                           T.C. Summary Opinion 2013-15



                          UNITED STATES TAX COURT



      RENATO R. GHILARDI AND MARILYN GHILARDI, Petitioners v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 3640-11S.                           Filed February 21, 2013.



      Renato R. Ghilardi and Marilyn Ghilardi, pro sese.

      Eugene Kornel, Jessica Browde, and Gerard Mackey, for respondent.



                                SUMMARY OPINION


      GALE, 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 Pursuant to


      1
      Unless otherwise noted, all section references are to the Internal Revenue
Code of 1986, as in effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
                                          -2-

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.

      Respondent determined deficiencies in petitioners’ 2008 and 2009 Federal

income tax of $10,880 and $10,048, respectively, and accuracy-related penalties

under section 6662(a) of $2,176 and $2,009.60, respectively. The issues for decision

are: (1) whether section 469 precludes petitioners’ deductions of rental real estate

losses for 2008 and 2009 in excess of those respondent allowed; and (2) whether

petitioners are liable for accuracy-related penalties.2

                                      Background

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

facts and the accompanying exhibits are incorporated herein by this reference. At the

time the petition was filed, petitioners resided in New York.

      Mr. Ghilardi was a licensed real estate salesperson during the years at issue.

He operated under the supervision of a real estate broker and reported net losses on

Schedules C, Profit or Loss From Business, attached to petitioners’ joint Federal

income tax returns for the years at issue. Mr. Ghilardi did not close any transactions

as a real estate salesperson in 2008 or 2009, and he reported no income from such

      2
       The notice of deficiency also increased the taxable amount of petitioners’
Social Security benefits by $1 for each year. Petitioners have not contested those
adjustments.
                                          -3-

work for either year. During those years Mr. Ghilardi also worked between 15 and

18 hours per week as a driver education instructor. Mrs. Ghilardi worked as a

software writer for a computer technology company.

      Mr. Ghilardi owned 50% of a two-unit residential rental property during the

years at issue. Petitioners reported deductible losses from the rental property of

$53,604 for 2008 and $46,449 for 2009 on Schedules E, Supplemental Income and

Loss, attached to their returns for those years.

      Respondent disallowed the rental real estate losses petitioners claimed for

2008 and 2009 in the respective amounts of $48,825 and $40,185.50 on the grounds

that the losses were generated by a passive activity, resulting in a deficiency for each

year.3 Petitioners timely petitioned for redetermination.

                                       Discussion

Rental Real Estate Losses

      Deductions are a matter of legislative grace, and the burden of showing

entitlement to a claimed deduction is on the taxpayer.4 Rule 142(a); INDOPCO, Inc.

v. Commissioner, 503 U.S. 79, 84 (1992). Section 469 generally prohibits individual


      3
        Pursuant to sec. 469(i) respondent allowed petitioners’ deductions for rental
real estate losses of $4,779 for 2008 and $6,263.50 for 2009.
      4
       Petitioners have not claimed or shown entitlement to any shift in the burden
of proof pursuant to sec. 7491(a).
                                          -4-

taxpayers from currently deducting “passive activity” losses. A passive activity is,

generally speaking, the conduct of any trade or business in which the taxpayer does

not “materially participate”. Sec. 469(c)(1). In general, a taxpayer is treated as

materially participating in a trade or business if the taxpayer is involved in the

operations of the trade or business on a regular, continuous, and substantial basis.5

Sec. 469(h)(1). A “passive activity loss” is the amount by which the aggregate

losses from all passive activities for the taxable year exceed the aggregate income

from all passive activities for such year. Sec. 469(d)(1).

      Rental activities are generally treated as per se passive activities regardless of

whether the taxpayer materially participates. Sec. 469(c)(2), (4). However, the

rental activities of taxpayers in real property trades or businesses (real estate

professionals) are not per se passive activities but are treated as trades or businesses

subject to the material participation requirements of section 469(c)(1).6 Sec. 1.469-




      5
       Congress delegated the Secretary authority to prescribe regulations which
specify what constitutes “material participation”. Sec. 469(l)(1). The Secretary
promulgated seven regulatory tests in sec. 1.469-5T(a), Temporary Income Tax
Regs., 53 Fed. Reg. 5725 (Feb. 25, 1988). A taxpayer who satisfies any one of the
seven tests meets the material participation requirement.
      6
       A real property trade or business means any real property development,
redevelopment, construction, reconstruction, acquisition, conversion, rental,
operation, management, leasing, or brokerage trade or business. Sec. 469(c)(7)(C).
                                           -5-

9(e)(1), Income Tax Regs. Under section 469(c)(7)(B) a taxpayer is a real estate

professional if:

             (i) 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, and

             (ii) such taxpayer performs more than 750 hours of services
      during the taxable year in real property trades or businesses in which
      the taxpayer materially participates.

In the case of a joint return, the foregoing requirements for qualification as a real

estate professional are satisfied if, and only if, either spouse separately satisfies the

requirements. Sec. 469(c)(7)(B). Thus, if either spouse qualifies as a real estate

professional, the rental activities of the real estate professional are not per se passive

under section 469(c)(2).

      With respect to the evidence that a taxpayer may use to establish his or her

hours of participation in a trade or business, section 1.469-5T(f)(4), Temporary

Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988), provides:

      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
                                          -6-

      services during such period, based on appointment books, calendars, or
      narrative summaries.

While the regulations allow taxpayers some latitude in establishing the extent of their

participation in an activity, we have consistently held that they do not allow a

postevent “ballpark guesstimate”. See Goshorn v. Commissioner, T.C. Memo.

1993-578; see also Moss v. Commissioner, 135 T.C. 365, 369 (2010); Fowler v.

Commissioner, T.C. Memo. 2002-223.

      Petitioners argue that their rental real estate losses are not passive activity

losses because Mr. Ghilardi was a real estate professional and he materially

participated in the operation of the rental property.7 Petitioners did not offer any

contemporaneous evidence of the time Mr. Ghilardi spent performing services in real

property trades or businesses during the years at issue. Instead, to substantiate their

claim they rely on a narrative and calendars Mr. Ghilardi prepared after the Internal

Revenue Service (IRS) began its examination of petitioners’ 2008 and 2009 returns.8

The calendars and the narrative purport to show that Mr. Ghilardi spent over 750

hours performing services as a real estate salesperson in each of 2008 and 2009.


      7
       Petitioners do not contend that Mrs. Ghilardi was a real estate professional
during the years at issue.
      8
       Mr. Ghilardi generated blank 2008 and 2009 calendars on a Web site and
printed them. He wrote shorthand notations on the calendars and explained the
notations in a one-page email he sent to an IRS employee (narrative).
                                         -7-

Petitioners did not offer any evidence indicating the amount of time Mr. Ghilardi

spent performing services with respect to the rental property.

      We have found postevent narratives sufficient to establish taxpayers’

participation in an activity when such narratives are supported by credible testimony

and other objective evidence. See Assaf v. Commissioner, T.C. Memo.

2005-14; Pohoski v. Commissioner, T.C. Memo. 1998-17; Harrison v.

Commissioner, T.C. Memo. 1996-509. However, the materials petitioners submitted

and Mr. Ghilardi’s supporting testimony are not credible. According to the calendars

and narrative Mr. Ghilardi performed the following activities throughout 2008 and

2009: (1) showed rental properties for two hours every Tuesday; (2) viewed new

real estate listings for three hours every Wednesday; (3) showed homes to

prospective buyers for five hours every Sunday, including the Sunday after Christmas

and Easter Sunday; and (4) attended a one-hour meeting every weekday, except on

certain Federal holidays. Thus, petitioners ask us to believe that Mr. Ghilardi’s

weekly real estate activities were identical in nature and duration for two consecutive

years, slightly exceeding the 750 hours per year necessary to qualify him as a real

estate professional for each year. We decline to do so, especially in the light of the

complete lack of corroborating evidence and petitioners’ admission that Mr. Ghilardi

closed no transactions and earned no income as a real estate salesperson during the
                                          -8-

years at issue. The calendars and the narrative do not appear to be a good-faith

attempt to reconstruct Mr. Ghilardi’s activities for 2008 and 2009; at best, they

represent a postevent ballpark guesstimate, the likes of which we have consistently

rejected.

      We conclude that the method petitioners used to approximate Mr. Ghilardi’s

participation in real property trades or businesses is not reasonable within the

meaning of section 1.469-5T(f)(4), Temporary Income Tax Regs., supra. Petitioners

have failed to prove that Mr. Ghilardi spent more than 750 hours performing services

in real property trades or businesses during either year at issue. See sec.

469(c)(7)(B)(ii). They have also failed to prove that Mr. Ghilardi spent more time

performing services in real property trades or businesses than he spent teaching

driver education. See sec. 469(c)(7)(B)(i). Because Mr. Ghilardi does not qualify as

a real estate professional under section 469(c)(7), petitioners’ rental real estate

activity is treated as a per se passive activity under section 469(c)(2).9

      Even though we have held that petitioners’ rental real estate losses were

passive, they are able to deduct a portion of those losses under section 469(i).

Section 469(i) provides a limited exception to the general rule that passive activity

      9
        Because petitioners failed to establish that Mr. Ghilardi was a real estate
professional for either year at issue, we need not analyze whether he materially
participated in the rental real estate activity.
                                           -9-

losses are disallowed. A taxpayer who “actively participated” in a rental real estate

activity for the taxable year may deduct a loss of up to $25,000 per year related to

the activity.10 Sec. 469(i)(1). The $25,000 maximum allowable deduction is reduced

by 50% of the amount by which adjusted gross income (AGI), as modified by section

469(i)(3)(F), exceeds $100,000 and is thus fully phased out when modified AGI

reaches $150,000. Sec. 469(i)(3)(A).

      In the notice of deficiency respondent conceded that petitioners “actively

participated” in the rental real estate activity that gave rise to the claimed losses for

2008 and 2009 and pursuant to section 469(i) allowed them deductions for rental real

estate losses of $4,779 for 2008 and $6,263.50 for 2009. However, it is apparent

that respondent erroneously calculated the loss petitioners are entitled to claim for

each year. The notice of deficiency correctly determined that, in petitioners’ case,

modified AGI under section 469(i)(3)(F) equals AGI after the application of section

469(c)(2) and (a), plus the deductions allowed under section 219 for qualified

retirement contributions, less the taxable amount of Social Security benefits under

section 86. See also sec. 1.469-9(j), Income Tax Regs. However, respondent


      10
        The “active participation” standard is met as long as the taxpayer
participates in a significant and bona fide sense in making management decisions or
arranging for others to provide services such as repairs. See Madler v.
Commissioner, T.C. Memo. 1998-112.
                                        - 10 -

erroneously used total (or gross) income for each year instead of AGI as the starting

point in calculating petitioners’ allowable deductions. As a consequence,

petitioners’ $6,000 deduction for qualified retirement contributions for each year was

effectively added back twice, thereby overstating modified AGI by $6,000 for each

year. The result is that respondent’s computations understate the deductions

allowable to petitioners under section 469(i) by $3,000 for each year.11

      Consequently, we conclude and hold that petitioners are entitled to deductions

for their rental real estate losses of $7,779 and $9,263 for 2008 and 2009,

respectively.




      11
         For 2008 petitioners’ AGI after application of sec. 469(a) and (c)(2) was
$142,498 ($88,894 in reported AGI plus $53,604 in claimed losses from passive
activities). They claimed a $6,000 deduction for qualified retirement contributions
and had $14,056 of taxable Social Security benefits. Thus, their modified AGI for
2008 was $134,442 ($142,498 + $6,000 - $14,056 = $134,442). Accordingly,
under sec. 469(i) petitioners were allowed to deduct $7,779 of their rental real
estate losses for 2008, calculated as follows: $25,000 - ($134,442 - $100,000) / 2 =
$7,779.
       For 2009 petitioners’ AGI after application of sec. 469(a) and (c)(2) was
$140,346 ($93,897 in reported AGI plus $46,449 in claimed losses from passive
activities). They claimed a $6,000 deduction for qualified retirement contributions
and had $14,872 of taxable Social Security benefits. Thus, petitioners’ modified
AGI was $131,474 ($140,346 + $6,000 - $14,872 = $131,474). Accordingly, under
sec. 469(i) petitioners were allowed to deduct $9,263 of their rental real estate
losses for 2009, calculated as follows: $25,000 - ($131,474 - $100,000) / 2 =
$9,263.
                                         - 11 -

Accuracy-Related Penalties

      Section 6662(a) and (b)(2) imposes a penalty of 20% of an underpayment of

tax required to be shown on a return that is attributable to a substantial

understatement of income tax. An “understatement” is the excess of the amount of

tax required to be shown on a return over the amount of tax shown on the return.

Sec. 6662(d)(2)(A). An understatement is substantial when it exceeds the greater of

10% of the tax required to be shown on the return or $5,000. Sec. 6662(d)(1)(A).

      The Commissioner bears the burden of production with respect to a taxpayer’s

liability for penalties. Sec. 7491(c). To satisfy that burden, the Commissioner must

offer sufficient evidence to indicate that it is appropriate to impose the penalty. See

Higbee v. Commissioner, 116 T.C. 438, 446 (2001). If the Commissioner satisfies

his burden of production, the taxpayer bears the burden of proving it is inappropriate

to impose the penalty because of reasonable cause, substantial authority, or a similar

provision. Id.

      Respondent determined that petitioners are liable for accuracy-related

penalties for 2008 and 2009 because their underpayments of tax for those years are
                                         - 12 -

due to negligence and/or a substantial understatement of income tax.12 Petitioners’

disallowed deductions for their rental real estate losses, as redetermined by this

Court, result in income tax understatements that exceed both 10% of the tax required

to be shown on petitioners’ returns for those years and $5,000. Thus, respondent has

met his burden of production.

        The section 6662(a) penalty is not imposed on any portion of an underpayment

as to which the taxpayer acted with reasonable cause and in good faith. Sec.

6664(c)(1). The determination of whether a taxpayer acted with

reasonable cause and good faith is made on a case-by-case basis, taking into account

all pertinent facts and circumstances, the most important of which is the taxpayer’s

effort to assess his or her proper tax liability. Sec. 1.6664-4(b)(1), Income Tax

Regs.

        Petitioners claim they used TurboTax software to prepare their returns and

accurately answered the questions it presented to them. They argue they are not

liable for accuracy-related penalties because their actions were not “deliberately

negligent” or intentional. However, a showing that the errors on petitioners’ returns

were not intentional would fall far short of demonstrating reasonable cause, which

        12
        Because we conclude hereinafter that there were substantial
understatements of income tax on petitioners’ 2008 and 2009 returns, we need not
address whether petitioners were also negligent. See sec. 6662(b).
                                         - 13 -

concerns whether a good-faith effort to comply was made. Petitioners claimed losses

of $53,604 and $46,449 for 2008 and 2009, respectively, with respect to the rental

real estate activity--amounts approximately half of their reported income for each

year. At trial Mr. Ghilardi admitted that he did not consult with anyone regarding

how to report the results of the rental real estate activity and acknowledged that he

was unaware of the passive activity loss rules until the IRS selected petitioners’

returns for examination. Further, petitioners provided no evidence of the information

that they entered into TurboTax, a preliminary showing that would be required to

decide whether the software program is in any way at fault for petitioners’

underpayments. See Anyika v. Commissioner, T.C. Memo. 2011-69; Paradiso v.

Commissioner, T.C. Memo. 2005-187.

      Given the magnitude of the claimed losses, we conclude that petitioners have

failed to show that they made a reasonable effort to assess the proper treatment of

their rental real estate losses. Accordingly, they did not have reasonable cause for

the underpayments for either year. We therefore sustain respondent’s determination

of the accuracy-related penalties for 2008 and 2009.
                            - 14 -

To reflect the foregoing,


                                           Decision will be entered

                                     under Rule 155.
