of the
aggregate losses over the aggregate income from all passive
activities. Sec. 469(d)(1). A passive activity is any trade or
business or an activity engaged in for the production of income
in which the taxpayer does not materially participate. Sec.
469(c)(1), (6). Material participation means that the taxpayer
is involved in the activity’s operations on a regular,
continuous, and substantial basis. Sec. 469(h); see also sec.
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1.469-5T(a), Temporary Income Tax Regs., 53 Fed. Reg. 5725 (Feb.
25, 1988) (an individual is treated as materially participating
if the individual satisfies any one of the seven enumerated
tests).
The general rule is that a rental activity is treated as a
per se passive activity regardless of whether the taxpayer
materially participates. Sec. 469(c)(2), (4). But under section
469(c)(7), rental activities of a qualifying taxpayer in a real
property trade or business are not a per se passive activity
under section 469(c)(2). Kosonen v. Commissioner, T.C. Memo.
2000-107. Rather, the qualifying taxpayer’s rental activities
are treated as a trade or business--subject to the material
participation requirements of section 469(c)(1). Fowler v.
Commissioner, T.C. Memo. 2002-223; sec. 1.469-9(e)(1), Income Tax
Regs. And in determining whether a taxpayer materially
participates, the participation of the taxpayer’s spouse is taken
into account. Sec. 469(h)(5).
A taxpayer may qualify for the real property trade or
business exception if: (1) More than one-half of the personal
services performed in trades or businesses by the taxpayer during
the taxable year are performed in real property trades or
businesses in which the taxpayer materially participates; and
(2) the taxpayer performs more than 750 hours of services during
the taxable year in real property trades or businesses in which
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the taxpayer materially participates. Sec. 469(c)(7)(B)(i) and
(ii). In the case of a joint return, either spouse must satisfy
both requirements. Sec. 469(c)(7)(B).
Section 469(c)(7)(C) defines the term “real property trade
or business” as “any real property development, redevelopment,
construction, reconstruction, acquisition, conversion, rental,
operation, management, leasing, or brokerage trade or business.”
[Emphasis added.]
A. The Parties’ Arguments
Petitioners argue that real estate agents should be
considered real estate professionals because real estate agents
are engaged in a real property brokerage business in that real
estate agents “bring together buyers and sellers”.
In reply, respondent argues that Mrs. Agarwal was a licensed
real estate agent, not a licensed real estate broker. Thus,
under California law, according to respondent, Mrs. Agarwal could
not be engaged in a brokerage trade or business, and therefore,
she was not engaged in a real property trade or business as
defined by section 469(c)(7)(C).
B. Brokerage Defined
The term “brokerage” is not defined in section 469, within
the legislative history of section 469, or by any court decision.
Thus, the Court turns to principles of statutory construction to
determine its meaning. See Baker v. Wash. Group Intl., Inc., No.
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1:06-CV-1874 (M.D. Pa. Mar. 14, 2008); Sierra Club v. Leavitt,
355 F. Supp. 2d 544, 555 (D.D.C. 2005); Weber v. Heitkamp (In re
Hopson), 324 Bankr. 284, 287 (S.D. Tex. 2005).
“Statutory words are uniformly presumed, unless the contrary
appears, to be used in their ordinary and usual sense, and with
the meaning commonly attributed to them.” Caminetti v. United
States, 242 U.S. 470, 485-486 (1917). In addition, a statutory
term is construed “in its context and in light of the terms
surrounding it.” Leocal v. Ashcroft, 543 U.S. 1, 9 (2004); see
also Jarecki v. G. D. Searle & Co., 367 U.S. 303, 307 (1961) (“a
word is known by the company it keeps”). Legislatures are
presumed to have intended that a statute’s terms “‘be given a
reasonable construction’”. Hazlett v. Evans, 943 F. Supp. 785,
788 (E.D. Ky. 1996) (quoting D.L.C. v. Walsh, 908 S.W.2d 791 (Mo.
Ct. App. 1995)); see also Beck v. N. Natural Gas Co., 170 F.3d
1018, 1024 (10th Cir. 1999); In re Nofziger, 925 F.2d 428, 435
(D.C. Cir. 1991).
A term’s common or approved usage may be established by a
dictionary. Rousey v. Jacoway, 544 U.S. 320 (2005); Smith v.
United States, 508 U.S. 223, 228-229 (1993). Webster’s Third New
International Dictionary 282 (2002) defines the term “brokerage”
as “the business of a broker” or “the fee or commission for
transacting business as a broker.” [Emphasis added.]
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The Court concludes that Congress is presumed to have
defined the term “brokerage” in its common or ordinary meaning.
The Court further concludes that for purposes of section 469, the
“business” of a real estate broker includes, but is not limited
to: (1) Selling, exchanging, purchasing, renting, or leasing
real property; (2) offering to do those activities; (3)
negotiating the terms of a real estate contract; (4) listing of
real property for sale, lease, or exchange; or (5) procuring
prospective sellers, purchasers, lessors, or lessees. See Hooper
v. California, 155 U.S. 648, 657 (1895); Lawrence Gas Co. v.
Hawkeye Oil Co., 165 N.W. 445, 447 (Iowa 1917); Schmidt v.
Maples, 289 N.W. 140, 143 (Mich. 1939); Commonwealth v. Jones &
Robins, Inc., 41 S.E.2d 720, 727 (Va. 1947); In re Pipes, 748
A.2d 118, 121 (N.J. Super. Ct. App. Div. 2000); Commonwealth v.
Fahnestock, 15 Pa. C. 598 (Pa. Quar. Sess. 1895); see also Ky.
Rev. Stat. Ann. sec. 324.010(1) (LexisNexis 2007) (defining “Real
estate brokerage”); Md. Code Ann. Bus. Occ. & Prof. sec.
17-101(l) (LexisNexis 2004 & Supp. 2008) (defining “Provide real
estate brokerage services”); Wis. Stat. Ann. sec. 452.01(3e)
(West 2006) (defining “Brokerage service”).
C. Application of the Definition to Mrs. Agarwal’s
Activities
As is relevant here, California law defines the term “real
estate broker” as a person who does, or negotiates to do, any one
of the enumerated activities for compensation. Cal. Bus. & Prof.
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Code sec. 10131 (West 2008). Similarly, California law also
defines the term “real estate salesman” as a person who is
employed by a broker and who does any one of the enumerated
activities. Cal. Bus. & Prof. Code sec. 10132 (West 2008). But
whether Mrs. Agarwal is characterized as a broker or a
salesperson for State law purposes is irrelevant for Federal
income tax purposes–-the test is whether she was engaged in
“brokerage” within the meaning of section 469, as defined supra.
Consistent with her real estate salesman’s license and pursuant
to her contract with the brokerage firm, Mrs. Agarwal was engaged
in “brokerage”; i.e., she sold, exchanged, leased, or rented real
property and solicited listings. Therefore, Mrs. Agarwal was
engaged in a “brokerage” trade or business within the meaning of
section 469(c)(7)(C).
Because Mrs. Agarwal owned an interest in a rental property,
performed more than one-half of her personal services in real
property trades or businesses in which she materially
participated, and performed more than 750 hours of services in
real property trades or businesses in which she materially
participated, she is a qualifying taxpayer. See sec. 469(c)(7);
sec. 1.469-9(b)(6), (c)(1), Income Tax Regs. Because Mrs.
Agarwal is a qualifying taxpayer and she materially participated
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with respect to each property,4 petitioners are entitled to
deduct their 2001 and 2002 Schedule E losses. See sec.
469(c)(7); sec. 1.469-9(e)(1), (3), (4) Example (i), Income Tax
Regs.; sec. 1.469-5T(a), Temporary Income Tax Regs., supra
(defining material participation); see also Fowler v.
Commissioner, T.C. Memo. 2002-223; Shaw v. Commissioner, T.C.
Memo. 2002-35.
III. Accuracy-Related Penalty
Initially, the Commissioner has the burden of production
with respect to any penalty, addition to tax, or additional
amount. Sec. 7491(c). The Commissioner satisfies this burden of
production by coming forward with sufficient evidence that
indicates that it is appropriate to impose the penalty. See
Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once the
Commissioner satisfies this burden of production, the taxpayer
must persuade the Court that the Commissioner’s determination is
4
If the taxpayer is a qualifying taxpayer, then each
interest in rental real estate is treated as a separate activity
unless the taxpayer elects to treat all interests in rental real
estate as one activity. Sec. 469(c)(7)(A); Fowler v.
Commissioner, T.C. Memo. 2002-223. And the determination of
whether the qualifying taxpayer materially participated pursuant
to sec. 469(c)(1) must be met with respect to each rental
activity, unless the taxpayer elected to treat all of the
taxpayer’s rental activities as a single activity. Sec.
469(c)(7)(A); Fowler v. Commissioner, supra; Shaw v.
Commissioner, T.C. Memo. 2002-35; sec. 1.469-9(e)(1), (4) Example
(i), Income Tax Regs.
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in error by supplying sufficient evidence of reasonable cause,
substantial authority, or a similar provision. Id.
In pertinent part, section 6662(a) and (b)(1) and (2)
imposes an accuracy-related penalty equal to 20 percent of the
underpayment that is attributable to: (1) Negligence or
disregard of rules or regulations; or (2) a substantial
understatement of income tax.5 Section 6662(c) defines the term
“negligence” to include “any failure to make a reasonable attempt
to comply with the provisions of this title,” and the term
“disregard” to include “any careless, reckless, or intentional
disregard.” Negligence also includes any failure by the taxpayer
to keep adequate books and records or to substantiate items
properly. Sec. 1.6662-3(b)(1), Income Tax Regs.
Section 6664(c)(1) provides an exception to the section
6662(a) penalty: no penalty is imposed with respect to any
portion of an underpayment if it is shown that there was
reasonable cause therefor and the taxpayer acted in good faith.
Section 1.6664-4(b)(1), Income Tax Regs., incorporates a facts
and circumstances test to determine whether the taxpayer acted
with reasonable cause and in good faith. The most important
factor is the extent of the taxpayer’s effort to assess his
5
Because the Court finds that petitioners were negligent or
disregarded rules or regulations, the Court need not discuss
whether there is a substantial understatement of income tax. See
sec. 6662(b); Fields v. Commissioner, T.C. Memo. 2008-207.
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proper tax liability. Id. “Circumstances that may indicate
reasonable cause and good faith include an honest
misunderstanding of fact or law that is reasonable in light of
* * * the experience, knowledge, and education of the taxpayer.”
Id.
Because petitioners concede that they are not entitled to
certain deductions, see supra note 1, the Court finds that
respondent has met his burden of production and that petitioners
were negligent. Petitioners did not establish a defense for
their noncompliance with the Code’s requirements. See sec. 6001
(requiring taxpayers to keep records sufficient to establish the
amounts of the items required to be shown on their Federal income
tax returns). Respondent’s determination is sustained.
To reflect the foregoing,
Decision will be entered
under Rule 155.