                        T.C. Memo. 2000-386



                     UNITED STATES TAX COURT



         KENNETH M. AND DELORES J. HAIRSTON, Petitioners
         v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 12452-98.                  Filed December 20, 2000.



     Wylie Joseph Neal, for petitioners.

     C. Glenn McLauglin, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     THORNTON, Judge:   For taxable years 1995 and 1996,

respondent determined deficiencies of $11,620 and $5,994,

respectively, in petitioners’ Federal income taxes.

     The primary issue for decision is whether petitioners’

equipment rental activity constitutes a passive activity under

section 469(c)(2).
                               - 2 -

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the taxable years in

issue.


                         FINDINGS OF FACT

     The parties have stipulated some of the facts, which are so

found.   When they filed their petition, petitioners resided in

Tulsa, Oklahoma.

     Since 1985, petitioners have owned and operated Hairston,

Inc. (Hairston), a subchapter C corporation engaged in the

business of leasing heavy construction equipment to third

parties.   During 1995 and 1996, petitioners were employed full

time by Hairston.

     During 1993 through 1996, petitioners purchased in their

names eight pieces of heavy construction equipment (petitioners’

equipment).   They leased this equipment to Hairston, which

subleased petitioners’ equipment to its customers (end users).

     Petitioners entered into a written lease agreement with

Hairston reflecting the lease of petitioners’ equipment to
                              - 3 -

Hairston (the lease agreement).1   Petitioners’ equipment was

essentially the same type of heavy construction equipment that

also was owned directly and leased by Hairston to its end users.

Throughout 1995 and 1996, petitioners’ equipment was stored in

and subleased from Hairston’s rental equipment storage yard,

where petitioners’ equipment was commingled with Hairston’s

equipment.

     As consideration for leasing their equipment to Hairston,

the lease agreement states that petitioners “may be” paid by

Hairston up to 40 percent of Hairston’s basic end-user lease



     1
        The entire lease agreement between petitioners and
Hairston, Inc., provided as follows:

                    EQUIPMENT LEASE AGREEMENT

          Ken and Delores Hairston may from time to time
     purchase equipment by check or personal bank loan and
     may lease that equipment to Hairston, Inc. dba A.I.M.
     Equipment Rental.

          A.I.M. Rental will assume all responsibility for
     the leased equipment, providing insurance, collecting
     and paying appropriate taxes, etc.

          Ken and Delores may be paid up to 40% of the basic
     rental rate only (excludes tax, fuel, delivery and p.u.
     charges). Repairs to maintain the equipment may be
     charged against the amount paid to Ken and Delores
     Hairston.

          Payments may be paid each quarter or when
     sufficient revenues have been collected.

          Ken and Delores will calculate and maintain
     records and will be responsible for loan re-payments
     and personal income taxes.
                                - 4 -

charge.   Consequently, as compensation for subleasing

petitioners’ equipment to end users, Hairston was entitled to

retain at least 60 percent of the basic rental charge to the end

users.    In addition, Hairston retained 100 percent of additional

end-user fees such as taxes and charges for delivery and fuel.

     Pursuant to the lease agreement, Hairston assumed “all

responsibility” for petitioners’ equipment.   Hairston was

required to service and maintain the equipment, to provide

insurance, and to collect and pay any taxes on the equipment.

Hairston was to make or arrange for all repairs and to charge

petitioners for the repair costs by subtracting them from the

40-percent portion of the end-user lease payments Hairston might

otherwise pay to petitioners.   During 1995 and 1996, Hairston

charged petitioners only minimal amounts for repairs on

petitioners’ equipment.

     The officers and employees of Hairston, including

petitioners, were responsible for supervising and performing

maintenance and repairs on petitioners’ equipment and on the

equipment owned by Hairston, for dealing with the end users, and

for billing and collecting lease payments from end users of the

equipment.   Occasionally, after hours or on weekends, petitioners

would check on the status of the equipment they personally owned.
                               - 5 -

     The sublease agreements between Hairston and the end users

typically had terms of 7.93 days in 1995 and 11.63 days in 1996.

All of petitioners’ equipment was leased to end users in the name

of and under lease agreements with Hairston, not with

petitioners.

     On their 1995 and 1996 joint Federal income tax returns,

with regard to the lease of their equipment, petitioners claimed

Schedule C ordinary deductions under section 162, reported rental

income from Hairston, and claimed net losses after depreciation

as follows:

               Sec. 162
     Year      Expenses     Rental Income    Net Losses
                               1
     1995       $1,371             $15,000    $58,899
     1996          350              37,500     38,499
     1
       On audit for 1995, respondent charged petitioners with
an additional $22,800 in unreported income from the lease of
their equipment, to which additional income petitioners agree.


                              OPINION

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

certain passive activities of individual taxpayers.   Generally, a

passive activity includes the conduct of a trade or business in

which the taxpayer does not materially participate.   In addition,

rental activity (except certain rental activity involving real

estate) is generally treated as a passive activity without regard

to whether the taxpayer materially participates.   See sec.

469(c)(1), (2), (4), (7).
                                 - 6 -

         Rental activity is defined as any activity where payments

are principally for the use of tangible property.    See sec.

469(j)(8); sec. 1.469-1T(e)(3)(i), Temporary Income Tax Regs., 53

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

     Petitioners contend that under the applicable temporary

regulations, their equipment rental activity qualifies for two

exceptions from the above definition of rental activity.

     First, rental activity will not be treated as such for

purposes of section 469 where the average period of customer use

of the property is 30 days or less and where significant personal

services are provided by or on behalf of the owner of the

property in connection with making the property available for use

by customers.     See sec. 1.469-1T(e)(3)(ii)(B), Temporary Income

Tax Regs., 53 Fed. Reg. 5702 (Feb. 25, 1988).2

     Second, otherwise passive rental activity will not be

treated as such for purposes of section 469 where extraordinary

personal services are provided by or on behalf of the owner of

the property in connection with renting the property to customers

(without regard to the average period of customer use).    See

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



     2
        The temporary regulations provide additional exceptions
to the definition of rental activity, but petitioners do not
claim that their equipment rental activity qualifies for any of
the additional exceptions. See sec. 1.469-1T(e)(3)(ii)(D), (E),
and (F), Temporary Income Tax Regs., 53 Fed. Reg. 5702 (Feb. 25,
1988).
                                 - 7 -

Reg. 5702 (Feb. 25, 1988).   For this purpose, extraordinary

personal services are provided only if performed by individuals

and the customers’ use of the property is incidental to their

receipt of the services.   See sec. 1.469-1T(e)(3)(v), Temporary

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

     The lease agreement had an indefinite term and extended over

a number of years.   Petitioners’ equipment was maintained in the

equipment yard of Hairston and was available for use and sublease

by Hairston at all times throughout each year.       Under section

1.469-1(e)(3)(iii)(A) and (D), Income Tax Regs., Hairston’s right

to use petitioners’ equipment is properly treated as one period

of customer use extending for the entirety of each taxable year.

     Petitioners contend that they had an agency, not a lease,

relationship with Hairston and that they individually should be

regarded as the lessors of their equipment to end users for

average periods of customer use of less than 30 days.

Petitioners’ contention is contrary to the evidence and is

rejected.   In light of the form of the lease agreement and the

course of conduct between petitioners and Hairston, under

Oklahoma law, the arrangement with regard to petitioners’

equipment constituted a lease from petitioners to Hairston (i.e.,

a transfer of the right of possession and use of property for a

term in return for consideration).       See Okla. Stat. tit. 12A,

sec. 2A-103(j) and (k) (1991).
                               - 8 -

     Accordingly, we conclude that the average period of use by

Hairston of petitioners’ equipment exceeded 30 days.   On this

score alone, petitioners fail to satisfy the requirements of the

first exception described above.

     Moreover, the evidence does not establish that petitioners

in their individual capacities provided either significant or

extraordinary personal services in connection with making their

equipment available for use either by petitioners’ customer

(namely, Hairston) or for use by Hairston’s customers under the

subleases.   Under the terms of the lease agreement between

petitioners and Hairston, petitioners individually had little or

no responsibility for upkeep and maintenance of the equipment.

Rather, Hairston assumed “all responsibility” for the equipment.

     The services of petitioners as officers and employees of

Hairston in maintaining all of the equipment and in handling

subleases of the equipment to end users do not qualify as

services of petitioners (or as services rendered on behalf of

petitioners) as owners of the equipment.   Under the lease

agreement with Hairston, petitioners were not obligated as owners

of the equipment to provide any services to Hairston or end

users.   Any services that petitioners might have performed as

Hairston officers or employees were unrelated to petitioners’

obligations as owners of the equipment.
                               - 9 -

     In any event, no credible evidence supports petitioners’

contention that significant or extraordinary services were

performed either by them or on their behalf as owners of the

equipment.   Personal services were not a dominant or significant

aspect of either the equipment rental relationship between

petitioners and Hairston or of the relationship between Hairston

and end users.   See Frank v. Commissioner, T.C. Memo. 1996-177.

The evidence does not establish that the type, frequency, and

value of the services that were provided to end users by

petitioners, as owners of the equipment or as officers and

employees of Hairston, were significant in comparison to the

value of the use of the equipment by end users.   See sec. 1.469-

1T(e)(3)(iv) and (v), Temporary Income Tax Regs., 53 Fed. Reg.

5702 (Feb. 25, 1988).

     Petitioners cite a portion of the legislative history of

section 469 which describes a short-term rental of automobiles as

not constituting a rental activity under section 469 where the

lessor furnishes significant services.   See S. Rept. 99-313, at
                               - 10 -

742 (1986), 1986-3 C.B. (Vol. 3) 1, 742.3     This legislative

history provides petitioners little support.     As previously

discussed, petitioners provided no significant services in their

capacities as lessors to Hairston or as owners of the equipment.

Moreover, their property rentals were not short term, since their

lease of their heavy construction equipment to Hairston was for

an indefinite term.

     Petitioners’ equipment rental activity constitutes a passive

rental activity subject to the loss limitations of section 469.



                                     Decision will be entered for

                                respondent.




     3
         The Senate report states in pertinent part:

          For example, an activity consisting of the short-
     term leasing of motor vehicles, where the lessor
     furnishes services including maintenance of gas and
     oil, oil changing and lubrication and engine and body
     repair, is not treated as a rental activity. By
     contrast, furnishing a boat under a bare boat charter,
     or a plane under a dry lease (i.e., without pilot,
     fuel, or oil), 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, at 742 (1986), 1986-3 C.B. (Vol. 3)
     1, 742.]
