Francis J. Dirico and Jennifer Dirico v. Commissioner

FRANCIS J. DIRICO AND JENNIFER DIRICO, PETITIONERS v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Docket No. 16202–09. Filed November 13, 2012.

P–H leased land and telecommunication towers to S, his
wholly owned S corporation, in exchange for a percentage of
S’s revenues from its leases of tower access to third parties.
P–H also leased three parcels of land to S that were without
towers. S also sold and serviced radios and provided special-
ized mobile radio (SMR) services to customers for a monthly
subscriber fee. Four of the towers leased to S housed antennas
in free (unused) space for the rent-free use of S’s SMR cus-
tomers. P–H reported the net income from his leases to S as
passive activity rental income pursuant to I.R.C. sec.
469(c)(2). R alleges that (1) P–H’s rental income from his
tower and land rentals to S constituted income from property
used in a trade or business in which P–H materially partici-
pated and, therefore, constituted non-passive-activity income
pursuant to sec. 1.469–2(f)(6), Income Tax Regs., (2) that
regulation applies only to P–H’s profitable tower and land
leases to S so that P–H’s losses from unprofitable tower and
land leases to S remain passive activity losses, and (3) P–H’s
income from the three land-only leases to S constituted non-
passive-activity income pursuant to sec. 1.469–2T(f)(3), Tem-
porary Income Tax Regs., 53 Fed. Reg. 5721 (Feb. 25, 1988),
because less than 30% of the leased property’s unadjusted
basis was subject to depreciation.
1. Held: S used the towers and associated land leased from
P–H in a rental (not a trade or business) activity with the
result that P–H’s income from those leases constituted passive
activity income (or loss) pursuant to I.R.C. sec. 469(c)(2),
regardless of P–H’s material participation in that activity. See
I.R.C. sec. 469(c)(4).
2. Held, further, the prior holding renders moot Ps’ objection
to treating P–H’s losses from unprofitable tower and land
leases to S as passive activity losses.
3. Held, further, because the land included in the land-only
leases was not ‘‘provided in connection with’’ any of the towers
P–H leased to S, those leases may not be grouped with P–H’s
tower and land leases to S, see sec. 1.469–4(d)(2), Income Tax
Regs., and, therefore, because less than 30% of the property

396

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 (396) DIRICO v. COMMISSIONER 397

covered by those leases was depreciable, P–H’s income there-
from constituted non-passive-activity income pursuant to sec.
1.469–2T(f)(3), Temporary Income Tax Regs., supra.

Donald-Bruce Abrams, Daniel A. Nelson, and Lawrence I.
Silverstein, for petitioners.
Nina P. Ching, for respondent.
HALPERN, Judge: By notice of deficiency respondent deter-
mined deficiencies in petitioners’ Federal income tax liabil-
ities of $69,910 and $216,845 for their 2004 and 2005 tax-
able, calendar, years (years in issue), respectively.
Unless otherwise indicated, all section references are to the
Internal Revenue Code in effect for the years in issue. All
dollar amounts have been rounded to the nearest dollar.
The issues for decision are (1) whether rental income paid
to Francis J. Dirico (petitioner), or to one of his wholly owned
grantor or nominee trusts, by his wholly owned subchapter
S corporation for the use of telecommunication towers and
land constituted income from a passive activity (passive
activity income) pursuant to section 469(c)(2) or income from
a nonpassive activity (non-passive-activity income) pursuant
to section 1.469–2(f)(6), Income Tax Regs., (2) whether the
rental income involved in deciding the first issue is the net
income derived from all of the property leased to petitioner’s
wholly owned subchapter S corporation or that derived from
the profitable rentals only, (3) whether, in deciding the first
issue, we should exclude from consideration petitioner’s
income from rentals of land without a tower and treat that
income as non-passive-activity income pursuant to section
1.469–2T(f)(3), Temporary Income Tax Regs., 53 Fed. Reg.
5721 (Feb. 25, 1988). 1

1 The notice of deficiency also reflects reductions in petitioners’ itemized deductions for the

years in issue, which derive from the principal adjustment and are not directly disputed by peti-
tioners. Additionally, in their petition, petitioners argue that they are entitled to treat the por-
tion of petitioner’s income from his wholly owned subchapter S corporation that was attributable
to that corporation’s tower rental income as passive activity income even though the corporation
reported his entire 100% distributive share of its income for the years in issue as ‘‘ordinary busi-
ness income’’, a characterization that carried over to petitioners’ individual joint returns for
those years. On brief, however, petitioners abandon that argument, apparently because the
record does not include a breakdown between the corporation’s tower rental and other income
for the years in issue. Therefore, we do not address that issue.

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 398 139 UNITED STATES TAX COURT REPORTS (396)

FINDINGS OF FACT

Residence
At the time the petition was filed, petitioners resided in
Key Largo, Florida.
Background
Petitioner attended high school, college, and graduate
school in Massachusetts. He earned an undergraduate degree
in public health and epidemiology and did graduate-level
courses in various technical areas. After completing his
schooling, he worked in Boston as a staff engineer in his
father’s manufacturing business.
In the early 1970s, he formed what became Industrial
Communications & Electronics, Inc. (ICE). ICE’s business,
which petitioner initially conducted out of his home in Pem-
broke, Massachusetts, was electrical contracting, servicing
two-way radios, and, later, performing specialized services
for cellular carriers. ICE moved, first to Kingston and then to
Marshfield, Massachusetts, where, at the time of the trial, its
corporate headquarters had been for the preceding 10 years.
ICE also maintains small offices in Miami and Naples,
Florida.
Before and during the years in issue, ICE was engaged in
a variety of radio-related activities, including construction of
and leasing access to telecommunications towers (towers),
sales and servicing of Motorola radios, and providing special-
ized mobile radio services (SMR) for a monthly subscriber fee.
It constructed towers both for unrelated parties and for its
own use, the latter for rental to customers, including
Verizon, T-Mobile, AT&T, paging companies, and government
entities.
SMR was a pre-cellular-telephone-technology, push-to-talk
radio system with some telephone capabilities. Before the cel-
lular telephone industry matured, SMR was an attractive
technology, offering party-line or intercom-like services to
such users as security companies, plumbers, electricians,
construction companies, and tow-truck and rubbish compa-
nies.
By 1997 or 1998, ICE and Nextel each owned half of the
SMR frequencies in Boston. ICE used its frequencies in its SMR
business, but, by then, Nextel’s use of digital technology on

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 (396) DIRICO v. COMMISSIONER 399

its frequencies resulted in interference that caused ICE’s cus-
tomers to have difficulty in using their SMR radios. The fre-
quencies involved in the SMR business were both 800 and 900
megacycles (megs), and it was Nextel’s use of the former that
hurt ICE’s customers and led to ICE’s loss of some 90% of
those customers. As a result, in 1997 or 1998 ICE disposed to
Nextel all of its 800 megs frequencies in exchange for cash
and Nextel’s 900 megs frequencies. Thereafter, ICE rebuilt its
SMR business as a 900 megs business, which continued
during the years in issue. ICE mounted the SMR antennas on
a small number (perhaps four) of the towers that it leased
from petitioner during the years in issue. ICE placed the SMR
antennas on what was otherwise free space, i.e., space not
already used by lessee antennas.
During the years in issue, ICE was an S corporation (within
the meaning of section 1361(a)(1)), and petitioner owned
100% (in 2004, indirectly, through another wholly owned S
corporation, and, in 2005, directly) of its stock.
Petitioner’s Ownership and Leasing of Telecommunications
Towers and Land to ICE
During the years in issue, either individually or through
grantor or nominee trusts, petitioner owned towers and land
that he leased to ICE. In all, petitioner leased to ICE 19 prop-
erties in 2004 (10 consisting of both a tower and land owned
by a nominee trust, 6 consisting of land owned by a nominee
trust on which was situated a tower owned by ICE, and 3 con-
sisting of land owned by petitioner with no tower) and 21
properties in 2005 (1 consisting of both a tower and land
owned by petitioner, 10 consisting of both a tower and land
owned by a nominee trust, 7 consisting of land owned by a
nominee trust on which was situated a tower owned by ICE,
and 3 consisting of land owned by petitioner with no tower).
Those properties were in Massachusetts, Rhode Island, New
Hampshire, and Florida. During both years, petitioner
incurred net losses with respect to four of the properties
leased to ICE, each consisting of tower and land.
Under the typical lease from either petitioner or one of the
nominee trusts to ICE, the lessor leased the land, towers, and
other property at a specified address to ICE for a five-year
initial term with provision for indefinite five-year renewals in

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 400 139 UNITED STATES TAX COURT REPORTS (396)

consideration of ‘‘base rent of 25% of the gross tower rent
revenue.’’ ICE was responsible for payment of utilities and for
maintenance of the leased property.
With respect to both the towers it leased from petitioner or
a nominee trust and the towers it owned (on land it leased
from a nominee trust), ICE leased tower access to unrelated
third parties, including mobile telecommunication service
providers such as Verizon and Nextel. ICE leased tower
access to 3 to 20 tenants per tower, and each of those tenants
would install up to 30 antennas on a tower. Under the typ-
ical tower access lease (entitled ‘‘License Agreement for
Antenna Site’’), the ‘‘licensee’’ is allowed to ‘‘install, operate,
and maintain’’ at its ‘‘sole expense and risk’’ specified items
of equipment (typically, antennas and transmission lines) in
consideration of a ‘‘monthly license fee.’’ The ‘‘licensor’’ is
liable for repairs except those ‘‘required because of the fault
or negligence of * * * [the licensee] or its designated mainte-
nance company’’, in which event the ‘‘licensee’’ becomes
responsible for the repairs. ICE, as lessor or ‘‘licensor’’, gen-
erally maintained each tower, made sure that it was painted
and that the lights were working, picked up papers and other
debris, plowed snow, etc.
Petitioner’s Involvement With ICE
Petitioner was immersed in ICE’s business operations,
working long hours 51⁄2 to 6 days every week, at least until
the sale of the 800 megs SMR frequencies to Nextel in 1997
or 1998. Shortly after that sale, he and his family moved
from Massachusetts to Key Largo, Florida. Thereafter, peti-
tioner’s involvement with the day-to-day activities of ICE less-
ened. 2
2 The trial testimony, certain of the exhibits, and the parties’ briefs address the extent of peti-

tioner’s involvement with ICE during the years in issue. Assuming ICE used the towers and
land leased from petitioner or a nominee trust in a ‘‘trade or business activity’’ as defined in
sec. 1.469–4(b)(1), Income Tax Regs., the question is whether petitioner’s involvement in that
activity rose to the level of material participation therein, as defined in sec. 1.469–5T, Tem-
porary Income Tax Regs., 53 Fed. Reg. 5725 (Feb. 25, 1988), thereby triggering the application
of sec. 1.469–2(f)(6), Income Tax Regs., to convert petitioner’s tower and land rental income from
passive activity to non-passive-activity income. For the reasons discussed below, we find that
ICE did not use the towers and land leased from petitioner or a nominee trust in a trade or
business activity, which renders moot the issue of whether petitioner materially participated in
ICE’s tower access leasing activity during the years in issue. Therefore, we do not address or
attempt to resolve the conflicting evidence in the record regarding petitioner’s involvement in
the day-to-day operations of ICE during those two years.

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 (396) DIRICO v. COMMISSIONER 401

Petitioners’ and ICE’s Tax Returns
Petitioners’ returns for the years in issue reported the
income and loss from the leasing of towers and land to ICE
as passive activity income and loss for purposes of section
469. Those returns listed each of the individual land and
tower rentals as a separate activity.
ICE’s returns for the years in issue did not separately
report the income or loss from its various activities. Rather,
ICE reported its total net income as ‘‘ordinary business
income’’. Moreover, on the Form 1120S Schedule K–1, Share-
holder’s Share of Income, Deductions, Credits, etc., it issued
to petitioner for each of the years in issue, ICE included peti-
tioner’s entire 100% distributive share of its income for the
year in Box 1, ‘‘Ordinary business income (loss)’’. Consistent
with those Schedules K–1, petitioner reported his distribu-
tive share of ICE’s income for the years in issue as ordinary,
non-passive-activity income on Schedule E, Supplemental
Income and Loss.
Respondent’s Adjustments at Issue
For each of the years in issue, respondent recharacterized
petitioner’s income from profitable rentals of towers and/or
land from passive activity income to non-passive-activity
income for purposes of section 469. He did not, however, so
recharacterize petitioner’s losses from unprofitable tower and
land rentals. On that basis, respondent recharacterized
$428,128 and $590,054 for 2004 and 2005, respectively, from
passive activity income to non-passive-activity income, attrib-
utable to profitable rental properties, but he did not so re-
characterize $143,829 and $157,824 for 2004 and 2005,
respectively, of losses attributable to unprofitable rental
properties.
As noted supra note 1, for each of the years in issue,
respondent also made correlative adjustments that are not in
dispute.

OPINION

I. Burden of Proof
Each party argues that the other should bear the burden
of proof. We have found many facts without the need to

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 402 139 UNITED STATES TAX COURT REPORTS (396)

determine who bears the burden of proof. With respect to one
possible material fact, i.e., whether petitioner materially
participated in ICE’s tower access leasing activity, the parties
propose conflicting findings. Because our disposition of the
case makes it unnecessary to find whether petitioner materi-
ally so participated, see supra note 2, there are no facts left
to be found, only issues of law as applied to undisputed facts.
Therefore, it is unnecessary to assign burden of proof.
II. Applicable Law
A. General Principles
Section 469(a) disallows the passive activity loss of an indi-
vidual taxpayer. The term ‘‘passive activity loss’’ means the
amount, if any, by which the aggregate losses from all pas-
sive activities for the taxable year exceed the aggregate
income from all passive activities for such year. Sec.
469(d)(1). A ‘‘passive activity’’ is any activity involving the
conduct of a trade or business in which the taxpayer does not
materially participate. 3 Sec. 469(c)(1). In addition, with an
exception that is inapplicable herein, see sec. 469(c)(7), the
term ‘‘passive activity’’ includes any rental activity (defined
in section 469(j)(8) as ‘‘any activity where payments are prin-
cipally for the use of tangible property’’), regardless of the
taxpayer’s material participation therein, sec. 469(c)(2), (4);
see Carlos v. Commissioner, 123 T.C. 275, 278 (2004). A tax-
payer’s ‘‘activities’’ include those conducted through an S cor-
poration. Sec. 1.469–4(a), Income Tax Regs.
Section 1.469–1T(e)(3)(i), Temporary Income Tax Regs., 53
Fed. Reg. 5702 (Feb. 25, 1988), states that an activity is a
‘‘rental activity’’ for the taxable year if ‘‘(A) [d]uring such
* * * year, tangible property held in connection with the
activity is used * * * or held for use by customers’’ and
(B) The gross income attributable to the conduct of the activity during
such taxable year represents (or, in the case of an activity in which prop-
erty is held for use by customers, the expected gross income from the con-
duct of the activity will represent) amounts paid or to be paid principally
for the use of such tangible property (without regard to whether the use
of the property by customers is pursuant to a lease or pursuant to a
service contract or other arrangement that is not denominated a lease).

3 See sec. 469(h) for the definition of ‘‘material participation’’.

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 (396) DIRICO v. COMMISSIONER 403

Section 1.469–1T(e)(3)(ii)(A)–(F), Temporary Income Tax
Regs., 53 Fed. Reg. 5702 (Feb. 25, 1988), lists six exceptions
or instances in which an activity involving the use of tangible
property is not a ‘‘rental activity’’ for the taxable year, none
of which is alleged by respondent to be applicable herein.
B. Recharacterization of Passive Activity Rental Income
Section 469(l), in relevant part, directs the Secretary to
issue ‘‘such regulations as may be necessary or appropriate
to carry out provisions of * * * [section 469] including regu-
lations * * * (3) requiring net income or gain from a * * *
passive activity to be treated as not from a passive activity’’. 4
Pursuant to that legislative directive, the Commissioner
promulgated section 1.469–2T(f), Temporary Income Tax
Regs., supra, which incorporates by reference section 1.469–
2(f)(5) and (6), Income Tax Regs., and is entitled ‘‘Re-
characterization of passive income in certain situations.’’
Only section 1.469–2T(f)(3), Temporary Income Tax Regs.,
supra, and section 1.469–2(f)(6), Income Tax Regs., are
alleged by respondent to be applicable herein; both apply to
rental activities. The former provides, in relevant part, that,
if less than 30% of the unadjusted basis of rental property
is subject to the allowance for depreciation under section 167,
the taxpayer’s net passive activity income from the property
shall be treated as non-passive-activity income (sometimes,
the 30% test). The latter provides, in relevant part, as fol-
lows:
(6) Property rented to a nonpassive activity.—An amount of the taxpayer’s
gross rental activity income for the taxable year from an item of property
equal to the net rental activity income for the year from that item of prop-
erty is treated as not from a passive activity if the property—
(i) Is rented for use in a trade or business activity * * * in which the
taxpayer materially participates (within the meaning of sec.1.469–5T) for
the taxable year * * *

In general, ‘‘trade or business activities’’ constitute ‘‘activi-
ties, other than rental activities’’. Sec. 1.469–4(b)(1), Income
Tax Regs.
4 The conference report accompanying the enactment of sec. 469 cites, as an example of pas-

sive activity income to be converted into non-passive-activity income, income from ‘‘related party
leases or sub-leases, with respect to property used in a business activity, that have the effect
of reducing active business income and creating passive income’’. H.R. Conf. Rept. No. 99–841
(Vol. II), at II–147 (1986), 1986–3 C.B. (Vol. 4) 1, 147.

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 404 139 UNITED STATES TAX COURT REPORTS (396)

Thus, application of section 1.469–2(f)(6), Income Tax Regs.
(sometimes, the self-rental rule), requires the satisfaction of
two conditions: (1) property must be rented for use in a trade
or business and (2) the lessor-taxpayer must materially
participate in the trade or business. 5
The fact that section 1.469–2(f)(6), Income Tax Regs., re-
characterizes the net rental activity income from ‘‘an item of
property’’ rather than the net income from the taxpayer’s
entire rental activity means that the passive losses generated
by unprofitable rental properties remain passive activity
losses. Therefore, those losses do not offset the recharacter-
ized (from passive activity to non-passive-activity) income
from the taxpayer’s profitable rental properties. Veriha v.
Commissioner, 139 T.C. 45, 49 (2012); Carlos v. Commis-
sioner, 123 T.C. at 280–282.
C. Rules for Grouping Activities
Section 1.469–4(c), Income Tax Regs., entitled ‘‘General
rules for grouping activities’’, provides: ‘‘(1) Appropriate eco-
nomic unit. One or more trade or business activities or rental
activities may be treated as a single activity if the activities
constitute an appropriate economic unit for the measurement
of gain or loss for purposes of section 469.’’ Section 1.469–
4(c)(2), Income Tax Regs., applies a facts and circumstances
test for determining whether activities constitute ‘‘an appro-
priate economic unit’’.
Section 1.469–4(d), Income Tax Regs., provides limitations
on the grouping of activities. In that regard, section 1.469–
4(d)(1)(i), Income Tax Regs., provides that ‘‘[a] rental activity
may not be grouped with a trade or business activity unless
the activities * * * constitute an appropriate economic unit’’
and
(A) The rental activity is insubstantial in relation to the trade or busi-
ness activity;
(B) The trade or business activity is insubstantial in relation to the
rental activity; or
(C) Each owner of the trade or business activity has the same propor-
tionate ownership interest in the rental activity, in which case the portion
5 Although sec. 1.469–2(f)(6), Income Tax Regs., has been challenged as invalid, its validity

has been upheld repeatedly. See, e.g., Krukowski v. Commissioner, 279 F.3d 547, 552 (7th Cir.
2002), aff ’g 114 T.C. 366 (2000); Sidell v. Commissioner, 225 F.3d 103, 107–108 (1st Cir. 2000),
aff ’g T.C. Memo. 1999–301; Fransen v. United States, 191 F.3d 599, 601 (5th Cir. 1999); Shaw
v. Commissioner, T.C. Memo. 2002–35.

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 (396) DIRICO v. COMMISSIONER 405

of the rental activity that involves the rental of items of property for use
in the trade or business activity may be grouped with the trade or business
activity.

Pursuant to section 1.469–4(d)(2), Income Tax Regs., real
and personal property rental activities (other than where one
type of property is provided in connection with the other)
may not be grouped and treated as a single activity.
A shareholder in a section 469 entity such as an S corpora-
tion ‘‘may not treat activities grouped together by * * * [the
S corporation] as separate activities.’’ Sec. 1.469–4(d)(5)(i),
Income Tax Regs. (last sentence).
Pursuant to section 1.469–4(e)(1), Income Tax Regs., ‘‘once
a taxpayer has grouped activities * * *, the taxpayer may
not regroup those activities in subsequent taxable years.’’
However: ‘‘If it is determined that a taxpayer’s original
grouping was clearly inappropriate * * *, the taxpayer must
regroup the activities’’. Sec. 1.469–4(e)(2), Income Tax Regs.
III. Summary of the Parties’ Arguments
A. Respondent’s Arguments
Respondent argues that, during the years in issue, peti-
tioner (either individually or through a nominee trust) rented
to ICE for use in its trade or business activities (1) tele-
communications towers and land and (2) land on which ICE-
owned towers were situated (together, tower and land
rentals). Respondent further argues that, within the meaning
of section 1.469–5T, Temporary Income Tax Regs., 53 Fed.
Reg. 5725 (Feb. 25, 1988), petitioner materially participated
in those ICE activities. Therefore, respondent concludes, peti-
tioner’s income from those rentals must be recharacterized
from passive activity income to non-passive-activity income
pursuant to the self-rental rule of section 1.469–2(f)(6),
Income Tax Regs. 6
6 The parties appear to agree that petitioner’s tower and land rentals to ICE constituted a

single activity. Presumably, both parties accept (and we agree) that those rentals represent the
rental of personal property ‘‘provided in connection with’’ real property, or vice versa. Therefore,
they come within the exception to the general prohibition against grouping real and personal
property rentals. See sec. 1.469–4(d)(2), Income Tax Regs. Moreover, because petitioner’s activi-
ties include those he conducted through ICE, see sec. 1.469–4(a), Income Tax Regs., his rentals
of land with ICE-owned towers situated thereon are properly includable within that grouping
as rentals of real property ‘‘provided in connection with’’ personal property indirectly provided
by petitioner through ICE.

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 406 139 UNITED STATES TAX COURT REPORTS (396)

Respondent’s argument that ICE’s leasing of tower access to
unrelated third parties constituted a trade or business is
based, in part, on his view that (1) ‘‘ICE was in the trade or
business of leasing and managing tower access to unrelated
parties’’ and (2) that ‘‘business’’ and ICE’s other business
activities complemented one another with the overall result
that they should be considered a single trade or business.
Respondent also refers to ICE’s maintenance of the towers, its
payment of the electrical bills, and its providing of technical
specifications to the lessees regarding how they should
install their antennas. Respondent’s argument that ICE’s
tower access rental activity must be considered a part of and
included within its overall trade or business activity is based
principally on the fact that ICE, on its returns and on the
Schedules K–1 issued to petitioner for the years in issue,
grouped all of its activities and reported the income there-
from as ‘‘ordinary business income’’. Respondent argues that,
pursuant to section 1.469–4(d)(5)(i) (last sentence) and (e)(1),
Income Tax Regs., petitioners are bound by ICE’s grouping of
its activities and may not treat any of them as separate
activities. Respondent further argues that ICE’s grouping was
correct on the ground that its activities constituted ‘‘an
appropriate economic unit’’ and petitioner had the same
proportionate interest (100%) in both his rental activity and
ICE’s trade or business activities. See sec. 1.469–4(d)(1)(C),
Income Tax Regs.
Respondent also argues that, pursuant to section 1.469–
2(f)(6), Income Tax Regs., he properly recharacterized, from
passive activity income to non-passive-activity income, only
petitioner’s income from profitable tower and land rentals. In
support of that argument, respondent cites Carlos v.
Commissioner, 123 T.C. 275, and, in particular, our observa-
tion in Carlos that section 1.469–2(f)(6), Income Tax Regs.,
‘‘explicitly recharacterizes net rental activity income from an
‘item of property’ rather than net income from the entire
rental ‘activity’ ’’. Id. at 280–281.
Lastly, respondent argues that petitioner’s rental income
for the years in issue from the three parcels of land without
a tower that he leased to ICE (land-only rentals) must be re-
characterized as non-passive-activity income pursuant to the
30% test of section 1.469–2T(f)(3), Temporary Income Tax
Regs., supra, which requires such recharacterization with

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 (396) DIRICO v. COMMISSIONER 407

respect to income from rental property less than 30% of the
unadjusted basis of which is subject to the allowance for
depreciation under section 167.
B. Petitioners’ Arguments
Petitioners argue that, because ICE’s leasing of tower
access to third parties was a rental activity under section
469(j)(8), which, by definition, cannot be a trade or business
activity, see sec. 1.469–4(b)(1), Income Tax Regs., petitioner
(either individually or through a nominee trust) did not lease
any properties to ICE for use in a trade or business. There-
fore, the self-rental rule of section 1.469–2(f)(6), Income Tax
Regs., does not apply to petitioners’ rental income from those
leases, which remains passive activity income, regardless of
whether petitioner materially participated in the rental (or
other) activities of ICE.
Petitioner argues alternatively that, even if ICE’s leasing of
tower access were treated as a trade or business (i.e., non-
passive) activity, petitioners’ rental income would still be
passive activity income because petitioner did not, within the
meaning of the regulations, materially participate in the
activity.
Petitioner also objects to respondent’s failure to net his
profitable and unprofitable property rentals to ICE in deter-
mining the amount of income subject to recharacterization as
non-passive-activity income under section 1.469–2(f)(6),
Income Tax Regs. Petitioners argue that both the profitable
and unprofitable rentals arose out of the same rental activity
so that if the profits are to be treated as nonpassive so must
the losses. Thus, petitioners reject as ‘‘excessive’’ respond-
ent’s treatment of the profits from profitable rentals as non-
passive while allowing the losses from nonprofitable rentals
to remain passive and, therefore, unavailable to offset the
non-passive-activity rental income.
Petitioners make a similar argument in opposition to
respondent’s citation of section 1.469–2T(f)(3), Temporary
Income Tax Regs., supra, as grounds for recharacterizing,
from passive activity income to non-passive-activity income,
his income from land-only rentals. Petitioners argue that, in
determining whether less than 30% of the unadjusted basis
of petitioners’ property leased to ICE was depreciable,
respondent should have included in the computation all of

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 408 139 UNITED STATES TAX COURT REPORTS (396)

the property leased to ICE, not just the real property included
in the land-only rentals. Petitioner also argues that respond-
ent’s position with respect to the land-only rentals was first
raised on brief and, for that reason, should be rejected as
untimely.
IV. Analysis and Conclusions
A. Application of the Self-Rental Rule: Section 1.469–2(f)(6),
Income Tax Regs.
1. Introduction
Application of section 1.469–2(f)(6), Income Tax Regs., to
petitioner’s tower and land rentals to ICE during the years in
issue depends upon our finding that two conditions existed
with respect to those rentals: (1) ICE used those properties in
a trade or business activity (which, for purposes of section
469, is an activity other than a rental activity, see sec. 1.469–
4(b)(1), Income Tax Regs.), and (2) petitioner materially
participated in that trade or business activity. Because, for
the reasons set forth below, we find that ICE did not use
those properties in a trade or business activity, we do not
address the issue of whether petitioner materially partici-
pated in ICE’s tower access rental activities, and we hold that
section 1.469–2(f)(6), Income Tax Regs., is inapplicable to
petitioner’s income from tower and land rentals to ICE.
2. Analysis
The fact that the typical tower lease between ICE and its
tower access customers was denominated a ‘‘License Agree-
ment for Antenna Site’’ is of no consequence. If the customer
is paying for the use of tangible property, the activity is a
rental activity ‘‘without regard to whether the use of the
property * * * is pursuant to a lease * * * a service contract
or other arrangement that is not denominated a lease.’’ Sec.
1.469–1T(e)(3)(i)(B), Temporary Income Tax Regs., 53 Fed.
Reg. 5702 (Feb. 25, 1988).
Also, the fact that ICE’s various activities may have com-
plemented one another does not alter the fundamental fact
that ICE’s leasing of towers and land to unrelated third par-
ties was a rental activity within the meaning of section
469(j)(8) and section 1.469–1T(e)(3)(i), Temporary Income

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 (396) DIRICO v. COMMISSIONER 409

Tax Regs., supra. 7 The few services that ICE provided in
connection with its rentals (e.g., painting the towers, making
sure the lights worked, plowing the snow around the towers)
were equivalent to the services routinely provided by any
lessor or landlord in order to make premises habitable by a
lessee. They were no more than supportive of ICE’s rental
activities and did not turn those activities into trade or busi-
ness activities as defined in section 1.469–4(b)(1), Income Tax
Regs. More importantly, ICE’s performance of those services
did not bring its tower leasing activities within any of the
exceptions to the definition of a rental activity that are
described in section 1.469–1T(e)(3)(ii)(A)–(F), Temporary
Income Tax Regs., supra. Those exceptions, none of which is
alleged by respondent to be applicable herein, describe cir-
cumstances under which ‘‘an activity involving the use of
tangible property’’ will not be considered a rental activity for
the taxable year. They include rentals of ‘‘seven days or less’’
(subdivision (A)); rentals of 30 days or less accompanied by
‘‘significant’’ lessor-provided services (subdivision (B) and sec.
1.469–1T(e)(3)(iv), Temporary Income Tax Regs., 53 Fed.
Reg. 5702 (Feb. 25, 1988)); rentals accompanied by ‘‘extraor-
dinary personal services’’ (i.e., the use of the property is
‘‘incidental’’ to the receipt of the services) (subdivision (C)
and sec. 1.469–1T(e)(3)(v), Temporary Income Tax Regs., 53
Fed. Reg. 5702 (Feb. 25, 1988)); rentals ‘‘incidental to a non-
rental activity of the taxpayer’’ (subdivision (D) and sec.
1.469–1T(e)(3)(vi), Temporary Income Tax Regs., 53 Fed.
Reg. 5702 (Feb. 25, 1988)); rentals where the property is
made available ‘‘during defined business hours for nonexclu-
sive use by various customers’’ (subdivision (E)); rentals to a
passthrough entity (e.g., an S corporation) where the tax-
payer has made property available to the entity ‘‘in the tax-
payer’s capacity as an owner of an interest in’’ the entity
(e.g., by way of capital contribution) for use in a nonrental
activity (subdivision (F) and sec. 1.469–1T(e)(3)(vii), Tem-
porary Income Tax Regs., 53 Fed. Reg. 5702 (Feb. 25, 1988)).
Four of those exceptions (section 1.469–1T(e)(3)(ii)(A), (B),
7 That ICE’s activities may have complemented one another is an indication that those activi-

ties may have constituted an ‘‘appropriate economic unit’’ within the meaning of sec. 1.469–
4(c)(1), Income Tax Regs. But, as discussed infra, that fact alone, even if proven, would not jus-
tify the grouping of ICE’s rental and nonrental activities. See sec. 1.469–4(d)(1), Income Tax
Regs.

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 410 139 UNITED STATES TAX COURT REPORTS (396)

(E), and (F), Temporary Income Tax Regs., supra), are inap-
plicable by their terms, and respondent does not seek to
apply the other two exceptions (section 1.469–1T(e)(3)(ii)(C)
and (D), Temporary Income Tax Regs., supra), presumably
because the facts herein overwhelmingly demonstrate their
inapplicability, i.e., there is no basis for concluding that ICE’s
peripheral services afforded to tower lessees were ‘‘extraor-
dinary personal services’’ as defined in section 1.469–
1T(e)(3)(v), Temporary Income Tax Regs., supra, or that ICE’s
rental activity was ‘‘incidental’’ to its nonrental activities
within the meaning of section 1.469–1T(e)(3)(vi), Temporary
Income Tax Regs., supra. 8
Respondent relies heavily on the fact that, for the years in
issue, ICE reported (both on its own returns and on the
Schedules K–1 issued to petitioner) all of its income as a
single, undifferentiated amount denominated as ‘‘ordinary
business income’’. He further notes: ‘‘There is no evidence in
the records [sic] showing what income and expenses are
attributable to each of ICE’s business operations.’’ Respondent
argues that ICE’s grouping of its activities as a single activity
producing ‘‘ordinary business income’’ was proper under sec-
tion 1.469–4(c) and (d), Income Tax Regs., and that, (1) under
section 1.469–4(e)(1), Income Tax Regs., ICE may not
‘‘regroup’’ those activities and (2) under section 1.469–
4(d)(5)(i), Income Tax Regs. (last sentence), petitioner may
not treat those activities as separate activities for the years
in issue.
Petitioners respond that, even if ICE’s tower rental activity
was to be combined with its other activities as part of ‘‘an
appropriate economic unit’’ within the meaning of section
1.469–4(c)(1), Income Tax Regs., the actual disconnect
between that activity and ICE’s other activities, save for ‘‘the
limited and rent-free use in the SMR business of antennas
mounted in ‘free space’ * * * [atop] some of the towers’’,
mandates its treatment as a passive activity thereby ren-
8 ICE’s only trade or business activity to which its tower rentals conceivably could have been

considered ‘‘incidental’’ was its SMR business for which it provided ‘‘free space’’ for SMR anten-
nas atop no more than four of those towers. The record indicates that ICE received no rent for
providing that space. Under those circumstances, it is beyond dispute that the towers in ques-
tion were not ‘‘predominantly used in * * * [the SMR business] during the taxable year or dur-
ing at least two of the five taxable years * * * [immediately preceding] the taxable year’’ as
required by sec. 1.469–1T(e)(3)(vi)(C)(2), Temporary Income Tax Regs., 53 Fed. Reg. 5703 (Feb.
25, 1988).

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 (396) DIRICO v. COMMISSIONER 411

dering the self-rental rule of section 1.469–2(f)(6), Income
Tax Regs., inapplicable to petitioner’s tower and land rentals
to ICE during the years in issue. We agree with petitioner.
ICE’s grouping of its activities and its reporting of those
activities on its returns for the years in issue and on the
Schedules K–1 issued to petitioner as a single business
activity generating ‘‘ordinary business income’’ was improper.
Section 1.469–4(d)(1), Income Tax Regs., prohibits the
grouping of a rental activity and a trade or business activity
unless those activities constitute an ‘‘appropriate economic
unit’’ (as defined in paragraph (c) of the regulation) and one
of three additional conditions is satisfied. Respondent does
not argue that either ICE’s tower rental activity or its non-
rental activities is ‘‘insubstantial’’ in relation to the other,
i.e., he agrees that neither of the first two conditions applies
herein. See sec. 1.469–4(d)(1)(i)(A) and (B), Income Tax Regs.
Respondent does argue, however, that the third condition, set
forth in section 1.469–4(d)(1)(i)(C), Income Tax Regs., applies
because ‘‘petitioner had the same proportionate ownership
interest in each of ICE’s activities (including the rental
activity)’’ and that, therefore, ‘‘the grouping of ICE’s non-
rental and rental activities was proper.’’
Section 1.469–4(d)(1)(i)(C), Income Tax Regs., permits the
grouping of a taxpayer’s rental and trade or business activi-
ties, which form an ‘‘appropriate economic unit’’, and ‘‘[e]ach
owner of the trade or business activity has the same propor-
tionate ownership interest in the rental activity, in which
case the portion of the rental activity that involves the rental
of items of property for use in the trade or business activity
may be grouped with the trade or business activity.’’
(Emphasis added.)
As petitioner points out, respondent’s argument does not
take into account the emphasized language. Pursuant to that
language, only the portion of ICE’s tower rental activity that
involves the rental of petitioner’s towers for use in an ICE
trade or business activity may be grouped with that trade or
business activity. ICE’s only use of petitioner’s towers in a
trade or business activity was its use of perhaps four of peti-
tioner’s towers to house antennas used in ICE’s SMR business.
But the SMR customers’ use of those towers was on a rent-
free basis, and that use was de minimis as compared to the
use of the towers by ICE’s tower rental customers. Thus, no

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 412 139 UNITED STATES TAX COURT REPORTS (396)

portion of the income from ICE’s rental activity involved ‘‘the
rental of ’’ petitioner-owned towers for use in ICE’s SMR busi-
ness. 9 Therefore, we conclude that section 1.469–4(d)(1)(i)(C),
Income Tax Regs., does not support respondent’s application
of the self-rental rule to recharacterize, from passive activity
to non-passive-activity income, any portion of petitioner’s
income from his tower and land rentals to ICE.
The question, then, is whether ICE’s erroneous grouping of
its rental and other activities and its treatment of those
activities as a single ‘‘ordinary business’’ activity is, by virtue
of the last sentence of section 1.469–4(d)(5)(i), Income Tax
Regs., and section 1.469–4(e)(1), Income Tax Regs., binding
on petitioner with respect to his tower and land rentals to
ICE with the result that the self-rental rule of section 1.469–
2(f)(6), Income Tax Regs., is applicable to his income there-
from (assuming that petitioner materially participated in
that ‘‘ordinary business’’ activity).
Pursuant to the last sentence of section 1.469–4(d)(5)(i),
Income Tax Regs., petitioner, in his capacity as ICE’s sole
shareholder, may not treat any of ICE’s activities as separate
activities (‘‘A shareholder * * * may not treat activities
grouped together by a section 469 entity as separate activi-
ties.’’). 10 That provision might serve as the basis for denying
to petitioner the right to treat his 100% distributive share of
the income from ICE’s tower rentals to third parties as
income from a separate activity generating passive activity
income, even if he were able to determine the amount of that
income. 11 It is not, however, authority for the application of
the self-rental rule to petitioner’s income from his tower and
land rentals to ICE. Petitioner derived that income as a lessor
of property to ICE, not as a shareholder. Because petitioner
wore his lessor hat (and not his shareholder hat), the last
9 Respondent does not claim, nor is there any evidence to support a conclusion, that we should

treat a portion of the monthly subscriber fee paid by ICE’s SMR customers as payment for the
use of tower space, i.e., as a tower rental payment. Therefore, we consider ICE’s installation
of SMR antennas on a few of its towers to be a gratuitous accommodation to its SMR customers.
10 The consistency requirement of the last sentence of sec. 1.469–4(d)(5)(i), Income Tax Regs.,

parallels that of sec. 6037(c)(1), which requires a shareholder of an S corporation to ‘‘treat a
subchapter S item in a manner which is consistent with the treatment of such item on the cor-
porate return.’’ By reporting his 100% distributive share of ICE’s income as ordinary income,
petitioner acted in accordance with both provisions.
11 Whether such separate activity treatment would be proper is, as stated supra note 1, an

issue we need not address because petitioner has conceded it.

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 (396) DIRICO v. COMMISSIONER 413

sentence of section 1.469–4(d)(5)(i), Income Tax Regs., is
inapplicable to him.
Section 1.469–4(e)(1), Income Tax Regs., prohibits only the
regrouping of activities by ‘‘the taxpayer’’ (in this case, ICE)
and, therefore, constitutes a limitation on the manner in
which the taxpayer (i.e., ICE) reports its income for purposes
of section 469. It does not affect petitioner’s reporting of ICE’s
rental payments to him.
3. Conclusion
We find that petitioner’s tower and land rentals con-
stituted the rental of property to ICE for use in a rental
activity, which, by definition, see sec. 1.469–4(b)(1), Income
Tax Regs., is not a trade or business activity. As a result,
section 1.469–2(f)(6), Income Tax Regs., is inapplicable to
petitioner’s income from those rentals for the years in issue,
and respondent may not treat that income as non-passive-
activity income pursuant to that regulation.
We recognize that, because ICE erroneously reported all of
its income as ordinary business (non-passive-activity) income,
nonapplication of the self-rental rule of section 1.469–2(f)(6),
Income Tax Regs., to ICE’s rental payments to petitioner, in
effect, results in the reduction of what was reported as
‘‘active business income’’ and the offsetting creation of ‘‘pas-
sive income’’ in seeming contravention of the congressional
conferees’ directive to issue regulations preventing that
result. See H.R. Conf. Rept. No. 99–841 (Vol. II), at II–147
(1986), 1986–3 C.B. (Vol. 4) 1, 147. We do not believe, how-
ever, that ICE’s tax return mischaracterization of its tower
access rental income from third parties should control the
application of the self-rental rule where, as here, it is, by its
terms, inapplicable, i.e., where petitioner’s towers were not,
in fact, used in a trade or business. Moreover, we are not
persuaded that the result we reach herein violates the con-
ferees’ directive as it does not, in fact, permit ‘‘passive
income’’ to offset ‘‘active business income’’.

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 414 139 UNITED STATES TAX COURT REPORTS (396)

B. Separate Treatment of Tower Rentals Producing Net
Losses
1. Analysis
Petitioner objects to what he refers to as the ‘‘selective’’ re-
characterizing of the income from his profitable tower and
land rentals to ICE but not the losses from the unprofitable
rentals. On his returns for the years in issue, he character-
ized all of his property rentals to ICE as passive activities
generating either passive activity income or loss. In effect,
petitioner grouped all of his property rentals to ICE and
treated them as a ‘‘single activity’’ pursuant to section 1.469–
4(c)(1), Income Tax Regs. He argues that the ‘‘losses were
generated from the same type of activity as the profits * * *
and if the profits from the profitable Towers and Underlying
Land are active, then the net losses from the unprofitable
Towers must be treated as active as well.’’ In short, peti-
tioner argues for consistency of treatment. Therefore, we
assume that, because we reject respondent’s treatment of
petitioner’s profitable tower and land rentals to ICE as gener-
ating non-passive-activity income, petitioner would be willing
to adhere to his return position whereby he treated all of his
property rentals to ICE as passive activities generating either
passive activity income or passive activity loss. Moreover,
that is the treatment required by section 469(c)(2), which
generally requires ‘‘any rental activity’’ to be treated as a
passive activity. Thus, the issue regarding the proper
characterization of petitioner’s rentals producing net losses is
now moot.
2. Conclusion
There is no change to petitioner’s reporting of his losses
from unprofitable tower and land rentals to ICE as passive
activity losses.
C. Separate Treatment of the Land-Only Rentals
1. Introduction
During each of the years in issue, petitioner made three
land-only rentals to ICE. Each of those leases generated net
rental income to petitioner, which he reported as passive
activity income on his returns for the years in issue.

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 (396) DIRICO v. COMMISSIONER 415

Respondent argues that the rental income from those land-
only rentals was properly recharacterized as non-passive-
activity income pursuant to section 1.469–2T(f)(3), Tem-
porary Income Tax Regs., supra, which requires such re-
characterization with respect to income from a rental activity
where ‘‘less than 30 percent of the unadjusted basis of the
property used * * * by customers in * * * [that] activity
* * * during the taxable year is subject to the allowance for
depreciation under section 167’’.
Petitioners reject respondent’s argument on two grounds:
(1) respondent improperly separated (‘‘ungrouped’’) the land-
only rentals from petitioners’ other rentals of towers and
land to ICE in applying the 30% test of section 1.469–2T(f)(3),
Temporary Income Tax Regs., supra, and (2) respondent’s
argument was first raised on brief and, for that reason alone,
should be rejected as untimely.
2. Analysis and Conclusions
a. Timeliness
Petitioners cite the following language set forth in respond-
ent’s pretrial memorandum as demonstrating respondent’s
intent to apply the 30% test on an aggregate basis to all of
the properties (towers and land) leased to ICE:
Alternatively, under Treas. Reg. section 1.469–2T(f)(3), the income
earned by petitioner from leasing the telecommunications towers and the
land upon which they sit, is non-passive income since less than 30 percent
of the unadjusted basis of the property is subject to the allowance for
depreciation under section 167. Simply stated, income from leased land is
nonpassive. Land has an indefinite useful life and is not depreciable.
Accordingly, under Treas. Reg. section 1.469–2T(f)(3), unless petitioner
produces documentation that more than 30% of the unadjusted basis of the
property is depreciable, then the rental activity is nonpassive.

Petitioners allege that, consistent with that language, they
‘‘presented evidence at trial that ‘more than 30 percent of the
unadjusted basis of [all of] the [leased] property’ * * * is
depreciable.’’ They further allege: ‘‘Had the Commissioner
asserted that there was a further question as to whether the
rentals of the Underlying Land and the rentals of the Towers
(or any of them) were separate activities, evidence on that
point could have been introduced as well.’’ Thus, petitioners
claim both surprise and prejudice with respect to respond-

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 416 139 UNITED STATES TAX COURT REPORTS (396)

ent’s application of the 30% test exclusively to the land-only
rentals, and, in support of their argument, they cite our deci-
sion in Seligman v. Commissioner, 84 T.C. 191, 197–199
(1985), aff ’d, 796 F.2d 116 (5th Cir. 1986), which involved
surprise and prejudice to the taxpayer in regard to the
Commissioner’s initial assertion in his opening brief of ‘‘addi-
tional bases for his disallowance of specific items’’. Under
those circumstances we declined to consider the newly raised
issues.
In this case, petitioners may have been surprised by
respondent’s argument, but they were not prejudiced. The
issue respondent raises (application of the 30% test to the
land-only rentals) presents an issue of law. The fact that
there were three land-only rentals in each of the years in
issue is not in dispute. Therefore, we fail to see what addi-
tional evidence petitioners were prevented from introducing
in refutation of respondent’s argument (i.e., it is beyond dis-
pute that 100% of each of those rentals consisted of non-
depreciable land). Moreover, any surprise to petitioners was
mitigated by their ability to address the merits of respond-
ent’s argument in their reply brief, which, in fact, they did.
The element of surprise was further mitigated by the above-
quoted portion of respondent’s pretrial memorandum, which,
although ambiguous regarding respondent’s intent to sepa-
rately apply the 30% test to the land-only rentals, at least
suggests that possibility by observing that ‘‘income from
leased land is nonpassive.’’ Under those circumstances, we
find Seligman distinguishable and, therefore, not controlling.
Rather, we are guided in this matter by our analysis in Ware
v. Commissioner, 92 T.C. 1267, 1268 (1989), aff ’d, 906 F.2d
62 (2d Cir. 1990), wherein we stated:
The rule that a party may not raise a new issue on brief is not absolute.
Rather, it is founded upon the exercise of judicial discretion in determining
whether considerations of surprise and prejudice require that a party be
protected from having to face a belated confrontation which precludes or
limits that party’s opportunity to present pertinent evidence. * * *

As discussed above, we do not believe that the circumstances
herein warrant our rejection of respondent’s argument on the
ground that it was not timely raised. Moreover, it is always
open to this Court to apply the correct law to the facts before
it. See, e.g., Concord Consumers Hous. Coop. v. Commis-

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 (396) DIRICO v. COMMISSIONER 417

sioner, 89 T.C. 105, 126 (1987) (Ko¨rner, J. concurring) (‘‘Nei-
ther party can avoid the application of the correct law to the
facts of the case by failing to plead or argue it. That is the
province of the Court.’’).
We shall consider the issue of whether it is proper to sepa-
rately apply the 30% test to petitioners’ land-only rentals.
b. Application of Section 1.469–2T(f)(3), Temporary Income
Tax Regs., to Petitioners’ Land-Only Rentals
Petitioners argue that, because all of the property rentals
to ICE ‘‘involved the same landlord (or grantor trusts owned
by the same landlord), the same tenant, and the same gen-
eral types of property used for the same purpose’’, there is
no basis for applying the 30% test separately to the land-only
rentals. Thus, petitioners make the same argument with
respect to the application of the 30% test that they did with
respect to the application of the self-rental rule: Both should
be applied to the aggregate of the properties he leased to ICE
on the ground that all of those rentals constituted a ‘‘single
activity’’ pursuant to section 1.469–4(c), Income Tax Regs.
We disagree.
Respondent’s separate application of the 30% test to peti-
tioners’ land-only rentals to ICE is supported by section
1.469–4(d)(2), Income Tax Regs., which provides as follows:
(2) Grouping real property rentals and personal property rentals prohib-
ited.—An activity involving the rental of real property and an activity
involving the rental of personal property (other than personal property
provided in connection with the real property or real property provided in
connection with the personal property) may not be treated as a single
activity.

The section 469 regulations do not furnish illustrative
examples of the foregoing provision’s parenthetical exception.
Nonetheless, we find no basis for concluding that it applies
to petitioners’ land-only rentals. The land is not ‘‘provided in
connection with’’ any personal property situated thereon, and
it is not ‘‘provided in connection with’’ the towers situated on
other parcels of land where petitioner provides both a tower
and land, one ‘‘in connection with’’ the other.
Therefore, we find that respondent correctly applied the
30% test of section 1.469–2T(f)(3), Temporary Income Tax
Regs., supra, to the land-only rentals to ICE, and that, pursu-

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 418 139 UNITED STATES TAX COURT REPORTS (396)

ant to that provision, petitioners’ income from those leases
constituted non-passive-activity income.
Decision will be entered under Rule 155.

f

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