                          T.C. Summary Opinion 2014-20



                         UNITED STATES TAX COURT



                       AMY L. HARLOFF, Petitioner v.
              COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 2641-12S.                       Filed March 6, 2014.



      Mark D. Allison, Timothy J. Sullivan, and Sara A. Silverstein, for

petitioner.

      Eugene A. Kornel, for respondent.



                              SUMMARY OPINION


      PANUTHOS, Chief Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in effect when the

petition was filed. 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
                                         -2-

for any other case. Unless otherwise indicated, subsequent 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.

      Respondent determined a deficiency of $19,851 in Amy L. Harloff’s 2008

Federal income tax and an accuracy-related penalty of $3,970.20 under section

6662(a).

      After concessions, the issues for decision are: (1) whether petitioner was

engaged in passive activities with respect to two rental properties in 2008; and (2)

whether petitioner is liable for the accuracy-related penalty under section 6662(a).

                                     Background

      Some of the facts have been stipulated, and we incorporate the stipulation of

facts by this reference. At the time the petition was filed, petitioner resided in

New York.

      Before the year in issue, petitioner worked for Morgan Stanley. Petitioner

was laid off in 2007 and remained unemployed throughout 2008.

      Petitioner had an ownership interest in, as relevant here, two separate

properties in 2008, one in British Columbia and the other in Hawaii.1

      1
      Petitioner owned an interest in a third property in 2008, a timeshare, and
claimed a deduction for losses of $7,194 with respect to that timeshare interest.
                                                                      (continued...)
                                         -3-

I.    The Whistler Property

      The British Columbia property in which petitioner had an ownership

interest was at 4090 Whistler Way, Whistler, British Columbia (Whistler

property). The Whistler property contained 83 hotel units, with each owner

sharing in the revenue and expenses of the property. Petitioner’s specific

ownership interest in the property related to unit 480, a studio hotel suite with a

kitchenette. The average length of a customer stay at the Whistler property in

2008 was four days.

      A.     Management of the Whistler Property

      O’Neill Hotels and Resorts Ltd. managed and operated the Whistler

property in 2008. The Whistler property also employed a general manager, and

unit owners were represented by an owners council and by a managing body called

the Strata council. The owners council, the Strata council, and an owners

representative (who reported to the owners council) worked on behalf of Whistler

property owners.




      1
       (...continued)
Respondent disallowed the claimed loss deduction in the notice of deficiency.
Petitioner later conceded that she was not entitled to the claimed loss deduction
with respect to that property. The average customer stay at the timeshare property
was seven days in 2008.
                                        -4-

      The general manager of the Whistler property managed the day-to-day

operations of the property. The general manager provided monthly statements and

reports detailing hotel operations and performance, revenue and expense items,

and any new property initiatives. The hotel provided a Web site for unit owners,

and petitioner often logged on to retrieve her investor statements and the general

manager’s monthly statements and reports.

      The owners council was a representative body of owners elected by the

owners to represent their interests. In 2008 the owners council’s primary

responsibility was to renegotiate the hotel management agreement (management

agreement).

      The Strata council served as a quasi-board of directors for the property and

held monthly meetings to carry out the hotel’s business. Its primary activity

related to the hotel budget.

      Although petitioner had previously served as a representative on the owners

council, she was not a member and did not attend the owners council or Strata

council meetings in 2008. However, petitioner received and reviewed updates

summarizing the meetings.
                                       -5-

      B.    Whistler Property Activities--2008

      The Whistler property owners and management considered several changes

in 2008. Management suggested that the hotel undergo interior renovations to

update the hotel decor in anticipation of the upcoming winter Olympics.

Management also proposed a room reconfiguration for suite owners, suggesting a

more “dorm-like” feature, which would accommodate additional guests per room.

Petitioner opposed the room reconfiguration and discussed this issue with other

owners. Petitioner drafted a letter to the property manager voicing her

disagreement with the reconfiguration. As a result, petitioner’s unit was not

reconfigured in 2008.

      As a result of alleged misconduct by the Whistler property hotel

management company before and during 2008, the owners council began

renegotiating the management agreement. The management agreement governed

the responsibilities of the owners and the hotel management and required approval

by the owners. Petitioner reviewed reports, legal opinions, and financial audits

pertaining to the management agreement. Petitioner also discussed the status of

the renegotiation with other owners and held group discussions through a Yahoo!

group forum.
                                        -6-

      Three meetings were held in 2008 concerning the Whistler property, each

lasting approximately six hours. Petitioner reviewed materials pertinent to the

agenda of each meeting and attended all three meetings via webcast.

      Petitioner received and reviewed approximately 300 emails in 2008 relating

to the Whistler property, 100 of which contained attachments for review. These

email communications regarded: (1) issues pertaining to the annual general

meeting, which took place in February 2008; (2) issues pertaining to the special

general meetings which took place in June and November 2008; (3) the

renegotiation of the management agreement; (4) general owner information,

including owner updates and newsletters; (5) information relating to Strata council

meetings; and (6) the reconfiguration of the Whistler property units. Most of the

emails pertained to the renegotiation of the management agreement.

      In addition to the foregoing activities, petitioner also reviewed business

reports, performed market analyses, made mortgage payments, and organized

records for the Whistler property.

II.   The Hawaii Property

      The Hawaii property, a condominium complex, was at 111 Kahului Beach

Road, Kahului, Maui, Hawaii 96793 (Hawaii property). Petitioner owned one

condominium in the complex: a two-bedroom one-and-a-half bath unit on the first
                                         -7-

floor. Petitioner’s unit was managed in 2008 by Kanani Realty, LLC, and was

rented out on an annual basis. The property also employed an onsite manager and

a security guard.

      One meeting was held in 2008 concerning the Hawaii property. This

meeting addressed the general operation of the property, proposed changing the

metering from collective to individual metering, and proposed the installation of a

security gate around the complex. Petitioner reviewed pertinent documents before

the meeting and voted at the meeting via proxy.

      Petitioner’s condominium was rented out in 2007, but near the close of 2007

she experienced problems with her tenant. One evening in late December 2007

the tenant arrived home and began knocking and kicking on the front door of a

neighboring apartment. When the neighbor opened his door, the tenant tried to

force his way into the neighbor’s apartment. The neighbor resisted, and there was

an altercation. Both security and the police were called, and the tenant was

arrested. As a result of the tenant’s behavior management imposed several fines

on petitioner and requested that she evict the tenant. In early 2008 petitioner

evicted the tenant and later initiated legal proceedings.

      Petitioner’s unit was in substantial disrepair; the floors and doors were

broken, tiles were cracked, the toilet and refrigerator were broken, screens were
                                        -8-

torn, and the unit required cleaning. Because petitioner anticipated that the

damaged floor was going to be the most expensive item to repair, she researched

various flooring options for the lowest cost repair. Petitioner eventually decided

to dispense with major renovations (including repairing the floor) in order to get

her unit out on the market quickly.

       Petitioner researched the local market. Because of the poor economy in

2008, she decided to lower her offering price. Petitioner finally found a tenant in

July 2008. Petitioner’s tenant fell behind on rent soon after occupying the unit.

       Throughout 2008 petitioner communicated frequently with her management

company, with an attorney, and with contractors. Petitioner addressed project cost

estimates, legal and rental disputes, finding a new tenant, and other general issues

for her condominium. Petitioner also reviewed mail, filed documents, researched

insurance policies, reconciled rental and maintenance payments, and organized

records for the Hawaii property.

III.   Time Reconstruction

       Petitioner estimated that she spent approximately 895 hours “managing” the

Whistler property and 534 hours “managing” the Hawaii property.
                                         -9-

IV.   2009 Federal Income Tax Return

      Petitioner claimed deductions for 2008 for a net loss of $27,721 for the

Whistler property and a net loss of $31,778 for the condominium. Petitioner offset

the net losses against non-rental-related income. Petitioner did not elect to treat

her rental property interests as one activity for 2008.

      Respondent issued petitioner a notice of deficiency and determined that

portions of the claimed 2008 loss deductions were subject to the passive loss

limitations under section 469 and determined an accuracy-related penalty under

section 6662(a).

                                     Discussion

      Section 469(a) generally disallows for the taxable year any passive activity

loss. A passive activity loss is 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 is any trade or business in which

the taxpayer does not materially participate. Sec. 469(c)(1). Under section

469(h)(1) a taxpayer materially participates in an activity only if such individual is

involved in the operations of the activity on a basis that is regular, continuous, and

substantial. A taxpayer may show material participation, as relevant here, by
                                         - 10 -

participating in the activity for more than 500 hours during such year.2 See sec.

1.469-5T(a)(1), Temporary Income Tax Regs., 53 Fed. Reg. 5725 (Feb. 25, 1988).

      Rental real estate activity is generally treated as a per se passive activity

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

However, the rental activities of a taxpayer who is a real estate professional

pursuant to section 469(c)(7)(B) are not treated as per se passive activities. Sec.

469(c)(7)(A)(i). Instead, the rental activities are treated as a trade or business and

are subject to the material participation requirements of section 469(c)(1).

Sec. 1.469-9(e)(1), Income Tax Regs.

      Respondent contends that, with respect to both properties, petitioner was

engaged in passive activities under section 469(c). Petitioner asserts that she was

a real estate professional and that she materially participated with respect to both

properties and in the alternative that she materially participated in the Whistler

property and actively participated in the Hawaii property.




      2
        Petitioner does not assert that she satisfies the other “material participation”
tests set forth in the regulations. See generally sec. 1.469-5T(a), Temporary
Income Tax Regs., 53 Fed. Reg. 5725-5726 (Feb. 25, 1988).
                                         - 11 -

      A taxpayer qualifies as a real estate professional and is not engaged in a per

se passive activity 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.
      Sec. 469(c)(7)(B).

      For purposes of determining whether a taxpayer is a real estate professional,

a taxpayer’s material participation is determined separately with respect to each

rental property unless the taxpayer makes an election to treat all interests in rental

real estate as a single rental real estate activity. Sec. 469(c)(7)(A); sec. 1.469-

9(e)(1), Income Tax Regs. Petitioner did not elect to treat the rental properties as

a single activity. Thus, the material participation standard in section 469(h)(1)

must be met.

I.    The Whistler Property

      The parties agree that because the average length of a customer stay at the

Whistler property in 2008 was less than seven days, petitioner’s Whistler property

activity was not a rental activity and therefore, was not a per se passive activity.
                                        - 12 -

See sec. 1.469-1T(e)(3)(ii), Temporary Income Tax Regs., 53 Fed. Reg. 5702

(Feb. 25, 1988).

      A taxpayer may deduct losses attributable to an activity if the taxpayer can

demonstrate material participation in the activity. With respect to material

participation, the regulations provide that

      [w]ork done by an individual in the individual’s capacity as an
      investor in an activity shall not be treated as participation in the
      activity for the purposes of this section unless the individual is
      directly involved in the day-to-day management or operations of the
      activity * * * [W]ork done by an individual in the individual’s
      capacity as an investor in an activity includes--(1) [s]tudying and
      reviewing financial statements or reports on the operations of the
      activity; (2) [p]reparing or compiling summaries or analyses of the
      finances or operations of the activity for the individual’s own use; and
      (3) [m]onitoring the finances or operations of the activity in a non-
      managerial capacity.

Sec. 1.469-5T(f)(2)(ii)(A) and (B), Temporary Income Tax Regs., 53 Fed. Reg.

5727 (Feb. 25, 1988).

      Petitioner asserts that the activities she performed for the Whistler property

in 2008 are managementlike activities and are analogous to those of the taxpayers

in Scheiner v. Commissioner, T.C. Memo. 1996-554, and Mordkin v.

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

      In Scheiner, the taxpayer owned an interest in a condominium hotel. The

taxpayer was a board member of the condominium and performed a wide range of
                                         - 13 -

activities as a board member. The Court accepted that all of the taxpayer’s time

spent on board matters constituted material participation in the condominium

rental activity.

       The taxpayer in Mordkin also owned an interest in a condominium. The

taxpayer attended board meetings as representative of the condominium owners

and also was a chairman of certain committees of the condominium. The Court

found that all of the hours that were spent by the taxpayer as a board member and

officer representing the owners of the condominium qualified as management

activity.

       In the foregoing cases, each taxpayer’s activities were performed in the

capacity of a member of management, as either a board member or a representative

of the owners of the property. Petitioner’s activities, however, were not performed

in her capacity as a member of management. The regulations specifically provide

that work performed by an individual in the individual’s capacity as an investor in

an activity shall not be treated as material participation unless the individual is

directly involved in the day-to-day management or operations of the activity. Sec.

1.469-5T(f)(2)(ii)(A) and (B), Temporary Income Tax Regs., supra.

       Despite this provision in the regulations, petitioner asserts that this Court

has found that administrative activities constituted management activities for
                                          - 14 -

purposes of section 469, citing Trzeciak v. Commissioner, T.C. Memo. 2012-83,

and Hassanipour v. Commissioner, T.C. Memo. 2013-88. Petitioner’s reliance on

these cases is misplaced.

      In Trzeciak, the taxpayers initiated an action in this Court seeking

reasonable litigation costs as a result of the Internal Revenue Service’s (IRS)

issuance of a notice of deficiency disallowing, in pertinent part, deductions for

certain section 469 losses. The IRS later conceded the section 469 issue, and the

Court never made a finding as to whether the taxpayers’ activities constituted

management activities within the meaning of section 469. Accordingly, this case

does not support petitioner’s position.

      In Hassanipour, the Court found as fact that the taxpayers “performed

various duties in relation to the rental properties including repairs, administrative

tasks, communicating with tenants, researching landlord/tenant law, preparing tax

returns, and other management activities.” Petitioner, presumably from this

statement, concludes that the Court found that administrative tasks constituted

management activities and that preparation of tax returns and research related to

landlord/tenant law also constituted management activity. The Court ultimately

concluded that it need not consider whether the taxpayers’ activities constituted

management activities because the taxpayers did not spend more than one-half of
                                        - 15 -

their working hours performing personal services for rental activities in a real

property trade or business in which they materially participated.

      Notwithstanding whether petitioner’s participation in the Whistler activity

exceeded 500 hours, petitioner’s primary activity consisted of investor activity.

Her involvement with the renegotiation of the management agreement, which

constituted most of her activity for the Whistler property in 2008, rose only to the

level of an interested investor because she was not a council member or a

representative of the owners. See sec. 1.469-5T(f)(2)(ii)(A) and (B), Temporary

Income Tax Regs., supra. Unit owners were kept apprised of negotiations and

may have been interested in reviewing documents, lending a voice, and voting on

the final negotiated agreement, but actual negotiation of the management

agreement took place between the owners council and the management company.

      Petitioner’s remaining activities consisted of filing reports, tracking

expenses, discussing issues with other owners, reviewing investor statements and

manager’s reports, attending meetings via webcast, and reviewing materials

pertinent to the meetings, most if not all of which are in the nature of investor

activities unless performed as a part of the day-to-day management. The only

activity petitioner engaged in as a material participant was the proposed

renovation of her own unit in the Whistler property. However, the record reflects
                                        - 16 -

that petitioner spent 12 to 20 hours on this activity, which is far below the 500

hours required for material participation.

      The Court finds that petitioner did not materially participate in the Whistler

property in 2008 and that it was a passive activity.

II.   The Hawaii Property

      Petitioner does not assert that her activity in the Hawaii property was not

per se passive as a rental activity under section 469(c)(2). Instead, petitioner

asserts that she was a real estate professional in 2008 with respect to this property.

Thus, if petitioner meets the requirements of section 469(c)(7) and is a real estate

professional, the material participation standard in section 469(c)(1) must be met

with respect to each separate interest in rental real estate. See sec. 469(c)(7)(A).

By petitioner’s own admission she spent a total of only 534 hours “managing” the

Hawaii property in 2008. Because petitioner did not show that she materially

participated in other real property trades or businesses except to the extent of at

most, 20 hours, petitioner does not meet the 750-hour requirement for a real estate

professional in 2008; therefore, the Hawaii property rental activity was a per se

passive activity in 2008.

      In the alternative, petitioner asserts that she actively participated in the

Hawaii property.
                                        - 17 -

      Section 469(i) provides an additional exception to the general rule of

disallowance of passive activity losses. A taxpayer who “actively participated” in

a rental real estate activity can deduct a maximum loss of $25,000 per year related

to the activity. Sec. 469(i)(1) and (2). This exception is fully phased out,

however, when adjusted gross income equals or exceeds $150,000. Sec.

469(i)(3)(A), (E), (F).

      The active participation standard for deduction of rental real estate activity

losses can be satisfied without regular, continuous, and substantial involvement in

an activity. Madler v. Commissioner, T.C. Memo. 1998-112. Instead, taxpayers

may satisfy the active participation requirement by participating in management

decisions, such as approving new tenants, deciding rental terms, and arranging

services and repairs. Id.

      Many events transpired in 2008 with respect to the Hawaii property that

required petitioner’s significant attention and decisionmaking authority. Petitioner

was forced to evict a tenant, she initiated legal proceedings against the tenant, she

extensively researched various options for fixing her unit, she researched the local

economy and the reasonableness of her rent, she engaged in efforts to locate a new

tenant, and she communicated with other owners, the management company and

attorneys to resolve various issues. Given petitioner’s significant involvement in
                                        - 18 -

managing the Hawaii property in 2008, the Court is satisfied that she actively

participated in the management activities of the Hawaii property in 2008.

Accordingly, petitioner is entitled to deduct the claimed real estate losses pursuant

to section 469(i)(1) to the extent these losses are not otherwise limited under

section 469(i)(3)(A).3

III. Accuracy-Related Penalty

      Section 6662(a) and (b)(1) and (2) imposes a penalty of 20% of the portion

of an underpayment of tax attributable to the taxpayer’s negligence, disregard of

rules or regulations, or substantial understatement of income tax. “Negligence”

includes any failure to make a reasonable attempt to comply with the Code,

including any failure to keep adequate books and records or to substantiate items

properly. See sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. A “substantial

understatement” includes an understatement of income tax that exceeds the greater

of 10% of the tax required to be shown on the return or $5,000. See sec. 6662(d);

sec. 1.6662-4(b), Income Tax Regs.




      3
        Petitioner reported income and compensation from various sources on her
2008 Federal income tax return, including wages, miscellaneous income,
unemployment compensation, retirement distributions, taxable refunds, credits or
offsets of State and local income taxes, and business income. The combined
income or compensation from these sources exceeded $150,000.
                                        - 19 -

       The section 6662(a) accuracy-related penalty does not apply with respect to

any portion of an underpayment if the taxpayer proves that there was reasonable

cause for such portion and that he acted in good faith with respect thereto. Sec.

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

and in good faith depends on the pertinent facts and circumstances, including the

taxpayer’s efforts to assess the proper tax liability; the knowledge and the

experience of the taxpayer; and any reliance on the advice of a professional, such

as an accountant. Sec. 1.6664-4(b)(1), Income Tax Regs. Generally, the most

important factor is the taxpayer’s effort to assess the taxpayer’s proper tax

liability. Id.

       The underpayment of tax required to be shown on petitioner’s return is the

result of a substantial understatement of income tax because the understatement of

$19,851 exceeds $5,000, which is greater than 10% of the tax required to be

shown on the return.4 See sec. 6662(b)(2), (d)(1); sec. 1.6662-4(b)(1), Income Tax

Regs. Respondent’s burden of production has been satisfied. See sec. 7491(c).

Accordingly, because respondent has met his burden of production, petitioner


       4
       Petitioner reported tax due of $1,489 for 2008. Because petitioner’s
allowed claim for a certain amount of expenses associated with the Hawaii
property is likely phased out under sec. 469(i)(3)(A), see supra note 3, the
deficiency would remain unchanged for purposes of sec. 6662(b)(2) and (d)(1).
                                       - 20 -

must come forward with persuasive evidence that the accuracy-related penalty

should not be imposed with respect to the underpayment because she acted with

reasonable cause and in good faith. See sec. 6664(c)(1); Rule 142(a); Higbee v.

Commissioner, 116 T.C. 438, 446 (2001).

      Petitioner provided email snapshots demonstrating the extensive

communications she engaged in for both properties in 2008. Petitioner also

communicated with other owners and management, she researched and reviewed

documents in anticipation of meetings, and participated in the meetings by

attending or voting. Petitioner also provided a summary and credible testimony

regarding her involvement and the activities she engaged in for the Whistler

property and the Hawaii property. Although most of petitioner’s activities did not

constitute “management” activities for purposes of section 469, these activities

might otherwise have qualified as management (as opposed to investment)

activities if she had performed them as a member of day-to-day management.

Because she had been a representative of the owners in prior years (and a part of

the day-to-day management), it was reasonable for petitioner to presume that the

same activities she performed in 2008 as she had in other years constituted

management activities, even though they were not performed as a member of the

owners council.
                                        - 21 -

      The Court finds that petitioner was credible and detailed in her testimony

and had reasonable cause to claim deductions for the losses associated with the

Whistler property and the Hawaii property given her extensive participation in

these rental activities in 2008. Accordingly, petitioner is not liable for the

accuracy-related penalty under section 6662 for 2008 with respect to the portions

of the underpayment due to the deduction of losses claimed for the Whistler

property and the Hawaii property.

      Petitioner asserts that she also should not be liable for the accuracy-related

penalty with respect to the deduction of losses that she claimed for her timeshare

property. Petitioner asserts that she actively participated in the timeshare activity

in 2008, but unbeknownst to her, because the average customer stay for 2008 was

exactly seven days, the active participation exception was not available because

the property was not considered rental real estate. Sec. 1.469-1T(e)(3)(ii)(A),

Temporary Income Tax Regs., supra. Consequently, she conceded that she was

not entitled to the claimed loss deduction for the timeshare property. See supra

note 1.

      Although petitioner may have acted reasonably under the circumstances, she

did not provide other evidence or testify regarding her involvement and activities

in the timeshare property, and the Court is unable to conclude that she acted
                                       - 22 -

reasonably and in good faith with respect to the claimed loss deduction.

Accordingly, the Court sustains the imposition of the accuracy-related penalty

with respect to the portion of the underpayment due to the disallowed loss

deduction relating to the timeshare property for 2008.

      We have considered the parties’ arguments and, to the extent not discussed

herein, we conclude the arguments to be irrelevant, moot, or without merit.

      To reflect the foregoing,


                                                     Decision will be entered

                                                under Rule 155.
