DocketNumber： Docket No. 21304-09S.
Judges： DEAN
Filed Date： 7/6/2011
Status： Non-Precedential
Modified Date： 4/18/2021
PURSUANT TO
Decision will be entered under Rule 155.
DEAN,
Respondent determined deficiencies in petitioners' Federal income tax of $10,330 for 2005 and $8,403 for 2006. Respondent also determined under section 6662(a) accuracy-related penalties of $2,066 for 2005 and $1,680.60 for 2006.
The parties agree that petitioners are entitled to deduct rental real estate losses on Schedule E, Supplemental Income and Loss, incurred in connection with the Vandalia, Ohio, vacation home in 2005 and the Cape Coral, Florida, vacation home for 2005 and 2006.*80 whether petitioners are entitled to deduct real estate losses on Schedule E in excess of those determined or agreed to by respondent and whether petitioners are liable for accuracy-related penalties under section 6662(a) for 2005 and 2006.Background Petitioners, Aris Jende (petitioner) and Marilyn Jende (Mrs. Jende), are retired educators. Petitioner retired as a school superintendent, and Mrs. Jende retired as an assistant superintendent of schools. They have invested in real estate for over 30 years, including the years at issue. In 2005 and 2006, in addition to their personal residence, *81 petitioners owned interests in six residential properties. Properties in Vandalia, Ohio, and Cape Coral, Florida, are homes that were unfurnished and rented to long-term tenants in 2005 and 2006. Petitioners owned a timeshare in Fort Myers, Florida, and condominiums in Gatlinburg, Tennessee, Pigeon Forge, Tennessee, and Destin, Florida. Petitioners deducted losses of $44,613 for 2005 and $45,131 for 2006 on their Schedules E in connection with the six residential rental properties. The average stay in the Fort Myers timeshare and the condominium units in Gatlinburg and Pigeon Forge was less than 7 days in 2005. The average rental stay for the condominium unit in Destin was more than 7 days in 2005. The average stay for all three condominium units was less than 7 days in 2006. Petitioners maintained for 2005 and 2006 a Web site advertising the Gatlinburg and Pigeon Forge, Tennessee, condominiums that instructed interested persons to contact a "firm" to schedule reservations at the condominiums. Petitioners made one trip to the Crystal Sands condominium in Destin in 2005 and one in 2006. In both 2005 and 2006 petitioners were members of the Crystal Sands Owners Association*82 (CSOA). The manager of CSOA was responsible for 277 condominium units (including petitioners' Destin, Florida, unit) in five different complexes in Destin, Florida. The CSOA manager spent several hours a week at petitioners' complex, but her main office was at another complex in Destin. In connection with the condominium in Destin, petitioners entered into a seasonal property management agreement in 2004 with Abbot Resorts, Inc. (Abbot). Under the agreement, Abbot was to receive 28 percent of "base rental income" as a fee for its services, which included acquiring tenants, collecting rents, and managing the property. Abbot conducted a semiannual inspection in order to determine the maintenance condition and appearance of the units under its management. In addition to its normal housekeeping services, Abbot conducted a semiannual "deep, general interior housecleaning" of the units. In 2005 and 2006 CSOA contracted with Resort Quest to secure renters for the Crystal Sands complex, including petitioners' unit. A Resort Quest representative was present part time at the complex in which petitioners' unit was located. Petitioners reported management fees paid to either or both Abbot and Resort *83 Quest of $5,551 for 2005 and $7,841 for 2006 in connection with the Destin property. Petitioners reported income from the Destin unit of $20,661 in 2005 and $29,081 in 2006. Petitioners made two trips to the Highlands condominium in Gatlinburg in 2005 and one in 2006. During the years at issue petitioners were members of the Highlands Owners Association (HOA). HOA is responsible for maintaining the exterior of the condominium complex in which petitioners' Gatlinburg condominium is located. During 2005 and 2006 HOA contracted with Werner Enterprises, Inc., to "operate" the 78-unit complex in which petitioners' unit was located. Petitioners deducted management fees of $6,069 for 2005 and $5,945 for 2006 in connection with the Highlands unit. Petitioners reported rental income from the unit of $17,341 for 2005 and $16,985 for 2006. Petitioners visited the Whispering Pines condominium in Pigeon Forge three times in 2005 and once in 2006. During the years in issue petitioners were members of the Whispering Pines Owners Association (WPOA). WPOA hired Werner Enterprises, Inc. (Werner), to receive rental requests, assign renters, and assist *84 owners. On December 12, 2006, petitioners signed an exclusive rental management agreement with Resort Properties Management, LLC (Resort) regarding the Pigeon Forge condominium. The agreement provided that Resort would receive 40 percent of petitioners' gross monthly receipts from rental income in return for their services. Among other provisions of the agreement, Resort received the exclusive right to: (1) Rent the property at rates it set; (2) make repairs at the owners' expense; (3) use the property for marketing through advertisement and promotional stays; (4) collect and remit rent less deductions; (5) provide maid service and supply paper products and cleaning products; (6) provide maintenance and security services; (7) actively promote and advertise the units within the development; and (8) operate and maintain a reservation system to process rental reservations for the premises. Petitioners deducted management fees in connection with the Pigeon Forge condominium of $5,922 for 2005 and $6,066 for 2006. They reported rental income from the property of $13,797 for 2005 and $15,318 for 2006. Generally, the Commissioner's determinations in a notice of deficiency are presumed *85 correct, and the taxpayer has the burden of proving that those determinations are erroneous. See Rule 142(a); Section 162 allows deductions for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. Section 212 allows deductions for all the ordinary and necessary expenses paid or incurred during the taxable year for the production of income or the management or maintenance of property held for the production of income. If a taxpayer is an individual, however, the "passive activity loss" for the taxable year shall not be allowed. An activity involving an average period of customer use of tangible personal property for 7 days or less is not treated as rental activity. The average rental stay for the condominium unit in Destin was more than 7 days in 2005 and was therefore a rental activity and a passive activity *87 regardless of petitioners' level of participation. Respondent alleges that petitioners did not materially participate in their trade or business activities with respect to the Destin condominium and the Fort Myers timeshare in 2005 and the condominium units in Destin, Gatlinburg, and Pigeon Forge in 2006. Petitioners argue that they have materially participated in each real estate activity and that they have elected under Material participation means that the taxpayer is involved in *88 the operations of the activity on a regular, continuous, and substantial basis. In determining whether a taxpayer materially participated in an activity, the participation of a spouse shall be taken into account. According to petitioners, their condominium fees paid for hiring the resort manager, hiring the maintenance workers, maintaining the common areas and exterior, maintaining the swimming pool, any kind of "replacements", and utilities *90 and insurance for the complex, "not the individual units." The parties have stipulated that petitioners compiled 2005 and 2006 "time logs" and narrative "trip activity logs" related to their activities in connection with the condominiums. At trial respondent suggested that petitioners' compilations may not be contemporaneous. Petitioner testified that they kept receipts, records, documentation activity, and "hour logs" that they "consolidate during tax time" and at a "later date" transferred to a formal log. The time logs purport to provide a summary of the number of hours each petitioner spent on various activities in connection with five of their properties, including the three condominiums but excluding the timeshare in Fort Myers. The trip activity logs purport to give for the condominiums a date and description of each category of activity for which hours are listed in the time logs for petitioner: (1) Bank deposits, (2) phone log, (3) post office, (4) recordkeeping and tax preparation, (5) maintenance and repairs, (6) travel time, and (7) Web site maintenance and Internet research. For Mrs. Jende the time logs and trip activity logs list hours for: (1) Recordkeeping and tax preparation, *91 (2) maintenance and repairs, and (3) travel time. Work done by an individual in his capacity as an investor in an activity is not treated as participation in the activity for purposes of Petitioners were not involved in the day-to-day management of their condominiums as they paid substantial fees under contracts to Abbot and Werner or others for such services. The Court concludes that petitioners may not treat the hours they devoted to "Bank Deposits", "Post Office" and "Record Keeping & Tax preparation" as participation for purposes of Petitioners treated all of their time traveling to and from the condominiums as "work" for purposes of determining their material *92 participation in the condominium activities. The Court recognizes that travel in some circumstances can be "work" done in connection with a trade or business. The legislative history of The Court's examination of the time logs leads to the conclusion that the hours listed for "maintenance and repairs" are exaggerated. The hours listed for maintenance and repairs for 2005 by each petitioner are exactly the same for two of the properties and differ by only 1 hour for the third. For 2006 there is somewhat more divergence, but the hours remain substantially similar. The duplication of hours by petitioners in this category appears to result in large part from the excessive number of hours the trip activity *93 logs attribute to shopping for, designing with, discussing, viewing, and considering for the three condominiums various household items including: Furniture, pictures, fabrics, decorations, kitchen appliances, dinnerware, and other items. For example, in entries for March 5, 2005, each petitioner claims to have shopped for 11 hours related to the Pigeon Forge unit. The following day, Sunday, March 6, 2005, time log entries show each petitioner spending 15-1/2 hours, not including lunch or dinner, looking for decorations or pictures for the Gatlinburg condominium. In another set of entries, for the Destin unit, petitioners claim that on June 4 each of them shopped for 6 hours. Each petitioner claims to have shopped on Sunday, June 5, 2005, for 11-1/2 hours followed by another 11-1/2 hour shopping day on Monday, June 6, 2005. According to petitioners' time logs, the June 6 marathon shopping day was followed by a day, June 7, in which each of them shopped for 9 hours. The time log indicates that on June 8 each petitioner shopped for 5-1/2 hours and on June 9 for 10 hours. That is a lot of shopping. Petitioners did not submit any of the receipts, records, or documentation on which they say *94 the logs were based to verify their stated extended shopping efforts. Petitioners' exaggerated claims of hours spent shopping cast doubt on the hours listed in the other entries in their time logs, and the Court finds them unreliable. Petitioners do not claim to have participated in any of the trade or business activities at issue for more than 500 hours for either 2005 or 2006. Petitioners' participation in the activities for the years at issue do not constitute substantially all of the participation of all individuals in the activities for the years at issue. The Court has determined that petitioners may not include as hours of material participation time spent on investor activities and travel. Petitioners' excessive claims of time spent on maintenance and repairs has rendered the claims unreliable, and therefore petitioners have not shown that they participated in each of their trade or business activities for more than 100 hours in 2005 and 2006.*95 firms who ran the day-to-day operations of the units. See Because petitioners cannot show that their participation with respect to each activity equaled or exceeded 100 hours for each year, they cannot meet the test 4 requirements. See The record contains no evidence that would support a finding that petitioners meet test 5 or 6 for their trade or business activities. Petitioners cannot meet test 7 requirements for any of their trade or business activities because they have not shown that their participation in each activity exceeded 100 hours. See Petitioners argue that even if they do not meet the requirements *96 for material participation for each property at issue separately, they are real estate professionals and are entitled to group their real estate activities for purposes of the material participation test. The general rule is that a rental activity is treated as a per se passive activity regardless of whether the taxpayer materially participates. A taxpayer qualifies for the real property business election if: (1) More than one-half of the personal services performed in trades or businesses by the taxpayer *97 during the taxable year are performed in real property trades or businesses in which he materially participates; and (2) the taxpayer performs For purposes of the 750-hour threshold, the Court looks at all of the taxpayer's rental activities to determine whether that requirement is satisfied. See If the taxpayer is a qualifying taxpayer, then the general rule is that each interest in rental real estate is treated as a separate activity unless the taxpayer elects to treat all interests in rental real estate as one activity. With respect to the real property business election, The Court has determined that a taxpayer must clearly inform the Commissioner of his intent to make the real property business election. See Petitioner testified that in 1998 petitioners discussed with their accountant the desirability of treating all their rental properties as "one entity" or a group. According to petitioner, they agreed to file an election to be so treated. Petitioners stated in their pretrial memorandum, however, that they believe the election was made by their accountant in 2001. Respondent represented that he searched his records back to 2000 and was unable to find an election. Petitioners were unable to produce any documentary evidence of making the election. If petitioners could show that they made a proper election, it might affect the treatment of the Destin property for 2005. It would not, however, affect the treatment of the timeshare and the other condominiums for 2005 or any *100 of the properties for 2006. The average stay in the Fort Myers timeshare and the condominium units in Gatlinburg and Pigeon Forge was less than 7 days in 2005. The average rental stay for all three condominium units was less than 7 days in 2006. These activities were trades or businesses and not rental activities. See For 2005 petitioners' AGI computed without regard to passive activity losses was $143,381 ($98,768 + $44,613). Their AGI so computed was $43,381 in excess of $100,000. Reducing the $25,000 offset by 50 percent of $43,381, or $21,690.50, resulted in an allowance by respondent of a $3,310 loss. The parties have since agreed, however, that petitioners are entitled to the losses from the Cape Coral property of $5,435 and the Vandalia property of $1,684. The agreement of the parties reduces petitioners' passive activity losses from $44,613 to $37,494 ($44,613 - $7,119). Under the agreement, petitioners' *102 adjusted AGI computed without regard to passive activity losses is $136,262. Their AGI so computed is $36,262 in excess of $100,000. Reducing the $25,000 offset by 50 percent of $36,262, or $18,131.50, results in an allowable loss under Section 7491(c) imposes on the Commissioner the burden of production in any court proceeding with respect to the liability of any individual for penalties and additions to tax. Respondent determined that for 2005 and 2006 petitioners underpaid a portion of their income *103 taxes due to negligence or disregard of rules or regulations or a substantial understatement of income tax. Section 6662(a) imposes a 20-percent penalty on the portion of an underpayment of tax attributable to any one of various factors, including negligence or disregard of rules or regulations and a substantial understatement of income tax. See sec. 6662(b)(1) and (2). Negligence includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code, including any failure to keep adequate books and records or to substantiate items properly. See sec. 6662(c); A substantial understatement includes an understatement of income tax that exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000. See sec. 6662(d); Section 6664(c)(1) provides that the penalty under section 6662(a) shall not apply to any portion of an underpayment if it is shown that there was reasonable cause for the taxpayer's position and that the taxpayer acted in good faith with respect to that portion. The determination of whether a taxpayer acted with reasonable cause and in good *104 faith is made on a case-by-case basis, taking into account all the pertinent facts and circumstances. Petitioners have a substantial understatement of income tax for each of the years in issue since the understatement amount exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000. The Court concludes that respondent has produced sufficient evidence to show that the accuracy-related penalties under section 6662(a) are appropriate for both years. The accuracy-related penalties will apply unless petitioners demonstrate that there was reasonable cause for the underpayments and that they acted in good faith with respect to the underpayments. See sec. 6664(c). Petitioners did not show that there was *105 reasonable cause for, and that they acted in good faith with respect to, the underpayments. Respondent's determination of the accuracy-related penalties under section 6662(a) for 2005 and 2006 is sustained. To reflect the foregoing,
1. Respondent determined in the notice of deficiency that pursuant to
2. Adjustments to petitioners' itemized deductions are computational and will be resolved consistent with the Court's opinion.↩
3. A loss disallowed under
4. Petitioners, however, have argued that they are covered by the real property trade or business exception under
5. Destin was a rental, and thus passive, activity in 2005. Petitioners offered no evidence on their material participation in the operations of the Fort Myers timeshare for 2005 or 2006.↩
6. A qualifying taxpayer is one who owns at least one interest in real estate and is in the real property business as described in
7. Petitioners did not treat their contested activities as trade or business activities and therefore did not elect to group their trade or business activities for purposes of
8. In 2005 the Destin condominium was rental real estate and accounted for a loss of $19,025.↩