Glenn Cunningham Ballard & Yu-Yuan Pu v. Commissioner

T.C. Summary Opinion 2018-53
UNITED STATES TAX COURT
GLENN CUNNINGHAM BALLARD AND YU-YUAN PU, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12792-13S. Filed November 27, 2018.
Glenn Cunningham Ballard and Yu-Yuan Pu, pro sese.
Sarah E. Sexton Martinez and Nicholas R. Rosado, for respondent.
SUMMARY OPINION
ASHFORD, 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 years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure. Some monetary amounts are rounded
(continued...)
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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.
By statutory notice of deficiency dated March 8, 2013, respondent
determined deficiencies in petitioners’ Federal income tax and accuracy-related
penalties pursuant to section 6662(a) for the 2008, 2009, and 2010 taxable years
(years at issue) as follows:
Accuracy-related penalty
Year Deficiency sec. 6662(a)
2008 $22,486 $4,497
2009 300 60
2010 7,959 1,592
After concessions,2 the issues remaining for decision are whether
1
(...continued)
to the nearest dollar.
2
Petitioners failed to assign error in their petition to respondent’s inclusion
of their State income tax refunds for the years at issue, partial disallowance of a
mortgage interest deduction for 2009 claimed on Schedule A, Itemized
Deductions, and full disallowance of a mortgage interest deduction for 2010
claimed on Schedule E, Supplemental Income and Loss. Accordingly, these issues
are deemed conceded. See Rule 34(b)(4) (failure to assign error is deemed
concession); Funk v. Commissioner, 123 T.C. 213, 215 (2004). Mr. Ballard also
conceded the State income tax refunds issue on the record at trial. Respondent
conceded the accuracy-related penalty issue for 2009 on the record at trial.
Additional issues not discussed herein are computational adjustments based on
other adjustments to petitioners’ Federal income tax returns.
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petitioners3 (1) are entitled to rental real estate loss deductions they claimed on
their Schedules E for the years at issue (over and above the amounts respondent
allowed pursuant to section 469(i)) and (2) are liable for accuracy-related penalties
for 2008 and 2010. We resolve both issues in favor of respondent.
Background
Some of the facts have been stipulated and are so found. The stipulation of
facts and the attached exhibits are incorporated herein by this reference.
Petitioners resided in California when they timely filed their petition with the
Court.
I. Petitioners and Their Residential Rental Properties
Mr. Ballard and Ms. Pu were married in 2003 and had three children under
six years old during the years at issue. During the years at issue Ms. Pu was a
homemaker caring for these children; Mr. Ballard was a certified public
accountant (C.P.A.). He earned a bachelor’s degree in business administration
with a concentration in accounting, and a master’s degree in taxation. During the
years at issue Mr. Ballard attended part time (Saturdays from August to May with
a brief break in December) the University of California, Berkeley, for a master’s
3
Ms. Pu did not appear in Court at trial, but Mr. Ballard was authorized to
speak (and sign the stipulation of facts) for her; and the Court allowed this.
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degree in business administration (M.B.A.). He was awarded his M.B.A. in May
2010. During the years at issue Mr. Ballard experienced short periods of
unemployment but also worked full time at various technology companies.
Beginning in 1987 Mr. Ballard started acquiring residential rental property.
During the years at issue petitioners owned and rented out six properties--five
single-family homes in Georgia and one condominium in California.4 In 2010
petitioners also owned and rented out a seventh property--a single-family home in
San Jose, California. Petitioners visited their rental properties in California but
did not visit their Georgia rental properties during the years at issue.
Petitioners sought prospective tenants by posting advertisements on
Craigslist. They received rent directly from tenants, and Mr. Ballard received
maintenance requests from tenants. He hired third-party vendors to make repairs
and carry out maintenance on the Georgia properties, which included yard work,
rodent control, trash removal, and painting. In petitioners’ Georgia rental
agreements they designated an agent who would provide keys to tenants, hold
apartment showings, perform maintenance, and inspect the properties.
4
Ms. Pu had owned and resided in the condominium before marrying Mr.
Ballard.
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II. Petitioners’ Joint Federal Income Tax Returns
Petitioners prepared and timely filed (using TurboTax) their Forms 1040,
U.S. Individual Income Tax Return, for the years at issue. As relevant here, they
attached Schedules E to each Form 1040, reporting rental income and expenses
attributable to their residential rental properties. On their 2008 Schedules E they
claimed loss deductions totaling $91,571. On their 2009 Schedules E they claimed
loss deductions totaling $119,337. On their 2010 Schedules E they claimed loss
deductions totaling $100,646.
Approximately one year after filing their Form 1040 for 2010 petitioners
submitted a Form 1040X, Amended U.S. Individual Tax Return, for 2010. On this
form they made adjustments to their adjusted gross income and itemized
deductions, causing a decrease in taxable income. They also substituted on one of
the Schedules E which they attached to the Form 1040X a San Jose, California,
property with an address different from the one reported on their original return.
On these Schedules E they claimed loss deductions totaling $80,356.
III. Audit and Determination
Respondent audited petitioners’ returns for the years at issue. During the
audit petitioners provided time logs for 2008 which reported 1,669 and 772 hours
spent by Mr. Ballard and Ms. Pu, respectively, relative to their residential rental
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properties. These logs were not kept contemporaneously; Mr. Ballard created
them from his recollection of activities in conjunction with reviewing emails,
phone records, receipts, rental applications, and rental agreements. With respect
to Ms. Pu’s hours in particular, many of them were for nonmanagerial activities,
i.e, investor-type activities. Petitioners did not provide time logs for 2009 and
2010 but provided to respondent on the day of trial copies of documents consisting
of invoices, receipts, checks, rental applications, rental agreements, and letters.
Except to the extent allowed by application of section 469(i), respondent
disallowed petitioners’ claimed loss deductions for the years at issue because their
residential rental activities were passive activities in the context of section 469.
The record includes a completed Civil Penalty Approval Form for the
section 6662(a) accuracy-related penalties for the years at issue. The form
includes a signature on the line provided on the form for “Group Manager
Approval to Assess Penalties Identified Above” dated March 30, 2012, before the
issuance of the notice of deficiency.5
5
As explained infra pp. 14-18, we are reopening the record to admit the
Civil Penalty Approval Form and a declaration of Internal Revenue Service
Revenue Agent Teresa Welch insofar as it authenticates the Civil Penalty
Approval Form for purposes of Fed. R. Evid. 902(11).
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Discussion
I. Burden of Proof
In general, the Commissioner’s determinations set forth in a notice of
deficiency are presumed correct, and the taxpayer bears the burden of proving
otherwise. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Tax
deductions are a matter of legislative grace, and the taxpayer bears the burden of
proving entitlement to any deduction or credit claimed. Segel v. Commissioner,
89 T.C. 816, 842 (1987). As relevant here, this burden requires the taxpayer to
demonstrate that the claimed deductions are allowable pursuant to some statutory
provision and to substantiate claimed loss deductions by maintaining and
producing adequate records. Sec. 6001; Higbee v. Commissioner, 116 T.C. 438,
440 (2001). If the taxpayer produces credible evidence with respect to any factual
issue relevant to ascertaining his Federal income tax liability and meets certain
other requirements, the burden of proof shifts from the taxpayer to the
Commissioner as to that factual issue. Sec. 7491(a)(1) and (2).
Petitioners allege (only in passing in their answering brief) that the burden
of proof should shift to respondent under section 7491(a) because they “responded
in good faith to the IRS’[] audit of 2008, and produced mountains of
contemporaneous supporting documents.” As discussed infra, the evidence does
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not establish that the burden of proof should shift from petitioners to respondent
under section 7491(a) as to any issue of fact.
II. Section 469 Losses From Residential Rental Activities
A taxpayer is allowed deductions for certain business and investment
expenses under sections 162 and 212. Where the taxpayer is an individual,
however, section 469 generally disallows any passive activity loss for the taxable
year in which the loss is sustained and treats it as a deduction allocable to the same
activity for the next taxable year. Sec. 469(a) and (b). A “passive activity loss” is
defined as the excess of the aggregate losses from all passive activities for the
taxable year over the aggregate income from all passive activities for that year.
Sec. 469(d)(1). A passive activity generally is any activity involving the conduct
of a trade or business in which the taxpayer does not materially participate. Sec.
469(c)(1). A taxpayer is treated as materially participating in an activity only if
his or her involvement in the operations of the activity is regular, continuous, and
substantial. Sec. 469(h)(1). Rental activity is treated as a per se passive activity,
regardless of whether the taxpayer materially participates. Sec. 469(c)(2), (4).
As relevant here, section 469(c)(7) provides an exception to the rule that a
rental activity is per se passive. The rental activities of a taxpayer in a real
property trade or business who meets certain enumerated requirements (a real
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estate professional) are not subject to the per se rental activity rule. Sec.
469(c)(7)(A); sec. 1.469-9(b)(6), (c)(1), Income Tax Regs. Rather, the rental
activities of a real estate professional are subject to the material participation
requirements of section 469(c)(1). See sec. 1.469-9(e)(1), Income Tax Regs.
Petitioners contend that they were real estate professionals during the years
at issue. A taxpayer qualifies as a real estate professional if: (1) more than one-
half of the personal services performed in trades and businesses by the taxpayer
during the taxable year are performed in real property trades or businesses in
which the taxpayer materially participates and (2) the taxpayer performs more than
750 hours of services during the taxable year in real property trades or businesses
in which the taxpayer materially participates. Sec. 469(c)(7)(B)(i) and (ii). In the
case of a joint Federal income tax return, such as here, these two requirements are
satisfied if and only if either spouse separately satisfies these requirements; there
can be no aggregation of spouses’ hours to satisfy the requirements. See sec.
469(c)(7)(B) (flush language); Moss v. Commissioner, 135 T.C. 365, 368-369
(2010).
A taxpayer may establish hours of participation in a real property trade or
business by any reasonable means. Sec. 1.469-5T(f)(4), Temporary Income Tax
Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988). Contemporaneous daily reports are not
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required if the taxpayer can establish participation by other reasonable means. Id.
Reasonable means include “appointment books, calendars, or narrative
summaries” that identify the services performed and “the approximate number of
hours spent performing such services”. Id. However, this Court has noted
previously that it is not required to accept a postevent “ballpark guesstimate” or
the unverified, undocumented testimony of taxpayers. See, e.g., Moss v.
Commissioner, 135 T.C. 368-369; Lum v. Commissioner, T.C. Memo. 2012-
103; Estate of Stangeland v. Commissioner, T.C. Memo. 2010-185.
In determining whether Mr. Ballard and Ms. Pu were real estate
professionals during the years at issue, we assume (without deciding) that their
residential rental activities constituted a real property trade or business and that
they both materially participated in this real property trade or business. However,
even with these favorable assumptions, we find that neither Mr. Ballard nor Ms.
Pu qualified as a real estate professional for any of the years at issue.
Petitioners attempt to show that they were real estate professionals during
the years at issue by relying on Mr. Ballard’s testimony at trial,
noncontemporaneous time logs for 2008, and documents for 2009 and 2010
consisting of invoices, receipts, checks, rental applications, rental agreements, and
letters. The 2008 time logs--one for Mr. Ballard and another for Ms. Pu--list 1,669
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and 772 hours of personal time that they respectively purportedly spent relative to
their residential rental properties. These logs, which Mr. Ballard created on
recollection several years after the fact in connection with the audit of petitioners’
returns for the years at issue, were duplicative, and the hours reflected therein
were inflated. The log entries were short and did not state with any specificity
how the time for each entry was spent. The 2008 time log for Mr. Ballard, for
example, indicates that he spent 24 hours on June 14, 2008, doing the following:
“[p]ost Internet Ads”, “coordinating with new * * * applicants [for one of the
Georgia properties] for next year”, “coordinate with * * * renters [of one of the
Georgia properties] about showing house to prospective tenants”, “[s]um/verify
checks; deposit ticket; trip to bank to deposit funds”, and “analyze cities for real
estate investment”. During the years at issue, in addition to owning the residential
rental properties, Mr. Ballard held full-time positions with various technology
companies and was enrolled in an M.B.A. program, attending classes on Saturdays
from August to May (with a brief break in December). The 2008 time log for Ms.
Pu, for example, contains repeated entries for “operational & financial review”;
“detailed review of expenses”; “strategic review, alternative scenarios,
recommendations”; “[a]nalyze” and “review” new tenant applications; “review
existing insurance/call insurance brokers; shop around for better deals”; “review
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lease agreements - look for other (better) examples”; “seek investors - partnership
in rental real estate”; and “seek refinancing - contact mortgage brokers/lenders”.
It is apparent that Ms. Pu, who was a homemaker caring for her and Mr. Ballard’s
three young children during the years at issue, performed little to no day-to-day
management or operations of petitioners’ real estate activities. Indeed, these log
entries establish that Ms. Pu’s activities, if anything, were more akin to those of an
investor, and thus do not count towards the 750-hour requirement for the years at
issue. See Barniskis v. Commissioner, T.C. Memo. 1999-258, slip op. at 11-12;
sec. 1.469-5T(f)(2)(ii), Temporary Income Tax Regs., supra.
We conclude that the 2008 time logs are not trustworthy and decline to rely
on them to reach the result petitioners desire. As for the documents petitioners
produced for 2009 and 2010, they do not establish how many hours petitioners
spent with respect to their residential rental activities. Many of the documents
show that petitioners had an agent to handle the day-to-day management of their
Georgia residential rental properties and that they hired numerous workers to
repair and maintain all of their residential rental properties.
Ms. Pu did not appear in Court at trial. And as for Mr. Ballard’s testimony,
we find much of it to be incredible, uncorroborated, and self-serving. Under the
circumstances, “[a]s we have stated many times before, this Court is not bound to
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accept a taxpayer’s self-serving, unverified, and undocumented testimony”, Shea
v. Commissioner, 112 T.C. 183, 189 (1999) (citing Tokarski v. Commissioner, 87
T.C. 74, 77 (1986)), and we do not here.
Petitioners have failed to prove they met the requirements set forth in
section 469(c)(7)(B) for the years at issue. Accordingly, they were not real estate
professionals. We sustain respondent’s determination that petitioners’ Schedule E
rental real estate loss deductions are not, except to the extent provided by section
469(i), allowed for the years at issue.
III. Accuracy-Related Penalty
We now address whether petitioners are liable for accuracy-related penalties
under section 6662(a) for 2008 and 2010.
Various grounds for the imposition of these penalties are set forth in the
notice of deficiency although only one accuracy-related penalty may be applied
with respect to any given portion of an underpayment, even if that portion is
subject to the penalty on more than one ground. Sec. 1.6662-2(c), Income Tax
Regs. We need address only respondent’s claim that petitioners are liable for
accuracy-related penalties for 2008 and 2010 on the ground that petitioners’
underpayments of tax for 2008 and 2010 were attributable to substantial
understatements of income tax under section 6662(b)(2). For purposes of section
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6662(b)(2), an understatement of tax generally means the excess of tax required to
be reported on the return over the amount shown on the return. Sec.
6662(d)(2)(A). An understatement of income tax is substantial in the case of an
individual if it exceeds the greater of 10% of the tax required to be shown on the
return for the taxable year or $5,000. Sec. 6662(d)(1). Petitioners’ income tax
was understated by $22,846 and $7,959, respectively, for 2008 and 2010. As
determined in the notice of deficiency petitioners’ understatements of income tax
for 2008 and 2010 were substantial.
The Commissioner bears the burden of production with respect to accuracy-
related penalties. Sec. 7491(c). Once the Commissioner meets this burden, the
taxpayer must come forward with persuasive evidence that the Commissioner’s
determination is incorrect. See Rule 142(a); Welch v. Helvering, 290 U.S. at 115;
Higbee v. Commissioner, 116 T.C. 447. Section 6751(b)(1) provides that “[n]o
penalty * * * shall be assessed unless the initial determination of such assessment
is personally approved (in writing) by the immediate supervisor of the individual
making such determination or such higher level official as the Secretary may
designate.” In Graev v. Commissioner (Graev III), 149 T.C. __, __ (slip op. at 13-
14) (Dec. 20, 2017), supplementing and overruling in part Graev v. Commissioner
(Graev II), 147 T.C. 460 (2016), we held that the Commissioner’s burden of
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production under section 7491(c) includes establishing compliance with the
supervisory approval requirement of section 6751(b).
Trial of this case was held, and the record was closed, before we vacated in
part our decision in Graev II and issued Graev III. In the light of Graev III, we
ordered respondent to file a response addressing the effect of section 6751(b) on
this case and directing the Court to any evidence of section 6751(b) supervisory
approval in the record, and petitioners to respond. Respondent was unable to
direct the Court to any evidence in the record that satisfies his burden of
production with respect to section 6751(b)(1) and filed a motion to reopen the
record to offer into evidence (1) the declaration of Ms. Welch, the Internal
Revenue Service revenue agent who conducted the examination of petitioners’
returns and recommended imposing section 6662(a) accuracy-related penalties for
the years at issue and (2) the Civil Penalty Approval Form for the years at issue,
dated before the issuance of the notice of deficiency and signed by Lynn Buckley,
Ms. Welch’s immediate supervisor. Petitioners objected to the introduction of any
additional evidence with respect to the penalties and requested that the Court deny
respondent’s motion.
Reopening the record for the submission of additional evidence lies within
the Court’s discretion. Zenith Radio Corp. v. Hazeltine Research, Inc., 401 U.S.
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321, 331 (1971); Butler v. Commissioner, 114 T.C. 276, 286-287 (2000); see also
Nor-Cal Adjusters v. Commissioner, 503 F.2d 359, 363 (9th Cir. 1974) (“[T]he
Tax Court’s ruling [denying a motion to reopen the record] is not subject to review
except upon a demonstration of extraordinary circumstances which reveal a clear
abuse of discretion.”), aff’g T.C. Memo. 1971-200. We will not grant a motion to
reopen the record unless, among other requirements, the evidence relied on is not
merely cumulative or impeaching, is material to the issues involved, and probably
would change some aspect of the outcome of the case. Butler v. Commissioner,
114 T.C. 287; see also SEC v. Rogers, 790 F.2d 1450, 1460 (9th Cir. 1986)
(explaining that the trial court “should take into account, in considering a motion
to hold open the trial record, the character of the additional * * * [evidence] and
the effect of granting the motion”), overruled on other grounds by Pinter v. Dahl,
486 U.S. 622 (1988).
In reviewing motions to reopen the record, courts have considered when the
moving party knew that a fact was disputed, whether the evidentiary issue was
foreseeable, and whether the moving party had reason for the failure to produce
the evidence earlier. See, e.g., George v. Commissioner, 844 F.2d 225, 229-230
(5th Cir. 1988) (holding that refusal to reopen the case was not an abuse of
discretion because the issue was foreseeable to the taxpayers and the court could
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see no excuse for the taxpayers’ failure to produce evidence earlier) (and cases
cited thereat), aff’g Frink v. Commissioner, T.C. Memo. 1984-669. We also
balance the moving party’s diligence against the possible prejudice to the
nonmoving party. In particular we consider whether reopening the record after
trial would prevent the nonmoving party from examining and questioning the
evidence as it would have during the proceeding. See, e.g., Estate of Freedman v.
Commissioner, T.C. Memo. 2007-61; Megibow v. Commissioner, T.C. Memo.
2004-41.
The evidence that is the subject of respondent’s motion would not be
cumulative of any evidence in the record and it would not be impeaching material.
Respondent bears the burden of production with respect to penalties and would
offer the evidence as proof that the requirements of section 6751(b)(1) have been
met. The subject evidence is material to the issues involved in the case, and we
conclude that the outcome of the case will be changed if we grant respondent’s
motion.
Petitioners argue that “[i]t is not just to allow [r]espondent * * * to reopen
the record now, at such a late date”. Petitioners also question the reliability of the
Civil Penalty Approval Form. When this case was submitted and the record
closed, Graev III had not been issued. We agree with respondent that the Civil
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Penalty Approval Form is not cumulative and is material to the penalty issue in
this case. We also agree with respondent that the Civil Penalty Approval Form is
a record kept in the ordinary course of a business activity and is authenticated by
the declaration of Ms. Welch. See Fed. R. Evid. 803(6), 902(11). We will admit
the Civil Penalty Approval Form into evidence and the declaration for purposes of
authentication under rule 902(11) of the Federal Rules of Evidence. See Clough v.
Commissioner, 119 T.C. 183, 190-191 (2002). Respondent has met his burden of
production for the accuracy-related penalties for 2008 and 2010.
Since respondent has met his burden, petitioners must come forward with
persuasive evidence that the penalties are inappropriate because, for example, they
had reasonable cause and acted in good faith. See sec. 6664(c)(1); Higbee v.
Commissioner, 116 T.C. 446-447. The determination whether the taxpayer had
reasonable cause and acted in good faith depends upon the pertinent facts and
circumstances of a particular case. Sec. 1.6664-4(b)(1), Income Tax Regs. We
consider, among other factors, the experience, education, and sophistication of the
taxpayer; however, the principal consideration is the extent of the taxpayer’s
efforts to assess the proper tax liability. Id.; see also Higbee v. Commissioner, 116
T.C. 448. Taking into consideration the taxpayer’s experience, education, and
sophistication, an honest misunderstanding of fact or law may indicate reasonable
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cause and good faith. Higbee v. Commissioner, 116 T.C. 449 (citing Remy v.
Commissioner, T.C. Memo. 1997-72). In addition, reliance on professional advice
may indicate reasonable cause and good faith if, in the light of all the facts and
circumstances, such reliance was reasonable and the taxpayer acted in good faith.
Id. at 448-449.
Petitioners, however, have not presented evidence to show reasonable cause
or good faith for their rental real estate loss deductions for 2008 and 2010. They
did not provide any testimony that they relied on advice from a tax professional
when preparing their Federal income tax returns for those years. They used
TurboTax to prepare their returns. This Court has noted that “[t]ax preparation
software is only as good as the information one inputs into it.” See Bunney v.
Commissioner, 114 T.C. 259, 267 (2000). The software does not constitute
professional advice which this Court can rely on in a reasonable cause-good faith
analysis.
Given Mr. Ballard’s experience, knowledge, and education, there is no
justification for his misunderstanding of the law. He testified that he has never
dealt with tax preparation in his work experience although he is a C.P.A. with a
professional degree in taxation. Mr. Ballard has owned residential rental
properties for over 10 years. His professional background and real estate
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experience make it unreasonable for him to conduct these activities and not
properly document the time that was invested into petitioners’ residential rental
properties. Accordingly, we sustain respondent’s determination regarding the
accuracy-related penalties for 2008 and 2010.
We have considered all of the arguments made by the parties and, to the
extent they are not addressed herein, we find them to be moot, irrelevant, or
without merit.
To reflect the foregoing,
An appropriate order will be issued
and decision will be entered.