T.C. Memo. 2012-14
UNITED STATES TAX COURT
RAYMOND AND KATHLEEN VANDEGRIFT, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11704-09. Filed January 12, 2012.
J. Richard Greenstein, for petitioners.
James H. Harris, Jr., for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge: Respondent determined an income tax
deficiency for 2005 and an accuracy-related penalty pursuant to
section 6662(a).1 As a result of the parties’ concessions before
1
All section references are to the Internal Revenue Code
(Code) in effect for the year in issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
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trial, the issues remaining for decision all center around the
real estate business activities of petitioner Raymond Vandegrift
(Mr. Vandegrift), specifically, (1) whether he was a real estate
professional under section 469(c)(7)(B), and (2) whether several
real properties sold in 2005 were part of his real estate
business. For the reasons explained herein, we hold that Mr.
Vandegrift was not a real estate professional, the properties
sold were part of his real estate business, and the sale proceeds
must be netted against the loss on passive activities. We also
uphold the accuracy-related penalty but only regarding the
underpayment related to the overstated basis in the properties
sold.
FINDINGS OF FACT
Petitioners resided in Pennsylvania at the time they filed
their petition. They timely filed a joint Federal income tax
return for 2005. Petitioners had nine children, whom they
claimed as dependents on their return.
Some of the facts have been stipulated, and those facts are
incorporated by this reference.
Respondent issued a notice of deficiency to petitioners in
February 2009 in which he determined for 2005 a deficiency of
$53,568 and an accuracy-related penalty of $10,713.60.
During 2005 petitioners owned nine real estate properties in
addition to their residence, six of which were actively rented.
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The remaining three of these properties were acquired as rental
properties and were to be rehabilitated to be prepared as rental
units, but they were sold before they were rented. The three
properties which were sold were acquired as part of the rental
operations Mr. Vandegrift directed. These three properties were
at 7844 Gilbert Street, 3023 Dowitcher Street, and 3319 G Street
(the three properties). The three properties sold were held for
less than 1 year before sale.
Petitioners treated all nine properties as rental properties
on their 2005 return and deducted losses from all nine of the
properties from the gains they reported from the sale of the
three properties. The 2005 return reflected a total real estate
loss of $25,385, of which $11,674, including depreciation, was
associated with the three properties petitioners sold and the
remaining $13,711 was from the six properties which were
generating rent. The 2005 return reflected a gain on the three
sales of $39,388; respondent maintains the actual gain is
$102,579.
Mr. Vandegrift, in addition to his real estate activity, was
employed as a salesman by Hillyard, Inc. He earned roughly
$120,000 in this position in 2005. He maintains that he spent
over one-half of his business-related time and over 750 hours on
the real estate activities. He did not maintain contemporaneous
records of his time, and the trial record does not reflect any
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objective measure of the time he spent as either an employee of
Hillyard, Inc., or as a real estate businessman.
The sale of the property at 3023 Dowitcher Street in
Philadelphia required petitioners to pay $3,000 in State transfer
taxes, which was not allowed as an offset of the sale proceeds by
respondent and is properly treated as additional basis.
OPINION
I. Burden of Proof
The Commissioner’s determinations in the notice of
deficiency are presumed correct, and the taxpayer bears the
burden of proving that the Commissioner’s determinations are
incorrect. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115
(1933). However, section 7491(a)(1) provides that subject to
certain limitations, where a taxpayer introduces credible
evidence with respect to a factual issue relevant to ascertaining
the taxpayer’s tax liability, the burden of proof shifts to the
Commissioner with respect to such issue. Section 7491(a)(2)
provides that section 7491(a)(1) shall apply with respect to a
factual issue only if the taxpayer has complied with certain
substantiation requirements and maintained all records required
by the Code and cooperated with reasonable requests by the
Secretary for witnesses, information, documents, meetings, and
interviews. Petitioners did not maintain contemporaneous records
accurately accounting for the time Mr. Vandegrift spent as an
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employee of Hillyard, Inc., or as a real estate businessman.
Accordingly, we find that petitioners have the burden of proof in
this case under Rule 142(a) because section 7491(a) does not
operate to shift the burden to respondent on this record. We
note also that respondent does have the burden of production
regarding the penalty. See sec. 7491(c).
II. Whether Mr. Vandegrift Was in the Real Estate Business Under
Section 469(c)(7)
Section 469(a)(1)(A) operates to generally disallow passive
activity losses. A passive activity loss is defined as the
excess of the aggregate losses from all passive activities for a
year over the aggregate income from all passive activities for
the year. Sec. 469(d)(1). Passive activities include any trade
or business in which the taxpayer does not “materially
participate”. Sec. 469(c)(1). Section 469(c)(2) provides that
except as provided in section 469(c)(7), the term “passive
activity” definitively includes any rental activity.
Section 469(c)(7)(B) defines the taxpayers relieved from
passive loss treatment as those who perform more than one-half of
their personal services in real property trades or businesses in
which they materially participate, and who perform more than 750
hours of services in real property trades or businesses in which
they materially participate. For taxpayers filing a joint
return, only one need qualify.
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Petitioners maintain Mr. Vandegrift qualifies as such an
individual. He testified that over one-half of the total time he
spent in business activity was devoted to the real estate
business. We found Mr. Vandegrift to be generally honest and
forthright, but his time estimate is suspect given his employment
as a salesman for an employer in a business unrelated to the real
estate activity. His subjective estimate also suffers from a
lack of contemporaneous verification by records or other
evidence. 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.
We have held that the regulations do not allow a postevent
“ballpark guesstimate” of time committed to participation in a
rental activity. Moss v. Commissioner, 135 T.C. 365, 369 (2010);
Bailey v. Commissioner, T.C. Memo. 2001-296; Goshorn v.
Commissioner, T.C. Memo. 1993-578. We are forced to find on the
record before us that petitioners have failed to carry their
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burden of establishing that Mr. Vandegrift spent over one-half
his work time in the real estate business. Accordingly, we hold
that Mr. Vandegrift does not satisfy the terms of section
469(c)(7)(B) for 2005.
III. Whether the Properties Sold Were Part of the Rental Real
Estate Business, and Whether the Rental Losses May Be
Netted Against the Sale Gains
Respondent argues that because the three properties sold in
2005 were not rented, there is short-term capital gain on the
sales which may not be offset by the losses on the other real
estate activity. Because of our prior holding, the rental real
estate loss is passive. Respondent argues the loss may not be
offset against petitioners’ income because petitioners’ gross
income exceeds the limitations on allowable passive real estate
losses. See sec. 469(i).2 Petitioners counter that regardless
of whether the rental real estate loss is passive, all of the
real estate activities were part of one single business, and the
2
Sec. 469(i)(1) provides:
In the case of any natural person, subsection (a) shall
not apply to that portion of the passive activity loss
or the deduction equivalent * * * of the passive
activity credit for any taxable year which is
attributable to all rental real estate activities with
respect to which such individual actively participated
in such taxable year * * *
The sec. 469(i) exception is limited to $25,000. Sec.
469(i)(2). The $25,000 maximum “offset”, however, begins to be
phased out for taxpayers whose adjusted gross income exceeds
$100,000 and is completely phased out for taxpayers whose
adjusted gross income is $150,000 or more. Sec. 469(i)(3)(A).
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losses and gains in that single business must be netted to
determine passive income.
This issue is resolved by our factual determination that the
real estate activities constituted one trade or business and by
the definitions of passive activity in section 469(c) and of
passive activity loss in section 469(d)(1). Section 469(c)(1)
provides that passive activity means an activity involving the
conduct of a trade or business in which the taxpayer does not
materially participate. Mr. Vandegrift’s real estate activities
meet this definition. Section 469(d)(1) requires that aggregate
losses from passive activities be netted with aggregate income
from such activities.
Mr. Vandegrift testified he initially acquired the three
properties sold in 2005 with the intent to rent them; however,
various circumstances eventually made a quick sale of the
properties more advantageous to his real estate business. His
testimony in this regard was credible, and we hold that the
properties sold were part of the same passive real estate
activity as the rental properties and that the proceeds should be
netted with the rental loss to determine the correct amount of
passive income for 2005.
IV. Whether the Penalty Is Applicable
Section 6662 authorizes the Commissioner to impose a 20-
percent penalty on an underpayment of tax that is attributable
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to, among other items, negligence or any substantial
understatement of income tax. Sec. 6662(a) and (b)(1) and (2).
For purposes of section 6662, “negligence” is defined as any
failure to make a reasonable attempt to comply with the
provisions of the Code, and “disregard” includes any careless,
reckless, or intentional disregard. Sec. 6662(c); see also Neely
v. Commissioner, 85 T.C. 934, 947 (1985) (negligence is lack of
due care or failure to do what a reasonably prudent person would
do under the circumstances). A return position that has a
reasonable basis is not attributable to negligence. Sec. 1.6662-
3(b)(1), Income Tax Regs. Similarly, under section 6664(c)(1),
no penalty is imposed under section 6662 with respect to any
portion of an underpayment if it is shown that there was
reasonable cause for such portion and that the taxpayer acted in
good faith with respect to such portion.
Respondent has determined that the 20-percent penalty under
section 6662(a) is applicable on the basis of negligence and a
substantial understatement of income tax. Petitioners argue that
they relied in good faith on their return preparer and that such
reliance was reasonable cause for their underpayment. Regarding
the underpayment related to the overstated itemized deductions
which they did not contest at trial, we find petitioners’
reliance on their return preparer to be reasonable. Also, we
find that because of the technical nature of the question of
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whether Mr. Vandegrift was a real estate professional, they were
acting in good faith in claiming the activities were not passive.
However, we find that their underpayment is not subject to a
reasonable cause defense with regard to the overstated basis and
expenses in the real estate business. The errors in reporting
these items cannot be laid solely at the feet of the return
preparer. Mr. Vandegrift is primarily responsible for the
numbers on the return regarding the real estate business. To the
extent excess basis and expenses were claimed on the return, an
underpayment results and the accuracy-related penalty is
applicable and upheld.
To reflect the foregoing and concessions by the parties,
Decision will be entered
under Rule 155.