T.C. Memo. 2011-69
UNITED STATES TAX COURT
YUSUFU YERODIN ANYIKA AND CECELIA FRANCIS-ANYIKA, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 23437-08. Filed March 24, 2011.
Yusufu Yerodin Anyika and Cecelia Francis-Anyika, pro sese.
Lisa Blades, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
WELLS, Judge: Respondent determined deficiencies of $5,302
and $4,599 in petitioners’ Federal income taxes for their 2005
and 2006 tax years, respectively. Respondent also determined
penalties pursuant to section 6662(a) of $1,055.40 and $827.80,
respectively. The issues we must decide are: (1) Whether
petitioners are real estate professionals as defined in section
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469(c)(7)(B); (2) if petitioners are not real estate
professionals, whether their rental real estate losses are phased
out pursuant to section 469(i); (3) whether petitioners are
liable for a section 6662(a) penalty for substantial
understatement of income tax and/or negligence for 2005; (4)
whether petitioners are liable for a section 6662(a) penalty for
negligence for 2006; and (5) whether petitioners are liable for a
penalty pursuant to section 6673(a)(1).1
FINDINGS OF FACT
Some of the facts and certain exhibits have been stipulated.
The parties’ stipulations of fact are incorporated in this
opinion by reference and are found accordingly. At the time they
filed their petition, petitioners resided in Pennsylvania.
Petitioners, Yusufu Yerodin Anyika (Mr. Anyika) and Cecelia
Francis-Anyika (Mrs. Francis-Anyika), are married and filed joint
returns for tax years 2005 and 2006. Mr. Anyika is employed as
an engineer, and he works 37.5 hours per week, 48 weeks per year.
Mrs. Francis-Anyika is employed as a nurse, and she works 24
hours per week.
Mr. Anyika has been purchasing, renovating, managing, and
selling rental properties since the 1990s. He views his rental
1
All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
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real estate activity as a second job and as an investment.
During 2005 and 2006, Mr. Anyika owned two rental properties.
Petitioners used TurboTax software to prepare their 2005 and
2006 tax returns, and they did not consult a tax professional.
Petitioners reported $133,117 and $167,630 in wages on their 2005
and 2006 tax returns, respectively. On their 2005 tax return,
petitioners deducted $23,551 in rental real estate losses. On
audit, respondent disallowed all but $5,428 of the claimed
deductions. On their 2006 tax return, petitioners deducted
$15,265 in rental real estate losses. On audit, respondent
disallowed the entire amount of petitioners’ claimed rental real
estate deductions. As a result of the disallowances and a few
other adjustments that petitioners do not dispute, respondent
adjusted petitioners’ tax liabilities from $14,451 to $19,753 for
their 2005 tax year and from $20,552 to $25,151 for their 2006
tax year. In accordance with the adjustments, respondent
determined deficiencies in petitioner’s taxes of $5,302 and
$4,599, respectively, and issued a notice of deficiency.
After receiving respondent’s notice of deficiency,
petitioners timely petitioned this Court. This case was
originally scheduled for trial on November 16, 2009, but was
rescheduled for March 2010. Unfortunately, in spite of the
continuance and in spite of our order compelling petitioners to
answer respondent’s interrogatories and turn over documents they
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planned to use as evidence at trial, petitioners failed to
provide respondent with any of the requested items. Petitioners
contend that they had reached an agreement with respondent’s
counsel that respondent’s counsel would obtain the requested
documents from the Internal Revenue Service employee responsible
for auditing petitioners’ returns. Respondent denies that such
an agreement ever existed. Respondent has moved, pursuant to
section 6673(a)(1), for sanctions against petitioners on the
basis of their failure to cooperate with respondent’s requests
for documents.
OPINION
Generally, the Commissioner’s determination of a deficiency
is presumed correct, and the taxpayer has the burden of proving
it incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933). Deductions are a matter of legislative grace, and
taxpayers bear the burden of proving that they have met all
requirements necessary to be entitled to the claimed deductions.
Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84
(1992). The burden of proof on a factual issue that affects a
taxpayer’s liability for tax may be shifted to the Commissioner
where the “taxpayer introduces credible evidence with respect to
* * * such issue.” Sec. 7491(a)(1). Petitioners have neither
claimed nor shown that they complied with the substantiation
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requirements of section 7491(a). Therefore, the burden of proof
remains on petitioners. See Rule 142(a).
Section 469 generally disallows any passive activity loss.
A passive activity is the conduct of any trade or business 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 year
over the aggregate income from all passive activities. Sec.
469(d)(1). A rental activity generally is treated as a per se
passive activity regardless of whether the taxpayer materially
participates.2 Sec. 469(c)(2). 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 real estate activity. Sec. 469(c)(7)(A).
An exception to the rule that a rental activity is per se
passive is found in section 469(c)(7), which provides that the
rental activities of a taxpayer who is a real estate professional
are not per se passive activities but are treated as a trade or
business subject to the material participation requirements of
section 469(c)(1). Sec. 1.469-9(e)(1), Income Tax Regs.
2
A rental activity is “any activity where payments are
principally for the use of tangible property.” Sec. 469(j)(8).
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A taxpayer qualifies as a real estate professional and is
therefore not engaged in a passive activity under section
469(c)(2) 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 foregoing
requirements for qualification as a real estate professional are
satisfied if, and only if, either spouse separately satisfies the
requirements. Id. Thus, if either spouse qualifies as a real
estate professional, the rental activities of the real estate
professional are not per se passive under section 469(c)(2).
Section 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed.
Reg. 5727 (Feb. 25, 1988), sets forth the requirements necessary
to establish the taxpayer’s hours of participation as follows:
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.
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Although “reasonable means” may be interpreted broadly, a
postevent “ballpark guesstimate” will not suffice. Moss v.
Commissioner, 135 T.C. 365, 369 (2010) (and cases cited therein).
Even if taxpayers fail to qualify as real estate
professionals under section 469(c)(7) and must therefore treat
losses from their rental properties as passive activity losses,
they may still be eligible to deduct a portion of their losses
pursuant to section 469(i)(1). Section 469(i) provides a limited
exception to the general rule that passive activity losses are
disallowed. A taxpayer who actively participates in a rental
real estate activity may deduct a maximum loss of up to $25,000
per year related to the activity. The deduction is phased out as
adjusted gross income, modified by section 469(i)(3)(E), exceeds
$100,000, with a full phaseout occurring when modified adjusted
gross income equals $150,000. Sec. 469(i)(3)(A).
Petitioners contend Mr. Anyika satisfies the section 469
requirements for being a real estate professional. To support
their contention, they rely principally on Mr. Anyika’s testimony
that he worked the equivalent of 8 hours per day, 5 days per
week, 48 weeks per year doing maintenance, repairs, and
renovations to petitioners’ rental properties. In their petition
and at trial, petitioners contended that Mr. Anyika qualified as
a real estate professional because he had spent at least 750
hours actively managing the rental properties. On Form 4564,
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Information Document Request, submitted by petitioners during
their audit, petitioners declared, under penalty of perjury, that
Mr. Anyika devoted 800 hours per year to working on the rental
properties during 2005 and 2006. During the trial, the Court
explained that, in order to qualify as a real estate professional
under section 469(c)(7)(B), a taxpayer must spend at least 750
hours materially participating in the real estate business and,
additionally, must devote more than one-half of his total
personal services working hours to his real estate business.
It was only after the Court had explained the law that Mr.
Anyika understood, for the first time, that he would have to have
spent at least 1,800 hours engaged in the real estate business in
order to qualify as a real estate professional under section
469(c)(7)(B). After understanding that, to qualify, he had to
spend more hours engaged in managing the rental properties than
he did working as an engineer, Mr. Anyika began to contend that
he had spent the equivalent of 8 hours per day, 5 days per week,
48 weeks per year (1,920 hours per year) working on the rental
properties. After being confronted during trial by the evidence
of his prior signed statement that he worked 800 hours per year
on the rental properties, Mr. Anyika stated that he was “speaking
from memory with the exact numbers”, and that to be sure, he
would need to look over the numbers more closely. In addition to
Mr. Anyika’s testimony, petitioners submitted real estate titles
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and various bills and receipts to substantiate Mr. Anyika’s work
on the rental properties.
Unfortunately for petitioners, Mr. Anyika’s testimony at
trial that he devoted approximately 1,920 hours per year to
working on the rental properties contradicts his prior statement
during the audit that he worked only 800 hours per year on the
rental properties. Mr. Anyika made the 800-hour estimate on a
Form 4564, which he signed under penalty of perjury.
We do not find Mr. Anyika’s testimony that he worked
approximately 1,920 hours per year on the rental properties
credible. Not only does it contradict his earlier signed
statement, but it also changed during trial once Mr. Anyika
realized that he would need to have devoted more hours to his
real estate properties than to his job as an engineer (i.e., he
would need to have spent more than 1,800 hours working on the
rental properties), instead of the 750 hours he had originally
believed would be sufficient for him to qualify as a real estate
professional under section 469(c)(7).3 We therefore conclude
that Mr. Anyika was not a real estate professional under section
469(c)(7) for 2005 or 2006. Accordingly, we hold that
3
Even if we did find Mr. Anyika’s trial testimony credible,
he admitted in his testimony that his numbers were simply an
estimate and that he did not remember the exact hours; and such a
rough, after-the-fact estimate of his hours would not qualify as
a “reasonable means” of establishing the extent of his
participation in the rental activity. See Moss v. Commissioner,
135 T.C. 365, 369 (2010).
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petitioners’ rental activities during 2005 and 2006 were passive
activities pursuant to section 469(c)(2).
Even though we have held that petitioners’ rental activities
were passive, we still must consider whether petitioners are
eligible to deduct a portion of their real estate losses pursuant
to section 469(i)(1) because of Mr. Anyika’s active participation
in managing the rental properties. The active participation
standard is 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. See
Moss v. Commissioner, 135 T.C. at 371; Madler v. Commissioner,
T.C. Memo. 1998-112. It is clear from the record that
petitioners fully own the rental properties and that Mr. Anyika
has personally been very active in managing the rental
properties. Moreover, respondent concedes that Mr. Anyika
actively participated in real estate activities during 2005 and
2006. Accordingly, we hold that petitioners are entitled to
deduct a portion of their real estate losses pursuant to section
469(i)(1).
However, petitioners’ income is subject to the phaseout
under section 469(i)(3)(A). During both 2005 and 2006,
petitioners’ modified adjusted gross income was more than
$100,000, requiring that the $25,000 maximum deduction be reduced
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by 50 percent of the amount by which their income exceeded
$100,000. Sec. 469(i)(3)(A).
We next consider the penalties determined pursuant to
section 6662. Subsection (a) of section 6662 imposes an
accuracy-related penalty of 20 percent of any underpayment that
is attributable to causes specified in subsection (b).
Subsection (b) applies the penalty to any underpayment
attributable to, inter alia, a “substantial understatement” of
income tax, sec. 6662(b)(2), or “negligence or disregard of rules
or regulations”, sec. 6662(b)(1).
There is a “substantial understatement” of income tax for
any tax year where the amount of the understatement exceeds the
greater of 10 percent of the tax required to be shown on the
return for the tax year or $5,000. Sec. 6662(d)(1)(A). However,
the amount of the understatement may be reduced by any portion of
the understatement attributable to any item for which there was
substantial authority for the taxpayer’s treatment, or with
respect to which the relevant facts were adequately disclosed on
the taxpayer’s return and there was a reasonable basis for the
taxpayer’s treatment. Sec. 6662(d)(2)(B).
Section 6662(a) also imposes a penalty for negligence or
disregard of rules or regulations. Under section 6662(c),
“negligence” is “any failure to make a reasonable attempt to
comply with the provisions of this title”. We have defined
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negligence as “a lack of due care or a failure to do what a
reasonable and prudent person would do under the circumstances.”
Bunney v. Commissioner, 114 T.C. 259, 266 (2000). Failure to
maintain adequate books and records or to substantiate items
properly constitutes negligence. Sec. 1.6662-3(b)(1), Income Tax
Regs. A taxpayer is considered to have disregarded rules or
regulations even if such disregard is “careless”, meaning that
the taxpayer “does not exercise reasonable diligence to determine
the correctness of a return position that is contrary to the rule
or regulation.” Sec. 1.6662-3(b)(2), Income Tax Regs.
Generally, the Commissioner bears the burden of production
with respect to any penalty, including the accuracy-related
penalty. Sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446
(2001). To meet that burden, the Commissioner must come forward
with sufficient evidence indicating that it is appropriate to
impose the relevant penalty. Higbee v. Commissioner, supra at
446. The Commissioner has the burden of production only; the
ultimate burden of proving that the penalty is not applicable
remains on the taxpayer. Id.
Respondent contends that the section 6662 penalty for 2005
is justified on the basis of substantial understatement of income
tax and/or negligence. See sec. 6662(b). For their 2005 tax
year, petitioners understated their tax liability by $5,302, an
amount which is greater than both $5,000 and 10 percent of the
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amount required to be shown on their return, $1,975. Petitioners
do not argue that the amount of their understatement should be
reduced because they had substantial authority for any item or
because their position with respect to any item was adequately
disclosed. Accordingly, we hold that petitioners are liable for
the section 6662(a) and (b)(2) penalty for 2005 because they
substantially understated their income tax.
Respondent contends that petitioners are liable for the
section 6662 penalty for 2006 on the basis of negligence. See
sec. 6662(b)(1). Petitioners did not consult a tax professional
when preparing their return for either year. Rather, petitioners
based their deductions on their belief that Mr. Anyika was a real
estate professional. However, petitioners have not explained how
they arrived at their conclusion that Mr. Anyika qualified as a
real estate professional, and Mr. Anyika acknowledged during
trial that he had misunderstood the relevant statute and the
requirements for being a real estate professional. A reasonable
person in Mr. Anyika’s position, understanding that the tax law
governing the deductions he claimed was complex, would have
consulted a tax professional instead of merely assuming that he
qualified on the basis of his own conclusions. Even if Mr.
Anyika had been correct in his understanding of the law, he was
negligent in ensuring that he complied with it. At trial, Mr.
Anyika was unsure of the number of hours he had spent working on
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the rental properties, and his testimony and prior statement
regarding the number of those hours were inconsistent. It is
clear that Mr. Anyika did not carefully document the hours he
worked on the rental properties and that petitioners therefore
failed to keep records adequate to substantiate the deductibility
of their real estate losses. Such a failure is evidence of
negligence. See sec. 1.6662-3(b)(1), Income Tax Regs. On the
basis of the record, we conclude that respondent has met the
burden of production in showing that petitioners were negligent
in preparing their tax returns for 2005 and 2006.
Section 6664(c) provides a reasonable cause and good faith
exception to penalties under section 6662. Section 6662
penalties will not apply to any portion of an underpayment to the
extent that the taxpayer had reasonable cause and acted in good
faith for that portion. Sec. 6664(c)(1). The decision as to
whether the taxpayer acted with reasonable cause and in good
faith depends upon all the pertinent facts and circumstances.
See sec. 1.6664-4(b)(1), Income Tax Regs. Relevant factors
include the taxpayer’s efforts to assess his proper tax
liability, including the taxpayer’s reasonable and good faith
reliance on the advice of a professional such as an accountant.
See id. Furthermore, an honest misunderstanding of fact or law
that is reasonable in the light of the experience, knowledge, and
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education of the taxpayer may indicate reasonable cause and good
faith. See Remy v. Commissioner, T.C. Memo. 1997-72.
Petitioners contend that they used TurboTax software to
prepare their returns for both years and that the software
program is to blame for any miscalculations in their income.
However, petitioners have not provided any evidence showing the
information that they entered into the software program, a
preliminary showing that would be required to decide whether the
software program is in any way at fault for petitioners’
underpayment. See Paradiso v. Commissioner, T.C. Memo. 2005-187.
Such software is only as good as the information the taxpayer
puts into it. See Bunney v. Commissioner, supra at 267. We have
held that the misuse of tax preparation software, even if
unintentional or accidental, is no defense to penalties under
section 6662. See Lam v. Commissioner, T.C. Memo. 2010-82.
Respondent has produced evidence that petitioners were
negligent in not maintaining records necessary to substantiate
that Mr. Anyika qualified as a real estate professional and that
they did not act as reasonable persons would have to ensure their
compliance with the tax laws; and petitioners have not shown that
their deficiencies were due to anything other than their own
negligence or disregard of the rules and regulations.
Petitioners are therefore liable for the section 6662 penalties.
See Higbee v. Commissioner, 116 T.C. at 449. Their use of
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TurboTax does not establish reasonable cause and good faith. See
Lam v. Commissioner, supra.
Respondent has satisfied the burden of production with
respect to the section 6662(a) penalties. Petitioners’
understatement of income tax on their 2005 return is substantial
under section 6662(d)(1)(A) because it exceeds $5,000 and is
greater than 10 percent of the amount required to be shown on
their return. Petitioners’ 2005 and 2006 returns were both filed
negligently. The burden therefore is on petitioners to prove
they acted with reasonable cause and in good faith. We conclude
that petitioners failed to carry their burden. Accordingly, we
hold that petitioners are liable for the section 6662(a)
accuracy-related penalties for their 2005 and 2006 tax years.
Finally, we consider whether petitioners are liable for a
penalty pursuant to section 6673(a)(1). Section 6673(a)(1)
provides that this Court may require the taxpayer to pay a
penalty not in excess of $25,000 whenever it appears to this
Court that: (a) The proceedings were instituted or maintained by
the taxpayer primarily for delay; (b) the taxpayer’s position is
frivolous or groundless; or (c) the taxpayer unreasonably failed
to pursue available administrative remedies. Respondent has
moved that the Court impose a penalty, contending that
petitioners instituted or maintained this proceeding primarily
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for delay and that petitioners’ position is frivolous or
groundless.
Although petitioners’ behavior was negligent and evidenced a
lack of respect for the relevant law and the Court’s procedures,
it does not appear from the record that petitioners’ primary
purpose in instituting or maintaining their case was delay.
Petitioners were uncooperative and failed to reply to
respondent’s requests for documents or to this Court’s order
compelling the same, but we note that petitioners are pro se and
to a certain extent appeared confused by the proceedings. No
doubt their confusion was due in part to Mr. Anyika’s failure to
read some of the documents sent to him, but negligent
disorganization does not amount to purposeful delay.
Additionally, although petitioners were mistaken about the
applicable law and although the evidence they offered did little
to support their position, their shortcomings do not make their
case frivolous or groundless. See DeMoss v. Commissioner, T.C.
Memo. 1993-636. Accordingly, we decline to impose a penalty
under section 6673.
In reaching these holdings, we have considered all the
parties’ arguments, and, to the extent not addressed herein, we
conclude that they are moot, irrelevant, or without merit.
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To reflect the foregoing,
An appropriate order and
decision will be entered.