PURSUANT TO INTERNAL REVENUE CODE
SECTION 7463(b),THIS OPINION MAY NOT
BE TREATED AS PRECEDENT FOR ANY
OTHER CASE.
T.C. Summary Opinion 2013-43
UNITED STATES TAX COURT
PETER H. HOFINGA AND MARGARET M. WONG, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 21704-09S. Filed June 3, 2013.
Shannon Gallagher, for petitioners.
Sebastian Voth, for respondent.
SUMMARY OPINION
CARLUZZO, Special Trial Judge: This case was heard pursuant to the
provisions of section 7463 of the Internal Revenue Code in effect when the
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petition was filed.1 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.
In a notice of deficiency dated August 21, 2009, respondent determined
deficiencies of $23,706 and $27,653 in petitioners’ 2006 and 2007 Federal income
tax, respectively. The issue for decision for each year is whether petitioners are
entitled to a deduction for a rental real estate loss. The resolution of the issue
depends upon whether Peter H. Hofinga (petitioner) is a taxpayer described in
section 469(c)(7) for either year in issue.
Background
Some of the facts have been stipulated and are so found. At the time the
petition was filed, petitioners resided in California.
Over the years after they married in 1982, petitioners purchased, and as
necessary renovated and remodeled, residential real estate properties that they held
for rent. As of the close of 2006, petitioners owned eight rental properties; as of
the close of 2007, petitioners owned nine rental properties (collectively, rental
properties). Because of an election they made for Federal income tax purposes,
1
Unless otherwise indicated, section references are to the Internal Revenue
Code of 1986, as amended, in effect for the year in issue. Rule references are to
the Tax Court Rules of Practice and Procedure.
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petitioners’ interests in the rental properties are treated as one activity. See sec.
469(c)(7)(A).
Before retiring in 1993 petitioner was employed as a soccer coach and
professor of physical education by the University of California Irvine (UCI). He
was not employed in any capacity during either year in issue. At all times
relevant, Margaret M. Wong (Mrs. Wong) was also employed by UCI.
As between the two of them, petitioner was more responsible for the
management of the rental properties. For the most part he did so from his
den/office in petitioners’ residence. Routinely and regularly he reviewed and paid
various bills, considered and made arrangements for repairs, arranged for the
purchase of supplies, reviewed rental applications, from time to time inspected a
rental property for various reasons, and supervised and/or made the arrangements
for renovating and remodeling a rental property when necessary. Neither
petitioner, however, kept any sort of contemporaneous log or record that shows the
amount of time either spent, or specific services either provided, with respect to
any specific rental property on any specific date.
Petitioners also employed property managers for some of the rental
properties. Routinely, the property managers were responsible for collecting rent,
responding to inquiries or complaints from tenants, and making/supervising
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repairs, the costs of which did not exceed a designated amount set by petitioners.
In addition to the fees paid to the property managers, a review of petitioners’
Federal income tax returns for the years in issue shows deductions for expenses
attributable to the rental properties for cleaning, maintenance, gardening, pest
control, plumbers, electricians, and commissions.
On their 2006 and 2007 Federal income tax returns, petitioners deducted
losses of $111,042 and $141,133, respectively, attributable to the rental properties
(rental property losses). If the rental property losses are not taken into account,
then petitioners’ adjusted gross income as reported on each of those returns would
exceed $150,000.
The rental property losses are disallowed in the notice of deficiency.
According to respondent’s explanation, “[r]ental activities of any kind, regardless
of material participation, are considered passive activities unless the requirements
of section 469(c)(7) of the Internal Revenue Code are met in tax years beginning
after December 31, 1993”. According to respondent, those “requirements”, which
will be more fully discussed below, have not been “met”. Other adjustments made
in the notice of deficiency are computational and will not be discussed.
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Discussion
The explanation for the disallowances of the rental property losses provided
in the notice of deficiency includes terms of art, such as “material participation”
and “passive activities”, which are used and defined in section 469 and its
corresponding regulations. In an article published in the October 24, 2011, edition
of Tax Notes, Professor George S. Jackson states that section 469 contains “almost
4,500 words” (we did not count) and “exemplifies why federal tax law is
incomprehensible for most citizens.” George S. Jackson, “Passive Activity
Limitations: Time for a New Paradigm?”, 133 Tax Notes 447, 459 (2011).
Describing section 469 as “incomprehensible” is probably an overstatement; that
section, however, is hardly uncomplicated.2 The dispute between the parties in
this case, however, allows us to avoid a discussion of many of the complexities of
section 469, and a summarization of the relevant provisions of that section is
sufficient.
2
Sec. 469 was enacted as part of the Tax Reform Act of 1986, Pub. L. No.
99-514, sec. 501, 100 Stat. at 2233, to prevent affected taxpayers from using
deductions from a passive activity to shelter wages or other active income. See
generally Staff of J. Comm. on Taxation, General Explanation of the Tax Reform
Act of 1986, at 209-215 (J. Comm. Print 1987).
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In general and as relevant here, an individual is not entitled to a deduction
for a passive activity loss incurred during the taxable year. See sec. 469(a). A
passive activity is any activity which involves the conduct of any trade or business
in which the taxpayer does not materially participate. See sec. 469(c)(1).
“Material participation” is defined generally in the statute and more specifically in
the regulations. See sec. 469(h); sec. 1.469-5T, Temporary Income Tax Regs., 53
Fed. Reg. 5725 (Feb. 25, 1988).
In general, a rental activity is treated as a passive activity regardless of
whether the taxpayer materially participates. See sec. 469(c)(2), (4). There are
two exceptions to this general rule, each subject to a variety of limitations and
conditions if the taxpayer’s rental activity is a real estate rental activity. One of
those exceptions, which allows a limited deduction if a taxpayer actively
participates in the rental real estate activity, is not relevant here because
petitioners’ adjusted gross income, as that term is defined in section 469(i)(3)(F),
exceeds $150,000 for each year in issue. See sec. 469(i)(2) and (3)(A).
The relevant exception is found in section 469(c)(7). If a taxpayer is
described in that section (sometimes that taxpayer is referred to as a “real estate
professional”), then section 469(c)(2) does not apply and the taxpayer’s rental real
estate activity, if conducted as a trade or business or for the production of income,
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is not treated as a passive activity if the taxpayer materially participates in the
activity. Sec. 469(c)(1); Fowler v. Commissioner, T.C. Memo. 2002-223; sec.
1.469-9(e), Income Tax Regs.
We need not get into the complicated definition of the term “material
participation” set forth in section 469(h) and its corresponding regulations.
Keeping that definition in mind, and because petitioners elected to treat the rental
properties as a single activity, we are satisfied that they materially participated in
the rental property activity during each year in issue, and respondent does not
seem to suggest otherwise. Instead, the disagreement between the parties focuses
on whether petitioner is a taxpayer described in section 469(c)(7).3 According to
petitioners, he is; according to respondent, he is not.
Section 469(c)(7) contains two tests that a taxpayer must satisfy to be
described in that section. One requires that the taxpayer perform more than 750
hours of services during the taxable year in real property trades or businesses in
which the taxpayer materially participates. See sec. 469(c)(7)(B)(ii). The other
requires that “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”. See sec.
3
Mrs. Wong does not claim to be a taxpayer so described.
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469(c)(7)(B)(i). Because petitioner was not otherwise employed during either year
in issue, we need turn our attention only to the first test (the 750-hour test).
Ideally, a taxpayer who claims to be described in section 469(c)(7) would
maintain a contemporaneous log or record showing with particularity the amount
of time devoted to the rental real estate activity on an event-by-event basis. See
sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25,
1988). Ideally, the log would be detailed enough to allow for someone who
reviewed it to make an informed judgment as to the accuracy of the information
reported. The creation and availability of a detailed log is important, especially if
that reviewing “someone” is an Internal Revenue Service employee considering
the log in connection with an examination of the taxpayer’s return on which rental
real estate losses are deducted. Apparently, petitioners were not aware of the
importance of keeping such a log and, as noted, neither kept a log during either
year in issue.
Recognizing that many taxpayers might not be aware of the importance of
keeping a contemporaneous log of time devoted to the taxpayer’s rental real estate
activity, the Commissioner’s regulations provide a second-best alternative.
Section 1.469-5T(f)(4), Temporary Income Tax Regs., supra, provides:
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(4) Methods of proof. 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.
Although petitioners did not maintain contemporaneous logs of the time
devoted to their rental real estate activity, they tried to establish petitioner’s
participation by other reasonable means (e.g., noncontemporaneous logs based on
petitioners’ records) in compliance with section 1.469-5T(f)(4), Temporary
Income Tax Regs., supra. During the examination of the years here in dispute, and
in response to a request by the examining agent, Mrs. Wong prepared several sets
of logs showing estimates of time spent on various events. According to Mrs.
Wong, she used calendars, bank statements, credit card records, property trip files,
bills, receipts, and other records to construct the logs. According to petitioners,
these logs establish that petitioner has satisfied the 750-hour test. According to
respondent, they do not. For the following reasons, we agree with respondent.
The estimates of time shown for some entries on the first set of logs Mrs.
Wong prepared include a combination of time spent by both petitioners. For
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purposes of the 750-hour test, however, only the hours petitioner spent are taken
into account. See sec. 469(c)(7)(B). Having had this problem pointed out to her
during the examination, she prepared a second set of logs using a generalized
allocation of time spent by each of them. For the most part, she supported the
allocation of time on the basis of the amount of time petitioner spent in his
den/office at their residence.4 The logs contain generalized entries such as:
Hours Hours
Address Week of (Petitioner) (Mrs. Wong) Description
All properties 2/6/2006 8 --- Payment of bills, filing of bills,
paperwork, monthly statement
reviews, cross-checking, keeping in
touch with property management
companies
All properties 2/13/2007 9 1 Payment of bills, filing of bills,
paperwork, monthly statement
reviews, cross-checking, keeping in
touch with property management
companies
4
Petitioner’s health prevented his appearance at trial. The trial was
continued twice to allow for the possibility that his health would improve so that
he could be called as a witness. But petitioner’s health did not improve and, as it
turned out, only Mrs. Wong testified on petitioners’ behalf when the matter was
tried. Her testimony as to what he was doing while in his den/office and out of her
presence might very well have been objectionable under Fed. R. Evid. 602 and
802, see sec. 7453, but for petitioners’ sec. 7463 election. Because this case is
subject to that election, “evidence deemed by the Court to have probative value
shall be admissible.” See Rule 174(b). Probative value, however, does not
necessarily equate to persuasive effect.
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All properties 1/1/2007 9 1 Payment of bills, filing of bills,
paperwork, monthly statement
reviews, cross-checking, keeping in
touch with property management
companies
All properties 1/8/2007 7 1 Payment of bills, filing of bills,
paperwork, monthly statement
reviews, cross-checking, keeping in
touch with property management
companies
On the other hand, some of the entries in the logs reference specific
properties and provide a distinct description, such as:
Hours Hours
Address Week of (Petitioner) (Mrs. Wong) Description
RPT-25 Park City 1/2/2006 4 --- Discuss winter rentals, hot tub
repair, roof repair
Miraflores 4/3/2006 3 --- Walk-through inspection, assess
patio cover, painting needs
82401 Odlum 4/23/2007 6 --- Work with handyman to identify
repairs, window coverings,
installation
Although we expect petitioners, in their role of landlords, expended
significant time during each year in issue providing services in connection with
the rental properties, we are unable, from what has been submitted, to quantify the
total time that petitioner spent doing so, and we cannot ignore the deductions
attributable to others’ providing management and maintenance services in
connection with the rental properties. Simply put, the logs do not allow for a
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review of activity related to the rental properties on an event-by-event basis to the
extent necessary to establish that the 750-hour test has been satisfied.5
Petitioners have failed to establish that petitioner satisfied the 750-hour test
for either year in issue; consequently, petitioner is not a taxpayer described in
section 469(c)(7) for either of those years. That being so, petitioners’ rental real
estate activity is treated as a passive activity for both of those years. It follows
that respondent’s disallowances of the rental property losses attributable to that
activity are sustained.
To reflect the foregoing,
Decision will be entered
for respondent.
5
Giving petitioners the benefit of the doubt, and keeping in mind the
infirmities of time logs prepared after the fact, see Moss v. Commissioner, 135
T.C. 365, 369 (2010) (we are not required to accept a postevent “ballpark
guesstimate”); Bailey v. Commissioner, T.C. Memo. 2001-296 (the regulations do
not allow a postevent “ballpark guesstimate”), to the extent that the logs reference
specific properties or events, at best they show that petitioner spent 379.5 hours
during 2006 and 526 hours during 2007 performing services in connection with
the rental properties.