                  T.C. Summary Opinion 2004-139



                     UNITED STATES TAX COURT



          GARY W. AND DARLENE E. WHITE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 414-03S.              Filed October 12, 2004.


     Gary W. and Darlene E. White, pro sese.

     Robert S. Scarbrough, for respondent.



     ARMEN, Special Trial Judge:    This case was heard pursuant to

the provisions of 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, all subsequent section
references are to the Internal Revenue Code in effect for 1999
and 2000, the taxable years in issue. All Rule references are to
the Tax Court Rules of Practice and Procedure.
                                 - 2 -

     Respondent determined deficiencies in petitioners’ Federal

income taxes of $1,568 and $3,696 for the taxable years 1999 and

2000, respectively.

     After respondent’s concessions,2 the issue for decision is

whether the losses petitioners incurred in their sailboat charter

business are subject to the passive activity loss rules of

section 469.   We hold that they are.

Background

     Some of the facts have been stipulated, and they are so

found.   We incorporate by reference the parties’ stipulation of

facts and accompanying exhibits.

     At the time that the petition was filed, petitioners resided

in Kirkland, Washington.   (References to petitioners individually

are to Mr. White or Mrs. White.)

     During the years in issue, Mr. White was employed full time

as a glazing estimator, and Mrs. White was employed full time as

a project coordinator.

     At a time not disclosed in the record, petitioners started a

sailboat charter business called GW Rentals, which they operated

throughout the years in issue.    The sailboat used in petitioners’

business during the years in issue was a 1998 42-foot Catalina



     2
        Respondent concedes that: (1) Petitioners’ sailboat
charter activity is a trade or business; and (2) petitioners
incurred net losses from their sailboat charter business of
$5,593 for 1999 and $13,186 for 2000.
                                 - 3 -

sailboat named Moonshadow.3   Petitioners purchased Moonshadow new

in December 1997 for approximately $185,000, at which time they

traded in their former 36-foot Catalina sailboat.4

     Moonshadow is a single sloop mast sailboat with a diesel

engine.   It features, among other things, two double-berth

staterooms, two cabins, two toilet compartments, and a galley

complete with a microwave, refrigerator, freezer, three-burner

propane gas stove with oven, and hot and cold running water.

Moonshadow also has on board a global positioning system with

chart plotter, an Autohelm navigation system, a Freedom 20

inverter system, a TV/DVD, and a complete stereo system with

speakers in front and in back.    Petitioners took possession of

Moonshadow in March 1998, and have remained the sole owners of it

throughout the years in issue.

     During the years in issue, petitioners docked Moonshadow at

the Anacortes Marina, which was operated by Anacortes Yacht

Charters (AYC), a charter company.5      Petitioners initially


     3
        Petitioners have owned various Catalina sailboats for the
past 40 years. Mr. White is also an experienced sailor who built
his first boat at the age of 13 and crewed on boats racing in the
Columbia River.
     4
        Petitioners apparently did not pay Washington State sales
tax when they purchased Moonshadow based on their declaration to
the Washington State Revenue Department that the sailboat was
purchased for charter purposes and not for personal use.
     5
        AYC has a fleet of 110 boats, including Moonshadow,
available for charters. AYC also maintains skippers and crews
                                                   (continued...)
                                - 4 -

entered into a yacht owners’ contract with AYC on May 26, 1998,

granting AYC the exclusive right to charter Moonshadow as a bare

boat charter.6   This contract continued until January 31, 1999,

when petitioners signed a new contract with AYC under terms

substantially similar to the prior year’s contract.    This

contract was automatically renewed and remained in effect for the

year 2000.    Under this contract, AYC had the exclusive right to

lease Moonshadow and to further sublease it to third-party

charterers.   The lease granted AYC possession, dominion, and

control over the vessel.    The terms of the contract provided that

AYC was responsible for the day-to-day management and operation

of Moonshadow to include: (1) Arranging charters through

advertising, boat show displays, distribution of brochures, and

AYC’s internet site;7 (2) providing certain services, to include

cleaning and inspection, provisioning and ground transportation,

and the personnel needed to perform these services; (3) handling

all reservations, collection of charter fees, Washington State

sales tax, daily insurance fund and service fees, payment of


     5
      (...continued)
for hire.
     6
        A bare boat charter means that the charter party receives
a seaworthy vessel in “bare” condition; i.e., the charter party
provides its own skipper, bears the cost of supplies and voyage
costs such as fuel and port charges, and is directly responsible
for operating and maintaining the vessel during the charter.
     7
        Petitioners pay a separate fee to list and update a link
for Moonshadow on AYC’s internet site.
                              - 5 -

Washington State sales tax to the State, and disbursement of

funds to petitioners; and (4) performing necessary repairs or

maintenance to make Moonshadow charter ready.8    For these

services, petitioners paid AYC a commission, after deducting the

turn fee, of 30-percent of the gross charter fee (or 20-percent

of the gross charter fees for charters arranged by petitioners).9

The contract further provided that petitioners:    (1) Reserved no

right to nonbusiness private use of Moonshadow; (2) agreed to pay

AYC a commission of 5-percent if they leased Moonshadow for

personal use; and (3) agreed to insure Moonshadow at their own

expense under the AYC group insurance program.

     Typically, AYC’s contracts with individual charterers set

forth the terms of a charter period as follows:

     A CHARTER WEEK is 7 days/6 nights. Example: Noon
     Sunday to Noon Saturday. Daily pro-rated items are
     based on number of days in charter.

At the end of each month, AYC would mail petitioners a detailed

income activity statement indicating the name of the charterer,



     8
        The contract authorized AYC to spend up to $500 for
repairs or maintenance needed to make the vessel ready for the
next charter. AYC was required to make every reasonable effort
to contact petitioners before authorizing repairs or maintenance
in excess of $500, or to provide notice at the first opportunity
if contact was not possible.
     9
        Petitioners elected to pay the optional turn fee (which
provides that AYC personnel will clean Moonshadow after every
charter) because “being that it’s [Moonshadow] located where it
is, it would be--and we work full time--it makes sense to have
them [AYC] take care of it for us.”
                               - 6 -

the start and finish dates, the number of charter days, the

charter income, and the charter expenses.   At the end of each

year, AYC would also mail petitioners a yacht owners’ annual

summary worksheet showing the monthly figures totaled for the

full year by income, charter expenses, and maintenance and other

expenses.   These reports demonstrate that AYC arranged 13

charters for a total of 92 charter days in 1999 and 15 charters

for a total of 97 charter days in 2000.10

     In addition to the services provided by AYC, petitioners

performed various services for their sailboat charter business.

For example, during the charter season petitioners would check on

the sailboat, wash the rugs, and perform maintenance.11

Specifically, in 1999 petitioners performed a major repair to

their sailboat when they installed a new windlass.   At the end of

the charter season, petitioners would meet with the charter

representative to review the postseason report, which lists any

problems on the sailboat, the status of the systems, the

inventory on board, the hull condition, and any cosmetic

problems.   During the off-season, petitioners would work on any

problems noted in the postseason report, conduct engine



     10
        In 1999, petitioners charted Moonshadow for a total of
12 charter days; in 2000, they charted Moonshadow for a total of
7 charter days.
     11
        AYC’s charter season is typically the last week of May
through the end of September.
                               - 7 -

maintenance, refinish the interior, wax the sailboat, and switch

the pumps.   During the preseason, petitioners would conduct a

maintenance check, which AYC would verify based on a preseason

readiness checklist.   Petitioners also rented a storage locker in

the marina building where they stored proprietary parts that AYC

or petitioners could use for repairs on Moonshadow.

     To document their work, petitioners maintained

contemporaneous handwritten logs identifying the dates that they

worked on Moonshadow and the type of work completed.    The work

logs indicate a timeframe for each day Mr. White or petitioners

together worked on Moonshadow.    The work logs, however, do not

detail the amount of time actually spent on a specific task, do

not indicate which petitioner performed a particular task, and do

not account for lunch breaks that petitioners testified they took

during the day.

     Petitioners timely filed a Form 1040, U.S. Individual Income

Tax Return, for each of the years in issue.   Petitioners attached

to each return, inter alia, a Schedule C, Profit or Loss From

Business (Sole Proprietorship).   On each Schedule C, petitioners

identified their business name as GW Rentals and their principal

business or profession as boat charters and tours.    On the

Schedules C, petitioners marked “Yes” on Line G:   “Did you

‘materially participate’ in the operation of this business”.

Petitioners reported losses from GW Rentals on the Schedules C as
                                     - 8 -

follows:

       Year       Gross Income       Total Expenses        Net Loss
       1999         $36,273              $41,866            $5,593
       2000          40,863               54,049            13,186

Expenses consisted of advertising, automobile expenses,

commissions and fees, depreciation, insurance, mortgage, legal

and professional services, repairs and maintenance, taxes and

licenses, meals and entertainment, utilities, and other expenses.

       In response to an audit for the years in issue, petitioners

created on June 18, 2002, activity logs based on their

contemporaneous work logs, receipts, photos, checkbook, and

statements.      These activity logs itemized the type of work

petitioners allegedly performed in their sailboat charter

business as follows:

Year          Total Hours   Labor Hours[1]   Travel Time    Investment Time
1999            591.25        390.75            178              22.5
2000            616.38        406.5             178.38           31.5

     [1]
         We note that many of the activity items are improperly categorized as
labor hours. For instance, attending AYC meetings and barbecues are not labor
services.

       In the notice of deficiency, respondent disallowed

petitioners’ business losses.          Respondent determined that

petitioners’ sailboat charter business is a rental activity, and

that petitioners’ business losses therefore constitute passive

activity losses.

       Petitioners timely filed a petition with the Court disputing

the determined deficiencies.         Paragraph 4 of the petition states

in part as follows:
                                  - 9 -

          Taxpayers disagree with the disallowance.
     Taxpayers furnished the Service numerous schedules
     supported by affidavits and receipts documenting that
     all losses in question were allowed due to material
     participation under Treas. Reg. 1.469-5T(a)(1) and
     1.469-5T(a)(3).

          The Service’s primary rebuttal to abundance of
     documentation has been that it is not possible for the
     husband and wife, i.e., taxpayers Gary & Darlene White,
     to have worked a combined total of 18 hours in any
     given day. Apparently the most the Service believes
     that 2 people can work in one day is 16 hours!
     Taxpayers contend that the Service’s position is
     unreasonable and without any authoritative support.

Discussion12

     Generally, the Commissioner’s determinations are presumed

correct, and the taxpayer bears the burden of proving that those

determinations are erroneous.      Rule 142(a); Welch v. Helvering,

290 U.S. 111, 115 (1933).

     Section 469 generally disallows for the taxable year passive

activity losses incurred by individual taxpayers.      Sec.

469(a)(1).     A passive activity loss is the amount by which the

aggregate losses from all passive activities for the taxable year

exceed the aggregate income from all passive activities for such

year.     Sec. 469(d)(1)(A).   A passive activity is any trade or

business in which the taxpayer does not materially participate.

Sec. 469(c)(1).     The term passive activity includes any rental

activity regardless of whether the taxpayer materially


     12
        We decide the issue in this case without regard to the
burden of proof under sec. 7491(a) because the issue is
essentially one of law.
                                - 10 -

participates in the activity.    Sec. 469(c)(2), (4).   A rental

activity is “any activity where payments are principally for the

use of tangible property.”   Sec. 469(j)(8).

     As relevant herein, exceptions to the general rule that an

activity involving the use of tangible property is a rental

activity are:

               (A) The average period of customer use
          for such property is seven days or less;

               (B) The average period of customer use
          for such property is 30 days or less, and
          significant personal services (within the
          meaning of paragraph (e)(3)(iv) of this
          section) are provided by or on behalf of the
          owner of the property in connection with
          making the property available for use by
          customers;

               (C) Extraordinary personal services
          (within the meaning of paragraph (e)(3)(v) of
          this section) are provided by or on behalf of
          the owner of the property in connection with
          making such property available for use by
          customers (without regard to the average
          period of customer use).

Sec. 1.469-1T(e)(3)(ii)(A) through (C), Temporary Income Tax

Regs., 53 Fed. Reg. 5702 (Feb. 25, 1988).

     The period of customer use is the period during which a

customer has a continuous or recurring right to use an item of

property held in connection with the activity (without regard to

whether the customer uses the property for the entire period).

Sec. 1.469-1(e)(3)(iii)(D), Income Tax Regs.    The average period

of customer use is calculated by dividing the aggregate number of
                             - 11 -

days in all periods of customer use of the property for the year

by the total number of periods of customer use for the year.

Sec. 1.469-1(e)(3)(iii), Income Tax Regs.

     Section 1.469-1T(e)(3)(iv), Temporary Income Tax Regs., 53

Fed. Reg. 5702 (Feb. 25, 1988), defines significant personal

services as follows:

     In determining whether personal services provided in
     connection with making property available for use by
     customers are significant, all of the relevant facts
     and circumstances shall be taken into account.
     Relevant facts and circumstances include the frequency
     with which such services are provided, the type and
     amount of labor required to perform such services, and
     the value of such services relative to the amount
     charged for the use of the property.

     Significant personal services include only services

performed by individuals and do not include excluded services as

defined under section 1.469-1T(e)(3)(iv)(B), Temporary Income Tax

Regs., 53 Fed. Reg. 5702 (Feb. 25, 1988).   As relevant herein,

excluded services are defined as services necessary to permit the

lawful use of the property and services performed in connection

with the performance of repairs that extend the property’s useful

life for a period substantially longer than the average period

for which such property is used by customers.   Id.

     Section 1.469-1T(e)(3)(v), Temporary Income Tax Regs., 53

Fed. Reg. 5702 (Feb. 25, 1988), defines extraordinary personal

services as follows:

     For purposes of paragraph (e)(3)(ii)(C) of this
     section, extraordinary personal services are provided
                                - 12 -

     in connection with making property available for use by
     customers only if the services provided in connection
     with the use of the property are performed by
     individuals, and the use by customers of the property
     is incidental to their receipt of such services. * * *

     Petitioners contend that several of the exceptions to the

definition of a rental activity apply in this case.    For 2000,

petitioners contend that the average rental period was less than

7 days.   For both 1999 and 2000, petitioners contend that they

personally contributed significant and extraordinary personal

services.   On the other hand, respondent contends that the

average rental period was based on the contract between

petitioners and AYC as lessee, and that petitioners did not

contribute significant or extraordinary personal services.      We

agree with respondent.

     The yacht owners’ contract concerning Moonshadow was an

annual exclusive lease agreement between petitioners and AYC,

which was automatically renewable each year unless otherwise

terminated.   AYC is a professional organization engaged in the

charter boat business.    Under the terms of the contract,

petitioners leased Moonshadow to AYC, granted AYC possession,

dominion, and control over Moonshadow, and gave AYC the exclusive

right to sublease Moonshadow to third-party bare boat charterers

for the entire year.     AYC would then enter into individual

charter contracts with third parties.     Petitioners were not a

party to the individual charter contracts, and, indeed,
                              - 13 -

petitioners were not involved with any aspect of qualifying

charterers or establishing such charters.   Moreover, petitioners

reserved no right to reserve Moonshadow for nonbusiness private

use and agreed to pay AYC a reduced commission if they leased it

for their personal use.   Under Washington State law, petitioners’

contract with AYC constituted a lease agreement.   See Wash. Rev.

Code Ann. sec. 62A.A2-103(1)(j) and (k) (West 2003).     Therefore,

AYC’s exclusive right to lease Moonshadow for a 1-year period

constitutes the average rental period for purposes of section

1.469-1(e)(3)(iii), Income Tax Regs.   See Hairston v.

Commissioner, T.C. Memo. 2000-386 (holding that an arrangement

where taxpayers leased equipment to their corporation, which was

engaged in the business of leasing such equipment to third

parties, for an indefinite term over a number of years was one

period of customer use for each taxable year); Kelly v.

Commissioner, T.C. Memo. 2000-32 (holding that an arrangement

where taxpayer leased his aircraft for 1-year periods to a

company that would in turn use the aircraft or rent it to other

pilots was a yearly-basis rental); Frank v. Commissioner, T.C.

Memo. 1996-177 (holding that the flight training schools were the

lessees where taxpayer leased his plane to flight training

schools that rented the plane to customers).   Accordingly, the 7-

day and 30-day exceptions under section 1.469-1T(e)(3)(ii)(A) and
                              - 14 -

(B), Temporary Income Tax Regs., 53 Fed. Reg. 5702 (Feb. 25,

1988), do not apply in the instant case.

     We now turn to the extraordinary services exception under

section 1.469-1T(e)(3)(ii)(C), Temporary Income Tax Regs., 53

Fed. Reg. 5702 (Feb. 25, 1988).    Respondent asserts that

petitioners did not provide extraordinary personal services in

their sailboat charter business.    Petitioners, however, contend

that they provided extraordinary personal services by, for

example, updating Moonshadow’s web page on AYC’s internet site,

searching for and acquiring proper repair parts, performing

installations, repairs (e.g., repair of windlass) and routine

maintenance, and using an outstanding full-service charter broker

to facilitate the check-in and embarkation process.    Petitioners

argue that performing extensive work on Moonshadow to keep it in

pristine condition constitutes exceptional personal services.

     The personal services provided by petitioners in conjunction

with AYC’s services clearly contributed to maintaining

Moonshadow’s immaculate condition and to its marketability to

prospective charterers.   Such services, however, are not those

ordinarily contemplated under the extraordinary personal services

exception.   In other words, for that exception to be applicable,

the use by customers of the sailboat would have to be incidental

to the receipt of petitioners’ personal services.
                             - 15 -

     The legislative history of section 469 states:

     furnishing a boat under a bare boat charter * * *
     constitutes a rental activity under the passive loss
     rule, because no significant services are performed in
     connection with providing the property. [S. Rept. 99-
     313 (1986), 1986-3 C.B. (Vol. 3) 742.]

Moreover, section 1.469-1T(e)(3)(v), Temporary Income Tax Regs.,

53 Fed. Reg. 5702 (Feb. 25, 1988), provides the following

examples:

     the use by patients of a hospital’s boarding facilities
     generally is incidental to their receipt of the
     personal services provided by the hospital’s medical
     and nursing staff. Similarly, the use by students of a
     boarding school’s dormitories generally is incidental
     to their receipt of the personal services provided by
     the school’s teaching staff.

Section 1.469-1T(e)(3)(viii), Example (3), Temporary Income Tax

Regs., 53 Fed. Reg. 5703 (Feb. 25, 1988), further illustrates

this exception:

     The taxpayer is engaged in an activity of transporting
     goods for customers. In conducting the activity, the
     taxpayer provides tractor-trailers to transport goods
     for customers pursuant to arrangements under which the
     tractor-trailers are selected by the taxpayer, may be
     replaced at the sole option of the taxpayer, and are
     operated and maintained by drivers and mechanics
     employed by the taxpayer. The average period of
     customer use for the tractor-trailers exceeds 30 days.
     Under these facts, the use of the tractor-trailers by
     the taxpayer’s customers is incidental to their receipt
     of personal services provided by the taxpayer.
     Accordingly, the services performed in the activity are
     extraordinary personal services * * * and, * * *
     [thus], the activity is not a rental activity.

     The underlying purpose of petitioners’ business, as well as

AYC’s business, is to charter Moonshadow.   During the years in
                               - 16 -

issue, petitioners exclusively leased Moonshadow to AYC for 1-

year periods, and AYC then chartered Moonshadow to third parties.

Under the contract, petitioners were obligated to ensure that

Moonshadow was charter ready at the start of the charter season.

As such, petitioners performed cleaning, maintenance, and

repairs.   During the charter season, only AYC was responsible for

the day-to-day maintenance and operation of Moonshadow.     Although

petitioners were not otherwise obligated to provide services

during the charter season, they did perform routine maintenance,

repairs, and cleaning in addition to the same services provided

by AYC.    During the postseason, petitioners themselves attempted

to correct any problems noted in the postseason report.     On at

least one occasion, petitioners performed a major repair to their

sailboat when they replaced the windlass.

     All of petitioners’ personal services, however, were

provided in connection with the use of their sailboat by AYC and

AYC’s third-party charterers, and such use of petitioners’

sailboat was not incidental to the personal services provided by

petitioners.    Indeed, the personal services provided by

petitioners were performed in their capacity as owners of

Moonshadow with the objective of preserving their investment in

the sailboat.    Although prospective charterers may have selected

Moonshadow because of its pristine condition, a charterer’s

objective is to rent a well-maintained sailboat rather than to
                             - 17 -

obtain a sailboat incidental to the receipt of petitioners’

cleaning, maintenance, and repair services.   Therefore, we

conclude that petitioners did not contribute extraordinary

personal services to their sailboat charter business during the

years in issue.

     Accordingly, we sustain respondent’s determination

disallowing petitioners’ business losses.

     We have considered all of petitioners’ arguments, and, to

the extent that we have not specifically addressed them, we

conclude they are without merit.

     Reviewed and adopted as the report of the Small Tax Case

Division.

     To reflect the foregoing,



                                        Decision will be entered

                                   for respondent.
