                  T.C. Summary Opinion 2002-150



                     UNITED STATES TAX COURT



             KARL AND BIRGIT JAHINA, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 13483-00S.              Filed November 21, 2002.



     Birgit Jahina, pro se.

     Igor S. Drabkin, for respondent.



     COUVILLION, Special Trial Judge:    This case was heard

pursuant to section 7463 of the Internal Revenue Code in effect

at the time the petition was filed.1    The decision to be entered

is not reviewable by any other court, and this opinion should not

be cited as authority.


     1
          Unless otherwise indicated, subsequent section
references are to the Internal Revenue Code in effect for the
years at issue.
                                - 2 -


     Respondent determined deficiencies in petitioners' Federal

income taxes of $19,336 and $26,084, respectively, for 1996 and

1997 and the accuracy-related penalty under section 6662(a) for

1997 in the amount of $5,216.80.   At trial, petitioners conceded

a charitable contributions adjustment for the year 1996.   The

issues for decision are:    (1) Whether the passive loss rules of

section 469 preclude petitioners from deducting real estate

rental losses of $128,168 for 1996 and $95,553 for 1997, and (2)

whether petitioners are liable for the accuracy-related penalty

under section 6662(a) for 1997.

     Some of the facts were stipulated.   Those facts, with the

annexed exhibits, are so found and are made part hereof.

Petitioners’ legal residence at the time the petition was filed

was Pasadena, California.

     Petitioners Karl (Mr. Jahina) and Birgit Jahina (Mrs.

Jahina) were married during the years at issue.   They owned real

estate rental property consisting of five apartment buildings and

three single-family condominiums during the years at issue.

These properties are collectively referred to as the rental

properties.   The apartment buildings included the Hermitage

Property, with 14 units; Coldwater Property, 19 units; Santa

Anita Property, 22 units; Moorpark Property, 29 units; and

Buffalo Property, 25 units.   All of these properties were located

in the Los Angeles area.
                                 - 3 -


     Mr. Jahina has a Ph.D. in engineering.    During all of 1996

and 1997, Mr. Jahina was employed full time as a structural

engineer for the Parsons Corp.    He did not participate in the

real estate activities.

     Mrs. Jahina’s background was in accounting.    She had an

undergraduate degree in English and an M.B.A. degree.     She had 6

years' experience working for the accounting firms Deloitte and

Touche and Sing Young.    Following her accounting firm

experiences, Mrs. Jahina worked in banking.    She was assistant

treasurer of the First Interstate Bank in California.     During all

of 1996 and until August 1997, Mrs. Jahina was employed full time

as the controller for ColorGraphics, Inc.    After leaving

ColorGraphics, she took 6 weeks off, then worked part time for

the accounting firm Deloitte and Touche for the remainder of

1997.   Mrs. Jahina also worked for another employer, Continental

Graphics, during 1997.

     Mrs. Jahina’s standard work expectation at ColorGraphics was

1,800 hours per year.    This was not a minimum requirement but a

standard figure.   She was a salaried employee.   Her actual hours

of work there were not documented by her employer, and she did

not keep track of them.

     In addition to working in her full- and part-time jobs, Mrs.

Jahina was actively engaged in managing petitioners’ rental

properties.   She often worked in the very early morning hours,
                                - 4 -


prior to her salaried employment, on financial statements, tenant

correspondence, and paperwork related to the rental properties.

She personally obtained credit checks of potential renters.    She

placed ads in local newspapers to fill vacancies.   She reconciled

the gross rents every month, determined who was delinquent, and

delivered warning notices.   When necessary, she filed eviction

summonses and complaints and handled the court appearances.    She

visited the properties regularly.   She tracked and supervised the

repairs performed at each property, maintaining detailed records.

She monitored, in her words:


     every phase of the business. The costs, the revenues, what
     the neighbors are doing, how much they are charging. How
     much the various plumbers charge, how much the roofers
     charge, everything.


Mrs. Jahina performed some of her work managing the rental

properties from her job at ColorGraphics through the use of the

telephone.

     In managing their rental properties, petitioners also

utilized resident property managers for the Coldwater, Santa

Anita, Moorpark, and Buffalo properties as was required under

local law.   These managers received free rent as their sole

compensation.   They were not permitted to work more than 10 hours

per week.    The resident managers received maintenance complaints,

arranged for emergency repairs, showed vacant apartments to
                               - 5 -


prospective tenants, received rental applications, collected rent

checks from tenants, and issued receipts for rental payments.

The managers forwarded rental applications and rent checks to

Mrs. Jahina, who made all the decisions relative thereto.

     In 1996, the rental properties generated approximately

$767,000 in earnings before depreciation and amortization of

$128,000.   In 1997, the rental properties generated approximately

$811,000 before depreciation and amortization of $153,000.    These

earnings represented gross profit margins of 17 percent and 19

percent, respectively, for 1996 and 1997.    Mrs. Jahina credited

her hands-on management for the financial results.   She described

the rental property activity as a “healthy” and “well run”

business.   In mid-2000, Mrs. Jahina resigned her outside

employment and thereafter devoted herself to the full-time

management of the subject rental properties.

     During the years at issue, Mrs. Jahina maintained a desk

calendar.   On the calendar she noted her activities with respect

to the rental properties.   She kept the calendar “because the

regulations asked me to.”   On the calendar, Mrs. Jahina did not

go into great detail about her activities.   However, her

notations generally suggest what she did and how much time she

spent with respect to the rental properties daily or weekly.     She

also maintained telephone records for the periods in question,

which indicate telephone calls made and received with regularity
                                 - 6 -


relating to the rental properties.       Such calls were placed both

from petitioners’ home and from her place of employment.      Mrs.

Jahina also maintained a variety of other records in conducting

the rental property activities.

     When petitioners were audited by respondent, Mrs. Jahina

prepared summaries of her activities for the revenue agent.      She

prepared the summaries based on her calendars, phone records,

correspondence, bills, and other records.      The summaries suggest

that Mrs. Jahina spent 2,591 hours in 1996 and 2,639 hours in

1997 on the rental properties.    However, the hours indicated on

the summaries exceeded the hours shown on Mrs. Jahina’s

contemporaneous calendars.   Mrs. Jahina admitted at trial that

she prepared the summaries hurriedly for purposes of the audit,

using a computer program that would not charge less than 1 hour

for any entry.   She admitted that the summaries overstated the

hours devoted to the real estate properties.      However,

petitioners maintain that she devoted well in excess of 1,800

hours annually to the rental activities; i.e., more time than she

spent working for her employers.2

     2
          When Mrs. Jahina prepared the summaries, she felt
frustrated that the revenue agent had not fully credited her time
spent working on the rental properties, despite her attempts to
cooperate by presenting phone and other business records.   Mrs.
Jahina objected that the revenue agent only counted the actual
minutes of phone time listed on the records. Mrs. Jahina
maintained that the agent should have credited her with a span of
                                                   (continued...)
                                - 7 -


     Petitioners filed their 1996 and 1997 Federal income tax

returns timely.    On the 1996 return, Mr. Jahina’s occupation was

listed as “engineer”.   Mrs. Jahina’s occupation was listed as

“controller”.   On the 1997 return, Mr. Jahina’s occupation was

again listed as “engineer”.   Mrs. Jahina’s occupation was listed

as “accountant”.   Petitioners included Schedule E, Supplemental

Income and Loss statement, with their returns for both years.

They completed line 42, Reconciliation for Real Estate

Professionals, on the Schedule E.    They aggregated their real

estate income and losses and, in each year, attached breakdowns

of income and expenses by property.      They reported net losses of

$128,167 in 1996 and $95,533 in 1997.

     For 1996, petitioners did not include with their original

return or otherwise file an election to treat their rental

properties as one rental activity.      Mrs. Jahina claims to have

provided an election form to the revenue agent later.      For 1997,

petitioners claim to have filed the election with their original

return; however, no such election was attached to the 1997

return.   Neither claimed election was offered into evidence at

trial.


     2
      (...continued)
time representing each session of desk work, which would have
included both the actual phone time and the intervening time
spent preparing for and following up on the phone calls, toward
her participation in the rental property activity.
                                 - 8 -


     The first issue is whether the passive loss rules under

section 469 preclude petitioners from deducting real estate

rental losses in the amounts of $128,168 for 1996 and $95,553 for

1997.    The specific issue is whether Mrs. Jahina qualifies as a

real estate professional under section 469(c)(7).3

     Petitioners contend that they are entitled to deduct their

losses from their real estate rental properties because Mrs.

Jahina was a real estate professional under section 469(c)(7),

and that petitioners’ rental properties were a trade or business

in which they materially participated.   Respondent maintains that

the real estate rental activities generating the net losses were

per se passive activities under section 469(c)(2) because Mrs.

Jahina did not establish that she was a real estate professional

pursuant to section 469(c)(7).    Respondent further maintains that

petitioners did not elect to treat the rental properties as one

activity under section 469(c)(7)(A), and, therefore, Mrs. Jahina

must qualify as a real estate professional with respect to each




     3
          Sec. 7491, in certain instances, places the burden of
proof on respondent with respect to examinations of returns
commencing after July 22, 1998. There is no evidence in the
record regarding the date the examination of petitioners’ returns
commenced. Moreover, petitioners do not contend that the
examination of their return commenced after July 22, 1998, or
that sec. 7491 is applicable in this case. Even if sec. 7491 is
applicable, the Court decides this case without regard to the
burden of proof.
                                - 9 -


property.    Petitioners contend that they filed such an election

for 1997.

       Section 469 generally disallows for the taxable year any

passive activity loss.    Sec. 469(a).   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 is any trade or business in which the taxpayer does not

materially participate.    Sec. 469(c)(1).   Rental activity is

generally treated as a per se passive activity regardless of

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

(4).    However, under section 469(c)(7), the rental activities of

a taxpayer in the real property business, i.e., a real estate

professional, are not per se passive activities under section

469(c)(2).    Rather, the rental activities of a real estate

professional are treated as a trade or business and subject to

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

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

       A taxpayer qualifies as a real estate professional and

therefore is not engaged in a per se passive activity pursuant to

section 469(c)(2), 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
                              - 10 -


          (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).   In the case of a joint return, the above

requirements for qualification as a real estate professional are

satisfied if and only if either spouse separately satisfies these

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 a per se passive activity

under section 469(c)(2).

     The applicable temporary regulation addresses how a taxpayer

may establish the amount of time spent on rental property

activities.   To wit, that regulation provides:


          (4) Methods of proof. The extent of an individual’s
     participation in an activity may be established by any
     reasonable means. Contemporaneous daily time reports, logs,
     or similar documents are not required if the extent of such
     participation may be established by other reasonable means.
     Reasonable means for purposes of this paragraph may include
     but are not limited to the identification of services
     performed over a period of time and the approximate number
     of hours spent performing such services during such period,
     based on appointment books, calendars, or narrative
     summaries.


Sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg.

5727 (Feb. 25, 1988).   This Court has acknowledged that the

passive loss regulations are somewhat ambivalent as to the

records to be maintained by taxpayers.    Goshorn v. Commissioner,
                                 - 11 -


T.C. Memo. 1993-578.      Nevertheless, the regulations do not allow

a post-event “ballpark guesstimate”.      Id.

     The general rule is that each interest of the taxpayer in

rental real estate is treated as a separate activity.      Sec.

469(c)(7)(A)(ii).    However, a taxpayer in the real property

business may elect to treat all interests in rental real estate

as one activity.    Sec. 469(c)(7)(A).    The election to treat all

interests in rental real estate as a single rental real estate

activity is made:


     by filing a statement with the taxpayer’s original income
     tax return for the taxable year. This statement must
     contain a declaration that the taxpayer is a qualifying
     taxpayer for the taxable year and is making the election
     pursuant to section 469(c)(7)(A). * * *


Sec. 1.469-9(g)(3), Income Tax Regs.      Such an election is binding

for the taxable year in which it is made and for all future years

in which the taxpayer qualifies as a real estate professional,

even if there are intervening years in which the taxpayer is not

a qualifying taxpayer.      Sec. 1.469-9(g)(1), Income Tax Regs.   The

election may be made in any year in which the taxpayer is a

qualifying taxpayer, and the failure to make the election in one

year does not preclude the taxpayer from making the election in a

subsequent year.    Id.

     On this record, the Court holds that petitioners did not

file a valid election to treat their rental properties as one
                               - 12 -


activity in either 1996 or 1997.   “To make an election, a

taxpayer must clearly notify the Commissioner of the taxpayer’s

intent to do so.”    Kosonen v. Commissioner, T.C. Memo. 2000-107.

Although petitioners claim that they provided an election for

1996 to a revenue agent during the examination and filed their

1997 election with their original return, neither election was

produced at trial.    For lack of evidence and proof, respondent

is sustained with respect to this issue.4

     Because petitioners did not properly elect to treat the

rental properties as a single activity, they cannot group them.

Krukowski v. Commissioner, 279 F.3d 547 (7th Cir. 2002), affg.

114 T.C. 566 (2000); Kosonen v. Commissioner, supra.    As an

additional consequence of the failure to elect, Mrs. Jahina must

qualify as a real estate professional with respect to each

property separately in order to avoid a determination that the

rental activities were per se passive under section 469(c)(2).



     4
          Even if the election had been made part of the record,
its validity would still be in question. Respondent disputes
that petitioners filed a proper election with either their 1996
or 1997 original return. To be valid, the election must be filed
with the original return. Sec. 1.469-9(g)(3), Income Tax Regs.
A taxpayer who aggregated real estate rental activities on his
tax returns but who failed to meet the literal requirements of
electing combination treatment has been held not to have given
clear notice of an intent to elect under sec. 469(c)(7). Kosonen
v. Commissioner, T.C. Memo. 2000-107. Moreover, petitioners did
not argue substantial compliance with the applicable regulation.
Cf. American Air Filter Co. v. Commissioner, 81 T.C. 709, 718-723
(1983).
                              - 13 -


Thus, to hold in petitioners’ favor, the Court must find:     (1)

That more than one-half of Mrs. Jahina’s personal services during

the taxable year were performed in each rental property activity

in which a loss deduction is claimed, and (2) that Mrs. Jahina

performed more than 750 hours of services during the taxable year

on each of the claimed properties.     Sec. 469(c)(7)(B); sec.

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

     The evidence fails to establish that Mrs. Jahina was a real

estate professional with respect to each of the rental properties

considered separately.5    The requirements of section

469(c)(7)(B) were not met with respect to any of the rental

properties individually.   During all of 1996 and until August

1997, Mrs. Jahina had a full-time job with a standard work

requirement of 1,800 hours per year.     During the latter months of

1997, she had a part-time job.    Even if she performed some of her

rental property activities from her wage jobs, double-counting

some of her time as she claimed, there were five apartment

buildings to be managed.   She did not work on any one of these

properties more than she worked on her wage jobs.     Further, she


     5
          With respect to that evidence, the Court disregards as
not credible the summaries prepared by Mrs. Jahina for purposes
of the audit purporting to establish her time spent on the rental
property activities. See Mowafi v. Commissioner, T.C. Memo.
2001-111; Bailey v. Commissioner, T.C. Memo. 2001-296
(“petitioner’s estimates are uncorroborated and do not reliably
reflect the hours that she devoted to her rental real estate
activities”).
                                 - 14 -


did not satisfy the 750-hour statutory minimum for any one of

them.    See Fowler v. Commissioner, T.C. Memo. 2002-223.       Her

testimony, phone records, and calendars reflect that she did not

spend sufficient time on the individual rental property

activities to satisfy either prong of section 469(c)(7)(B).

        The Court holds that Mrs. Jahina was not a real estate

professional with respect to petitioners' rental properties

during the years at issue.      Because Mrs. Jahina was not a real

estate professional, the rental property activities of

petitioners are treated as per se passive.        Sec. 469(c)(2), (4).

Accordingly, the general disallowance rule concerning passive

activity losses applies.      Sec. 469(a)(1)(A).    Respondent is

sustained on this issue.

        The final issue is whether petitioners are liable for the

accuracy-related penalty under section 6662(a) for 1997 in the

amount of $5,216.80.     Section 6662(a) provides for an accuracy-

related penalty equal to 20 percent of any portion of an

underpayment of tax required to be shown on the return that is

attributable to the taxpayer’s negligence or disregard of rules

or regulations.      Sec. 6662(a) and (b)(1).    "Negligence" consists

of any failure to make a reasonable attempt to comply with the

provisions of the Internal Revenue Code.        Sec. 6662(c).

"Disregard" consists of any careless, reckless, or intentional

disregard.     Id.
                               - 15 -


     The courts have refined the Code definition of negligence as

a lack of due care or failure to do what a reasonable and prudent

person would do under similar circumstances.      Allen v.

Commissioner, 925 F.2d 348, 353 (9th Cir. 1991), affg. 92 T.C. 1

(1989).   Treasury regulations further stipulate that negligence

includes any failure to exercise ordinary and reasonable care in

the preparation of a tax return, failure to keep books and

records, or failure to substantiate items properly.      Sec. 1.6662-

3(b)(1), Income Tax Regs.   A return position that has a

“reasonable basis” as defined in the regulation is not

attributable to negligence.    Id.

     An exception to the section 6662 penalty applies when the

taxpayer demonstrates:   (1) There was reasonable cause for the

underpayment, and (2) the taxpayer acted in good faith with

respect to the underpayment.   Sec. 6664(c).6    Whether the

taxpayer acted with reasonable cause and in good faith is

determined by the relevant facts and circumstances on a case-by-

case basis.   See Stubblefield v. Commissioner, T.C. Memo. 1996-

537; sec. 1.6664-4(b)(1), Income Tax Regs.      “Circumstances that

may indicate reasonable cause and good faith include an honest

misunderstanding of fact or law that is reasonable in light of

all the facts and circumstances, including the experience,

     6
          This section may provide relief even if a return
position does not satisfy the reasonable basis standard. Sec.
1.6662-3(b)(3), Income Tax Regs.
                                - 16 -


knowledge and education of the taxpayer.”      Sec. 1.6664-4(b)(1),

Income Tax Regs.    A taxpayer is not subject to the addition to

tax for negligence where the taxpayer makes honest mistakes in

complex matters, but the taxpayer must take reasonable steps to

determine the law and to comply with it.     Niedringhaus v.
Commissioner, 99 T.C. 202, 222 (1992).     The most important factor

is the extent of the taxpayer’s effort to assess the proper tax

liability.    Stubblefield v. Commissioner, supra; sec. 1.6664-

4(b)(1), Income Tax Regs.

     Petitioners demonstrated facts and circumstances that

establish their reasonable cause and good faith in this case.

Even before being audited, Mrs. Jahina took reasonable measures

to determine and comply with the law regarding passive activities

and real estate professionals.     She was aware of the passive loss

provisions and attempted to comply with them.     She kept

contemporaneous calendars and other business records to establish

her time and material participation.      See sec. 1.469-5T(f)(4),
Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988).

She testified, with detail, on the extent of her involvement with

the rental activities and her consistent treatment of them as a

going concern.     Her recordkeeping efforts and testimony were

credible, particularly given the complexity of the passive loss

provisions.   Cf. sec. 1.6662-3(b), Income Tax Regs.

(“‘Negligence’ includes any failure by the taxpayer to keep

adequate books and records or to substantiate items properly”).
                               - 17 -


     Further, although the timing of their attempt was incorrect,

petitioners attempted to elect combination treatment.    Had

petitioners effected a valid election, the law would not have

required a property-by-property analysis.    While the Court makes

no express finding on whether petitioners would have prevailed

had they made a valid election to combine the properties, the

standard would have been significantly less burdensome had they

done so.    Finally, the record shows that Mrs. Jahina left her

wage job in 2000 to devote her full-time efforts to their rental

properties.   This record indicates reasonable cause and good

faith with respect to the underpayment.   The Court holds that

petitioners did not act negligently with respect to the

underpayment and are not liable for the accuracy-related penalty

under section 6662(a).   See Shaw v. Commissioner, T.C. Memo.
2002-35 (taxpayer, a “sophisticated businessperson”, was not

liable for section 6662(a) penalty notwithstanding Court’s

holding that he was not a real estate professional).
     Reviewed and adopted as the report of the Small Tax Case

Division.



                                          Decision will be entered

                                for respondent on the deficiencies

                                and for petitioners on the section

                                6662(a) penalty.
