                         T.C. Memo. 2012-14



                       UNITED STATES TAX COURT



         RAYMOND AND KATHLEEN VANDEGRIFT, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 11704-09.                Filed January 12, 2012.



     J. Richard Greenstein, for petitioners.

     James H. Harris, Jr., for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GOEKE, Judge:    Respondent determined an income tax

deficiency for 2005 and an accuracy-related penalty pursuant to

section 6662(a).1    As a result of the parties’ concessions before



     1
      All section references are to the Internal Revenue Code
(Code) in effect for the year in issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
                                - 2 -

trial, the issues remaining for decision all center around the

real estate business activities of petitioner Raymond Vandegrift

(Mr. Vandegrift), specifically, (1) whether he was a real estate

professional under section 469(c)(7)(B), and (2) whether several

real properties sold in 2005 were part of his real estate

business.   For the reasons explained herein, we hold that Mr.

Vandegrift was not a real estate professional, the properties

sold were part of his real estate business, and the sale proceeds

must be netted against the loss on passive activities.    We also

uphold the accuracy-related penalty but only regarding the

underpayment related to the overstated basis in the properties

sold.

                          FINDINGS OF FACT

     Petitioners resided in Pennsylvania at the time they filed

their petition.    They timely filed a joint Federal income tax

return for 2005.    Petitioners had nine children, whom they

claimed as dependents on their return.

     Some of the facts have been stipulated, and those facts are

incorporated by this reference.

     Respondent issued a notice of deficiency to petitioners in

February 2009 in which he determined for 2005 a deficiency of

$53,568 and an accuracy-related penalty of $10,713.60.

     During 2005 petitioners owned nine real estate properties in

addition to their residence, six of which were actively rented.
                                - 3 -

The remaining three of these properties were acquired as rental

properties and were to be rehabilitated to be prepared as rental

units, but they were sold before they were rented.      The three

properties which were sold were acquired as part of the rental

operations Mr. Vandegrift directed.      These three properties were

at 7844 Gilbert Street, 3023 Dowitcher Street, and 3319 G Street

(the three properties).   The three properties sold were held for

less than 1 year before sale.

     Petitioners treated all nine properties as rental properties

on their 2005 return and deducted losses from all nine of the

properties from the gains they reported from the sale of the

three properties.   The 2005 return reflected a total real estate

loss of $25,385, of which $11,674, including depreciation, was

associated with the three properties petitioners sold and the

remaining $13,711 was from the six properties which were

generating rent.    The 2005 return reflected a gain on the three

sales of $39,388; respondent maintains the actual gain is

$102,579.

     Mr. Vandegrift, in addition to his real estate activity, was

employed as a salesman by Hillyard, Inc.      He earned roughly

$120,000 in this position in 2005.      He maintains that he spent

over one-half of his business-related time and over 750 hours on

the real estate activities.   He did not maintain contemporaneous

records of his time, and the trial record does not reflect any
                                - 4 -

objective measure of the time he spent as either an employee of

Hillyard, Inc., or as a real estate businessman.

     The sale of the property at 3023 Dowitcher Street in

Philadelphia required petitioners to pay $3,000 in State transfer

taxes, which was not allowed as an offset of the sale proceeds by

respondent and is properly treated as additional basis.

                               OPINION

I.   Burden of Proof

     The Commissioner’s determinations in the notice of

deficiency are presumed correct, and the taxpayer bears the

burden of proving that the Commissioner’s determinations are

incorrect.    Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115

(1933).   However, section 7491(a)(1) provides that subject to

certain limitations, where a taxpayer introduces credible

evidence with respect to a factual issue relevant to ascertaining

the taxpayer’s tax liability, the burden of proof shifts to the

Commissioner with respect to such issue.   Section 7491(a)(2)

provides that section 7491(a)(1) shall apply with respect to a

factual issue only if the taxpayer has complied with certain

substantiation requirements and maintained all records required

by the Code and cooperated with reasonable requests by the

Secretary for witnesses, information, documents, meetings, and

interviews.   Petitioners did not maintain contemporaneous records

accurately accounting for the time Mr. Vandegrift spent as an
                                  - 5 -

employee of Hillyard, Inc., or as a real estate businessman.

Accordingly, we find that petitioners have the burden of proof in

this case under Rule 142(a) because section 7491(a) does not

operate to shift the burden to respondent on this record.     We

note also that respondent does have the burden of production

regarding the penalty.   See sec. 7491(c).

II.   Whether Mr. Vandegrift Was in the Real Estate Business Under
      Section 469(c)(7)

      Section 469(a)(1)(A) operates to generally disallow passive

activity losses.   A passive activity loss is defined as the

excess of the aggregate losses from all passive activities for a

year over the aggregate income from all passive activities for

the year.   Sec. 469(d)(1).   Passive activities include any trade

or business in which the taxpayer does not “materially

participate”.   Sec. 469(c)(1).    Section 469(c)(2) provides that

except as provided in section 469(c)(7), the term “passive

activity” definitively includes any rental activity.

      Section 469(c)(7)(B) defines the taxpayers relieved from

passive loss treatment as those who perform more than one-half of

their personal services in real property trades or businesses in

which they materially participate, and who perform more than 750

hours of services in real property trades or businesses in which

they materially participate.   For taxpayers filing a joint

return, only one need qualify.
                               - 6 -

     Petitioners maintain Mr. Vandegrift qualifies as such an

individual.   He testified that over one-half of the total time he

spent in business activity was devoted to the real estate

business.   We found Mr. Vandegrift to be generally honest and

forthright, but his time estimate is suspect given his employment

as a salesman for an employer in a business unrelated to the real

estate activity.   His subjective estimate also suffers from a

lack of contemporaneous verification by records or other

evidence.   Section 1.469-5T(f)(4), Temporary Income Tax Regs., 53

Fed. Reg. 5727 (Feb. 25, 1988), sets forth the requirements

necessary to establish the taxpayer’s hours of participation as

follows:

     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.

We have held that the regulations do not allow a postevent

“ballpark guesstimate” of time committed to participation in a

rental activity.   Moss v. Commissioner, 135 T.C. 365, 369 (2010);

Bailey v. Commissioner, T.C. Memo. 2001-296; Goshorn v.

Commissioner, T.C. Memo. 1993-578.     We are forced to find on the

record before us that petitioners have failed to carry their
                                    - 7 -

burden of establishing that Mr. Vandegrift spent over one-half

his work time in the real estate business.        Accordingly, we hold

that Mr. Vandegrift does not satisfy the terms of section

469(c)(7)(B) for 2005.

III.       Whether the Properties Sold Were Part of the Rental Real
           Estate Business, and Whether the Rental Losses May Be
           Netted Against the Sale Gains

       Respondent argues that because the three properties sold in

2005 were not rented, there is short-term capital gain on the

sales which may not be offset by the losses on the other real

estate activity.       Because of our prior holding, the rental real

estate loss is passive.       Respondent argues the loss may not be

offset against petitioners’ income because petitioners’ gross

income exceeds the limitations on allowable passive real estate

losses.       See sec. 469(i).2   Petitioners counter that regardless

of whether the rental real estate loss is passive, all of the

real estate activities were part of one single business, and the


       2
        Sec. 469(i)(1) provides:

       In the case of any natural person, subsection (a) shall
       not apply to that portion of the passive activity loss
       or the deduction equivalent * * * of the passive
       activity credit for any taxable year which is
       attributable to all rental real estate activities with
       respect to which such individual actively participated
       in such taxable year * * *

     The sec. 469(i) exception is limited to $25,000. Sec.
469(i)(2). The $25,000 maximum “offset”, however, begins to be
phased out for taxpayers whose adjusted gross income exceeds
$100,000 and is completely phased out for taxpayers whose
adjusted gross income is $150,000 or more. Sec. 469(i)(3)(A).
                                - 8 -

losses and gains in that single business must be netted to

determine passive income.

      This issue is resolved by our factual determination that the

real estate activities constituted one trade or business and by

the definitions of passive activity in section 469(c) and of

passive activity loss in section 469(d)(1).   Section 469(c)(1)

provides that passive activity means an activity involving the

conduct of a trade or business in which the taxpayer does not

materially participate.    Mr. Vandegrift’s real estate activities

meet this definition.   Section 469(d)(1) requires that aggregate

losses from passive activities be netted with aggregate income

from such activities.

      Mr. Vandegrift testified he initially acquired the three

properties sold in 2005 with the intent to rent them; however,

various circumstances eventually made a quick sale of the

properties more advantageous to his real estate business.    His

testimony in this regard was credible, and we hold that the

properties sold were part of the same passive real estate

activity as the rental properties and that the proceeds should be

netted with the rental loss to determine the correct amount of

passive income for 2005.

IV.   Whether the Penalty Is Applicable

      Section 6662 authorizes the Commissioner to impose a 20-

percent penalty on an underpayment of tax that is attributable
                               - 9 -

to, among other items, negligence or any substantial

understatement of income tax. Sec. 6662(a) and (b)(1) and (2).

For purposes of section 6662, “negligence” is defined as any

failure to make a reasonable attempt to comply with the

provisions of the Code, and “disregard” includes any careless,

reckless, or intentional disregard.    Sec. 6662(c); see also Neely

v. Commissioner, 85 T.C. 934, 947 (1985) (negligence is lack of

due care or failure to do what a reasonably prudent person would

do under the circumstances).   A return position that has a

reasonable basis is not attributable to negligence.    Sec. 1.6662-

3(b)(1), Income Tax Regs.   Similarly, under section 6664(c)(1),

no penalty is imposed under section 6662 with respect to any

portion of an underpayment if it is shown that there was

reasonable cause for such portion and that the taxpayer acted in

good faith with respect to such portion.

     Respondent has determined that the 20-percent penalty under

section 6662(a) is applicable on the basis of negligence and a

substantial understatement of income tax.   Petitioners argue that

they relied in good faith on their return preparer and that such

reliance was reasonable cause for their underpayment.    Regarding

the underpayment related to the overstated itemized deductions

which they did not contest at trial, we find petitioners’

reliance on their return preparer to be reasonable.    Also, we

find that because of the technical nature of the question of
                              - 10 -

whether Mr. Vandegrift was a real estate professional, they were

acting in good faith in claiming the activities were not passive.

However, we find that their underpayment is not subject to a

reasonable cause defense with regard to the overstated basis and

expenses in the real estate business.   The errors in reporting

these items cannot be laid solely at the feet of the return

preparer.   Mr. Vandegrift is primarily responsible for the

numbers on the return regarding the real estate business.     To the

extent excess basis and expenses were claimed on the return, an

underpayment results and the accuracy-related penalty is

applicable and upheld.

     To reflect the foregoing and concessions by the parties,


                                         Decision will be entered

                                    under Rule 155.
