                  T.C. Summary Opinion 2001-174



                     UNITED STATES TAX COURT



          ROBERT W. AND LILA L. BLEWETT, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6277-00S.                 Filed November 8, 2001.



     Glen G. Utzman, for petitioners.

     Julie L. Payne, for respondent.



     WOLFE, 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



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

should not be cited as authority.

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the accompanying exhibits are

incorporated herein by this reference.    Petitioners resided in

Grangeville, Idaho, at the time the petition was filed.

     Respondent determined a deficiency of $8,506 in petitioners’

1996 Federal income tax.    After concessions,2 the issue for

decision is whether petitioners’ losses during 1996 constitute

nondeductible passive losses under section 469.

Background

     In 1976, Robert Blewett (petitioner) and his brother, Don

Blewett, organized Highland Enterprises, Inc. (Highland), a C

corporation.    Petitioner and his brother each owned 50 percent of

the outstanding stock of Highland during 1996.    Throughout the

year in issue, Highland was engaged in two separate businesses:

a general heavy construction business and a real estate sales

business.    Highland’s general heavy construction business

included building logging and fire roads for the U.S. Forest

Service and private logging companies, building roads for

governmental entities, constructing homes and commercial

buildings, and developing residential and commercial land

subdivisions (including the building of streets, curbs,


     2
      Petitioners concede that they improperly failed to report
interest income of $72 and income of $1,724 from a jewelry sales
business on their 1996 Federal income tax return.
                               - 3 -

sidewalks, and the installation of utilities).   The activities of

Highland’s real estate sales operation, which did business during

1996 as “Highland Realty”, included selling residential and

unimproved real estate.

     During 1996, both petitioner and his brother worked full-

time for Highland.   Petitioner provided services to both

Highland’s general heavy construction business and its real

property sales activity.   For the former, he managed the

corporate office, secured construction projects, acquired land

for property development, ordered construction materials and

supplies and assured their timely arrival at construction sites,

and reviewed construction progress at construction sites.   For

the latter, petitioner provided services as a real estate broker.

Petitioner is licensed as a real estate broker in the State of

Idaho.

     Prior to 1996, Highland suffered a series of setbacks that

put it in a dire financial situation.   The setbacks included a

cost overrun in excess of $1 million on a road job with the U.S.

Forest Service, a lengthy lawsuit involving the company’s

purchase of faulty equipment, and deliberate interference with

Highland’s work by an environmental group (Earth First) that

blocked its roads and destroyed hydraulic hoses and three major

pieces of equipment.

     Because of Highland’s poor financial condition, the company
                                - 4 -

was unable to lease or purchase equipment on credit.    Financial

institutions simply would not make any loan of any type to

Highland.    Highland’s continued existence depended on its

obtaining equipment.    Faced with this predicament, petitioner and

his brother separately purchased the necessary equipment in their

individual names and separately leased it to Highland.    There is

no dispute that petitioner and his brother were engaged in an

equipment leasing activity amounting to a trade or business

during the year in issue, and the record clearly supports that

characterization.    Respondent has not raised any questions as to

whether the leasing activity was for profit, and we treat that

matter as conceded by respondent.    Petitioner and his brother

each owned 100 percent of the equipment that he leased to

Highland; none of the equipment was jointly owned.    They leased

the equipment exclusively to Highland.    It was never used in

another trade or business.    Petitioners had no written rental

agreement with Highland.    During 1996, Highland did not pay

petitioners any rent.

     During 1995, Highland paid rent of $69,600 and $40,091 to

petitioners and Don Blewett, respectively.    During 1996, Highland

paid rent of $56,263 to Don Blewett and no rent to petitioners.

At trial, petitioner testified that because of Highland’s poor

financial condition, its rental payments to the Blewetts were

irregular.    In his words, “you pluck all the feathers off of that
                               - 5 -

bird, and it’s not going to lay any more eggs.”     Accordingly,

payments were made only when either petitioner or Don Blewett

needed the money to make payments to creditors for leased

equipment.

     Petitioners claimed a net loss of $50,033 from their

equipment leasing activity on Schedule C, Profit or Loss From

Business (Sole Proprietorship), of their 1996 Federal income tax

return.3   In the notice of deficiency, respondent disallowed the

entire loss on the ground that the leasing activity was subject

to the passive loss limitations of section 469.

Discussion

     Section 469(a)(1) limits the deductibility of losses from

certain passive activities.   Generally, a passive activity

includes the conduct of a trade or business in which the taxpayer

does not materially participate.     Rental activity is generally

treated as a passive activity without regard to whether the

taxpayer materially participates.4     Sec. 469(c)(1), (2), (4).

Rental activity is defined as “any activity where payments are

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


     3
      The loss was attributable primarily to deductions of
$30,062 and $17,141 for depreciation and sec. 179 expenses,
respectively.
     4
      A statutory exception that was added in 1993 provides that
certain real estate operators need not treat their interests in
rental real estate as passive activities. Sec. 469(c)(7). That
exception is inapplicable here, because the subject of this
controversy is personal property.
                                - 6 -

     Both parties agree that petitioners’ equipment leasing

activity falls within the definition of a rental activity in

section 469(j)(8), and that the income from that activity is

passive in nature, unless petitioner qualifies under one of the

six exceptions listed in the regulations.    See Tarakci v.

Commissioner, T.C. Memo. 2000-358; sec. 1.469-1T(e)(3)(ii)(A)

through (F), Temporary Income Tax Regs., 53 Fed. Reg. 5702 (Feb.

25, 1988).    Petitioner specifically relies upon the so-called

incidental exception, which we previously discussed in the recent

and analogous case of Tarakci v. Commissioner, supra, and also

the so-called grouping exception (section 1.469-4(d)(1), Income

Tax Regs.).   We agree with petitioner that the incidental

exception and the reasoning of the Tarakci opinion are applicable

here, so we discuss the rules of the grouping exception only

insofar as they relate to the provisions of the incidental

exception.

     Petitioners’ position is that their leasing activity is not

a rental activity because it qualifies as an exception to the

definition of a rental activity under section 1.469-1T(e)(3)

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

1988),5 which, together with paragraph (e)(3)(vi), provides that


     5
      Temporary regulations are entitled to the same weight as
final regulations with respect to the years to which they apply.
Nissho Iwai Am. Corp. v. Commissioner, 89 T.C. 765, 776 (1987).
Sec. 1.469-1T, Temporary Income Tax Regs., 53 Fed. Reg. 5700-5711
                                                   (continued...)
                               - 7 -

an activity involving the use of tangible property is not a

rental activity if the rental of such property is treated as

incidental to a nonrental activity of the taxpayer.    Section

1.469-1T(e)(3)(vi)(C), Temporary Income Tax Regs., 53 Fed. Reg.

5703 (Feb. 25, 1988), provides:

          (C) Property used in a trade or business. The
     rental of property during a taxable year shall be
     treated as incidental to a trade or business activity
     (within the meaning of paragraph (e)(2) of this
     section) if and only if–-

                 (1) The taxpayer owns an interest in
          such trade or business activity during the
          taxable year;

                 (2) The property was predominantly
          used in such trade or business activity
          during the taxable year or during at least
          two of the five taxable years that
          immediately precede the taxable year; and

                 (3) The gross rental income from such
          property for the taxable year is less than
          two percent of the lesser of-–

                      (i) The unadjusted basis of
               such property; and

                      (ii) The fair market value
               of such property.

     With respect to the application of the three tests of

subdivision (C), we consider it significant that the parties have

stipulated that during 1996:   (1) Petitioner owned 50 percent of



     5
      (...continued)
(Feb. 25, 1988), is effective for taxable years beginning after
Dec. 31, 1986. Sec. 1.469-11(a)(2), Income Tax Regs., 53 Fed.
Reg. 5686 (Feb. 25, 1988).
                               - 8 -

the outstanding stock of Highland; (2) the equipment in question

was used exclusively in Highland’s trade or business activity

throughout the year; and (3) petitioners did not receive any

gross rental income from Highland for the equipment.

     Respondent contends that section 1.469-1T(e)(3)(vi)(C),

Temporary Income Tax Regs., 53 Fed. Reg. 5703 (Feb. 25, 1988), is

inapplicable to the instant case because it requires that a

taxpayer at least temporarily stop using property in his trade or

business and start using the property in a rental activity.

Respondent argues that the exception is not available when the

property is used in the rental activity and the trade or business

activity simultaneously.   Respondent makes three arguments in

support of this construction of the regulation.    Respondent’s

arguments are set forth below, but we note that in our view here

“respondent advocates a strained interpretation of language

prepared by respondent’s own employees.”    See Ferguson v.

Commissioner, T.C. Memo. 1992-451.     In interpreting the language

in question, we bear in mind that respondent’s personnel drafted

that language, and the resolution of doubts against the draftsman

is appropriate in many circumstances.    See id. (and authorities

cited therein).

     First, respondent argues that section 1.469-1T(e)(3)(vi)(C),

Temporary Income Tax Regs., 53 Fed. Reg. 5703 (Feb. 25, 1988),

uses the past tense when referring to the use of the property in
                               - 9 -

the trade or business.   Respondent contends that use of the verb

“was” in paragraph (2) of the relevant regulation means that for

the purposes of the incidental exception, the property cannot be

used in the trade or business activity and the rental activity

simultaneously.

     We are not convinced by this argument.    Section 1.469-1T(e)

(3)(vi)(C), Temporary Income Tax Regs., 53 Fed. Reg. 5703 (Feb.

25, 1988), provides that the rental of property during a taxable

year shall be treated as incidental to a trade or business

activity if, inter alia, “The property was predominantly used in

such trade or business activity during the taxable year or during

at least two of the five taxable years that immediately precede

the taxable year”.   (Emphasis added.)   The word “was” in the

regulation refers not only to past years, but also to the current

taxable year.   The terms of the regulation are consistent with

the conclusion that the property can be used in the trade or

business activity at any time and still satisfy the requirements

for the incidental exception to the definition of a rental

activity.   We conclude that the language of the regulation does

not require that the taxpayer must cease using the property in a

trade or business activity before it can be used in the rental

activity.

     Second, respondent cites the preamble to T.D. 8175, the

Treasury Decision promulgating section 1.469-1T(e)(3)(vi)(C),
                              - 10 -

Temporary Income Tax Regs., 53 Fed. Reg. 5703 (Feb. 25, 1988).

The preamble states that the exception applies if “an

insubstantial amount of rental income is derived from property

that was recently used in a trade or business activity of the

taxpayer and is temporarily rented”.   Id.

     We apply a regulation according to its plain or ordinary

meaning unless such interpretation would lead to absurd results

or another construction is supported by unequivocal evidence of

administrative intent.   Phillips Petroleum Co. v. Commissioner,

101 T.C. 78, 107 (1993), affd. without published opinion 70 F.3d

1282 (10th Cir. 1995).   Respondent does not suggest that the

application of the plain meaning of section 1.469-1T(e)(3)

(vi)(C), Temporary Income Tax Regs., 53 Fed. Reg. 5703 (Feb. 25,

1988), leads to absurd results.   Thus, we must determine whether

the language from the preamble amounts to unequivocal evidence of

administrative intent to limit the exception to only those

situations where the property being rented is no longer being

used in the trade or business activity.

     The preamble does refer to the use of the property in the

trade or business activity in the past tense, and it does refer

to the use of the property in the rental activity in the present

tense.   However, in our view, rather than creating a separate

requirement in addition to the requirements set forth in the text

of the regulations, the preamble merely recites one example of a
                             - 11 -

situation that would satisfy section 1.469-1T(e)(3)(vi)(C)(2),

Temporary Income Tax Regs., 53 Fed. Reg. 5703 (Feb. 25, 1988).

The preamble’s general one-sentence introductory comment

concerning the regulation in question does not amount to

“unequivocal evidence of administrative intent” that use of the

property in the trade or business activity must cease before the

property is used in the rental activity.   A contrary conclusion

would import into the regulation a requirement that simply is not

in the terminology of the regulation.

     Third, respondent cites section 1.469-1T(e)(3)(viii),

Example (6), Temporary Income Tax Regs., 53 Fed. Reg. 5703 (Feb.

25, 1988) (hereinafter referred to as example (6)).    In example

(6), a taxpayer owns an interest in a farming activity, which is

a trade or business activity, and owns farmland that is used in

the farming activity in 1985 and 1986.   In 1987, 1988, and 1989,

the taxpayer does not use the land in the farming activity.

Instead, during those years he leases the land to other parties,

but continues his interest in the farming activity.    The taxpayer

is permitted to treat the rental of his land as incidental to his

farming activity in 1987 and 1989 based on the gross rental

income received.   Id.

     Example (6) does illustrate respondent’s narrow

interpretation of section 1.469-1T(e)(3)(vi)(C), Temporary Income

Tax Regs., 53 Fed. Reg. 5703 (Feb. 25, 1988).   Example (6) is the
                               - 12 -

only example in the regulations that applies section 1.469-

1T(e)(3)(vi)(C), Temporary Income Tax Regs., 53 Fed. Reg. 5703

(Feb. 25, 1988).    In our view, the applicability of the

regulation is not limited to the precise circumstances of an

example set forth in the regulation.    The example plainly is

illustrative rather than limiting or exclusive.

     Moreover, as stated above, section 1.469-1T(e)(3)(vi)(C)(2),

Temporary Income Tax Regs., 53 Fed. Reg. 5703 (Feb. 25, 1988),

permits the property to be used in the trade or business during

either the current year or 2 of the 5 years that precede the

taxable year.   Example (6) is an illustration of the property

being used in 2 of the 5 preceding years.    Subdivision (ii) of

example (6) provides:    “For 1987 and 1989, the taxpayer owns an

interest in a trade or business activity, and the farmland which

the taxpayer leases to the rancher was used in such activity for

two out of the five immediately preceding taxable years.”    Here,

petitioners’ property was used in the trade or business during

the current year.    The facts of example (6) and the facts of the

instant case relate to different clauses of section 1.469-

1T(e)(3)(vi)(C)(2), Temporary Income Tax Regs., 53 Fed. Reg. 5703

(Feb. 25, 1988).

     Respondent also argues that section 1.469-1T(e)(3)(vi)(C),

Temporary Income Tax Regs., 53 Fed. Reg. 5703 (Feb. 25, 1988),

does not apply to the facts here because the rental activity and
                              - 13 -

the trade or business activity must be conducted by the same

entity.   In effect, respondent argues that the regulation does

not apply because the equipment leasing activity of petitioners’

sole proprietorship was not incidental to any other trade or

business activity of their sole proprietorship.

     We previously ruled on this issue in Tarakci v.

Commissioner, T.C. Memo. 2000-358.     There, the taxpayer formed a

sole proprietorship that purchased equipment and leased it to a

general partnership in which the taxpayer and another individual

were equal partners.   In the notice of deficiency, the

Commissioner disallowed the taxpayer’s entire loss from his sole

proprietorship on the ground that the loss was subject to the

passive activity loss limitations of section 469.    The taxpayer

argued that section 1.469-1T(e)(3)(vi)(C), Temporary Income Tax

Regs., 53 Fed. Reg. 5703 (Feb. 25, 1988), applied, and that for

purposes of that section, the trade or business activities of the

partnership were trade or business activities of the sole

proprietorship.   The Commissioner contended that section 1.469-1T

(e)(3)(vi)(C), Temporary Income Tax Regs., 53 Fed. Reg. 5703

(Feb. 25, 1988), did not apply because the equipment leasing

activity of the sole proprietorship was not incidental to any

other activity of the sole proprietorship.

     We held that the trade or business activities of the

taxpayer for the year in issue included the trade or business
                               - 14 -

activities of the partnership for purposes of section 1.469-

1T(e)(3)(vi)(C), Temporary Income Tax Regs., 53 Fed. Reg. 5703

(Feb. 25, 1988).    We noted that the “The regulations require the

taxpayer own ‘an interest in such trade or business activity’,

not that the taxpayer be the sole owner of the trade or

business.”   Tarakci v. Commissioner, supra (quoting sec. 1.469-

1T(e)(3)(vi)(C)(1), Temporary Income Tax Regs., 53 Fed. Reg. 5703

(Feb. 25, 1988)).    There, the taxpayer was actively involved in

the affairs of the partnership, “substantially contribut[ing]

both time and effort to the success of * * * [it].”    Id.

     Here, petitioner’s ownership of 50 percent of Highland’s

stock, as well as his substantial time commitment to Highland,

satisfies the requirement that he have an interest in such trade

or business.

     Respondent argues that the holding of Tarakci conflicts with

the language of section 1.469-1T(e)(3)(vi)(C), Temporary Income

Tax Regs., 53 Fed. Reg. 5703 (Feb. 25, 1988), and section 1.469-

1T(e)(3)(viii) Example (6), Temporary Income Tax Regs., 53 Fed.

Reg. 5703 (Feb. 25, 1988).    We disagree with respondent’s

analysis.

     In our view, the reasoning and the holding in the Tarakci

case are correct and properly applicable to the facts and

circumstances here.    The trade or business activities of

petitioners for 1996 include the trade or business activities of
                              - 15 -

Highland for purposes of section 1.469-1T(e)(3)(vi)(C), Temporary

Income Tax Regs., 53 Fed. Reg. 5703 (Feb. 25, 1988).

     We hold that petitioners are entitled to treat their leasing

activity as incidental to Highland’s trade or business activities

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

53 Fed. Reg. 5703 (Feb. 25, 1988).     Consequently, petitioners’

leasing activity is not classified as a rental activity.     Sec.

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

5703 (Feb. 25, 1988).

     The passive loss limitations of section 469 still apply to

petitioners unless they meet the material participation standard.

Sec. 469(c)(1).   The regulations permit a taxpayer to group an

activity conducted through a C corporation subject to section 469

with another activity of the taxpayer for purposes of determining

whether the taxpayer materially or significantly participates in

the other activity.   Sec. 1.469-4(d)(5)(ii), Income Tax Regs.

Since petitioners conducted an activity through a C corporation

subject to section 469,6 petitioners are entitled to group their


     6
      The passive loss limitations of sec. 469 apply only to
individuals, estates, trusts, closely held C corporations, and
personal service corporations. Sec. 469(a)(2). A closely held C
corporation, for purposes of sec. 469(a)(2), is defined as any
corporation in which more than 50 percent in value of its
outstanding stock is owned, directly or indirectly, by or for not
more than five individuals at any time during the last half of
the taxable year. Secs. 469(j)(1), 465(a)(1)(B), 542(a)(2).
Since all of the stock of Highland, a C corporation, was owned
directly by two individuals during the year in issue, Highland is
                                                   (continued...)
                             - 16 -

activities for the purpose of determining material participation.

Since it is undisputed that petitioner materially participated in

the trade or business activities of Highland,7 petitioners

automatically meet the material participation standard with

respect to their leasing activity.

     For the foregoing reasons, petitioners’ losses during 1996

do not constitute nondeductible passive losses under section 469.

     Reviewed and adopted as the report of the Small Tax Case

Division.

                                          Decision will be entered

                                     under Rule 155.




     6
      (...continued)
subject to sec. 469.
     7
      An individual is treated as materially participating in an
activity for the taxable year if the individual participates in
the activity for more than 500 hours during such year. Sec.
1.469-5T(a)(1), Temporary Income Tax Regs., 53 Fed. Reg. 5725
(Feb. 25, 1988). The parties stipulated that during the year in
issue, petitioner worked 40 or more hours per week for Highland.
Thus, petitioner unquestionably satisfies the 500-hour
requirement.
