                          T.C. Memo. 1999-252



                        UNITED STATES TAX COURT



                CHARLES ROBERT SCHETZER, Petitioner v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 11089-98.                      Filed July 29, 1999.


        Charles Robert Schetzer, pro se.

        Deanna R. Kibler, for respondent.



                MEMORANDUM FINDINGS OF FACT AND OPINION


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

the provisions of section 7443A(b)(3) and Rules 180, 181, and

182.1



        1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
                                 - 2 -


     Respondent determined deficiencies in petitioner's Federal

income taxes for the taxable years 1994 and 1995 in the amounts

of $2,855 and $2,893, respectively, as well an accuracy-related

penalty under section 6662(a) for the taxable year 1994 in the

amount of $571.     After concessions by the parties,2 the issue for

decision is whether section 469(i) is unconstitutional.3

                           FINDINGS OF FACT

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

found.     Petitioner resided in Omaha, Nebraska, at the time that

his petition was filed with the Court.

         During the years in issue, petitioner was employed as a

telemarketer and received wages in the amount of $27,787 for 1994

and $31,859 for 1995.     Petitioner also operated an automobile

rental business.     For the years in issue, the average period of

customer use for petitioner's automobiles exceeded 30 days.        On

his 1994 and 1995 returns, petitioner claimed Schedule C losses




     2
        Respondent concedes that petitioner is not liable for the
accuracy-related penalty under sec. 6662(a) for 1994. The
parties agree that computation of the taxable portion of
petitioner's Social Security retirement benefits is a mechanical
matter the resolution of which is dependent on the disposition of
the issue for decision.
     3
        The parties also disagree as to whether certain Schedule
C deductions have been substantiated. However, given our holding
on the constitutional issue, we need not consider whether
petitioner has substantiated these deductions.
                               - 3 -

of $18,867 and $17,044, respectively, for the automobile rental

business.

     In the notice of deficiency, respondent determined that

petitioner was not entitled to the claimed Schedule C losses

under section 469(a) because petitioner's automobile rental

activity constituted a rental activity as defined in section

469(c)(2).

                              OPINION

     Generally, any passive activity loss claimed by a taxpayer

is not allowable as a deduction by virtue of section

469(a)(1)(A).   A passive activity is any activity that involves

the conduct of a trade or business in which the taxpayer does not

materially participate.   See sec. 469(c)(1).   However, section

469(c)(2) and (4) provides that regardless of material

participation, any rental activity, is generally a passive

activity.4   Rental activity is any activity where tangible

property held in connection with the activity is used by

customers or held for use by customers, and the gross income

attributable to the activity represents amounts paid principally

for the use of the tangible property.   See sec. 469(j)(8); sec.

1.469-1T(e)(3)(i)(A), and (B), Temporary Income Tax Regs., 53

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


     4
        An exception is statutorily provided for certain
taxpayers in real property trades or businesses. See sec.
469(c)(2), (7).
                               - 4 -

     Section 469(i) provides an exception, however, to this rule

of complete disallowance.   Section 469(i) allows a taxpayer who

is a natural person and who "actively participates" in a rental

activity to claim a maximum loss of $25,000 per year related to

the rental real estate.5

     Petitioner does not dispute that his automobile rental

activity constituted a rental activity as defined in section

469(c)(2).   Rather, petitioner claims that he should be entitled

to the $25,000 passive activity loss offset available for rental

real estate activity under section 469(i).   He contends that

disallowance of the losses from his automobile rental activity as

passive losses is unconstitutional because such disallowance

violates the Equal Protection Clause of the Fifth Amendment of

the Constitution.   Petitioner focuses on the classification

provided in section 469(i), which provides for a $25,000 offset

only for rental real estate activities.

     Generally, statutory classifications are valid if they bear

a rational relation to a legitimate governmental purpose.      See

Regan v. Taxation With Representation, 461 U.S. 540, 547 (1983).

A higher level of scrutiny is applied if a statute interferes

with the exercise of a fundamental right, such as freedom of


     5
        The exemption provided in sec. 469(i) is phased out for
taxpayers whose adjusted gross income is greater than $100,000.
See sec. 469(i)(3)(A).
                               - 5 -

speech, or employs a suspect classification, such as race.   See,

e.g., id; Harris v. McRae, 448 U.S. 297, 322 (1980).

     Congress' power to categorize and classify for tax purposes

is extremely broad.   See Regan v. Taxation With Representation,

supra; Lehnhausen v. Lake Shore Auto Parts Co., 410 U.S. 356, 359

(1973);   Charles C. Steward Mach. Co. v. Davis, 301 U.S. 548, 584

(1937); Brushaber v. Union Pacific R.R., 240 U.S. 1, 26 (1916);

Flint v. Stone Tracy Co., 220 U.S. 107, 158 (1911); see also

Barter v. United States, 550 F.2d 1239, 1240 (7th Cir. 1977) (per

curiam) (statutory difference in tax rates for married couples

and single individuals does not violate Due Process of law of the

Fifth Amendment; "perfect equality or absolute logical

consistency between persons subject to the Internal Revenue Code

[is not] a constitutional sine qua non").   In Regan v. Taxation

With Representation, supra at 547-548, the Supreme Court stated:

     Legislatures have especially broad latitude in creating
     classifications and distinctions in tax statutes. More
     than forty years ago we addressed these comments to an
     equal protection challenge to tax legislation:

               "The broad discretion as to classification
          possessed by a legislature in the field of taxation has
          long been recognized. * * * The passage of time has
          only served to underscore the wisdom of that
          recognition of the large area of discretion which is
          needed by a legislature in formulating sound tax
          policies. * * * Since the members of a legislature
          necessarily enjoy a familiarity with local conditions
          which this Court cannot have, the presumption of
          constitutionality can be overcome only by the most
          explicit demonstration that a classification is a
          hostile and oppressive discrimination against
          particular persons and classes. The burden is on the
          one attacking the legislative arrangement to negative
          every conceivable basis which might support it."
                                - 6 -

           [Citing Madden v. Kentucky, 309 U.S. 83, 87-88 (1940);
           fn. refs. omitted.]

     Thus, Congress has broad authority to grant one class of

taxpayers deductions not available to another and to recognize

differences between various kinds of business.    See Brushaber v.

Union Pac. R.R., supra at 24, and the provisions held

constitutional therein (for example, upholding the

constitutionality of the corporate income tax, and observing that

"The due process clause of the 5th Amendment * * * (does not

limit a tax imposed on a class of taxpayers unless it) was so

wanting in basis for classification as to produce such a gross

and patent inequality as to inevitably lead to the same

conclusion (an arbitrary confiscation of property.)"; High Plains

Agricultural Credit Corp. v. Commissioner, 63 T.C. 118, 127

(1974).   If Congress sees fit to establish classes of persons who

shall or shall not benefit from a deduction, there is no offense

to the Constitution, if all members of one class are treated

alike.    See Brushaber v. Union Pac. R.R., supra; High Plains

Agricultural Credit Corp. v. Commissioner, supra.

     Clearly, section 469(i) does not interfere with the exercise

of a fundamental right or employ a suspect classification.    Cf.

Regan v. Taxation With Representation, supra.    Therefore, we need

not apply a higher level of scrutiny but must decide whether the

statutory classification in section 469(i) bears a rational
                               - 7 -

relation to a legitimate governmental purpose.     See Regan v.

Taxation With Representation, supra at 547.

     Congress was rationally justified in enacting a revenue

measure under section 469(i) that preferentially treated certain

qualifying taxpayers in the rental real estate business.

Section 469 was generally enacted to reduce the number of tax

shelters prevalent at the time of its enactment.    The Senate

Finance Committee report provides that the extensive use of

rental activities for tax shelter purposes under prior law,

combined with the reduced level of personal involvement necessary

to conduct such activities, made it clear that a change in the

law was necessary to eliminate the losses claimed relating to

such activities.   See S. Rept. 99-313, at 713-746 (1985), 1986-3

C.B. (Vol. 3) 1, 713-746.   As to the reason for the allowance of

the $25,000 offset for rental real estate activities, the Senate

Finance Committee Report states:

          For the purposes of the passive loss provision,
     rental activities are treated as passive without regard
     to whether the taxpayer materially participates. * * *

          In the case of rental real estate, however, some
     specifically targeted relief has been provided because
     rental real estate is held, in many instances, to
     provide financial security to individuals with moderate
     incomes. In some cases, for example, an individual may
     hold for rental a residence that he uses part-time, or
     that previously was and at some future time may be his
     primary residence. Even absent any such residential
     use of the property by the taxpayer, the committee
     believes that a rental real estate investment in which
     the taxpayer has significant responsibilities with
                               - 8 -

     respect to providing necessary services, and which
     serves significant nontax purposes of the taxpayer, is
     different in some respects from the activities that are
     meant to be fully subject to limitation under the
     passive loss provision.22


        22
         For example, in the case of a rental real estate
     investor whose cash expenses with respect to the
     investment (e.g., mortgage payments, condominium or
     management fees, and costs of upkeep) exceed cash
     inflows (i.e., rent), tax losses other than those
     relating to depreciation may not be providing any cash
     flow benefit.

S. Rept. 99-313, supra, 1986-3 C.B. at 736.

     Accordingly, section 469(i) was enacted to provide relief to

moderate income taxpayers who invest in rental real estate as a

means of financial security, which purpose serves significant

nontax purposes of the taxpayer.   In light of the congressional

intent, it is appropriate that the statute provides a

classification relating to rental real estate investment.   We

therefore think that a rational basis exists for the enactment of

section 469(i) and the classification provided therein.

     Further, given that Congress has broad latitude in creating

classifications and distinctions in tax statutes, we cannot hold

that a rational basis does not exist for a classification of the

type provided in section 469(i).   Cf. Kozlowski v. Commissioner,

T.C. Memo. 1979-176.   By enacting section 469(i) Congress chose

to allow deductions in excess of gross income; i.e., a loss to

the extent of $25,000, related to rental real estate activities.
                                 - 9 -

Section 469(i) simply is an exercise by Congress of its broad

authority to recognize differences between various kinds of

activities.     See Brushaber v. Union Pac. R.R., 240 U.S. 1 (1916).

As for the disallowance of the loss for other passive activities,

such as petitioner's automobile rental activity, the effect is an

incidental financial burden and not an impermissible

interference.    See Maher v. Roe, 432 U.S. 464, 471 (1977); Black

v. Commissioner, 69 T.C. 505, 509-510 (1977).

     We hold that the legislative classification provided by

section 469(i) is constitutional.

     Petitioner has made other arguments that we have considered

in reaching our decision.    To the extent that we have not

discussed these arguments, we find them to be without merit.

     To reflect our disposition of the disputed issue, as well as

the parties' concessions,



                                              Decision will be entered

                                         for respondent as to the

                                         deficiencies in taxes and for

                                         petitioner as to the accuracy-

                                         related penalty for 1994.
