                              T.C. Memo. 2020-46



                        UNITED STATES TAX COURT



            ZAID HAKKAK AND LAYLA NAJI, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 20306-15.                        Filed April 13, 2020.



      Zaid Hakkak and Layla Naji, pro sese.

      Kimberly A. Santos, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      ASHFORD, Judge: By statutory notice of deficiency dated May 12, 2015,

respondent determined deficiencies in petitioners’ Federal income tax of $162,714

and $81,648 and accuracy-related penalties pursuant to section 6662(a) of $32,542
                                         -2-

[*2] and $16,329 for the 2011 and 2012 taxable years (years at issue),

respectively.1 After concessions, there is one issue remaining for decision:

whether petitioners are entitled to treat as nonpassive certain rental real estate

losses they previously treated as passive under section 469 on their Schedules E,

Supplemental Income and Loss, for the years at issue. We resolve this issue in

respondent’s favor.

                                FINDINGS OF FACT

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

facts and the attached exhibits are incorporated herein by this reference.

Petitioners resided in California when they timely filed their petition with the

Court.

I.       Petitioners’ Background

         During at least the years at issue Mr. Hakkak and Ms. Naji were a married

couple and had two children; Ms. Naji was a homemaker and Mr. Hakkak was an

attorney, licensed to practice in the State of California. Mr. Hakkak was

predominantly a personal injury attorney but handled other legal matters such as

bankruptcy and criminal matters. Petitioners reported Mr. Hakkak’s income and

         1
      Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
                                         -3-

[*3] expenses attributable to his non-personal injury work during the years at issue

on Schedules C, Profit or Loss From Business, as further discussed below. Mr.

Hakkak’s personal injury work was conducted through an S corporation, Z Dean

Hakkak, A Professional Law Corp. (Z Dean Hakkak), that he wholly owned.

Petitioners reported the net income attributable to Z Dean Hakkak during the years

at issue on Schedules E, as further discussed below. Z Dean Hakkak was

incorporated in the State of California; its office was in Los Angeles. During the

years at issue it had approximately five salaried employees (none of whom were

attorneys and not including Mr. Hakkak) and four to five “contract attorneys”.

      In addition to practicing law Mr. Hakkak held ownership interests in several

flowthrough entities that held rental real estate, as further discussed below.

II.   Mr. Hakkak’s Rental Real Estate Endeavors

      A.     Joshua Plaza

      Mr. Hakkak held 98% and 99% ownership interests in 2011 and 2012,

respectively, in Joshua Plaza, LLC (Joshua Plaza). Joshua Plaza was a limited

liability corporation registered with the State of Texas and had three members, Mr.

Hakkak and two of his siblings. They formed Joshua Plaza to hold commercial

rental property in Joshua, Texas (Joshua Plaza property). Joshua Plaza purchased

the Joshua Plaza property in 2007; the property is approximately 7,000 square feet
                                       -4-

[*4] and subdivided into five rental units. Joshua Plaza performed no activities

other than holding the Joshua Plaza property and renting the property’s units.

      During the years at issue most of the units in Joshua Plaza were leased.

However, the only lease agreement that Mr. Hakkak executed as the “managing”

or “authorized” member of Joshua Plaza during the years at issue with respect to a

unit was in 2011 for Unit 3. The lease agreements (including lease assignment

agreements) in the record for the other units were either executed before Joshua

Plaza acquired the Joshua Plaza property or by Mr. Hakkak on Joshua Plaza’s

behalf before the years at issue.

      B.     Conroe Plaza

      During the years at issue Mr. Hakkak held a 99% ownership interest in

Conroe Plaza, LLC (Conroe Plaza). Conroe Plaza was a limited liability

corporation registered with the State of Texas and had two members, Mr. Hakkak

and one of his siblings. They formed Conroe Plaza to hold commercial rental

property in Conroe, Texas (Conroe Plaza property). Conroe Plaza purchased the

Conroe Plaza property in 2008; the property is approximately 10,000 square feet
                                        -5-

[*5] and subdivided into 10 rental units.2 Conroe Plaza performed no activities

other than holding the Conroe Plaza property and renting the property’s units.

      During the years at issue most of the units in Conroe Plaza were leased.

However, the only lease agreements (including lease assignment agreements) that

Mr. Hakkak executed as the “managing” or “authorized” member of Conroe Plaza

during the years at issue with respect to a unit were for Unit A in 2011 and Units

C, D, and F in 2012. The lease agreements in the record for any other units were

either executed before Conroe Plaza acquired the Conroe Plaza property or by Mr.

Hakkak on Conroe Plaza’s behalf before the years at issue.

      C.    Mr. Hakkak’s Ownership Interests in Other Entities Holding Rental
            Real Property

      During the years at issue Mr. Hakkak also had ownership interests in the

following five flowthrough entities: (1) HMZ Holdings, LLC (HMZ Holdings),

(2) Rowlett Plaza, LLC (Rowlett Plaza), (3) Statewide Realty, (4) West Covina

Petroleum, Inc. (West Covina Petroleum), and (5) Kramer Center, LLC (Kramer

Center). HMZ Holdings owned commercial rental property in Texas (Landmark

900); Rowlett Plaza also owned commercial rental property in Texas; Statewide

Realty and Kramer Center owned residential rental property in California; and

      2
        Any lease agreement with respect to Conroe Plaza actually refers to a unit
as a “suite”.
                                          -6-

[*6] West Covina Petroleum owned a gas station also in California. Petitioners’

tax reporting with respect to these entities is not (or no longer) at issue in this case.

      D.       Management of Joshua Plaza Property and Conroe Plaza Property

      Jung Yu of JYU Realty Management (JYU Realty) in Austin, Texas,

managed the Joshua Plaza property and Conroe Plaza property.3 He (along with

his wife) collected rents from the tenants, deposited the rent checks that were not

directly deposited into the respective bank accounts of Joshua Plaza and Conroe

Plaza, and followed up with tenants regarding any late rents, including hiring a

collection agency to collect past-due rents. In addition to Mr. Hakkak and at least

one of his family members, Mr. Yu had signature authority over the bank accounts

of Joshua Plaza and Conroe Plaza, and he would sometimes pay bills pertaining to

the Joshua Plaza property and the Conroe Plaza property. Mr. Hakkak had no

direct contact with tenants during the years at issue; tenants would contact JYU

Realty for any issues with respect to their units and then Mr. Yu (or his wife)

would contact Mr. Hakkak. JYU Realty was paid a management fee for providing

these services.4


      3
      During the years at issue Mr. Yu also served as the registered agent for
Joshua Plaza and Conroe Plaza.
      4
          JYU Realty was paid a management fee not only for managing the Joshua
                                                                    (continued...)
                                        -7-

[*7] During the years at issue when units in the Joshua Plaza property or the

Conroe Plaza property were vacant and available for rent, different leasing agents

were used to facilitate their rental, including marketing the units and showing the

units to prospective tenants.

      During each year at issue Mr. Hakkak traveled to Texas approximately

twice (generally for three or four days) to check on the various properties in

Texas; however, the record is unclear as to whether he actually checked on the

Joshua Plaza property and the Conroe Plaza property, and petitioners had no

receipts from these travels.

      Various bank account, credit card, insurance, and loan statements and

documents pertaining to Joshua Plaza or Conroe Plaza were addressed to Mr.

Hakkak at the address in Covina, California, which petitioners indicated was their

home address on the 2011 joint return and the 2012 joint return.5 On the basis of


      4
       (...continued)
Plaza property and the Conroe Plaza property but also for managing Landmark
900 and another Texas property identified as “Emerald Plaza”; the record is silent
as to which entity owns Emerald Plaza. Additionally, one of the companies which
served as a leasing agent with respect to the Conroe Plaza property was paid a
nominal “Management Fee” in 2012; however, the record is unclear as to what
management services it provided.
      5
       At trial, however, petitioners stated that they resided in Upland, California,
during the years at issue. The Covina, California, address apparently is the
                                                                        (continued...)
                                         -8-

[*8] some of these statements and documents Mr. Hakkak prepared monthly or

quarterly financial reports with respect to the Joshua Plaza property and the

Conroe Plaza property spanning the years at issue.

III.   Petitioners’ Tax Returns

       Petitioners timely filed (with the assistance of a paid preparer) their Forms

1040, U.S. Individual Income Tax Return, for 2011 (2011 joint return) and 2012

(2012 joint return).

       A.    2011 Joint Return

       As relevant here, on the 2011 joint return petitioners reported Mr. Hakkak’s

“W-2” wages from Z Dean Hakkak of $98,000, a business loss of $5,457 (which

they detailed on a Schedule C attached to the 2011 joint return), and net income

from rental real estate of $135,297 (which they detailed on a Schedule E and a

Form 8582, Passive Activity Loss Limitations, attached to the 2011 joint return).

       On their 2011 Schedule C petitioners reported the gross receipts and

expenses attributable to Mr. Hakkak’s provision of legal services as a sole

proprietor (i.e., his non-personal injury work); they reported gross receipts of

$29,759 and total expenses of $35,216.


       5
       (...continued)
address for Mr. Hakkak’s parents.
                                        -9-

[*9] On their 2011 Schedule E and 2011 Form 8582 petitioners reported the

income attributable to Z Dean Hakkak of $351,4376 as net passive income and net

losses from Joshua Plaza, Conroe Plaza, HMZ Holdings, Rowlett Plaza, Statewide

Realty, West Covina Petroleum, and Kramer Center totaling $214,354 as allowed

passive losses.7 They also reported prior years’ unallowed passive losses from

these entities of $1,786 as allowed passive losses.

      B.     2012 Joint Return

      As relevant here, on the 2012 joint return petitioners reported Mr. Hakkak’s

“W-2” wages from Z Dean Hakkak of $48,193, a business loss of $2,197 (which

they detailed on a Schedule C attached to the 2012 joint return), “[o]ther income”

of $18,000 (described as “Dean Hakkak” on the 2012 joint return), self-

employment tax of $1,427, and a student loan interest deduction of $2,402. They

also attached a Schedule E and a Form 8582 to the 2012 joint return.

      On their 2012 Schedule C petitioners reported the gross receipts and

expenses attributable to Mr. Hakkak’s provision of legal services as a sole


      6
       This amount was based on Z Dean Hakkak’s total income of $1,593,616
and total deductions of $1,241,649 and Mr. Hakkak’s pro rata share of a sec. 179
deduction of $530, as reported on Z Dean Hakkak’s Form 1120S, U.S. Income
Tax Return for an S Corporation, for 2011.
      7
      As relevant here, the reported allowed passive losses from Joshua Plaza
and Conroe Plaza totaled $20,260 and $55,155, respectively.
                                         - 10 -

[*10] proprietor (i.e., his non-personal injury work); they reported gross receipts

of $8,175 and total expenses of $5,978.

      On their 2012 Schedule E and 2012 Form 8582 petitioners reported the

income attributable to Z Dean Hakkak of $33,5848 and the income attributable to

West Covina Petroleum of $5,209 as net passive income and net losses from

Joshua Plaza, Conroe Plaza, HMZ Holdings, Rowlett Plaza, Statewide Realty, and

Kramer Center totaling $38,793 as allowed passive losses.9

IV.   Audit and Determination

      Respondent audited the 2011 joint return and the 2012 joint return. During

the audit petitioners provided calendars handwritten by Mr. Hakkak for 2011 and

2012 that reported the time he purportedly devoted to Joshua Plaza and Conroe

Plaza. These calendars reflected approximations of the hours spent on certain

tasks, with many of them being investor-type activities. For example, the

calendars10 included entries on various dates for “Rev Listings”, “Verify [or


      8
       This amount was based on total income of $1,247,176 and total deductions
of $1,213,592, as reported on Z Dean Hakkak’s Form 1120S for 2012.
      9
        They also reported on the Form 8582 unallowed passive losses from these
entities of $107,769. As relevant here, the reported allowed passive losses from
Joshua Plaza and Conroe Plaza totaled $2,304 and $33,050, respectively.
      10
           The calendars are almost illegible. These examples are taken from partial
                                                                        (continued...)
                                        - 11 -

[*11] “Verified”] Expenses”, “Rev Deposits”, “New Tenant”, “Analyzed [or

“Analyze”] Financials”, “Transfer for the loan”, “Rev interest Rate”, “Verified

Deposits”, “W.C. analysis”, “Rev Returned Item”, “energy reduction”, “lowering

energy use”, “Rental Rates”, “W.C. re Lero Agr”, “Rev Tenants past due”,

“Escrow Statements”, “Loan Rev”, “Rev Tax and Insurance”, “Review TI Costs”,

“W. Covina Marketing”, “W. covina financial”, “W. covina status”, “W. covina

Image”, “W. covina supplier”, “W. Covina Supply Agr”, “Rev bank statements”,

“Rev property taxes”, “Rev CAM charges”, “W.C. re money”, and “Prepare

Document”. Some of the entries indicated the time spent, others did not; and some

of the same entries indicated the exact same amount of time spent.11 Totals of

1,521.5 and 755 hours are reflected for 2011 and 2012, respectively.

      Petitioners did not provide time logs or calendars reporting the time Mr.

Hakkak spent during the years at issue with respect to Z Dean Hakkak or his

Schedule C legal business. Mr. Hakkak suffered some health problems during the




      10
        (...continued)
transcriptions of these calendars that petitioners provided to respondent’s counsel
approximately a week before the trial of this case.
      11
         As far as the entries with no indicated time spent, Mr. Hakkak stated at
trial that the subsequent entry with time indicated represents the time spent for the
entry with the time indicated and the above-listed entry with no time indicated.
                                        - 12 -

[*12] years at issue, but at trial he acknowledged that he was able to work as an

attorney (primarily from home) during these years.

      In the May 12, 2015, notice of deficiency respondent made various

adjustments to petitioners’ income; to wit, respondent determined that the reported

passive income attributable to Z Dean Hakkak was nonpassive and that therefore

they could not net the reported passive losses from Joshua Plaza and Conroe Plaza

(and the other reported entities) against this income. The parties have resolved all

issues with respect to the years at issue except that petitioners now seek to treat as

nonpassive the losses from Joshua Plaza and Conroe Plaza that they previously

treated as passive.

                                      OPINION

I.    Burden of Proof

      In general, the Commissioner’s determinations set forth in a notice of

deficiency are presumed correct, and the taxpayer bears the burden of proving

otherwise. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Tax

deductions are a matter of legislative grace, and the taxpayer bears the burden of

proving entitlement to any deduction claimed. Segel v. Commissioner, 89 T.C.

816, 842 (1987). As relevant here, this burden requires the taxpayer to

demonstrate that the claimed deductions are allowable pursuant to some statutory
                                       - 13 -

[*13] provision and to substantiate claimed loss deductions by maintaining and

producing adequate records. Sec. 6001; Higbee v. Commissioner, 116 T.C. 438,

440 (2001). If the taxpayer produces credible evidence with respect to any factual

issue relevant to ascertaining his Federal income tax liability and meets certain

other requirements, the burden of proof shifts from the taxpayer to the

Commissioner as to that factual issue. Sec. 7491(a)(1) and (2).

      Petitioners allege that the burden of proof should shift to respondent

pursuant to section 7491(a) because they have provided “extensive,

comprehensive, and corroborating evidence from witnesses, testimony and

exhibits which consisted of over 3,000 pages, 135 exhibits, and a 10 hour trial” to

substantiate that the losses from Joshua Plaza and Conroe Plaza are nonpassive.

The evidence does not establish that the burden of proof should shift from

petitioners to respondent under section 7491(a) as to any issue of fact because, as

we conclude infra, petitioners have failed to maintain the requisite records and

comply with the requisite substantiation requirements. See sec. 7491(a)(2)(A)

and (B).

II.   Section 469 Losses From Rental Real Estate Activities

      A taxpayer is allowed deductions for certain business and investment

expenses under sections 162 and 212. Where a taxpayer is an individual, however,
                                         - 14 -

[*14] section 469 generally disallows any passive activity loss for the taxable year

in which the loss is sustained and treats it as a deduction allocable to the same

activity for the next taxable year. Sec. 469(a) and (b). A “passive activity loss” is

defined as the excess of the aggregate losses from all passive activities for the

taxable year over the aggregate income from all passive activities for that year.

Sec. 469(d)(1). A passive activity generally is any activity involving the conduct

of a trade or business in which the taxpayer does not materially participate. Sec.

469(c)(1). A taxpayer is treated as materially participating in an activity only if

his or her involvement in the operations of the activity is regular, continuous, and

substantial. Sec. 469(h)(1). Rental activity is treated as a per se passive activity,

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

      As relevant here, section 469(c)(7) provides an exception to the rule that a

rental activity is per se passive. The rental activities of a taxpayer in a real

property trade or business who meets certain enumerated requirements (a real

estate professional) are not subject to the per se rental activity rule. Sec.

469(c)(7)(A); sec. 1.469-9(b)(6), (c)(1), Income Tax Regs. Rather, the rental

activities of a real estate professional are subject to the material participation

requirements of section 469(c)(1). See sec. 1.469-9(e)(1), Income Tax Regs.
                                         - 15 -

[*15] Petitioners contend that Mr. Hakkak qualified as a real estate professional

during the years at issue.12 A taxpayer qualifies as a real estate professional if:

(1) more than one-half of the personal services performed in trades or businesses

by the taxpayer during the taxable year are performed in real property trades or

businesses in which the taxpayer materially participates and (2) the taxpayer

performs more than 750 hours of services during the taxable year in real property

trades or businesses in which he materially participates. Sec. 469(c)(7)(B)(i)

and (ii).

       A taxpayer may establish hours of participation in a real property trade or

business by any reasonable means. Sec 1.469-5T(f)(4), Temporary Income Tax

Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988). Contemporaneous daily reports are not

required if the taxpayer can establish participation by other reasonable means. Id.

Reasonable means includes “appointment books, calendars, or narrative

summaries” that identify the services performed and “the approximate number of

hours spent performing such services”. Id. However, this Court has noted


       12
        In the case of a joint Federal income tax return, such as here, the
requirements to qualify as a real estate professional are satisfied if either spouse
separately satisfies these requirements; there can be no aggregation of spouses’
hours to satisfy the requirements. See sec. 469(c)(7)(B) (flush language); Moss v.
Commissioner, 135 T.C. 365, 368-369 (2010). That being said, petitioners do not
contend that Ms. Naji was a real estate professional during the years at issue.
                                         - 16 -

[*16] previously that it is not required to accept a postevent “ballpark

guesstimate” or the unverified, undocumented testimony of taxpayers. See, e.g.,

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

T.C. Memo. 2018-169; Lum v. Commissioner, T.C. Memo. 2012-103; Estate of

Stangeland v. Commissioner, T.C. Memo. 2010-185.

      In determining whether Mr. Hakkak was a real estate professional during

the years at issue, there is no dispute that his rental real estate activities through

Joshua Plaza and Conroe Plaza (and the other flowthrough rental real estate

entities) constitute a real property trade or business. In addition we assume

(without deciding) that he materially participated in this real property trade or

business. However, even with this undisputed fact and favorable assumption, we

find that Mr. Hakkak did not qualify as a real estate professional for either of the

years at issue because petitioners failed to establish that Mr. Hakkak met the one-

half personal service hours requirement and the 750-hour requirement.

      Petitioners attempt to show that Mr. Hakkak was a real estate professional

during the years at issue by relying on his testimony at trial, handwritten calendars

(together with a partial transcription of these calendars), and documents consisting

of emails and other written correspondence, lease agreements, bank account and

credit card statements, invoices, loan statements and documents, photos, insurance
                                         - 17 -

[*17] documents, financial reports, property tax records, and various commercial

real estate news articles. They contend that the testimony and documentary

evidence show that Mr. Hakkak “exerted comprehensive and extensive time,

effort, labor, and consideration related to his operation, control and oversight over

Conroe Plaza and Joshua Plaza.” They contend that he handled the “day-to-day

activities, operation, control and oversight of” the Joshua Plaza property and the

Conroe Plaza property during the tax years at issue. They contend that he spent

“at least” 1,600 hours in 2011 and “at least” 1,500 hours in 2012 on his rental real

estate activities.

       The calendar entries as reflected by the partial transcriptions were

abbreviated and do not state with any specificity how Mr. Hakkak spent his time.

Indeed, the entries do not delineate the activities pertaining to the Joshua Plaza

property and the activities pertaining to the Conroe Plaza property; rather, there

are several entries related to activities with respect to West Covina Petroleum but

the rest are general in nature, seemingly lumping together activities with respect to

the Joshua Plaza property and the Conroe Plaza property (and the other

flowthrough rental real estate entities).13

       13
        We note that respondent contends that Mr. Hakkak’s ownership interests
in Joshua Plaza and Conroe Plaza must be treated as separate real estate activities
                                                                      (continued...)
                                         - 18 -

[*18] Mr. Hakkak’s vague testimony discussing (at best) generalities about what

he might have done and how long he might have spent does not sufficiently

supplement or explain the calendar entries (and their partial transcriptions).

Indeed, the entries establish that Mr. Hakkak’s real estate activities as a whole, if

anything, were more akin to those of an investor and thus do not count towards the

750-hour requirement for the years at issue. See Antonyshyn v. Commissioner,

at *10; see also Barniskis v. Commissioner, T.C. Memo. 1999-258, slip op. at 11-

12; sec. 1.469-5T(f)(2)(ii), Temporary Income Tax Regs., supra.

      The inadequacy of the calendars (and partial transcriptions) also highlights

petitioners’ inability to establish that Mr. Hakkak spent more than half of his

personal service hours on his rental real estate activities. At trial petitioners

discussed how Mr. Hakkak had health problems during the years at issue, and Mr.

Hakkak testified that he worked as an attorney only from “12 to three” about “two

times a week”. However, despite these claims Mr. Hakkak still managed to have

income of $449,437 in 2011 and $81,777 in 2012 from the practice of law (the

Schedule E income attributable to Z Dean Hakkak plus his “W-2” wages from

      13
         (...continued)
because petitioners failed to make an election to group the rental real estate
activities of Joshua Plaza and Conroe Plaza as a single activity. See sec. 1.469-
9(e)(1), Income Tax Regs. In the light of our holding we need not address this
contention.
                                        - 19 -

[*19] Z Dean Hakkak in each year),14 and petitioners did not produce any

calendars or timesheets related to Mr. Hakkak’s legal work because he apparently

had no such records. We decline to rely on petitioners’ self-serving and

uncorroborated testimony. “As we have stated many times before, this Court is

not bound to accept a taxpayer’s self-serving, unverified, and undocumented

testimony.” Shea v. Commissioner, 112 T.C. 183, 189 (1999) (citing Tokarski v.

Commissioner, 87 T.C. 74, 77 (1986)).

      We conclude that the calendars (and partial transcriptions) are not

trustworthy and decline to rely on them to reach the result petitioners desire. As

for the other documents, they fail to adequately explain the work done by Mr.

Hakkak with respect to Joshua Plaza and Conroe Plaza and the hours he spent on

that work. Indeed, many of the documents show that he did not (but other people

did) handle the day-to-day management of the Joshua Plaza property and the

Conroe Plaza property and that different leasing agents were used to market and

lease any vacant units in these properties.


      14
        For those years he also had Schedule C gross receipts but his Schedule C
expenses purportedly exceeded these gross receipts. We note that he claimed to
have driven his personal vehicle 13,350 and 9,000 miles in 2011 and 2012,
respectively, in connection with his non-personal injury work, resulting in
reported Schedule C car and truck expenses (using the standard mileage rate) of
$7,139 and $5,386, respectively.
                                       - 20 -

[*20] Petitioners have failed to prove that Mr. Hakkak met the requirements set

forth in section 469(c)(7)(B) for the years at issue. Accordingly, he was not a real

estate professional. Petitioners cannot treat the losses from Joshua Plaza and

Conroe Plaza as nonpassive losses.

      We have considered all of the arguments made by the parties and, to the

extent they are not addressed herein, we find them to be moot, irrelevant, or

without merit.

      To reflect the foregoing,


                                                Decision will be entered under

                                       Rule 155.
