                  T.C. Summary Opinion 2001-18



                     UNITED STATES TAX COURT



      STEVEN D. KUCERA AND TERESA M. KUCERA, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 10186-99S.            Filed February 27, 2001.


     Kent O. Littlejohn, for petitioners.

     Lisa K. Hartnett, for respondent.



     DEAN, Special Trial Judge:     This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed.    The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority.    Unless otherwise indicated,

subsequent section references are to the Internal Revenue Code in

effect for the years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.
                                 - 2 -

        Respondent determined deficiencies of $6,328, $4,018, and

$1,571 in petitioners’ Federal income taxes for tax years 1994,

1995, and 1996, respectively.     The issues for decision are:

(1) Whether petitioners’ share of income from a partnership in

1994, 1995, and 1996 is attributable to the rental of property

pursuant to written binding contracts entered into before

February 19, 1988; (2) whether the issue of petitioner Steven D.

Kucera’s (petitioner) participation in Business Management

Services, Inc. (BMS) is properly before the Court; and

(3) if so, whether petitioner materially participated in BMS such

that the rental income attributable to BMS should not be subject

to the recharacterization rule of section 1.469-2(f)(6), Income

Tax Regs.

                              Background

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the attached exhibits are

incorporated herein by reference.     Petitioners resided in Grand

Island, Nebraska, at the time the petition was filed in this

case.

     Petitioner is a certified public accountant and has been

during all years relevant in this case.     Petitioner prepared

joint Forms 1040, U.S. Individual Income Tax Returns, for himself

and his wife, Teresa M. Kucera, for each of the years at issue.
                                - 3 -

     Since at least July 1984, petitioner has conducted his

accounting practice through a professional corporation (PC) along

with several other accountants, with each accountant owning an

equal percentage of the PC.    During all relevant periods,

petitioner was a material participant in the PC.    The name of the

PC has been amended on several occasions since its inception to

properly reflect its practicing members and shareholders.

     Petitioner has been a partner in a partnership known as the

1203 Partnership since at least July 1984.    The 1203 Partnership

is the owner of the real estate and office building located at

1203 West Second in Grand Island, Nebraska (1203 office

building).   During all relevant times, the ownership of the 1203

Partnership was held equally by the same individuals who were

then shareholders of the PC.    Although there have been changes in

the partners of the 1203 Partnership, the partnership has never

been dissolved, liquidated, or terminated.

     Since at least July 1984, petitioner has been a shareholder

of Business Management Services, Inc. (BMS), which was organized

as a “C” corporation.   BMS functions as a computer service bureau

by preparing customers’ payroll and computerized general ledgers.

During all relevant times, the shareholders of BMS have been the

same individuals as the shareholders in the PC, with up to two

additional shareholders.   The additional shareholders were

neither accountants, nor owners of the PC.    The officers and
                               - 4 -

directors of BMS are all members of the PC, but the officers and

directors of BMS are not the same as those of the PC.

     For all relevant years, the PC’s business has been located

in the 1203 office building pursuant to a lease between the PC

and the 1203 Partnership.   BMS’s business also has been located

in the 1203 office building pursuant to a lease between BMS and

the 1203 Partnership.   The spaces occupied by the PC and BMS

within the 1203 office building are separate and distinct.

     On May 1, 1986, the PC and the 1203 Partnership executed a

document entitled “Real Estate Lease”.   The document states that

the owner of the leased property is the 1203 Partnership and that

the tenant is Larsen, Schroeder & Associates, PC.1   The leased

premises are the “Office building and parking lots at 1203 West

Second Street and parking lot at 1219 West Second Street, * * *

excepting that portion of said building occupied by Business

Management Services.”   The term of the lease is “from May 1,

1986, to April 30, 1987, to be renewed automatically year to year

on May 1”, and the monthly rental is $5,580.   The lease was

signed on behalf of the 1203 Partnership by George Schroeder,

General Partner, and on behalf of the PC by Tom Larsen,

President.



     1
        At this time, Tom Larsen, Matt Shonsey, George Schroeder,
Bob Almquist, Bruce Schreiner, Phil Maltzahn, and petitioner were
equal shareholders of the PC.
                              - 5 -

     On May 1, 1989, the PC and the 1203 Partnership executed a

document entitled “Real Estate Lease”.   The provisions of this

document are identical to the 1986 document in all respects

except that the name of the tenant was changed to Shonsey,

Schroeder, Almquist, Schreiner, Kucera & Maltzahn, P.C.,2 and the

term of the lease is “from May 1, 1989, to April 30, 1990, to be

renewed automatically year to year on May 1.”   Phil Maltzahn,

General Partner, signed the document on behalf of the 1203

Partnership and Matthew Shonsey, President, signed it on behalf

of the PC.

     On May 1, 1990, the PC and the 1203 Partnership executed a

document entitled “Real Estate Lease”.   The provisions in this

document are identical to those in the 1989 document, except that

the term of the lease is “from May 1, 1990 to April 30, 1991, to

be renewed automatically year to year on May 1”, and the rental

amount was increased from $5,580 to $7,425.   Phil Maltzahn and

Matthew Shonsey once again signed the document on behalf of the

parties.

     On May 1, 1993, the PC and the 1203 Partnership executed a

document entitled “Real Estate Lease”.   This document is

identical to the 1990 document except that the name of the tenant


     2
        As of May 1, 1989, one of the PC shareholders’ interest
in the PC had been redeemed. The PC amended its Articles of
Incorporation and changed its name to reflect the six individuals
who were equal shareholders of the PC.
                               - 6 -

was changed to Shonsey, Almquist, Kucera, Maltzahn, and Galloway,

PC,3 and the lease term was changed to run “from May 1, 1993 to

April 30, 1994, to be renewed automatically year to year on May

1.”

      On July 1, 1984, BMS and the 1203 Partnership executed a

document entitled “Real Estate Lease”.   The document was signed

on behalf of the 1203 Partnership by Gary Fitit, General Partner,

and on behalf of BMS by Danny Steele, President.   The lease

agreement provides that BMS will lease “Office space consisting

of one thousand two hundred seventy square feet, more or less,

and parking lot in back of building located at 1203 West Second

Street”.   The term of the lease is from July 1, 1984 with “no

ending term and the lease shall be offered by lessor and accepted

by lessee from month to month.”   The agreement provides for a

monthly rental of $915.

      On June 1, 1988, BMS and the 1203 Partnership executed a

document entitled “Real Estate Lease”.   The only differences in

this document and the prior lease are that the term of the lease

in the 1988 document is from June 1, 1988, and the document was

signed by Phil Maltzhan, General Partner, on behalf of the 1203

Partnership and by Michael Martin, President, on behalf of BMS.


      3
        As of May 1, 1993, all the stock of two shareholders had
been redeemed and one shareholder had been added to the ownership
of the PC. The name of the PC was changed to reflect the five
individuals who were equal shareholders of the PC.
                                - 7 -

     On November 1, 1989, BMS and the 1203 Partnership executed a

document entitled “Real Estate Lease”.   This document indicates

that the leased premises are “one thousand square feet, more or

less, and parking lot in back of building” and that the monthly

rental is $720.   The term of the lease starts November 1, 1989.

The document is signed by Phil Maltzahn, General Partner, on

behalf of the 1203 Partnership and by Mike Martin, President, on

behalf of BMS.    There is a handwritten notation on the document

stating “Current lease in effect”.

     Petitioners timely filed their 1994, 1995, and 1996 joint

Federal income tax returns.   On Part II of their Schedules E,

Supplemental Income and Loss, petitioners reported income from

the 1203 Partnership of $15,355, $11,933, and $4,920 for 1994,

1995, and 1996, respectively.   This income consists of

petitioner’s share of the net rental income from the real estate

and office building owned by the partnership.

     During the 3 years at issue, petitioners owned several

rental units which generated losses in each year.    They also had

passive activity loss carryovers from prior years.   Petitioners

offset the rental income received from the 1203 Partnership

against passive losses from petitioners’ other rental real

estate.   After consideration of the passive activity loss

limitations, petitioners claimed passive activity losses in the
                                 - 8 -

years 1994, 1995, and 1996 of $20,753, $18,151, and $4,920,

respectively.

     Respondent determined that the income from the 1203

Partnership was nonpassive income pursuant to the

recharacterization rule of section 1.469-2(f)(6), Income Tax

Regs.   After consideration of the passive activity loss

limitations, respondent determined that petitioners’ passive

activity losses were $412, $4,220, and $0 for 1994, 1995, and

1996, respectively.   Respondent increased petitioners’ taxable

income for the years accordingly.    As a result of respondent’s

adjustments, respondent reduced petitioners’ itemized deductions

in each year at issue and determined deficiencies in petitioners’

income taxes of $6,328, $4,018, and $1,571 for the 1994, 1995,

and 1996 respective tax years.

     Petitioners do not challenge respondent’s computations but

argue that their rental income from the 1203 Partnership is

passive income and not subject to the recharacterization rule of

section 1.469-2(f)(6), Income Tax Regs.

                            Discussion

     Section 469 sets forth the passive activity loss rule which

generally allows losses generated by passive activities to be

offset only against gains from other passive activities.   Section

469(c) defines a passive activity as any activity which involves

the conduct of any trade or business and in which the taxpayer
                                 - 9 -

does not materially participate.    Rental activity is generally

considered a passive activity.    See sec. 469(c)(2).

     The Secretary, however, is expressly authorized to prescribe

regulations necessary or appropriate to carry out the provisions

of section 469, including regulations “which specify what

constitutes an activity, material participation, or active

participation” and “requiring net income or gain from a limited

partnership or other passive activity to be treated as not from a

passive activity”.   Sec. 469(l)(1), (3).   Pursuant to this

authority, section 1.469-2(f)(6), Income Tax Regs.,

recharacterizes a taxpayer’s rental income from property rented

for use in a trade or business in which the taxpayer materially

participates as income not from a passive activity.4    Section

1.469-11(c)(1)(ii), Income Tax Regs., however, excludes “the

portion of the income (if any) that is attributable to the




     4
         The regulation, in relevant part, provides:

          (f)(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 property 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 § 1.469-5T)
           for the taxable year * * *[Sec. 1.469-2(f)(6),
           Income Tax Regs.]
                               - 10 -

rental of that item of property pursuant to a written binding

contract entered into before February 19, 1988” from the

recharacterization rule of section 1.469-2(f)(6), Income Tax

Regs.

     Petitioners contend that the lease agreements between the PC

and the 1203 Partnership and between BMS and the 1203 Partnership

in effect for the years in issue were both entered into before

February 19, 1988, and therefore, income derived from the 1203

Partnership’s rental activity is passive.   They further argue

that the 1203 Partnership’s income from BMS’s lease of office

space is passive income regardless of which lease agreement was

in effect for the years in issue because petitioner was not a

material participant in BMS.

     Respondent argues that new leases which changed material

provisions of the original leases were executed after February

19, 1988.   Respondent thus maintains that the net rental income

from the 1203 Partnership in 1994, 1995, and 1996 was not

attributable to leases entered into before February 19, 1988.

Respondent further argues that petitioners have failed to

properly bring before the Court the issue of petitioner’s

participation in BMS.

     Lease Agreements

     We first examine the lease agreements at issue.   State law

governs the nature of property rights, and Federal law determines
                              - 11 -

the appropriate tax treatment of those rights.   See United States

v. National Bank of Commerce, 472 U.S. 713, 722 (1985).     The

agreements at issue were executed within the State of Nebraska by

residents of Nebraska for the lease of property located in

Nebraska.   We thus look to Nebraska law to determine the nature

of the property rights created by the agreements.

     Four lease agreements between the PC and the 1203

Partnership were executed from May 1, 1986, to May 1, 1993.       Each

of the documents is a complete agreement entitled “Real Estate

Lease” and covers all material terms of the lease.   Each of the

agreements provides for a specified rental term of 1 year

beginning on the date the agreement was executed and contains a

provision that the lease is “to be automatically renewed year to

year”.

     Many states recognize a distinction between an extension and

a renewal of a lease.   See 51C C.J.S., Landlord and Tenant, sec.

54b, at 164 (1968); 49 Am.Jur.2d, Landlord and Tenant, sec. 141

(1995).   In such states, an extension creates on its own force an

additional term, and the same lease continues in force during the

additional period.   See 51C C.J.S., Landlord and Tenant, sec.

54b, at 164 (1968); 49 Am.Jur.2d, Landlord and Tenant, sec. 141

(1995).   In contrast, a renewal requires the execution of a new

lease and is regarded as a separate contract.    See 51C C.J.S.,

Landlord and Tenant, sec. 54b, at 164 (1968); 49 Am.Jur.2d,
                              - 12 -

Landlord and Tenant, sec. 141 (1995).   It appears that Nebraska

recognizes such a distinction.   In Mauzy v. Elliott, 22 N.W.2d

142, 147 (Neb. 1946), the Supreme Court of Nebraska quoting 35

C.J., Landlord and Tenant, sec. 178 at 1037, stated that “each

renewed lease is a new lease, and the taking of it operates as a

surrender of the old one.”   The court further noted that the

original lease could be considered to be continued only for the

protection of certain “legal interests carved out of it, which,

once created, the law will not permit to be destroyed”.     Id.; see

also Bishop Cafeteria Co. v. Ford, 129 N.W.2d 581, 588-589 (Neb.

1964).

     The use of the words “renewal” or “extension” in a lease,

however, may not be conclusive as to whether a lease grants a

covenant to renew or an agreement to extend.   See 51C C.J.S.,

Landlord and Tenant, sec. 54b at 165 (1968); 49 Am.Jur.2d,

Landlord and Tenant, sec. 143 (1995).   Instead, the terms of the

lease and the parties’ conduct may indicate that the parties

intended to continue for a subsequent term under the original

lease.   See 51C C.J.S., Landlord and Tenant, sec. 54b at 165

(1968); 49 Am.Jur.2d, Landlord and Tenant, sec. 143 (1995).

     With respect to the 1986 lease agreement between the PC and

the 1203 Partnership, the automatic nature of the renewal

provision suggests that the parties intended that the lease be

extended rather than renewed in subsequent years.   The fact that
                              - 13 -

no new agreement was executed until 3 years later supports such a

determination.   Having determined that the 1986 agreement’s

automatic renewal provision extended the agreement to subsequent

years, we now consider the agreements executed after the 1986

agreement.

     Under Nebraska law “‘A contract complete in itself will be

conclusively presumed to supersede and discharge another one made

prior thereto between the same parties concerning the same

subject matter, where the terms of the latter are inconsistent

with those of the former, so they cannot subsist together.’”      The

Nebraskans, Inc. v. Homan, 294 N.W.2d 879, 881 (Neb. 1980)

(quoting In re Estate of Wise, 13 N.W.2d 146 (Neb. 1944)(syllabus

of the court)); Goings v. Gerken, 263 N.W.2d 655 (Neb. 1978).     In

such case, “a merger of the agreements” occurs.    The Nebraskans,

Inc. v. Homan, supra.   The parties’ intent to discharge an old

agreement through the execution of a new agreement must clearly

appear.   See DeFilipps v. Skinner, 320 N.W.2d 737, 739 (Neb.

1982); In re Estate of Wise, supra.    “An inspection of the

contracts, together with examination of the circumstances, may

show that the later contract was intended as supplementary to the

first.”   DeFilipps v. Skinner, supra at 739.

     Petitioners argue that the original agreement remained in

effect for the years at issue and quote Moudry v. Parkos, 349

N.W. 2d 387, 389 (Neb. 1984), for the proposition that a year-to-
                              - 14 -

year tenancy can be terminated under Nebraska law only “by an

agreement of the parties, express or implied, or by notice given,

six calendar months ending with the period of the year at which

the tenancy commenced.”   Regardless of whether the automatic

renewal provision created a year-to-year tenancy,   however, the

parties agreed to discharge the initial agreement when they

executed the 1990 real estate lease.5

     The 1990 agreement increased the monthly rental price from

$5,580 to $7,425.   The rental price is a material term of the

lease and is inconsistent with the rental price stated in the May

1, 1986, agreement.   See Cooperative Refinery Association v.

Consumers Pub. Power Dist., 190 F.2d 852, 858 (8th Cir. 1951);

The Nebraskans, Inc. v. Homan, supra.   The parties’ intent to

replace their earlier agreement is evident in the 1990 agreement

itself.   The document is entitled “Real Estate Lease”, it

includes all material terms of the lease, and it was signed by a



     5
        The 1989 and 1993 agreements reflect changes in the PC’s
name. Respondent argues that the changes in the professional
corporation’s name constitute changes in a party to the lease. A
professional corporation, however, is a legal entity separate
from its shareholders and officers. See Neb. Rev. Stat. sec. 21-
2203 (1997); United States Natl. Bank v. Rupe, 296 N.W.2d 474
(Neb. 1980). A change in a professional corporation’s name does
not change the underlying entity. See Neb. Rev. Stat. secs. 21-
2204, 21-20,116, 21-20,124 (1997). Likewise, changes in the
ownership of the 1203 Partnership do not amount to a change in a
party to the lease. See Neb. Rev. Stat. secs. 67-306(1), 67-330
(1996); Ravenna Bank v. Custom Unlimited, 391 N.W.2d 557, 561-562
(Neb. 1986); Bailey v. McCoy, 193 N.W.2d 270, 273 (Neb. 1971).
                               - 15 -

general partner of the 1203 Partnership and by the president of

the PC.

     In contrast to the contracts at issue in In re Estate of

Wise, supra, where the Supreme Court of Nebraska determined that

a subsequent contract was intended to supplement an earlier

contract, the 1990 agreement makes no reference to any earlier

agreements executed between the PC and the 1203 Partnership.    The

1990 agreement is complete in and of itself.   As a contract

complete in itself, varying a material term, the 1990 agreement

replaces the 1986 agreement.

     The 1203 Partnership’s rental income from the PC during the

years in issue, therefore, is not attributable to a written

binding contract entered into before February 19, 1988.

     With respect to the three lease agreements between BMS and

the 1203 Partnership executed from July 1, 1984, to November 1,

1989, petitioners make the same arguments as with the PC rental

agreements.   The BMS agreements, however, are distinguishable in

that they create month-to-month tenancies.   Each agreement

provides that the term of the lease is from the date on which the

agreement was executed and further provides:   “There shall be no

ending term and the lease shall be offered by lessor and accepted

by lessee from month to month.”

     In some jurisdictions, a month-to-month tenancy is

considered a continuous tenancy, and in some it is considered a
                                - 16 -

recurring tenancy.    See 51C C.J.S., Landlord and Tenant, sec. 145

at 438 (1968); 49 Am.Jur.2d, Landlord and Tenant, sec. 130

(1995).    In those jurisdictions that view the tenancy as

recurring, the tenancy ends and recommences at the expiration of

every month.    See 51C C.J.S., Landlord and Tenant, sec. 145 at

438 (1968).    It is not clear from the case law whether Nebraska

views a month-to-month tenancy as continuous or recurring.

Nevertheless, we find that the initial agreement between the

Partnership and BMS was replaced by the November 1, 1989,

agreement.

     The 1989 agreement decreased the monthly rental from $915 to

$720.    It also decreased the office space rented from

approximately 1,270 square feet to approximately 1,000 square

feet.6    These changes to the material terms of the lease

incorporated in a complete contract executed by the parties are

inconsistent with the initial agreement between the parties.    The

intent of the parties that the 1989 agreement supercede the

earlier agreement is evident in the documents themselves.

     Thus, the rental income received by the 1203 Partnership

from BMS during the years in issue is not attributable to a

written binding contract entered into before February 19, 1988.

     6
        Because the space rented by the PC was described as the
1203 office building, “except that portion of said building
occupied by Business Management Services”, the decrease in the
space rented by BMS resulted in an increase in the space rented
by the PC.
                                - 17 -

     Material Participation

     Even if petitioners’ income is not attributable to property

leased under a written binding contract entered into before

February 19, 1988, petitioners argue that a portion of the income

is nevertheless passive income because petitioner was not a

material participant in BMS.    Respondent objects to petitioners’

argument, asserting that petitioners have not properly raised

this issue before the Court and that, in any case, petitioners

have failed to establish that the 1203 Partnership’s lease

relationship with BMS constitutes a separate activity from its

lease relationship with the PC.

     Rule 34 requires that the petition contain clear and concise

assignments of each and every error alleged and statements of

facts on which petitioner relies to sustain each assignment of

error.   See Rule 34(b)(4) and (5).      The purpose underlying the

Court’s pleadings requirements is to give the parties and the

Court fair notice of the matters in controversy.       See Rule 31(a).

Generally, issues not raised in the assignments of error in the

petition are deemed conceded.    See Rule 34(b)(4).    Nevertheless,

it is within the discretion of the Court to determine 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
                              - 18 -

evidence.   See Ware v. Commissioner, 92 T.C. 1267, 1268 (1989),

affd. 906 F.2d 62 (2d Cir. 1990).

     It is clear that petitioners did not provide notice in their

petition of an intent to challenge the extent of petitioner’s

participation in BMS.   Their petition states their disagreement

with respondent’s determination in the notice of deficiency

solely as follows:

          We disagree with the adjustment based on Reg. Sec.
     1.469-11(c)(1)(ii). The income from the “1203
     Partnership” was attributable to the rental of property
     pursuant to a written binding contract entered into
     before February 19, 1988, and thus was properly
     reported as passive income.

     Petitioners never amended their petition to raise or assert

any other issue.   No pretrial memoranda were filed by either

party.   Counsel for petitioners first raised the issue of

petitioner’s participation in BMS in his opening statement.

Nevertheless, petitioners argue that respondent should have been

on notice that petitioner’s participation in BMS was at issue

because petitioners stipulated that petitioner was a material

participant in the PC but did not make such a stipulation with

regard to BMS.

     Although the recharacterization rule applies only to a

taxpayer’s rental income from property rented for use in a trade

or business in which the taxpayer materially participates, see

sec. 1.469-2(f)(6), Income Tax Regs., rules governing the

grouping of activities prohibit a partner from treating
                                - 19 -

activities grouped together by a section 469 entity as separate

activities; see sec. 1.469-4(c)(5), Income Tax Regs.      Therefore,

if the 1203 Partnership grouped its rentals to the PC and to BMS

as a single activity, petitioners are not at liberty to treat the

income from the rentals as from two separate activities.      If the

rentals constitute a single activity, it is irrelevant whether

petitioner was a material participant in BMS.      His material

participation in the PC is sufficient to recharacterize all of

his share of the 1203 Partnership’s income.

       Under these circumstances, the fact that the parties made no

stipulation regarding petitioner’s participation in BMS would not

give respondent notice that petitioners intended to contest this

issue.    Respondent, however, did not object to testimony elicited

from the PC’s president concerning petitioner’s involvement with

BMS.    When issues not raised by the pleadings are tried by

implied consent of the parties, the issues are treated as if they

had been raised in the pleadings.    See Rule 41(b).    Failure to

amend the pleading, does not affect the result of the trial of

these issues.    See id.   When petitioner introduced the issue at

trial and respondent acquiesced in the introduction of evidence

on that issue without objection, Rule 41(b) was satisfied.         See

Parekh v. Commissioner, T.C. Memo. 1998-151; Chiu v.

Commissioner, T.C. Memo. 1997-199.       We, therefore, consider
                               - 20 -

whether the portion of rental income attributable to the BMS

lease is exempt from recharacterization.

     Material participation is defined as involvement in the

operations of an activity on a regular, continuous, and

substantial basis.   See sec. 469(h)(1).   A taxpayer materially

participates in an activity if he satisfies one of seven tests

provided in the regulations.   See sec. 1.469-5T(a), Temporary

Income Tax Regs., 53 Fed. Reg. 5725 (Feb. 25, 1988); see also

Mordkin v. Commissioner, T.C. Memo. 1996-187.

     Matthew Shonsey was petitioners’ sole witness.    When asked

whether he was familiar with the people who rendered “services

for Business Management Services to its clients”, he identified

four individuals as “programmers that rendered the major

services.”   Mr. Shonsey then was asked whether petitioner ever

rendered any services for BMS.   He responded “No.”   He further

testified that BMS does not have the same officers and directors

as the PC; however, he did not indicate whether petitioner was a
director or officer of BMS.

     We are not persuaded by Mr. Shonsey’s testimony that

petitioner did not provide any services for BMS.    It is unclear

whether Mr. Shonsey intended to testify that petitioner did not

render services for BMS’s clients or whether he did not provide

any services for BMS.   Further, he failed to provide specific

information about the management of BMS.    Under these

circumstances, petitioners have failed to establish that
                              - 21 -

petitioner was not a material participant in BMS.   See 1.469-

5T(a), Temporary Income Tax Regs., 53 Fed. Reg. 5725-5726 (Feb.

25, 1988).

     Regardless of whether petitioner materially participated in

BMS, petitioners have not provided any evidence that the 1203

Partnership treated their rentals to the PC and to BMS as

separate activities.   If the 1203 Partnership grouped its rentals

to the PC and to BMS as a single activity, petitioners may not

treat the income from the rentals as from two separate

activities.   See sec. 1.469-4(c)(5), Income Tax Regs.   Under the

general rules for grouping activities, one or more 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.   See 1.469-4(c)(1),

Income Tax Regs.   The facts and circumstances used to determine

whether activities constitute an appropriate economic unit all

point toward the two rentals’ being considered one economic unit.

See sec. 1.469-4(c)(2), Income Tax Regs.

     Accordingly, we uphold respondent’s determination that all

of petitioners’ income from the 1203 Partnership is not from a

passive activity pursuant to the recharacterization rule of

section 1.469-2(f)(6), Income Tax Regs.
                            - 22 -

    Reviewed and adopted as the report of the Small Tax Case

Division.

                                       Decision will be entered

                                  for respondent.
