                                              FRANK ARAGONA TRUST, PAUL ARAGONA, EXECUTIVE
                                                  TRUSTEE, PETITIONER v. COMMISSIONER OF
                                                     INTERNAL REVENUE, RESPONDENT
                                                    Docket No. 15392–11.                       Filed March 27, 2014.

                                                 T is a trust that owned rental real-estate properties and
                                               engaged in other real-estate activities. T’s rental real-estate
                                               activities would be considered per se passive activities under
                                               I.R.C. sec. 469(c)(2) unless T qualified for the exception found
                                               in I.R.C. sec. 469(c)(7). This exception is applicable if more

                                                                                                                                  165




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                                     166                 142 UNITED STATES TAX COURT REPORTS                                    (165)

                                               than one-half of the personal services performed in trades or
                                               businesses by the taxpayer are performed in real-property
                                               trades or businesses in which the taxpayer materially partici-
                                               pates and if the taxpayer performs more than 750 hours of
                                               services during the year in real-property trades or businesses
                                               in which the taxpayer materially participates. Held: A trust
                                               can qualify for the I.R.C. sec. 469(c)(7) exception. A trust is
                                               capable of performing personal services within the meaning of
                                               I.R.C. sec. 469(c)(7). Services performed by individual trustees
                                               on behalf of the trust may be considered personal services per-
                                               formed by the trust. Held, further, T materially participated
                                               in real-property trades or businesses.

                                           Richard S. Soble, for petitioner.
                                           Brett Chmielewski and Meso T. Hammoud, for respondent.
                                        MORRISON, Judge: The respondent (referred to here as the
                                     ‘‘IRS’’) issued a notice of deficiency to the Frank Aragona
                                     Trust (sometimes referred to here as the ‘‘trust’’), deter-
                                     mining the following deficiencies in federal income tax and
                                     the following penalties:
                                                                                                          Accuracy-related
                                                                                                              penalty
                                                        Year                   Deficiency                   sec. 6662(a)

                                                        2003                     $86,289                     $17,257.80
                                                        2004                     421,292                      84,258.40
                                                        2005                       -0-                           -0-
                                                        2006                      84,540                      16,908.00

                                     The trust filed a petition as permitted by section 6213(a). 1
                                     We have jurisdiction to redetermine the deficiencies and pen-
                                     alties under section 6214(a). After concessions, 2 the two
                                     issues remaining for decision are:
                                           1 Even
                                                though the petition was filed by Paul V. Aragona, the executive
                                     trustee, for ease of reference we refer to the trust as having filed the peti-
                                     tion. In any event we do not mean to suggest whether the petitioner in
                                     this case is the trustee or the trust. See sec. 7482(b)(1)(A) (providing that
                                     default appellate venue for deficiency cases is the circuit in which is lo-
                                     cated the legal residence of the petitioner). We do not reach that particular
                                     question.
                                        All references to sections are to the Internal Revenue Code of 1986, as
                                     in effect for the years at issue.
                                        2 The IRS conceded that the trust is not liable for any accuracy-related

                                     penalties for the 2003, 2004, and 2006 tax years. (The notice of deficiency
                                     did not determine a penalty for 2005.)




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                                     (165)                   ARAGONA TRUST v. COMMISSIONER                                        167


                                       (1) Does section 469(c)(7) apply to the trust? Yes.
                                       (2) Are the fees that the trust paid to its trustees properly
                                     characterized as expenses of the trust’s rental real-estate
                                     activities? We need not reach this issue because of our reso-
                                     lution of the first issue.

                                                                          FINDINGS OF FACT

                                        Some facts have been stipulated by the parties. The stipu-
                                     lated facts are incorporated in the Court’s findings of fact.
                                     The trust is a complex residuary trust that owns rental real-
                                     estate properties and is involved in other real-estate business
                                     activities such as holding real estate and developing real
                                     estate. Its principal place of business was in Michigan when
                                     it filed the petition. In 1979 Frank Aragona formed the trust
                                     with him as grantor and trustee and with his five children
                                     as beneficiaries. According to the trust instrument, the five
                                     children share equally in the income of the trust. Frank
                                     Aragona died in 1981. He was succeeded as trustee by six
                                     trustees. One of the six trustees was an independent
                                     trustee. 3 The other five trustees were Frank Aragona’s five
                                     children, including Paul V. Aragona, the executive trustee. 4
                                     Although the trustees formally delegated their powers to the
                                     executive trustee (in order to facilitate daily business oper-
                                     ations), the trustees acted as a management board for the
                                     trust and made all major decisions regarding the trust’s
                                     property. During 2005 and 2006 the board met every few
                                     months to discuss the trust’s business. Each of the six
                                     trustees was paid a fee directly by the trust (referred to here
                                     as a ‘‘trustee fee’’ or collectively as ‘‘trustee fees’’) in part for
                                     the trustee’s attending board meetings. Three of the chil-
                                     dren—Paul V. Aragona, Frank S. Aragona, and Annette
                                     Aragona Moran—worked full time for Holiday Enterprises,
                                     LLC, a Michigan limited liability company that is wholly
                                     owned by the trust. Holiday Enterprises, LLC, is a dis-
                                     regarded entity for federal income tax purposes. Holiday
                                     Enterprises, LLC, managed most of the trust’s rental real-
                                     estate properties. It employed several people in addition to
                                           3 The
                                              trust instrument gives the independent trustee the power to dis-
                                     tribute the principal of the trust under limited circumstances.
                                        4 When the petition was filed, Paul V. Aragona was a resident of Michi-

                                     gan.




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                                     168                  142 UNITED STATES TAX COURT REPORTS                                       (165)


                                     Paul V. Aragona, Frank S. Aragona, and Annette Aragona
                                     Moran, including a controller, leasing agents, maintenance
                                     workers, accounts payable clerks, and accounts receivable
                                     clerks. In addition to receiving a trustee fee, Paul V.
                                     Aragona, Frank S. Aragona, and Annette Aragona Moran
                                     each received wages from Holiday Enterprises, LLC.
                                       The trust conducted some of its rental real-estate activities
                                     directly, some through wholly owned entities, and the rest
                                     through entities in which it owned majority interests and in
                                     which Paul V. and Frank S. Aragona owned minority
                                     interests. It conducted its real-estate holding and real-estate
                                     development operations through entities in which it owned
                                     majority or minority interests and in which Paul V. and
                                     Frank S. Aragona owned minority interests.
                                       The table below summarizes the activities of the six
                                     trustees on behalf of the trust during 2005 and 2006:
                                                                                                                      Annual trustee
                                              Name of trustee                                 Role                        fee

                                           Salvatore S. Aragona            Full-time dentist; limited involve-
                                                                             ment in trust’s business                    $72,000
                                           Paul V. Aragona                 Executive trustee; full-time em-
                                                                             ployee of Holiday Enterprises,
                                                                             LLC                                          72,000
                                           Anthony F. Aragona              Disabled; limited involvement in
                                                                             trust’s business                            1 72,000

                                           Frank S. Aragona                Full-time employee of Holiday
                                                                             Enterprises, LLC                             72,000
                                           Annette Aragona Moran           Full-time employee of Holiday
                                                                             Enterprises, LLC                             72,000
                                           Charles E. Turnbull             Independent trustee; attorney
                                                                             with O’Reilly Rancilio, P.C.;
                                                                             limited involvement in trust’s
                                                                             business                                     14,400

                                             Total                                                                       374,400
                                             1 The $72,000 annual trustee fee for Anthony F. Aragona was reported as a dis-
                                           tribution from the trust for tax purposes.

                                        During the 2005 and 2006 tax years, the trust incurred
                                     losses from its rental real-estate properties. The losses were
                                     reported on the trust’s income-tax returns, Forms 1041, ‘‘U.S.
                                     Income Tax Return for Estates and Trusts’’ and on Schedules
                                     E, ‘‘Supplemental Income and Loss’’, and were reflected on
                                     line 5. Some of the losses were reported as being associated
                                     with Holiday Enterprises, LLC, including $302,400 (the
                                     $374,400 in trustee fees minus the $72,000 in trustee fees
                                     paid to Anthony F. Aragona). The losses reported as being




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                                     (165)                   ARAGONA TRUST v. COMMISSIONER                                        169


                                     associated with Holiday Enterprises, LLC, were subdivided
                                     into various categories of expenses; the $302,400 was
                                     reported in the category of ‘‘other’’ expenses. On its returns
                                     the trust treated its rental real-estate activities, in which it
                                     engaged both directly and through its ownership interests in
                                     a number of entities, as non-passive activities. So treated,
                                     the losses from these activities contributed to the amounts of
                                     net operating losses, which the trust carried back to its 2003
                                     and 2004 tax years.
                                        While reporting losses for its rental real-estate activities,
                                     the trust also reported gains from its other (non-rental) real-
                                     estate activities. The trust owned interests in a number of
                                     entities engaged in real-estate holding activities and real-
                                     estate development projects.
                                        On its Form 1041 for each year, the trust did not enter an
                                     amount on line 12, the line for deductions for ‘‘Fiduciary
                                     fees’’.
                                        In the notice of deficiency, the IRS determined that the
                                     trust’s rental real-estate activities were passive activities, 5 a
                                     determination that increased the passive-activity losses for
                                     2005 and 2006. 6 The increase in the passive-activity losses
                                     resulted in a decrease in the allowable deductions from gross
                                     income for each of those years, 7 which decreased the net-
                                     operating-loss carrybacks to the 2003 and 2004 years. The
                                     notice of deficiency determined that for each of 2005 and
                                     2006 the trust should be allowed a deduction of $302,400 for
                                     ‘‘Fiduciary fees’’. The notice of deficiency also determined
                                     that the trust’s Schedule E expenses, which, as reported on
                                     the returns, included the $302,400 in trustee fees, should be
                                     reduced by $302,400. Thus, the notice of deficiency reclassi-
                                           5 The
                                               notice of deficiency stated that ‘‘[t]he rental losses incurred are
                                     deemed passive’’.
                                        6 A passive-activity loss is the amount by which aggregate losses from all

                                     the taxpayer’s passive activities for the year exceed the aggregate income
                                     from all the taxpayer’s passive activities for the year. Sec. 469(d)(1). The
                                     trust’s losses from its rental real-estate activities exceeded its income from
                                     the activities. Therefore, characterizing the trust’s rental real-estate activi-
                                     ties as passive resulted in a net increase in the trust’s passive-activity loss
                                     for each year.
                                        7 The existence of a passive-activity loss for the year results in the dis-

                                     allowance of current deductions in the amount of the passive-activity loss
                                     for the year. Sec. 1.469–1T(a)(1)(i), Temporary Income Tax Regs., 53 Fed.
                                     Reg. 5701 (Feb. 25, 1988).




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                                     170                  142 UNITED STATES TAX COURT REPORTS                                    (165)


                                     fied the $302,400 amounts as fiduciary fees to be deducted on
                                     line 12 of Form 1041 instead of expenses deducted against
                                     rental income on Schedule E (and reflected on line 5 of Form
                                     1041). In explaining the reclassification of the $302,400 in
                                     fees, the notice of deficiency stated:
                                           It is determined your fiduciary fees of $302,400.00 and $302,400.00,
                                           should be reported on line 12 on the face of the return Form 1041
                                           instead of $302,400.00 and $302,400.00 shown as a rental expense
                                           deduction on the Schedule E for taxable years 2005 and 2006, respec-
                                           tively.
                                           The adjustment was made to the rental loss claimed by Holiday Enter-
                                           prises to disallow the trustee fees as an ‘‘other’’ expense and the expense
                                           was moved to Line 12 on the face of the return where they are required
                                           to be shown as ‘‘fiduciary fees’’.

                                     Computationally, the notice of deficiency did not include the
                                     $302,400 in the amount of the trust’s passive-activity-loss
                                     deductions for each year.

                                                                                   OPINION

                                       The petitioner generally bears the burden of proof (and
                                     therefore must prove the relevant facts by the preponderance
                                     of the evidence) except when the conditions of section 7491(a)
                                     are satisfied. Tax Ct. R. Pract. & Proc. 142(a); Welch v.
                                     Helvering, 290 U.S. 111, 115 (1933); Bronstein v. Commis-
                                     sioner, 138 T.C. 382, 384 (2012). Our findings of fact in this
                                     Opinion are based on the preponderance of the evidence.
                                     Thus, it is unnecessary to determine which party (i.e., the
                                     trust or the IRS) has the burden of proof. See Estate of
                                     Bongard v. Commissioner, 124 T.C. 95, 111 (2005).
                                     1. Does the section 469(c)(7) exception apply to the trust?
                                        In 1986 Congress enacted section 469. Tax Reform Act of
                                     1986, Pub. L. No. 99–514, sec. 501(a), 100 Stat. at 2233. Sec-
                                     tion 469(a)(1) provides that a taxpayer’s passive-activity loss
                                     is disallowed for the year if the taxpayer is ‘‘described in’’
                                     section 469(a)(2). 8 The following taxpayers are ‘‘described in’’
                                     section 469(a)(2): individuals, estates, trusts, closely held C
                                     corporations, and personal service corporations. A passive-
                                     activity loss is the amount by which the aggregate losses
                                       8 A loss from an activity disallowed under sec. 469(a) is treated as a de-

                                     duction allocable to such activity for the next tax year. Sec. 469(b).




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                                     (165)                    ARAGONA TRUST v. COMMISSIONER                                        171


                                     from all the taxpayer’s passive activities for the year exceeds
                                     the aggregate income from all the taxpayer’s passive activi-
                                     ties for such year. Sec. 469(d)(1); see also sec. 1.469–2T(b)(1),
                                     Temporary Income Tax Regs., 53 Fed. Reg. 5711 (Feb. 25,
                                     1988). A passive activity is any activity which involves the
                                     conduct of any trade or business in which the taxpayer does
                                     not materially participate. Sec. 469(c)(1). Under section
                                     469(c)(2), any rental activity is considered a passive activity,
                                     even if the taxpayer materially participates in the activity.
                                     Sec. 469(c)(4). Thus, any rental activity is passive per se.
                                        In 1993 Congress enacted section 469(c)(7), which provides
                                     that section 469(c)(2) does not apply to the rental real-estate
                                     activity of any taxpayer who meets the requirements of sec-
                                     tion 469(c)(7)(B). Omnibus Budget Reconciliation Act of 1993,
                                     Pub. L. No. 103–66, sec. 13143(a) and (b), 107 Stat. at 440,
                                     441. 9 Section 469(c)(7)(B) consists of two tests. The first test
                                     is met if more than one-half of the ‘‘personal services’’ per-
                                     formed in trades or businesses by the taxpayer during the
                                     taxable year is performed in real-property trades or
                                     businesses in which the taxpayer materially participates.
                                     Sec. 469(c)(7)(B)(i). The second test is met if the taxpayer
                                     performs more than 750 hours of ‘‘services’’ during the year
                                     in real-property trades or businesses in which the taxpayer
                                     materially participates. Sec. 469(c)(7)(B)(ii). Both tests must
                                     be met. 10
                                           9 The   following reason was given for the amendment:
                                             The passive loss rules limit deductions and credits from passive trade
                                           or business activities. Deductions attributable to passive activities, to the
                                           extent they exceed income from passive activities, generally may not be
                                           deducted against other income, such as wages, portfolio income, or busi-
                                           ness income that is not derived from a passive activity. * * *
                                                 *          *         *         *        *         *        *
                                           The committee considers it unfair that a person who performs personal
                                           services in a real estate trade or business in which he materially partici-
                                           pates may not offset losses from rental real estate activities against in-
                                           come from nonrental real estate activities or against other types of in-
                                           come such as portfolio investment income. * * *
                                              [H. R. Rept. No. 103–111, at 612–613 (1993), 1993–3 C.B. 1, 188–189.]
                                           10 Sec. 469(c)(7)(B) provides in part:

                                           This paragraph shall apply to a taxpayer for a taxable year 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
                                                                                                       Continued




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                                     172                  142 UNITED STATES TAX COURT REPORTS                                    (165)


                                       Section 469(c)(7)(D)(i) provides a special rule for deter-
                                     mining whether a closely held C corporation meets the
                                     requirements of section 469(c)(7)(B):
                                           In the case of a closely held C corporation, the requirements of subpara-
                                           graph (B) shall be treated as met for any taxable year if more than 50
                                           percent of the gross receipts of such corporation for such taxable year
                                           are derived from real property trades or businesses in which the corpora-
                                           tion materially participates.

                                     Thus, the determination of whether a closely held C corpora-
                                     tion meets the requirements of section 469(c)(7)(B) does not
                                     involve the one-half-of-personal-services test and the 750-
                                     hour test.
                                        The requirements of section 469(c)(7)(B) can be met only by
                                     a taxpayer who materially participates in a real-property
                                     trade or business. This is because the one-half-of-personal-
                                     services test, the 750-hour test, and the special rule for
                                     closely held C corporations all presuppose that the taxpayer
                                     materially participates in real-property trades or businesses.
                                     Sec. 469(c)(7)(B)(i) and (ii); see sec. 469(c)(7)(D); see also sec.
                                     1.469–9(c)(3), Income Tax Regs.
                                        The term ‘‘real property trade or business’’ is defined as
                                     any real-property development, redevelopment, construction,
                                     reconstruction, acquisition, conversion, rental, operation,
                                     management, leasing, or brokerage trade or business. Sec.
                                     469(c)(7)(C).
                                        Regulatory guidance regarding the section 469(c)(7) excep-
                                     tion is found in section 1.469–9, Income Tax Regs. This regu-
                                     lation states that only a ‘‘qualifying taxpayer’’ falls within
                                     the exception. Sec. 1.469–9(e)(1), Income Tax Regs. (‘‘Section
                                     469(c)(2) does not apply to any rental real estate activity of
                                     a taxpayer for a taxable year in which the taxpayer is a
                                     qualifying taxpayer[.]’’). The term ‘‘qualifying taxpayer’’ is
                                     defined by the regulation as ‘‘a taxpayer that owns at least
                                     one interest in rental real estate and meets the requirements
                                     of paragraph (c) of this section.’’ Sec. 1.469–9(b)(6), Income
                                     Tax Regs. Section 1.469–9(c), Income Tax Regs. (the para-

                                           real property trades or businesses in which the taxpayer materially par-
                                           ticipates, 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.




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                                     (165)                   ARAGONA TRUST v. COMMISSIONER                                        173


                                     graph (c) provision referred to in the quotation above), pro-
                                     vides: ‘‘(1) In general.—A qualifying taxpayer must meet the
                                     requirements of section 469(c)(7)(B).’’ Thus, to be a ‘‘quali-
                                     fying taxpayer’’ within the meaning of the regulation a tax-
                                     payer must own at least one interest in rental real estate
                                     and satisfy the requirements of section 469(c)(7)(B). Two
                                     other aspects of the regulation are of note. First, section
                                     1.469–9(b)(4), Income Tax Regs., provides, in part, that
                                     ‘‘[ p]ersonal services means any work performed by an indi-
                                     vidual in connection with a trade or business.’’ This is an
                                     interpretation of the term ‘‘personal services’’ used in the
                                     first test of section 469(c)(7)(B). Second, section 1.469–9(c)(2),
                                     Income Tax Regs., provides that ‘‘[a] closely held C corpora-
                                     tion meets the requirements of paragraph (c)(1) of this sec-
                                     tion by satisfying the requirements of section 469(c)(7)(D)(i).’’
                                         Section 469(h) provides that for the purposes of section 469
                                     a taxpayer is treated as materially participating in an
                                     activity only if the taxpayer is involved in the operation of
                                     the activity on a basis which is regular, continuous, and
                                     substantial. The test in section 469(h) has two functions.
                                     First, it is used to determine whether a particular activity is
                                     a passive activity. See sec. 469(c)(1) (defining passive activity
                                     as an activity, involving the conduct of a trade or business,
                                     in which the taxpayer does not materially participate).
                                     Second, it is used to determine whether a taxpayer materi-
                                     ally participates in real-property trades or businesses. See
                                     sec. 469(c)(7)(B)(i) and (ii). Thus, a taxpayer is treated as
                                     materially participating in real-property trades or businesses
                                     if the taxpayer is involved in the operation of real-property
                                     trades or businesses on a basis which is regular, continuous,
                                     and substantial.
                                           a. Can a trust qualify for the section 469(c)(7) exception?
                                           i. The IRS’s arguments
                                        For the section 469(c)(7) exception to apply, there must be
                                     ‘‘personal services performed * * * by the taxpayer’’. Sec.
                                     469(c)(7)(B)(i). Because ‘‘[p]ersonal services’’ are defined by
                                     regulation as ‘‘work performed by an individual in connection
                                     with a trade or business’’, the IRS contends that a trust
                                     cannot perform personal services. See sec. 1.469–9(b)(4),




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                                     174                 142 UNITED STATES TAX COURT REPORTS                                    (165)


                                     Income Tax Regs. Therefore, the IRS contends, a trust
                                     cannot qualify for the section 469(c)(7) exception.
                                       The IRS asserts that the legislative history of section
                                     469(c)(7) supports its view that Congress did not intend the
                                     section 469(c)(7) exception to apply to trusts. In describing
                                     the provision in the bill that would be adopted by the House,
                                     and enacted by Congress in amended form as section
                                     469(c)(7), the report of the House Ways and Means Com-
                                     mittee stated that the provision ‘‘applies to individuals and
                                     closely held C corporations.’’ H.R. Rept. No. 103–111, at 614
                                     (1993), 1993–3 C.B. 167, 190. The report further stated that
                                     an ‘‘individual taxpayer’’ meets the requirements of the
                                     exception ‘‘if more than half of the personal services the tax-
                                     payer performs in a trade or business are in real property
                                     trades or businesses in which he materially participates.’’ Id.
                                     (The bill adopted by the House had provided that the section
                                     469(c)(7) exception was applicable ‘‘if more than one-half of
                                     the personal services performed in trades or businesses by
                                     the taxpayer * * * are performed in real property trades or
                                     businesses in which the taxpayer materially participates.’’
                                     H.R. 2264, 103d Cong., sec. 14143 (1993). The bill did not yet
                                     include the 750-hour test now codified in section
                                     469(c)(7)(B)(ii).) The report also stated that a closely held C
                                     corporation meets the requirements of the section 469(c)(7)
                                     exception ‘‘if more than 50 percent of its gross receipts for
                                     the taxable year are derived from real property trades or
                                     businesses in which the corporation materially participates
                                     (within the meaning of sec. 469(h)(4)).’’ H.R. Rept. No. 103–
                                     111, supra at 614, 1993–3 C.B. at 190. The report did not
                                     describe how any class of taxpayer other than an individual
                                     or a closely held C corporation meets the requirements of the
                                     exception. Id. The report of the conference committee, also
                                     describing the bill adopted by the House, similarly stated
                                     that an ‘‘individual taxpayer’’ meets the requirements of the
                                     exception ‘‘if more than half of the personal services the tax-
                                     payer performs in trades or businesses during the taxable
                                     year are in real property trades or businesses in which he
                                     materially participates.’’ H.R. Conf. Rept. No. 103–213, at
                                     546 (1993), 1993–3 C.B. 393, 424. The conference report fur-
                                     ther stated that a closely held C corporation meets the
                                     requirements of the exception ‘‘if more than 50 percent of its
                                     gross receipts for the taxable year are derived from real prop-




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                                     (165)                    ARAGONA TRUST v. COMMISSIONER                                        175


                                     erty trades or businesses in which the corporation materially
                                     participates.’’ Id. The conference report also discussed the
                                     final version of the bill. Id. at 547, 1993–3 C.B. at 425. It
                                     described the section 469(c)(7) exception thus:
                                             The conference agreement follows the House bill, with a modification.
                                           Under the conference agreement, an individual taxpayer meets the eligi-
                                           bility requirements if (1) more than half of the personal services the tax-
                                           payer performs in trades or businesses during the taxable year are per-
                                           formed in real property trades or businesses in which the taxpayer mate-
                                           rially participates, and (2) 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. * * * [Id.]
                                           ii. Analysis
                                        The IRS argues that a trust is incapable of performing
                                     ‘‘personal services’’ because the regulation defines ‘‘personal
                                     services’’ to mean ‘‘any work performed by an individual in
                                     connection with a trade or business’’. Sec. 1.469–9(b)(4),
                                     Income Tax Regs. We reject the IRS’s argument. A trust is
                                     an arrangement whereby trustees manage assets for the
                                     trust’s beneficiaries. 1 Restatement, Trusts 3d, sec. 2 (2003)
                                     (a trust ‘‘is a fiduciary relationship with respect to property,
                                     * * * subjecting the person who holds title to the property
                                     to duties to deal with it for the benefit of ’’ others); see also
                                     sec. 301.7701–4(a), Proced. & Admin. Regs. (‘‘In general, the
                                     term ‘trust’ as used in the Internal Revenue Code refers to
                                     an arrangement created either by will or by an inter vivos
                                     declaration whereby trustees take title to property for the
                                     purpose of protecting or conserving it for the beneficiaries
                                     under the ordinary rules applied in chancery or probate
                                     courts.’’). If the trustees are individuals, and they work on a
                                     trade or business as part of their trustee duties, their work
                                     can be considered ‘‘work performed by an individual in
                                     connection with a trade or business.’’ Sec. 1.469–9(b)(4),
                                     Income Tax Regs. We conclude that a trust is capable of per-
                                     forming personal services and therefore can satisfy the sec-
                                     tion 469(c)(7) exception.
                                        Indeed, if Congress had wanted to exclude trusts from the
                                     section 469(c)(7) exception, it could have done so explicitly by
                                     limiting the exception to ‘‘any natural person’’. In section
                                     469(i), the Internal Revenue Code does exactly that. Section
                                     469(i) grants a $25,000 allowance to ‘‘any natural person’’
                                     who fulfills certain requirements. That Congress did not use




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                                     the phrase ‘‘natural person’’ but instead used the word ‘‘tax-
                                     payer’’ in section 469(c)(7) suggests that Congress did not
                                     intend to exclude trusts from the section 469(c)(7) exception,
                                     despite what the IRS argues here.
                                       We need not address the trust’s arguments regarding the
                                     regulation, which are that:
                                       (1) the word ‘‘individual’’ in the regulation should be inter-
                                     preted to include a trust, and
                                       (2) in the alternative, even if the word ‘‘individual’’ does
                                     not include a trust, then the regulation is inapplicable to tax-
                                     payers that are trusts.
                                       We now turn to the legislative history of the section
                                     469(c)(7) exception, which the IRS contends shows that trusts
                                     cannot qualify for that exception. The Ways and Means Com-
                                     mittee report states that the section 469(c)(7) exception
                                     applies to individuals and closely held C corporations. H.R.
                                     Rept. No. 103–111, supra at 614, 1993–3 C.B. at 190. The
                                     report does not say that the exception applies only to individ-
                                     uals and closely held C corporations. Therefore, the report
                                     does not compel the conclusion that only individuals and
                                     closely held C corporations can qualify for the section
                                     469(c)(7) exception.
                                       The legislative history states that an individual meets the
                                     requirements of section 469(c)(7) by meeting the one-half-of-
                                     personal-services test and, in discussing the final version of
                                     the legislation, the 750-hour test. Id.; H.R. Rept. No. 103–
                                     213, supra at 546, 1993–3 C.B. at 424. It is true that an indi-
                                     vidual falls within the section 469(c)(7) exception by meeting
                                     the two tests. But this does not mean that other types of tax-
                                     payers cannot fall within the exception.
                                           b. Does the trust qualify for the section 469(c)(7) exception?
                                       The IRS’s fallback position is that even if some trusts can
                                     qualify for the section 469(c)(7) exception, the trust does not
                                     qualify because it did not materially participate in real-prop-
                                     erty trades or businesses. The IRS concedes that the trust’s
                                     real-estate operations qualify as real property trades or
                                     businesses. Therefore the question to be resolved is whether
                                     the trust materially participated in its real-estate operations.
                                     We hold that it did so.
                                       Section 469(h) supplies the definition of what it means to
                                     materially participate in an activity. By that definition, a




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                                     (165)                    ARAGONA TRUST v. COMMISSIONER                                        177


                                     taxpayer is treated as materially participating in an activity
                                     only if the taxpayer is involved in the operations of the
                                     activity on a basis which is regular, continuous, and substan-
                                     tial. Sec. 469(h). Interpreting section 469(h), the Department
                                     of the Treasury has promulgated regulations for determining
                                     whether taxpayers who are individuals materially participate
                                     in an activity. See sec. 1.469–5T(a), (b), (c), and (d), Tem-
                                     porary Income Tax Regs., 53 Fed. Reg. 5725 (Feb. 25, 1988).
                                     Section 469(h)(4) provides a method for determining whether
                                     certain types of corporations 11 have met the tests for mate-
                                     rial participation. The statute does not provide a method for
                                     determining how a trust may materially participate in an
                                     activity, and no regulations have yet been promulgated for
                                     taxpayers that are trusts. See sec. 1.469–5T(g), Temporary
                                     Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988)
                                     (reserving a place for a regulation to be titled ‘‘Material
                                     participation of trusts and estates’’). Therefore, we must
                                     make the determination of whether a trust materially
                                     participates in an activity in the absence of regulatory guid-
                                     ance. 12
                                        The IRS argues that in determining whether a trust is
                                     materially participating in an activity, only the activities of
                                     the trustees can be considered and the activities of that
                                     trust’s employees must be disregarded. In support, the IRS
                                     cites S. Rept. No. 99–313, at 735 (1986), 1986–3 C.B. (Vol. 3)
                                     1, 735, which states that a trust ‘‘is treated as materially
                                           11 The
                                               IRS does not take the position that the trust should be treated
                                     as a corporation. See sec. 301.7701–4(b), Proced. & Admin. Regs. (business
                                     trusts, defined as devices created by beneficiaries to carry on profit-making
                                     businesses, are to be treated for federal tax law purposes as corporations
                                     or partnerships).
                                        12 A number of commentators have argued that there is a need for a reg-

                                     ulation that resolves questions regarding material participation of trusts
                                     and generally coordinates the passive-activity-loss rules of sec. 469 with
                                     the rules on taxation of trusts in subch. J. See, e.g., 1 Byrle K. Abbin,
                                     David K. Carlson, and Mark L. Vorsatz, Income Taxation of Fiduciaries
                                     and Beneficiaries, sec. 801, at 8003 to 8004 (2012 ed.) (‘‘Section 469 does
                                     not easily comport with subchapter J. To date no regulatory explanation
                                     has been forthcoming * * * [on questions including] where and how mate-
                                     rial participation is measured[.]’’); M. Carr Ferguson, James J. Freeland,
                                     and Mark L. Ascher, Federal Income Taxation of Estates, Trusts, and
                                     Beneficiaries, para. 8.01, at 8–1 to 8–8 (3d ed. 2003); Leo L. Schmolka,
                                     ‘‘Passive Activity Losses, Trusts, and Estates: The Regulations (If I Were
                                     King)’’, 58 Tax L. Rev. 191 (2005).




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                                     178                  142 UNITED STATES TAX COURT REPORTS                                    (165)


                                     participating in an activity * * * if an executor or fiduciary,
                                     in his capacity as such, is so participating.’’ The Senate com-
                                     mittee report also states that ‘‘the activities of * * *
                                     [employees] are not attributed to the taxpayer’’. 13
                                        On the basis of these legal principles, the IRS would have
                                     us ignore the activities of the trust’s non-trustee
                                     employees. 14 Additionally, the IRS would have us ignore the
                                     activities of the three trustees who are employees of Holiday
                                     Enterprises, LLC. It reasons that the activities of these three
                                     trustees should be considered the activities of employees and
                                     not fiduciaries because (1) the trustees performed their
                                     activities as employees of Holiday Enterprises, LLC, and (2)
                                     it is impossible to disaggregate the activities they performed
                                     as employees of Holiday Enterprises, LLC, and the activities
                                     they performed as trustees.
                                        If the Court adopts all these arguments made by the IRS,
                                     then it should ignore the activities of the 20 or so non-trustee
                                     employees and the 3 trustee-employees (Paul V. Aragona,
                                     Frank S. Aragona, and Annette Aragona Moran). This would
                                     leave only the relatively insignificant activities of the
                                     trustees who are not employees (Salvatore S. Aragona, a den-
                                     tist, Anthony F. Aragona, who is disabled and unable to
                                     work, and Charles E. Turnbull, an outside attorney who is
                                     the independent trustee).
                                        Even if the activities of the trust’s non-trustee employees
                                     should be disregarded, 15 the activities of the trustees—
                                     including their activities as employees of Holiday Enter-
                                     prises, LLC—should be considered in determining whether
                                     the trust materially participated in its real-estate operations.
                                     The trustees were required by Michigan statutory law to
                                           13 The   Senate committee report states:
                                          The fact that a taxpayer utilizes employees or contract services to per-
                                       form daily functions in running the business does not prevent such tax-
                                       payer from qualifying as materially participating. However, the activities
                                       of such agents are not attributed to the taxpayer, and the taxpayer must
                                       still personally perform sufficient services to establish material partici-
                                       pation. [S. Rept. No. 99–313, at 735 (1986), 1986–3 C.B. (Vol. 3) 1, 735.]
                                       14 The IRS disagrees with Carter Trust v. United States, 256 F. Supp. 2d

                                     536, 541 (N.D. Tex. 2003), which held that the activities of the trust’s non-
                                     trustee employees (and of the trustee) are considered in determining
                                     whether the trust materially participated in ranching activity.
                                       15 We need not and do not decide whether the activities of the trust’s

                                     non-trustee employees should be disregarded.




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                                     (165)                   ARAGONA TRUST v. COMMISSIONER                                        179


                                     administer the trust solely in the interests of the trust bene-
                                     ficiaries, because trustees have a duty to act as a prudent
                                     person would in dealing with the property of another, i.e., a
                                     beneficiary. Mich. Comp. Laws sec. 700.7302 (2001) (before
                                     amendment by 2009 Mich. Pub. Acts No. 46); see also In re
                                     Estate of Butterfield, 341 N.W.2d 453, 459 (Mich. 1983) (con-
                                     struing Mich. Comp. Laws sec. 700.813 (1979), a statute in
                                     effect from 1979 to 2000 that was a similarly-worded prede-
                                     cessor to Mich. Comp. Laws sec. 700.7302). Trustees are not
                                     relieved of their duties of loyalty to beneficiaries by con-
                                     ducting activities through a corporation wholly owned by the
                                     trust. Cf. In re Estate of Butterfield, 341 N.W.2d at 457
                                     (‘‘Trustees who also happen to be directors of the corporation
                                     which is owned or controlled by the trust cannot insulate
                                     themselves from probate scrutiny [i.e., duties imposed on
                                     trustees by Michigan courts] under the guise of calling them-
                                     selves corporate directors who are exercising their business
                                     judgment concerning matters of corporate policy.’’). Therefore
                                     their activities as employees of Holiday Enterprises, LLC,
                                     should be considered in determining whether the trust mate-
                                     rially participated in its real-estate operations. 16
                                        Considering the activities of all six trustees in their roles
                                     as trustees and as employees of Holiday Enterprises, LLC,
                                     the trust materially participated in its real-estate operations.
                                     Three of the trustees participated in the trust’s real-estate
                                     operations full time. The trust’s real-estate operations were
                                     substantial. The trust had practically no other types of oper-
                                     ations. The trustees handled practically no other businesses
                                     on behalf of the trust. The IRS argues that because Paul V.
                                     Aragona and Frank S. Aragona had minority ownership
                                     interests in all of the entities through which the trust oper-
                                       16 We need not consider the effect of sec. 469(c)(7)(D)(ii), which provides

                                     that for purposes of sec. 469(c)(7)(B) personal services performed as an em-
                                     ployee are generally not treated as performed in real-property trades or
                                     businesses. This rule has no application to the resolution of this case be-
                                     cause, as we explain infra, the IRS has confined its challenges to the
                                     trust’s qualification for sec. 469(c)(7) treatment to two challenges: (1) that
                                     trusts are categorically barred from sec. 469(c)(7) treatment, and (2) the
                                     trust did not materially participate in real-property trades or businesses.
                                     Thus, we need not, and do not, determine how many hours of personal
                                     services were performed by the trust in real-property trades or businesses.
                                     We also note that the IRS does not cite sec. 469(c)(7)(D)(ii) in its brief.




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                                     180                 142 UNITED STATES TAX COURT REPORTS                                    (165)


                                     ated real-estate holding and real-estate development projects
                                     and because they had minority interests in some of the enti-
                                     ties through which the trust operated its rental real-estate
                                     business, some of these two trustees’ efforts in managing the
                                     jointly held entities are attributable to their personal por-
                                     tions of the businesses, not the trust’s portion. Despite two
                                     of the trustees’ holding ownership interests, we are convinced
                                     that the trust materially participated in the trust’s real-
                                     estate operations. First, Frank S. and Paul V. Aragona’s com-
                                     bined ownership interest in each entity was not a majority
                                     interest—for no entity did their combined ownership interest
                                     exceed 50%. Second, Frank S. and Paul V. Aragona’s com-
                                     bined ownership interest in each entity was never greater
                                     than the trust’s ownership interest. Third, Frank S. and Paul
                                     V. Aragona’s interests as owners were generally compatible
                                     with the trust’s goals—they and the trust wanted the jointly
                                     held enterprises to succeed. Fourth, Frank S. and Paul V.
                                     Aragona were involved in managing the day-to-day oper-
                                     ations of the trust’s various real-estate businesses.
                                        We hold that the trust materially participated in real-prop-
                                     erty trades or businesses. For a taxpayer who has materially
                                     participated in real-property trades or businesses, the next
                                     steps in ascertaining whether the taxpayer benefits from the
                                     section 469(c)(7) exception are (1) to determine whether more
                                     than one-half of the personal services performed in trades or
                                     businesses by the taxpayer during the year are performed in
                                     real-property trades or businesses, and (2) to determine
                                     whether the taxpayer performed more than 750 hours of
                                     services during the year in the real-property trades or
                                     businesses. As to whether the trust qualifies for the section
                                     469(c)(7) exception, however, the IRS has limited its argu-
                                     ments to the two arguments discussed above, namely (1) that
                                     trusts are categorically barred from qualifying under the sec-
                                     tion 469(c)(7) exception, and (2) that the trust did not materi-
                                     ally participate in real-property trades or businesses. In the
                                     context of the arguments raised in this case, therefore, we
                                     hold the trust meets the section 469(c)(7) exception for the
                                     years at issue.
                                           c. Conclusion
                                       Once it is determined that the trust qualifies under the
                                     section 469(c)(7) exception, and that therefore the trust’s




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                                     (165)                    ARAGONA TRUST v. COMMISSIONER                                        181


                                     rental real-estate activities are not per se passive activities,
                                     a theoretical next step is to determine whether the trust
                                     materially participated in its rental real-estate activities. If
                                     the trust materially participated in its rental real-estate
                                     activities, then its rental real-estate activities are not passive
                                     activities. If the trust did not materially participate in its
                                     rental real-estate activities, then its rental real-estate activi-
                                     ties are passive activities. 17 The IRS argues only that the
                                     trust is not excepted by section 469(c)(7). It does not argue
                                     that—in the event that we determine that the trust is
                                     excepted by section 469(c)(7)—the trust did not materially
                                     participate in its rental real-estate activities. We hold that,
                                     in the context of the arguments presented in this case, the
                                     trust’s rental real-estate activities are not passive activities.
                                     2. Are the fees that were paid by the trust to its trustees
                                        properly characterized as expenses of the trust’s rental
                                        real-estate activities?
                                       The notice of deficiency determined that the trust’s rental
                                     real-estate activities were passive activities, a determination
                                     that if correct meant that all deductions related to the rental
                                     real-estate activities were passive-activity-loss deductions.
                                     The notice of deficiency treated the $302,400 in trustee fees
                                     as deductions other than passive-activity-loss deductions
                                     (and allowed the full deduction of $302,400). 18 The treat-
                                           17 In
                                             determining whether a taxpayer who qualifies for the sec. 469(c)(7)
                                     exception has materially participated in a rental real-estate activity, each
                                     interest in rental real estate is treated as a separate rental real-estate ac-
                                     tivity unless the taxpayer has made an election under section 469(c)(7)(A).
                                     If the taxpayer has made such an election, then all interests in rental real
                                     estate are treated as a single rental real-estate activity. Sec. 469(c)(7)(A).
                                     Before the years at issue, the trust made an election under sec.
                                     469(c)(7)(A)—an election that was binding for subsequent tax years, absent
                                     changed circumstances—to treat all of its interests in rental real estate as
                                     a single activity.
                                        18 A passive-activity loss is generally defined as the amount, if any, by

                                     which the passive-activity deductions for the year exceed the passive-activ-
                                     ity gross income for the tax year. Sec. 1.469–2T(b)(1), Temporary Income
                                     Tax Regs., 53 Fed. Reg. 5711 (Feb. 25, 1988). Passive-activity gross income
                                     is generally all items of gross income from a passive activity. Sec. 1.469–
                                     2T(c), Temporary Income Tax Regs., supra. A passive-activity deduction is
                                     generally defined as a deduction arising in connection with the conduct of
                                     a passive activity. Sec. 1.469–2T(d)(1), Temporary Income Tax Regs., 53
                                                                                                       Continued




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                                     182                 142 UNITED STATES TAX COURT REPORTS                                    (165)


                                     ment of the $302,400 in trustee fees as deductions other than
                                     passive-activity-loss deductions assumes that the trustee fees
                                     were not expenses of the trust’s rental real-estate activities.
                                     On brief, the IRS appears to defend this assumption: it
                                     apparently contends that the trustee fees were not the
                                     expenses of the trust’s rental real-estate activities. 19 The
                                     trust appears to disagree with the assumption in the notice
                                     of deficiency: the trust apparently contends that the trustee
                                     fees were the expenses of the trust’s rental real-estate activi-
                                     ties. 20
                                        The question of whether the trustee fees were the expenses
                                     of the trust’s rental real-estate activities is relevant only if
                                     the trust’s rental real-estate activities are passive activities.
                                     Contrary to the notice of deficiency, we hold that the trust’s
                                     rental real-estate activities were not passive activities. See
                                     supra part 1.c. Because of this holding, the losses associated
                                     with the trust’s rental real-estate activities are not passive-
                                     activity-loss deductions. Therefore, it is unnecessary to decide
                                     whether the trustee fees were expenses of the trust’s rental
                                     real-estate activity.
                                     3. Conclusion
                                        We have considered all of the arguments the parties have
                                     made, and to the extent that we have not discussed them, we
                                     find them to be irrelevant, moot, or without merit.




                                     Fed. Reg. 5716 (Feb. 25, 1988).
                                        19 In its brief, the IRS frames the issue of proper characterization of the

                                     trustee fees as: ‘‘Whether petitioner should have reported trustee fee ex-
                                     penses on the front of its U.S. Income Tax Return for Estates and Trusts,
                                     Form 1041, or on the Schedule E, for the 2005 and 2006 years.’’ It also
                                     frames the issue as: ‘‘Trustee Fees Are An Expense Of The Trust and not
                                     [Holiday Enterprises, LLC].’’ Both phrasings appear to be an obscure ref-
                                     erence to the notice of deficiency’s assumption that the trustee fees are not
                                     the expenses of the trust’s rental real-estate activity.
                                        20 In its reply brief, the trust argues that the trustee fees are ‘‘properly

                                     included in the determination of the Trust’s losses from its real estate ac-
                                     tivities.’’ Strictly speaking, however, the computations in the notice of defi-
                                     ciency assumed that the trustee fees were not the expenses of the trust’s
                                     rental real-estate activities.




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                                     (165)                   ARAGONA TRUST v. COMMISSIONER                                        183


                                           To reflect the foregoing,
                                                                     Decision will be entered under Tax Ct. R.
                                                                   Pract. & Proc. 155.

                                                                               f




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