                        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
                                          -2-

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.
                                          -3-

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
                                         -4-

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.
                                         -5-

                                     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).
                                          -6-

      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,
                                          -7-

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.
                                          -8-

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:
                                           -9-

             (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.
                                            -11-
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
                                          -12-

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.
