                       T.C. Memo. 1996-427



                     UNITED STATES TAX COURT



    BERNARD L. NADEAU, JR. AND NANCY L. NADEAU, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 22865-94.                Filed September 19, 1996.


     Bernard L. Nadeau, pro se.

     Blaine Holiday, for respondent.



                        MEMORANDUM OPINION


     GOLDBERG, Special Trial Judge:    This case was heard pursuant

to section 7443A(b)(3) and Rules 180, 181, and 182.1   Respondent

determined deficiencies in petitioners' 1990, 1991, and 1992


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

Federal income taxes in the respective amounts of $285, $2,761,

and $2,130, and additions to tax for 1991 and 1992 pursuant to

section 6651(a)(1) in the amounts of $276 and $455, respectively.

       References to petitioner are to Bernard Nadeau.

       After a concession by respondent,2 the issues for decision

are:    (1) Whether petitioners are entitled to deduct losses

attributable to petitioner's real estate rental activity, Nadeau

Rentals, in computing his net earnings from self-employment for

purposes of the self-employment tax; and (2) whether petitioners

are liable for additions to tax, pursuant to section 6651, for

failure to file timely returns for 1991 and 1992.

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

The stipulation of facts and the exhibits received into evidence

are incorporated by this reference.    Petitioners resided in

Minneapolis, Minnesota, at the time they filed their petition.

       Throughout the first half of the 1980's, petitioner

performed services as an agent for musicians.    Petitioner also

held a real estate license.    Petitioner wanted to get involved in

a business that would generate sufficient capital to allow him to

invest in real estate.    In 1986, petitioner formed his own

business, Art Rep Services, to represent photographers.




2
     Respondent concedes that petitioners have established the
amount of the loss from real estate activity resulting in a
recomputed deficiency of $1,709 and an addition to tax of $350
for the taxable year 1992.
                                   3

Petitioner operated the business of Art Rep Services throughout

the taxable years in issue.

     Petitioner purchased a single family home in St. Paul,

Minnesota, sometime in the early 1980's.     Petitioner originally

intended to renovate this house and sell it, recognizing

appreciation due to the market combined with his improvements.

Instead, petitioner rented it to a tenant within 3 months of

purchase.

     In 1984, petitioner purchased a second property, a duplex,

in Minneapolis, Minnesota, on Pillsbury Avenue (Pillsbury

property).   Petitioner purchased this property with the intention

of renting it while waiting for it to appreciate in value.

Petitioner rented the top floor to tenants and moved into the

first floor.

     In 1990, petitioners married.     Petitioner Nancy Nadeau owned

a town house (Eden Prairie property) which she purchased in 1988.

Beginning in 1990 petitioners received rental income from the

Eden Prairie property through Nadeau Rentals.

     In 1990, petitioners sold the Pillsbury property recognizing

a gain of approximately $27,000, and purchased another duplex in

Minneapolis, Minnesota, on Lyndale Avenue (Lyndale property)

anticipating it would appreciate in value.     Petitioners moved

into one of the two units and rented the other.     At the end of

1990, petitioners owned three properties, the St. Paul, Eden

Prairie, and Lyndale properties.
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     In 1992, petitioners sold the Eden Prairie property.

Petitioners recognized a loss on the sale in the amount of

$5,806.85.   At the end of 1992, petitioners still owned the other

two properties.

     On their 1990, 1991, and 1992 Federal income tax returns,

petitioners included the gross rental receipts from real estate

and the related deductions on petitioner's Schedule C, as profit

or loss from petitioner's business, Nadeau Rentals.       Petitioner

reduced his self-employment income by the loss from Nadeau

Rentals for each of these years.       In all of the years in issue,

petitioners claimed depreciation deductions for the properties as

residential real estate.   Petitioners' Federal tax return for

1990 reflects the sale of the Pillsbury property as the sale of a

personal residence and the sale of business property.

Petitioners recognized the portion of the gain attributable to

the sale of the business property, all of which represented

recapture of depreciation.

     Petitioners' 1991 Federal income tax return was due on or

before April 15, 1992.   Petitioners received an automatic

extension of time for filing that return until August 15, 1992,

and filed on September 21, 1992.       Petitioners' 1992 Federal

income tax return was due on or before April 15, 1993.

Petitioners were granted extensions of time for filing that

return until October 15, 1993, and filed it on February 24, 1994.
                                    5

     In the notice of deficiency, respondent determined that the

income and deductions from petitioner's rental activity should

have been reported on Schedule E, Supplemental Income and Loss,

not Schedule C, because the rental activity was passive, and

therefore subject to the limitations on passive activity losses.

The losses were allowed as deductions from adjusted gross income.

They were not allowed, however, in the computation of

petitioner's self-employment income.      Respondent's determination

with respect to petitioner's self-employment income had the

effect of increasing petitioners' earned income, thereby reducing

the allowable earned income credit for the taxable years 1991 and

1992.

     Petitioners argue that the income and expenses related to

petitioner's real estate activity should be included in the

calculation of petitioner's self-employment income.      Respondent

contends that these amounts are attributable to rentals from real

estate; that petitioner was not engaged in a trade or business as

a real estate dealer; and that therefore these amounts are

excluded from petitioner's self-employment income.      Respondent's

determinations are presumed correct, and the burden of proof is

on the taxpayer to prove that the determinations are erroneous.

Rule 142(a); Welch v. Helvering, 290 U.S. 111 (1933).

        Section 1401 imposes a tax on the self-employment income of

individuals.     Sec. 1401(a).   The term "net earnings from self-

employment" is defined by section 1402(a), in relevant part, as
                                 6

the gross income derived by an individual from any trade or

business carried on by such individual, less any allowable

deductions attributable to such trade or business.

     Generally, "rentals from real estate" and the attributable

deductions are excluded in determining net earnings from self-

employment, unless such rentals are received in the course of a

trade or business as a real estate dealer.   Sec. 1402(a)(1).

"Rentals from real estate" include generally "Payments for the

use or occupancy of entire private residences or living quarters

in duplex or multiple housing units".   Sec. 1.1402(a)-4(c)(1),

Income Tax Regs.

     Petitioner received the rental income for the use of

residential units.   Such income constitutes rentals from real

estate.   Accordingly, that rental income and the corresponding

deductions are excluded from petitioner's net earnings from self-

employment unless we determine that petitioner was engaged in the

trade or business of a real estate dealer and that the rentals

were received in the conduct of that business.

     The determination of whether an individual is engaged in the

trade or business of a real estate dealer is made by applying the

principles applied in respect of taxes imposed under sections 1

and 3 of the Code.   Sec. 1.1402(a)-4(a), Income Tax Regs.    An

individual who is engaged in the business of selling real estate

to customers may be classified as a real estate dealer.      Id.

However, an individual who holds real estate for investment or
                                   7

speculation and receives rentals therefrom is not a real estate

dealer.    Id.

       Whether property is held by a taxpayer for sale to customers

in the ordinary course of the taxpayer's business or for another

purpose is a question of fact, and each property must be

considered on an individual basis.      Cottle v. Commissioner, 89

T.C. 467, 486 (1987).    In this analysis, courts have applied

various factors including:    (1) The taxpayer's purpose for

acquiring the property and the duration of ownership; (2) the

number, frequency, regularity, and substantiality of the sales;

(3) the taxpayer's efforts, including advertising, to sell the

property; (4) the extent of developing and improving of the

property to increase sales; and (5) the taxpayer's time and

effort devoted to sales.     United States v. Winthrop, 417 F.2d

905, 910 (5th Cir. 1969); Cottle v. Commissioner, supra at 487.

These factors serve to guide the decision but none is necessarily

of controlling significance.     Cottle v. Commissioner, supra at

488.

       Applying these factors, we find that petitioners acquired

and held the Pillsbury and Lyndale properties as investments.

The purpose for acquiring the Eden Prairie property is not clear

from the record; however, petitioner testified that he held it

for investment beginning in 1990.      In contrast, petitioner

testified that when acquiring the St. Paul property he intended

to resell it immediately after purchase.      However, the existence
                                 8

of such intention does not compel a finding that petitioner was a

dealer with respect to that property in the absence of evidence

that petitioner held the property primarily for sale to customers

in the ordinary course of his business.     Howell v. Commissioner,

57 T.C. 546, 555 (1972); Ayling v. Commissioner, 32 T.C. 704, 709

(1959).

     Petitioners owned the Eden Prairie and Pillsbury for 4 and 6

years, respectively, prior to their sale.    Petitioner owned the

St. Paul property in excess of 10 years.    We find that the

duration of ownership supports respondent's contention that

petitioner was holding these properties for investment.

     In addition, petitioner's sales were isolated.    In the 3

years in issue, petitioner sold only two properties, including

the property that petitioner Nancy Nadeau purchased prior to

petitioners' marriage.   The infrequency of petitioner's sales

indicates that he held the properties for investment rather than

for sale in the ordinary course of his business.    See, e.g.,

United States v. Winthrop, supra (456 sales over 19 years was

evidence that taxpayer held properties for sale); Ayling v.

Commissioner, supra (13 sales over 4 years did not establish

frequency of sales characteristic of a business).

     Petitioner's sale in 1990 generated profits of approximately

$27,000.   This amount is substantial in comparison with

petitioner's other net income of $15,059.53.    This single

substantial sale is not enough, however, to support the
                                  9

conclusion that petitioner held the property for sale where other

factors indicate the property was held for investment.     Bramblett

v. Commissioner, 960 F.2d 526, 531 (5th Cir. 1992), revg. T.C.

Memo. 1990-296.   Petitioner's other sale resulted in a loss of

approximately $5,800.

     Petitioner made virtually no showing as to the extent of his

efforts to sell the properties, apart from his testimony that

petitioners listed the Eden Prairie property for sale with the

top real estate agent in Minnesota in 1990.   He did not testify

or offer any evidence as to the nature of his efforts to sell any

of the other properties or the amount of time he committed to

this activity.

     To support their position, petitioners rely on petitioner's

activities in repairing and improving the properties to make them

saleable.   A taxpayer may be engaged in the business of a real

estate dealer when gains on property are generated by the actions

and activities of the taxpayer, such as extensive improvements to

the property.    See Bynum v. Commissioner, 46 T.C. 295 (1966).

Petitioner testified that he devoted considerable time and funds

to renovating the properties.   However, petitioner offered no

corroborating evidence of the expenditures made to improve the

properties.   The only evidence in the record indicates that

petitioner's efforts did not, in fact, generate profits.

Petitioners sold the Eden Prairie property at a loss, and, while

the Pillsbury property was sold at a gain, that gain resulted in
                                 10

significant part from the recapture of the allowance for

depreciation.

     The testimony of petitioner regarding the sales of the

properties and his efforts connected with this activity was for

the most part general, inconsistent, unhelpful, and completely

uncorroborated.    Under these circumstances, we are not required

to rely on petitioner's testimony to support petitioners'

position.   Lerch v. Commissioner, 877 F.2d 624, 631-632 (7th Cir.

1989), affg. T.C. Memo. 1987-295; Geiger v. Commissioner, 440

F.2d 688, 689-690 (9th Cir. 1971), affg. per curiam T.C. Memo.

1969-159.

     In summary, we find that petitioners held each of the

properties for investment and that petitioner was not in the

trade or business of a real estate dealer.   Therefore, the rental

losses for the years at issue cannot be used to offset

petitioner's self-employment income.   We sustain respondent on

this issue.

     Respondent determined that petitioners are liable for

additions to tax under section 6651 for the taxable years 1991

and 1992.   Section 6651(a)(1) imposes an addition to tax for

failure to file a tax return timely.   The addition to tax is

equal to 5 percent of the amount of the tax required to be shown

on the return if the failure to file is not more than 1 month.

Sec. 6651(a)(1).   An additional 5 percent is imposed for each

month or fraction thereof in which the failure to file continues,
                                 11

to a maximum of 25 percent of the tax.     Id.   The addition to tax

is applicable unless petitioners establish that the failure to

file was due to reasonable cause and not willful neglect.        Id.

Petitioners bear the burden of establishing that they are not

liable for these additions to tax.    Rule 142(a).

     Petitioners filed their 1991 Federal tax return on September

21, 1992, 36 days after the filing deadline under the automatic

extension.    Petitioners filed their 1992 tax return on February

24, 1994, 4 months and 9 days after the filing deadline as

extended.    Petitioners have not established that their late

filings were due to reasonable cause.    Accordingly, we sustain

respondent on this issue.


                                      Decision will be entered

                                under Rule 155.
