T.C. Summary Opinion 2010-90
UNITED STATES TAX COURT
MARCEL AND JENNIFER AJAH, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18458-08S. Filed July 8, 2010.
Jennifer Ajah, pro se.
Diana P. Hinton, for respondent.
PANUTHOS, Chief 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.1 Pursuant to
section 7463(b), the decision to be entered is not reviewable by
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue. All
Rule references are to the Tax Court Rules of Practice and
Procedure.
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any other court, and this opinion shall not be treated as
precedent for any other case.
Respondent determined a $19,797 deficiency in petitioners’
2005 Federal income tax, an addition to tax under section
6651(a)(1) of $3,815, and a section 6662(a) accuracy-related
penalty of $3,959.2 The deficiency is based on respondent’s
disallowance of petitioners’ claimed losses from rental real
estate activities. The issues for decision are: (1) Whether
the section 469 passive activity rules preclude deducting losses
from rental real estate activities; (2) whether an addition to
tax under section 6651(a)(1) is applicable; and (3) whether an
accuracy-related penalty under section 6662(a) is applicable.3
Some of the facts have been stipulated, and they are so
found. The stipulation of facts and the attached exhibits are
incorporated herein by this reference. At the time of filing the
petition, petitioners were residents of the State of New York.
For matters of convenience, we will combine our findings and
discussion herein.
Petitioner Jennifer Ajah (Mrs. Ajah) is an attorney, and
petitioner Marcel Ajah (Dr. Ajah), her husband, is a medical
doctor. Petitioners owned two rental properties in 2005. One
2
All dollar amounts are rounded to the nearest dollar.
3
Other adjustments were made to petitioners’ return that
were computational and, therefore, will not be discussed.
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was a commercial property located in Jamaica, New York, which was
the location of Dr. Ajah’s medical practice. The second was a
single-family residence in Baltimore, Maryland. Only Mrs. Ajah
was involved in the rental real estate activities.4
The rental property in Maryland was sold for $80,000 in
2005. Petitioners did not report the sale on their 2005 joint
Federal income tax return.
Petitioners’ joint Federal income tax return for 2005 was
prepared by an accountant and filed on July 25, 2006.
Petitioners supplied the accountant with the requisite
documentation for the completion of their Federal income tax
return and complied with the accountant’s request for more
information. There is no record of an extension request’s being
filed. The return, as filed, showed an adjusted gross income of
$192,070. Mrs. Ajah’s 2005 Form W-2, Wage and Tax Statement,
showed earnings of $67,500, and Dr. Ajah’s showed earnings of
$130,000. A Schedule C, Profit or Loss From Business, was also
submitted showing $51,807 of net profit from a business. After
exemptions and deductions, petitioners’ return reflected a refund
of $724. With the return, petitioners filed Schedule E,
4
Dr. Ajah did not appear at trial and did not execute the
stipulation of facts. Therefore, the Court will dismiss this
case as to petitioner Marcel Ajah for lack of prosecution. See
Rule 123(b). The Court will enter a decision as to petitioner
Marcel Ajah consistent with the decision to be entered as to
petitioner Jennifer Ajah.
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Supplemental Income and Loss, reporting rental income for both
properties of $36,500 and total expenses, including depreciation,
for both properties of $97,415. Petitioners claimed losses of
$60,915 in connection with the rental properties. No election to
aggregate the rental properties was filed with the return.
Respondent’s motion for summary judgment was denied because
there was a genuine issue of material fact as to whether Mrs.
Ajah was a real estate professional in 2005.
Burden of Proof
The Commissioner’s determinations are presumed correct, and
the taxpayer bears the burden of proving that a determination set
forth in a notice of deficiency is incorrect. See Rule 142(a);
Welch v. Helvering, 290 U.S. 111, 115 (1933). Deductions are a
matter of legislative grace, and the taxpayer bears the burden of
proving that he is entitled to any deduction claimed. Rule 142;
New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).
Pursuant to section 7491(a), the burden of proof as to
factual matters shifts to the Commissioner under certain
circumstances. Mrs. Ajah neither alleged that section 7491(a)
applies nor established her compliance with the substantiation
and recordkeeping requirements. See sec. 7491(a)(2)(A) and (B).
Mrs. Ajah, therefore, bears the burden of proof. See Rule
142(a).
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Section 469 Losses From Rental Real Estate Activities
Mrs. Ajah argues that all of the passive losses from rental
real estate activities should be allowed to be taken as a
deduction against passive income because she was a real estate
professional in 2005. In general, passive activity credits and
losses are not allowed. Sec. 469(a). A passive activity is
defined as “any activity--(A) which involves the conduct of any
trade or business, and (B) in which the taxpayer does not
materially participate.” Sec. 469(c)(1). A passive activity
loss is defined as the excess of the aggregate losses from all
passive activities for the taxable year over the aggregate income
from all passive activities for that year. Sec. 469(d)(1).
Rental real estate activity is generally treated as a per se
passive activity regardless of whether the taxpayer materially
participates. Sec. 469(c)(2), (4).
Exceptions to the general per se passive activity rule
include: (1) If the taxpayer is in a real property business (a
real estate professional) under section 469(c)(7)(B), then he is
treated as involved in a trade or business and subject to the
material participation requirements of section 469(c)(1); and (2)
if the taxpayer actively participates in the rental real estate
activities, then he is entitled to an offset of up to $25,000
against his passive activity losses under section 469(i).
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A taxpayer qualifies as a real estate professional and is not
engaged in a passive activity if:
(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.
Sec. 469(c)(7)(B). In the case of a joint return, the same
spouse must satisfy each requirement. Id.
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). The taxpayer must clearly
notify the Commissioner of his intent to make an election to
treat multiple real estate activities as a single activity. See
Knight-Ridder Newspapers, Inc. v. United States, 743 F.2d 781,
795 (11th Cir. 1984). A statement of election must be filed with
the taxpayer’s original return declaring that the election is
under section 469(c)(7)(A). Sec. 1.469-9(g)(3), Income Tax Regs.
Section 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed.
Reg. 5727 (Feb. 25, 1988) provides:
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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.
This Court has acknowledged that these temporary regulations do
not explicitly state what records a taxpayer needs to maintain,
but we have consistently held that they do not allow a postevent
“ballpark guesstimate”. Fowler v. Commissioner, T.C. Memo. 2002-
223; Goshorn v. Commissioner, T.C. Memo. 1993-578.
Mrs. Ajah argues that she qualifies as a real estate
professional for the year in issue. She relies upon certificates
from the Long Island Board of Realtors, Inc., the Multiple
Listing Service of Long Island, Inc., and the State of New York
Department of State Division of Licensing Services. These
certificates reflect, respectively, that for 2005 she pledged to
adhere to the realtor code of ethics, had completed required
courses on broker rules and regulations, and was licensed as a
real estate broker. Mrs. Ajah testified that she worked at least
20 hours a week for the 52 weeks of 2005 on the two rental
properties. Mrs. Ajah did not offer any evidence as to the
number of hours she worked as an attorney in 2005. No
contemporaneous record, calendar, appointment book, or any other
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method of recording time spent between rental real estate
activities and activities as an attorney was provided. Thus, the
Court is unable to conclude that more than one-half of Mrs.
Ajah’s personal services were devoted to the rental properties.
We conclude that Mrs. Ajah’s method of calculating her time
spent participating in the rental activities constitutes an
impermissible “ballpark guesstimate”. See Fowler v.
Commissioner, supra; see also Goshorn v. Commissioner, supra.
Mrs. Ajah did not establish by reasonable means that she
performed more than one-half of her personal services in real
property trades or businesses.
Petitioners did not file an election with their return to
treat the two rental real estate interests as one activity.
Petitioners did aggregate the rental properties on their Schedule
E and may have done so in the past. This Court has consistently
held that aggregating rental properties on Schedule E is not a
deemed election under the requirements of section 469(c)(7)(A).
Trask v. Commissioner, T.C. Memo. 2010-78 (citing Kosonen v.
Commissioner, T.C. Memo. 2000-107 (aggregation of losses was not
clear notice of election under section 469(c)(7))). Therefore,
Mrs. Ajah would need to perform 750 hours of service for each
rental real estate interest for a total of 1,500 hours to meet
the test in section 469(c)(7)(B)(ii). If Mrs. Ajah’s testimony
(working a minimum of 20 hours per week) was accepted as the
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number of hours engaged in real estate activities, her total
hours for both rental properties would be 1,040 hours, less than
the required 1,500 hours.
Because we have concluded that Mrs. Ajah was not a real
estate professional under section 469(c)(7)(B), her rental real
estate activities in 2005 were per se passive activities. See
sec. 469(c)(2), (4). We must now decide whether Mrs. Ajah is
entitled to a $25,000 offset under section 469(i). A taxpayer
who “actively participated” in a rental real estate activity can
deduct a maximum loss of $25,000 per year related to the
activity. Sec. 469(i)(1) and (2). This exception is fully
phased out, however, when adjusted gross income (AGI) equals or
exceeds $150,000. Sec. 469(i)(3)(A). Petitioners reported AGI
of $192,070.
Accordingly, petitioners cannot deduct any of the passive
activity losses for 2005, and respondent’s determination is
sustained with respect to the section 469 disallowance.
Addition to Tax Under Section 6651(a)(1)
Section 6651(a)(1) imposes an addition to tax for failure to
file a return on the date prescribed (determined with regard to
any extension of time for filing) unless the taxpayer establishes
that the failure is due to reasonable cause and not due
to willful neglect. United States v. Boyle, 469 U.S. 241, 243
(1985). “Reasonable cause as applied in section 6651 has been
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defined as the ‘exercise of ordinary business care and
prudence.’” Estate of Duttenhofer v. Commissioner, 49 T.C. 200,
204 (1967) (quoting Se. Fin. Co. v. Commissioner, 153 F.2d 205,
205 (5th Cir. 1946), affg. 4 T.C. 1069 (1945)), affd. 410 F. 2d
302 (6th Cir. 1969); see also sec. 301.6651-1(c)(1), Proced. &
Admin. Regs. The section 6651(a)(1) addition to tax is equal to
5 percent of the amount of tax required to be shown on the return
if the failure is not for more than 1 month, with an additional 5
percent to be added for each month or partial month during which
the failure to file continues, not to exceed 25 percent in the
aggregate.
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
in error by supplying sufficient evidence of an applicable
exception. Id.
Respondent satisfied his burden here. Petitioners’ return
was not filed until July 25, 2006, more than 3 months after the
due date. There is no record of an extension request’s being
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filed for petitioners’ return. Therefore, it is up to
petitioners to persuade the Court that their failure to file was
due to reasonable cause and not willful neglect.
Mrs. Ajah relied on her claim that she and her husband
signed an extension request and gave it to their accountant to
show that they had reasonable cause for not timely filing their
return. The burden of prompt filing cannot be shifted from
petitioners to their employee or agent, which would include
petitioners’ accountant. See United States v. Boyle, supra at
249-250. The fact that petitioners’ accountant was expected to
attend to the matter did not relieve petitioners from their duty
to comply with the statute. See id. at 250.
Mrs. Ajah also argues that there was no willful neglect
because the return, as filed, reflected a refund of $724;
therefore, no tax was owed. Mrs. Ajah’s argument that the return
did not have to be timely filed because they believed a refund
was due is misplaced. All individuals who have gross income that
equals or exceeds the exemption amount must file a Federal income
tax return. Sec. 6012(a)(1)(A).5 Petitioners had gross income
well in excess of the exemption amount and were required to
timely file a Federal income tax return.
5
Petitioners fail to meet the criteria for any of the
exceptions listed in sec. 6012.
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Therefore, there was no reasonable cause for petitioners’
failure to timely file their 2005 Federal income tax return, and
they are liable for an addition to tax under section 6651(a)(1).
Accuracy-Related Penalty Under 6662(a)
Section 6662(a) and (b)(2) provides that a taxpayer may be
liable for a penalty of 20 percent of the portion of an
underpayment of tax attributable to a substantial understatement
of income tax. An understatement of income tax is substantial if
it exceeds the greater of 10 percent of the tax required to be
shown on the return or $5,000. Sec. 6662(d)(1)(A). Respondent
has the burden of production with respect to the accuracy-related
penalty. See sec. 7491(c).
Ten percent of the tax required to be shown on petitioners’
return was $4,535. Petitioners’ understatement must exceed
$5,000 to be deemed substantial. Petitioners understated their
tax by $19,797.6 Therefore, respondent has met his burden of
production.
Although a substantial understatement of income tax is
determined by a straightforward mathematical equation, the
reasonable cause and good faith exception of section 6664 still
applies if warranted. The exception is for any portion of an
6
Because we find that there was a substantial understatement
of income tax, there is no need to discuss other attributions to
which the accuracy-related penalty would apply.
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underpayment if there was reasonable cause and the taxpayer acted
in good faith for that portion. Sec. 6664(c). Whether a
taxpayer acted with reasonable cause and good faith is determined
by the relevant facts and circumstances on a case-by-case basis.
Stubblefield v. Commissioner, T.C. Memo. 1996-537; sec. 1.6664-
4(b)(1), Income Tax Regs. “Reliance on an information return,
professional advice, or other facts, however, constitutes
reasonable cause and good faith if, under all the circumstances,
such reliance was reasonable and the taxpayer acted in good
faith.” Sec. 1.6664-4(b)(1), Income Tax Regs.; see United States
v. Boyle, supra at 251. An honest misunderstanding of fact or
law that is reasonable in the light of the experience, knowledge,
and education of the taxpayer may indicate reasonable cause and
good faith. Remy v. Commissioner, T.C. Memo. 1997-72; sec.
1.6664-4(b)(1), Income Tax Regs. The most important factor is
the extent of the taxpayer’s effort to assess the proper tax
liability. Stubblefield v. Commissioner, supra; sec. 1.6664-
4(b)(1), Income Tax Regs.
Section 469 and its regulations cover a highly complex area
of the tax code. Although Mrs. Ajah is an attorney who runs her
own firm, she is not a tax attorney, and it is not unreasonable
for her to seek guidance in this complicated area. She and her
husband enlisted the advice and help of an accountant to complete
their 2005 Federal income tax return. We find Mrs. Ajah’s
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testimony credible that they presented the accountant with the
proper documents and complied with requests for additional
information when asked. The accountant then assured petitioners
that they were entitled to the losses generated by the rental
real estate activities. “To require the taxpayer to * * * seek a
‘second opinion,’ * * * would nullify the very purpose of seeking
the advice of a presumed expert in the first place.” United
States v. Boyle, 469 U.S. at 251 (citing Haywood Lumber & Mining
Co. v. Commissioner, 178 F.2d 769, 771 (2d Cir. 1950), modifying
12 T.C. 735 (1949)). We find, after considering all the facts
and circumstances, that petitioners are not liable for the
accuracy-related penalty under section 6662(a) for 2005.
To reflect the foregoing,
An appropriate order and
decision will be entered.