T.C. Summary Opinion 2011-43
UNITED STATES TAX COURT
JOSE B. MAGNO AND SUSAN A. O’CONNELL, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4600-10S. Filed April 6, 2011.
John E. Ellsworth, for petitioners.
Brett A. Saltzman, for respondent.
LARO, 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
1
Subsequent section references are to the applicable
versions of the Internal Revenue Code, and Rule references are to
the Tax Court Rules of Practice and Procedure. Some dollar
amounts are rounded.
- 2 -
to be entered is not reviewable by any other court, and this
opinion shall not be treated as precedent for any other case.
Respondent determined deficiencies in petitioners’ Federal
income taxes of $23,847, $36,684, and $30,145, and accuracy-
related penalties of $4,769, $7,337, and $6,029, for 2005, 2006,
and 2007 (subject years), respectively. After concessions,2 we
must decide whether: (1) Losses related to rental properties
owned by petitioners and claimed on their Federal income tax
returns for the subject years are subject to the passive activity
limitations of section 469; and (2) petitioners are liable for
section 6662(a) accuracy-related penalties for the subject years.
We hold for respondent as to both issues.
Background
Some of the facts have been stipulated and are so found.
The stipulated facts and the exhibits submitted therewith are
incorporated by this reference.
2
In addition to the concessions explicitly agreed to by the
parties, we consider petitioners to have conceded respondent’s
determination that for 2006 they may not deduct $17,141 of
mortgage interest claimed on Schedule E, Supplemental Income and
Loss, by virtue of the fact that petitioners did not address that
issue at trial or on brief. We hold without further comment that
petitioners may not deduct $17,141 of Schedule E mortgage
interest for 2006 because they have failed to introduce any
evidence with respect to the payment of that interest. See
Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985); Masloff v.
Commissioner, T.C. Memo. 1998-257; see also Mendes v.
Commissioner, 121 T.C. 308, 316 (2003).
- 3 -
Petitioners Jose B. Magno (Mr. Magno) and Susan A. O’Connell
(Ms. O’Connell) resided in Illinois when their petition was
filed. During the subject years Mr. Magno worked as a financial
planner. From 1998 until July 2003 petitioners lived in Michigan
(first residence).
In early 2003 petitioners began constructing a second house
in Michigan (second residence) and thereafter tried multiple
times to sell the first residence but without success. When
their sales efforts failed, petitioners often rented that
property. Tenants occupied the first residence without
interruption from July 2003 until the lease expired in August
2005. Petitioners tried to sell the first residence from August
2005 until March 2006. During that time Mr. Magno performed
general maintenance on the property, prepared it for sale, and
marketed it to prospective buyers. Despite Mr. Magno’s efforts,
however, the first residence did not sell, and petitioners again
rented that property.
In March 2006 petitioners leased the first residence to
tenants who broke the lease after 2 months. Petitioners
commenced an action against those tenants for breach of contract,
and Mr. Magno assisted the prosecution of that case. The lawsuit
settled, and petitioners again sought to sell the first residence
without success. Petitioners instead chose to lease the property
from November 2006 until November 2007. In connection with that
- 4 -
rental, Mr. Magno prepared the lease, verified the tenant’s
employment, and showed the property.
In 2006 Ms. O’Connell was offered a job promotion which
would require petitioners to move from Michigan to Illinois. Ms.
O’Connell accepted the promotion, and petitioners tried to sell
or lease the second residence. Petitioners secured tenants, and
they leased the second residence from October 2006 through the
end of 2007. During that time Mr. Magno performed maintenance on
the second residence, which required him to travel 370 miles from
Illinois to Michigan. These trips typically required Mr. Magno
to spend 2 days in Michigan, during which time he stayed with
family or at a hotel. Mr. Magno paid for these hotel stays with
cash or a credit card.
During each of these trips, Mr. Magno repaired or supervised
the repair of the second residence. The tasks which Mr. Magno or
his contractors performed included, among others, fixing a tub,
installing a sump pump, fixing an icemaker, removing a bone from
a garbage disposal, replacing heads on a sprinkler system,
winterizing that sprinkler system, and removing lint from a
clothes dryer and vent. When the repairs required Mr. Magno to
purchase parts, he paid with cash or a credit card and received
receipts. When he was unable to complete the repairs himself,
- 5 -
Mr. Magno hired repairmen to do so, though he could not recall
the names of the individuals he hired.3
Petitioners timely filed their Federal income tax return for
each of the subject years and reported on Schedules E total
rental real estate losses of $30,117, $57,275, and $86,321,
respectively. On each of those returns petitioners reported Mr.
Magno’s occupation as a provider of financial planning services.
Petitioners also reported on Schedules C, Profit or Loss From
Business, that Mr. Magno operated a financial services or
planning business during the subject years. Respondent issued to
petitioners a notice of deficiency dated November 20, 2009,
disallowing the Schedule E losses because respondent had
determined that section 469 prohibited recognition of the losses.
Petitioners petitioned the Court, and on September 27, 2010, a
trial was held in Chicago, Illinois.
Discussion
I. Burden of Proof
The Commissioner’s determinations in a notice of deficiency
are presumed correct, and the taxpayer bears the burden of
proving that those determinations are incorrect. Rule 142(a)(1);
Welch v. Helvering, 290 U.S. 111, 115 (1933). Under section
7491(a), the burden of proof as to factual matters may shift to
3
Mr. Magno also modified mortgages on the first and second
residences in 2007.
- 6 -
the Commissioner in certain circumstances. Petitioners have not
alleged that section 7491(a) applies, nor have they established
their compliance with the substantiation and recordkeeping
requirements of the Internal Revenue Code. See sec.
7491(a)(2)(A) and (B). Accordingly, petitioners bear the burden
of proof.
II. Real Estate Activities
Petitioners argue mainly that Mr. Magno is a qualifying real
estate professional because he meets the requirements of section
469(c)(7)(B) and that the rental portions of his real estate
activities are not passive because he materially participated in
those activities.4 Respondent argues that Mr. Magno’s rental
real estate activities are per se passive and that petitioners
may not deduct losses associated with those activities because
Mr. Magno is not a qualifying real estate professional.5 We
agree with respondent.
A taxpayer is generally allowed a deduction for all the
ordinary and necessary expenses paid or incurred in connection
with a trade or business or for the production of income. See
4
Petitioners do not contend that they are entitled to the
offset under sec. 469(i), nor are they.
5
Respondent does not argue in the main that the claimed
rental expenses should be disallowed on the grounds that the
first and second residences were not converted from personal use
property to property held for the production of income. See,
e.g., Saunders v. Commissioner, T.C. Memo. 2002-143, affd. 75
Fed. Appx. 494 (6th Cir. 2003).
- 7 -
secs. 162, 212. Section 469(a)(1), however, limits the
deductibility of losses from these activities where those losses
arise from passive activities. A passive activity is any
activity which involves the conduct of any trade or business in
which the taxpayer does not materially participate. Sec.
469(c)(1). The disallowed passive activity loss equals the
excess of the aggregate losses from all passive activities for a
taxable year over the aggregate income from all passive
activities for that year. Sec. 469(d)(1); sec. 1.469-2T(b)(1),
Temporary Income Tax Regs., 53 Fed. Reg. 5711 (Feb. 25, 1988).
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). However, a taxpayer may
avoid having his or her real estate activity classified as a per
se passive activity if the taxpayer is a qualifying real estate
professional. A taxpayer may qualify as a real estate
professional 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
service during the taxable year in real property trades
or businesses in which the taxpayer materially
participates.
Sec. 469(c)(7)(B). Where, as here, a joint return has been made,
the foregoing requirements are satisfied if either spouse
- 8 -
separately satisfies those requirements. Id. Thus, if Mr. Magno
meets the foregoing requirements, petitioners’ rental activities
are not per se passive and the normal passive activity loss rules
of section 469(c)(1) will apply. We consider in turn
petitioners’ ability to meet each of the requirements under
section 469(c)(7)(B).
A. Other Personal Services Mr. Magno Performed
Petitioners argue that the hours Mr. Magno spent on his
rental real estate activities accounted for more than one-half of
the total hours of personal services he performed in trades or
businesses during the subject years. See sec. 469(c)(7)(B)(i).
We are not persuaded. Petitioners did not elect to treat their
interests in the first and second residences as a single rental
activity, and they must therefore prove that Mr. Magno meets the
requirements of section 469(c)(7)(B) as to each property. See
sec. 469(c)(7)(A); sec. 1.469-9(g), Income Tax Regs.
During the audit stage of this proceeding, Mr. Magno told
respondent’s revenue agent that he worked approximately 25 to 30
hours per week on his financial planning and services business.
That conversation was documented in the revenue agent’s notes,
and the revenue agent testified credibly to its contents at
trial. At trial, however, Mr. Magno testified that he worked
principally as a financial consultant from January through August
2005. He also testified that he became a full-time manager of
- 9 -
the first and second residences in 2006 and 2007 and that he
reduced the number of hours which he devoted to his financial
consulting services business to “about” 500 hours per year.
We credit the testimony of respondent’s revenue agent and
therefore conclude that Mr. Magno must have worked more than
1,250 hours during each subject year in real property trades or
businesses to qualify as a real estate professional under section
469(c)(7)(B)(i).6 Mr. Magno was not able to corroborate with
written documentation his assertions that more than one-half of
the personal services he performed in trades or businesses during
the subject years were performed in real property trades or
businesses. Accordingly, we find that Mr. Magno has not proven
that he meets the requirements of section 469(c)(7)(B)(i).
B. 750-Hour Requirement
Assuming arguendo that we were persuaded by petitioners’
claim that more than one-half of Mr. Magno’s personal services
performed in trades or businesses during the subject years were
performed in real property trades or businesses, petitioners are
still unable to satisfy the 750-hour requirement of section
469(c)(7)(B)(ii). Petitioners argue that Mr. Magno spent more
than 750 hours on each of petitioners’ rental real estate
activities during each of the subject years. The extent of Mr.
6
The product of 25 hours per week for 50 weeks per year is
1,250 hours.
- 10 -
Magno’s participation in petitioners’ real estate activities may
be proven by “any reasonable means.” See sec. 1.469-5T(f)(4),
Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988).
Reasonable means include the identification of services performed
over a period of time and the approximate number of hours spent
performing those services, based on appointment books, calendars,
or narrative summaries. Id. It is well settled that although
the phrase “any reasonable means” is broad, a taxpayer may not
use a postevent “ballpark guesstimate” of the time committed to
the rental activity. See Hill v. Commissioner, T.C. Memo. 2010-
200; Lee v. Commissioner, T.C. Memo. 2006-193; Goshorn v.
Commissioner, T.C. Memo. 1993-578; cf. D’Avanzo v. United States,
67 Fed. Cl. 39, 42 (2005) (adopting same standard).
Petitioners rely solely on the testimony of Mr. Magno to
prove that they devoted the requisite number of hours to qualify
their rental activities under section 469(c)(7)(B)(ii). In so
doing, they present no calendars, narrative summaries, mileage
logs, receipts, or any other records which would support Mr.
Magno’s testimony, even though by Mr. Magno’s own admission they
possessed such items. The failure of petitioners to introduce
such evidence creates a presumption that such information was not
favorable to them. See Wichita Terminal Elevator Co. v.
Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th
Cir. 1947). But here we are concerned with more than just the
- 11 -
lack of corroborating evidence. In certain material respects, we
found the testimony of Mr. Magno to be vague and unpersuasive.
See Mowafi v. Commissioner, T.C. Memo. 2001-111.
For example, Mr. Magno testified that between August 2005
and March 2006 he devoted 250 hours to repairing or supervising
the repair of the first residence. That testimony does not allow
us to determine how much time Mr. Magno personally spent making
such repairs or whether such activity was material under section
469. See D’Avanzo v. Commissioner, supra at 44-45; cf. Trask v.
Commissioner, T.C. Memo. 2010-78 (crediting a taxpayer for time
spent to repair or supervise the repair of rental properties
where the taxpayer maintained detailed work logs which identified
the properties repaired and the contractors used). We are also
troubled by the fact that Mr. Magno is unable to recall basic
details about those repairs such as the dates they were performed
or the names of third parties whom he hired.
We also find Mr. Magno’s estimates of the time he devoted to
petitioners’ rental activities to be excessive in relation to the
tasks performed. See Hill v. Commissioner, supra. Mr. Magno
testified that he spent between 8 and 10 hours per day for 2 or 3
days to complete such seemingly simple tasks as removing a bone
from a garbage disposal, removing lint from a clothes dryer and a
dryer vent, and winterizing a sprinkler system. We do not credit
Mr. Magno’s assertion that he would drive approximately 740 miles
- 12 -
over the course of 16 or 20 hours to perform such simple and
routine tasks. See Rapp v. Commissioner, T.C. Memo. 1999-249.
Such is especially so given that Mr. Magno did not offer any
records to substantiate these trips or the expenses incurred
during them.7
Given the lack of corroborating evidence, we simply cannot
accept as fact that Mr. Magno worked the requisite number of
hours to qualify as a real estate professional for each of his
rental real estate activities. See Scheiner v. Commissioner,
T.C. Memo. 1996-554. We find that Mr. Magno’s method for proving
the time he devoted to his rental activities is not reasonable
under section 1.469-5T(f)(4), Temporary Income Tax Regs., supra.
Cf. Trask v. Commissioner, supra (relying on a taxpayer’s
testimony as proof that he spent more than 750 hours to resolve
over 80 issues for 11 pieces of property during a 1-year period).
C. Conclusion
We hold that Mr. Magno is not a qualifying real estate
professional under section 469(c)(7)(B) and that petitioners’
rental real estate activities are treated as per se passive under
section 469(c)(2).8 See Fowler v. Commissioner, T.C. Memo. 2002-
7
Mr. Magno testified that the record included copies of gas
receipts, but we find no such receipts in the record.
8
Given that holding, we need not consider whether Mr. Magno
materially participated in petitioners’ rental real estate
activities.
- 13 -
223. It follows that the losses petitioners sustained in
connection with their real estate activities may not be used to
reduce their nonpassive income. See sec. 469(a).
III. Accuracy-Related Penalties
Respondent determined that petitioners are liable for
accuracy-related penalties under section 6662(a) for the subject
years. Section 6662(a) and (b)(1) imposes an accuracy-related
penalty equal to 20 percent of any portion of an underpayment of
tax required to be shown on the return that is attributable to
negligence or disregard of rules or regulations.
The term “negligence” includes any failure to make a
reasonable attempt to comply with the provisions of the internal
revenue laws and any failure to keep adequate books and records
or to substantiate items properly. Sec. 6662(c); see also sec.
1.6662-3(b)(1), Income Tax Regs. Negligence may also be defined
as lack of due care or the failure to do what a reasonable and
ordinarily prudent person would do under similar circumstances.
Neely v. Commissioner, 85 T.C. 934, 947 (1985).
Respondent bears the burden of production with respect to
petitioners’ liability for the accuracy-related penalties
included in the notice of deficiency and must therefore produce
evidence that it is appropriate to impose those penalties. See
sec. 7491(c); see also Higbee v. Commissioner, 116 T.C. 438, 446
(2001). Once respondent has met his burden of production,
- 14 -
petitioners must then adduce proof sufficient to persuade the
Court that they were not negligent and that they did not act
carelessly, recklessly, or with an intentional disregard of rules
or regulations. Higbee v. Commissioner, supra at 446-447; see
also sec. 6662(c). Alternatively, petitioners may avoid
liability for the accuracy-related penalties by showing that
there was reasonable cause for the underpayment and that they
acted in good faith. See sec. 6664(c)(1).
We find that respondent has met his burden of production
because petitioners offered no documentation to support their
claim that they performed the requisite number of hours to be
engaged in a real property trade or business. See Smith v.
Commissioner, T.C. Memo. 1998-33. Petitioners did not address
their liability for the accuracy-related penalties at trial or on
brief, and on the basis of the record at hand, we find that
petitioners were negligent. They maintained no books and made no
apparent effort to substantiate the hours which Mr. Magno
purportedly spent on petitioners’ real estate activities. See
Stewart v. Commissioner, T.C. Memo. 2010-184. We believe that an
ordinarily reasonable and prudent person with Mr. Magno’s
expertise in financial planning would have sought the advice of a
tax expert before claiming more than $173,000 in losses over a 3-
year period. Petitioners made no such effort and in failing to
do so were negligent. Cf. Fowler v. Commissioner, supra (finding
- 15 -
a taxpayer who relied on the advice of an accountant not liable
for an accuracy-related penalty even though the taxpayer did not
meet the requirements of section 469(c)(7)(B)).
Nor does reasonable cause exist to excuse petitioners from
the accuracy-related penalties. We recognize that section 469
and the regulations thereunder cover a highly complex area of the
Internal Revenue Code, but complexity alone does not excuse a
taxpayer from taking reasonable steps to determine the law and
comply with it. Niedringhaus v. Commissioner, 99 T.C. 202, 222
(1992); see also sec. 1.6664-4(b)(1), Income Tax Regs.
Petitioners made no apparent effort to comply with the tax law or
to seek out the advice of someone who could help them do so. We
therefore hold petitioners liable for accuracy-related penalties
for the subject years.
We have considered all arguments made by the parties, and to
the extent that we have not specifically addressed them, we
conclude that they are moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
for respondent.