T.C. Summary Opinion 2015-27
UNITED STATES TAX COURT
RICHARD S. LEYH AND ELLEN P. O’NEILL, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 29908-13S. Filed April 13, 2015.
Richard S. Leyh and Ellen P. O’Neill, pro sese.
Brooke S. Laurie, for respondent.
SUMMARY OPINION
GERBER, 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
1
Unless otherwise indicated, all section references are to
the Internal Revenue 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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Pursuant to section 7463(b), the decision 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 a $12,011 income tax deficiency and a $2,404.20 section
6662(a) penalty for petitioners’ 2010 taxable year. The issues for our
consideration are: (1) whether petitioner Ellen P. O’Neill performed more than
750 hours of services in her rental real estate activity so as to be entitled to deduct
losses from non-passive-activity income within the meaning of section 469, and
(2) whether petitioners are liable for the accuracy-related penalty under section
6662(a).
Background
Petitioners resided in the vicinity of Austin, Texas, at the time their petition
was filed. Ellen P. O’Neill (petitioner) worked regularly in the rental real estate
activity. Mr. Leyh also worked full time but was not engaged in the rental real
estate activity.
The real estate activity involved petitioners’ ownership of 12 rental
properties. Petitioner was responsible for the operation of the rental real estate
activity and had been so engaged for a number of years. Eleven of the properties
were single family residences, and one was a condominium unit. Petitioner
performed some of the repairs and most of the maintenance on the properties. For
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example, if a tenant called about a plumbing or appliance problem, petitioner
would personally resolve the problem. Additionally, she handled the rental
activity, including advertising for, interviewing, and vetting of potential tenants.
She did all of the paperwork, bookkeeping, and research for potential properties to
purchase. During 2010 petitioner performed extensive research regarding
potential Florida rental properties for acquisition.
Petitioners resided on a ranch in Dripping Springs, Texas, that was
approximately 26 to 30 miles from the rental properties, depending on the route
taken. The 12 rental properties were in Austin, Texas, the drive to which took
approximately 42 to 55 minutes, again depending on the route taken and the traffic
conditions.
Petitioner regularly drove to the Austin area to resolve problems, perform
maintenance, and administer and operate the rental properties. Petitioner
maintained a contemporaneous log detailing the type of rental property activity
that she engaged in each day. Respondent had audited petitioner’s returns for
years before 2010, and petitioner had become aware of the requirements for
deducting losses from a rental real estate activity from non-passive income. In
particular, she knew that she had to “materially” participate in the business by
spending 750 hours or more involved in the activity during the taxable year.
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When it came time to have the 2010 income tax return prepared, petitioners’
return preparer from earlier years was not available and petitioner spent time
searching for a certified public accountant (C.P.A.) to prepare petitioners’ 2010
return. Petitioners provided their information, including information regarding the
rental real estate activity, to the C.P.A., and they deducted a $69,531 loss from the
rental real estate activity on their return to reduce their non-passive-activity
income.
Respondent examined the 2010 return, and petitioners offered petitioner’s
log in support of their position that they were entitled to deduct the real estate
losses from their non-passive-activity income. Although the log detailed the dates,
types of activity, and number of hours that petitioner spent in the activity, the
number of hours spent traveling from petitioners’ residence to the rental properties
had not been included. The original log that they presented to respondent during
the audit accounted for 632.5 hours spent in the real estate activity.
Petitioner revised and resubmitted the log to reflect the hours spent
traveling to the properties, but respondent refused to accept the additional hours.
Without the travel time, the hours in the log totaled less than the threshold of 750
hours. Including the travel time, petitioner’s hours totaled 846, exceeding the
750-hour threshold by almost 100 hours.
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Petitioner’s methodology in revising the log was to determine whether the
activity for any day reflected in the log took place in Austin or near her residence
in Dripping Springs. For each occasion where the activity occurred in Austin, she
computed a 45-minute trip or 1-1/2 hours round trip for that day. For example, on
a particular day that reflected only 1-1/2 hours involved in the activity in Austin,
petitioner added 1-1/2 hours for the travel to Austin from her home in Dripping
Springs, for a total of three hours engaged in the activity for that day.
Discussion
The primary issue is the narrow and purely factual question of whether
petitioner spent 750 hours or more as a real estate professional involved in her
rental real estate activity. Respondent concedes that petitioner meets all other
requirements to be entitled to deduct losses from a rental real estate activity from
non-passive income.
Generally, section 469 disallows a deduction attributable to a “passive
activity loss” that is used to reduce non-passive-activity income for any taxable
year. Sec. 469(a), (d)(1). A “passive activity” is a business in which the taxpayer
does not “materially participate.” Sec. 469(c)(1). Material participation in an
activity is regular, continuous, and substantial involvement. Sec. 469(h)(1).
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For purposes of determining whether a taxpayer is a real estate professional,
a taxpayer’s material participation is determined separately with respect to each
rental property unless the taxpayer makes an election to treat all interests in rental
real estate as a single rental real estate activity. Sec. 469(c)(7)(A); sec. 1.469-
9(e)(1), Income Tax Regs. Petitioners made an election to treat their rental
properties as a single activity. According to section 1.469-9(g)(1), Income Tax
Regs., this election is binding for the taxable year in issue.
Rental activity, however, is generally treated as passive per se regardless of
whether there is material participation. Sec. 469(c)(2), (4). Petitioner, however,
seeks to qualify under section 469(c)(7)(B), which provides that a real estate
professional may engage in a nonpassive real estate business if he or she meets
certain requirements. In particular, the taxpayer’s rental activity will not be per se
passive if he or she meets two requirements. First, more than one-half of the
personal services performed by the taxpayer in trades or businesses are performed
in the real property trades or businesses in which the taxpayer materially
participates. Second, the taxpayer performs more than 750 hours of services
during the tax year in the real property trades or businesses in which the taxpayer
materially participates. Sec. 469(c)(7)(B)(i) and (ii); Shaw v. Commissioner, T.C.
Memo. 2002-35; Bailey v. Commissioner, T.C. Memo. 2001-296.
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Respondent agrees that petitioner materially participated and spent more
than one-half of her time in the rental real estate activity but does not agree that
petitioner performed 750 hours of services in the activity. Respondent contends
that petitioner did not meet the 750-hour test because the hours reported in the
original log presented to respondent fell short of the 750-hour requirement.
Respondent further contends that petitioner’s revised log was insufficient to
remedy the perceived shortfall in the original log.
The pertinent requirements are set forth in section 1.469-5T(f)(4),
Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988), 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.
The focal point of the controversy, therefore, is whether petitioner’s revised
log is sufficient to show that she spent at least 750 hours in the activity. We hold
that it is.
The record reflects that petitioner kept a contemporaneous log and
accurately recorded her rental real estate activity for each day she engaged in the
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activity. The total hours originally recorded on the log, however, did not account
for petitioner’s travel time from her Dripping Springs home to Austin.
Accordingly, petitioner identified those days that she was in Austin and involved
in the activity and added 1-1/2 hours for travel to and from her home in Dripping
Springs. With those additional hours, petitioner would have met the threshold
hour requirement of the regulation.
Respondent, however, contends that the times on the original log were
inclusive of all of petitioner’s activity travel. Petitioner testified and had clear and
crisp recall of the activity reflected on the log and was easily able to identify those
occasions when the activity occurred in Austin. Respondent’s counsel cross-
examined petitioner but was able to show only a few minor discrepancies that
petitioner admitted were in error. Altogether, petitioner has shown that she spent
more than 750 hours engaged in the rental real estate activity during 2010.
Respondent relies on a series of Memorandum Opinions of this Court where
there was inadequate recordkeeping and insufficient evidence to support the
threshold hour requirement. In those cases, the Court recognized that the
recordkeeping requirements of the regulations are somewhat ambiguous
concerning the records to be maintained by taxpayers but that the regulations do
not allow a postevent “ballpark guesstimate”. See Bailey v. Commissioner, T.C.
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Memo. 2001-296; Speer v. Commissioner, T.C. Memo. 1996-323; Goshorn v.
Commissioner, T.C. Memo. 1993-578.
Those cases did not involve a detailed contemporaneous log such as the one
petitioner maintained. Petitioner provided day-by-day explanations of the specific
rental real estate activity in her log. Further, from the log it was easy to identify
days when the activity took place in Austin. Finally, petitioner has shown that the
travel time was not included in the original log. Petitioner’s log and her revised
log showing the travel time are well within the guidelines of section 1.469-
5T(f)(4), Temporary Income Tax Regs., supra.
Accordingly, petitioners are entitled to apply the losses from the real estate
activity against their non-passive-activity income, and they have shown that
respondent’s determination is in error. Because we hold that petitioners are
entitled to the disallowed loss deduction, there is no underpayment of income tax
and the accuracy-related penalty of section 6662(a) is, therefore, not applicable.
To reflect the foregoing,
Decision will be entered for
petitioners.