                                 T.C. Memo. 2017-226


                           UNITED STATES TAX COURT



                ASIF SYED AND AMTUL SYED, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 30265-13.                            Filed November 16, 2017.



      Robert K. Dowd, for petitioners.

      Adam L. Flick, Audrey M. Morris, Vivian Bodey, Kimberly A. Kazda, and

Linda L. Wong, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


      LAUBER, Judge: With respect to petitioners’ Federal income tax for 2009-

2011, the Internal Revenue Service (IRS or respondent) determined defici-

enciesand accuracy-related penalties under section 6662(a)1 as follows:


      1
          All statutory references are to the Internal Revenue Code (Code) in effect
                                                                        (continued...)
                                         -2-

[*2]
                  Year                Deficiency                Penalty

                  2009                  $47,176                 $9,435
                  2010                   68,171                 13,634
                  2011                    6,981                  1,396

In a stipulation of settled issues filed February 17, 2016, the parties resolved a

number of issues by mutual concession. The questions left for decision are whe-

ther petitioners: (1) qualify as real estate professionals under section 469(c)(7);

(2) materially participated in certain loss-generating activities; and (3) are liable

for accuracy-related penalties. We resolve these questions in respondent’s favor.

                                FINDINGS OF FACT

       At trial the parties filed a stipulation of facts with accompanying exhibits

and a stipulation of settled issues, both of which are incorporated by this reference.

Petitioners resided in Texas when they timely petitioned this Court.

       Petitioner husband, Asif Syed (Dr. Syed), is a medical doctor specializing in

urology. He was born in 1934 in India, where he studied medicine. He completed

residencies in Canada and the United States and eventually established a urology

practice in Dallas County, Texas.


       1
        (...continued)
for the years at issue, and all Rule references are to the Tax Court Rules of Prac-
tice and Procedure. We round all monetary amounts to the nearest dollar.
                                          -3-

[*3] Before coming to Texas Dr. Syed and Mrs. Syed had three children. During

the early years of Dr. Syed’s practice Mrs. Syed devoted her energies to raising

their children. After the children left for college, she began accompanying Dr.

Syed to work. She later became the office manager for the medical practice.

      One of petitioners’ sons, Nabeel Syed, also trained as a urologist and joined

the family practice in 1997. Shortly thereafter the practice hired a new office man-

ager; although Mrs. Syed continued to accompany Dr. Syed to work, her formal

duties thereafter were limited. In 2006 the practice began outsourcing to an out-

side management company all back-office functions, including payroll processing,

employee benefits, and insurance reimbursement. This arrangement was well in

place by 2009, the first tax year at issue.

      Dr. Syed’s practice consisted mostly of outpatient visits, though he devoted

about one day a week to surgeries at local hospitals. In 1999, soon after he turned

65, a tremor in his right hand forced him to reduce the number of major surgeries

he performed, and his son Nabeel took those over. But Dr. Syed continued to per-

form several different kinds of less invasive surgical procedures.

      Dr. Syed has long had a close relationship with the Texas Regional Medical

Center (Center). He has been involved with the Center “from the time the founda-

tion was laid to the time it became active,” and he held a limited partnership inter-
                                        -4-

[*4] est in it. By 2009 he had significantly reduced the number of surgeries he

performed at the Center. But he testified that he had continued to engage in “con-

sulting.”

      Petitioners offered no documentation (contemporaneous or otherwise) to

substantiate how many hours Dr. Syed devoted to the Center. He testified that he

spent “at least ten hours per week” there, but he offered no clear explanation as to

how he got to that number. The only type of consulting to which he testified in-

volved design of the Center’s work space. But the Center had been in full opera-

tion for many years previously, and we did not find it plausible that he devoted

meaningful hours during 2009 to consulting about work space design.

      Petitioners formed a partnership called AAM Group, LLC (AAM), to hold

two pieces of rental real estate: a commercial property in Dallas, Texas, and a

single-family home in Richardson, Texas. Mrs. Syed performed several tasks re-

lating to these properties, such as handling the bank account and occasionally

meeting with contractors. She wrote six to eight checks per month on that ac-

count, but many of these checks were for charitable contributions unconnected

with the real estate business. Many other checks were written to her son Hisham,

who served as property manager for the commercial property; he devoted 16 hours

a week to the property and was paid fees ranging from 16% to 54% of the gross
                                        -5-

[*5] receipts. Mrs. Syed hired a landscape company to maintain the outdoor

premises of the commercial property, and she hired contractors to do cleaning and

make required repairs for both properties. The tenant of the commercial property

credibly testified that he had never met either Mrs. Syed or Dr. Syed during the

four years of his tenancy.

      In 1989 petitioners formed Syed Family Limited Partnership (SFLP), in

which Dr. Syed ultimately held the entire beneficial interest. Through SFLP they

owned a ranch in Hunt County, about 50 miles north of their residence. They al-

legedly carried on haymaking and livestock activities through SFLP as well as a

rental real estate activity through two subsidiary passthrough entities. Petitioners

presented no evidence concerning SFLP’s alleged rental real estate activity.

      Petitioners regularly used the ranch as a weekend and vacation retreat. They

testified that they had tried raising crops, apart from haymaking, on the ranch, and

had investigated the possibility of raising animals; there is no evidence that they

actually raised animals during 2009-2011. Virtually all of the actual work on the

ranch was performed by laborers and hired contractors. Dr. Syed testified that he

spent many hours reading magazines about animal husbandry, talking with other

ranchers, and thinking about ranch matters. But petitioners presented no credible
                                             -6-

[*6] evidence to substantiate the number of hours they devoted to actual farming

or ranch tasks.

       For each year at issue petitioners filed a timely Form 1040, U.S. Individual

Income Tax Return, on which they sought to use flowthrough losses to shelter in-

come earned from Dr. Syed’s medical practice. All of those returns were prepared

by a tax return preparation firm. Upon examination of those returns the IRS dis-

allowed loss deductions as follows:

       • For 2009 the Center had allocated to Dr. Syed, as a limited partner, a flow-

through loss of $51,331. Petitioners claimed this as a nonpassive loss deduction

on Schedule E, Supplemental Income and Loss. The IRS recharacterized it as a

passive loss under section 469(h)(2), determining that Dr. Syed had not materially

participated in the partnership’s loss-generating activity.

       • For 2009, 2010, and 2011 petitioners claimed nonpassive loss deductions

on Schedules E for two types of flowthrough losses from AAM. These consisted

of ordinary business losses of $48,283, $84,390, and $16,520, respectively, and

rental real estate losses of $42,076, $49,178, and $86,212, respectively. The IRS

reclassified all of these losses as passive activity losses under section 469(c)(2),

determining that petitioners were not real estate professionals and did not materi-

ally participate in the rental activities.
                                           -7-

[*7] • Petitioners claimed nonpassive loss deductions on Schedules E for two

types of flowthrough losses from SFLP. For 2009, 2010, and 2011 these consisted

of ordinary business losses of $1,232, $167,144, and $15,547, respectively, attrib-

utable to their alleged haymaking and livestock activity. (The figure for 2011 re-

flects a concession that petitioners made in the stipulation of settled issues.) For

2010 they claimed a rental real estate loss deduction of $9,286 attributable to

SFLP’s alleged rental real estate activity. The IRS recharacterized all losses from

SFLP as passive activity losses under section 469(c)(1), determining that petition-

ers did not materially participate in the partnership’s supposed livestock or farm

activity or in its alleged rental real estate activity.

       The IRS sent petitioners a timely notice of deficiency setting forth these

adjustments. It also determined accuracy-related penalties based on “substantial

understatement[s] of income tax” under section 6662(d)(1)(A) and (alternatively)

on negligence under section 6662(b)(1). Petitioners timely petitioned this Court

for redetermination of the deficiencies and penalties.

                                        OPINION

       The IRS’ determinations in a notice of deficiency are generally presumed

correct, and the taxpayer bears the burden of proving them erroneous. Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Deductions are a matter of
                                        -8-

[*8] legislative grace; the taxpayer bears the burden of proving his entitlement to

deductions allowed by the Code and of substantiating the amounts underlying

claimed deductions. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992);

sec. 1.6001-1(a), Income Tax Regs.

I.    Burden of Proof

      Under section 7491(a) the burden of proof may shift to the Commissioner if

the taxpayer satisfies certain requirements. Section 7491(a)(1) requires the tax-

payer to present “credible evidence” with respect to relevant factual issues. “Cred-

ible evidence” is evidence that, upon critical analysis, would constitute a sufficient

basis for deciding the issue in the taxpayer’s favor if no contrary evidence were

submitted. Ocmulgee Fields, Inc. v. Commissioner, 132 T.C. 105, 114 (2009),

aff’d, 613 F.3d 1360 (11th Cir. 2010); Higbee v. Commissioner, 116 T.C. 438, 442

(2001). Section 7491(a)(2) requires the taxpayer to comply with substantiation

and recordkeeping requirements and cooperate with “reasonable requests by the

Secretary for witnesses, information, documents, meetings, and interviews.” Sec.

7491(a)(2)(A) and (B). The taxpayer bears the burden of proving satisfaction of

these tests. See Rolfs v. Commissioner, 135 T.C. 471, 483 (2010), aff’d, 668 F.3d

888 (7th Cir. 2012).
                                         -9-

[*9] Petitioners have not met this burden. The “activity logs” and other docu-

mentation they submitted to substantiate their material participation were wholly

inadequate. Petitioners’ failure to cooperate with respondent’s requests for infor-

mation and documents forced respondent’s counsel to serve formal discovery re-

quests on several occasions. Because petitioners have not met the requirements of

section 7491(a), they bear the burden of proof on all factual issues.2

II.   Deductibility of Flowthrough Losses

      Individual taxpayers may generally deduct, under sections 162 and 212 re-

spectively, ordinary and necessary expenses paid or incurred in carrying on a trade

or business or for the production of income. But the Code disallows any current

deduction for a “passive activity” loss. Sec. 469(a)(1), (b). A “passive activity

loss” is equal to the taxpayer’s aggregate losses from all passive activities less his

aggregate income from all such activities. Sec. 469(d)(1). Passive losses cannot

be used to offset income from nonpassive activities, such as wage income. See

Krukowski v. Commissioner, 279 F.3d 547, 549 (7th Cir. 2002), aff’g 114 T.C.

366 (2000).




      2
        Even if respondent bore the burden of proof under section 7491(a), we
would conclude that he met his burden by a preponderance of the evidence as to
all relevant facts.
                                        - 10 -

[*10] A “passive activity” is a trade or business in which the taxpayer does not

“materially participate.” Sec. 469(c)(1)(B). “Material participation” requires reg-

ular, continuous, and substantial involvement in the business operations. Sec.

469(h)(1). Regulations provide seven disjunctive tests for what constitutes “ma-

terial participation” in an activity. Sec. 1.469-5T(a), Temporary Income Tax

Regs., 53 Fed. Reg. 5725-5726 (Feb. 25, 1988).3 Section 469(b) allows passive

loss deductions disallowed for one year to be carried over to the next year, gener-

ally on an activity-by-activity basis. See sec. 1.469-1T(f)(2)(i), Temporary Income

Tax Regs., 53 Fed. Reg. 5706 (Feb. 25, 1988).

      A.    Flowthrough Loss From the Center

      Dr. Syed admitted that his interest in the Center was that of a limited part-

ner. Section 469(h)(2) provides: “Except as provided in regulations, no interest in

a limited partnership as a limited partner shall be treated as an interest with respect

to which a taxpayer materially participates.” The regulations specify three situa-

tions in which an exception may apply, namely, where a limited partner shows:

(1) participation in the activity for more than 500 hours during the tax year;

      3
       These regulations, still in temporary form, were issued before November
20, 1988, the effective date of section 7805(e)(2). That section provides that
“[a]ny temporary regulation shall expire within 3 years after the date of issuance
of such regulation.” See Technical and Miscellaneous Revenue Act of 1988, Pub.
L. No. 100-647, sec. 6232(a), 102 Stat. at 3735.
                                        - 11 -

[*11] (2) material participation in the activity (under the general regulatory tests)

for any 5 of the 10 preceding years; or (3) in the case of a personal service activity,

material participation (under the general regulatory tests) for any 3 prior tax years.

Sec. 1.469-5T(e)(1) and (2), Temporary Income Tax Regs., supra.

      There is no evidence in the record quantifying Dr. Syed’s participation in

the Center’s activities for any year before the tax years at issue. The second and

third tests listed above accordingly have no application here. To be eligible for

the limited partnership exception set forth in the regulations, therefore, petitioners

must prove that Dr. Syed devoted more than 500 hours of participation to the Cen-

ter’s activities during 2009.

      Petitioners have not met this burden. They offered no documentation (con-

temporaneous or otherwise) to substantiate how many hours Dr. Syed devoted to

the Center during 2009. Although he testified that he did “consulting,” the only

type of consulting he mentioned involved design of the Center’s work space. Be-

cause the Center had been in full operation for many years previously, we did not

find it plausible that he devoted meaningful hours during 2009-2011 to consulting

about work space design. He testified that he spent “at least ten hours per week”

at the Center, but his testimony on this point was vague. He offered no clear ex-
                                         - 12 -

[*12] planation as to how he got to that number; we believe he chose it because it

was the minimum number he needed to get to 500 hours per year.

      All in all, we find that petitioners have failed to meet their burden of prov-

ing they satisfied the 500-hour annual requirement under the relevant regulatory

test. The IRS thus correctly recharacterized petitioners’ $51,331 flowthrough loss

from the Center as a passive loss under section 469(h)(2).

      B.    Flowthrough Losses From AAM

      Section 469(c)(2) treats any “rental activity” as a passive activity regardless

of the taxpayer’s material participation unless the taxpayer was engaged in a “real

property trade or business” during the relevant year. Sec. 469(c)(7)(C). Taxpay-

ers who engage in a “real property trade or business” are often called “real estate

professionals.”

      Petitioners insist that they were real estate professionals during 2009-2011

by virtue of the activities they conducted through AAM. If that were true, AAM’s

rental real estate activities, attributed to petitioners, would not be per se passive.

See Kosonen v. Commissioner, T.C. Memo. 2000-107, 79 T.C.M. (CCH) 1765;

sec. 1.469-9(b)(6), (c)(1), Income Tax Regs. And if petitioners “materially parti-

cipated” in those activities, the activities would be treated as nonpassive, and the

passive activity loss rule of section 469(a) would not apply. See Shiekh v. Com-
                                       - 13 -

[*13] missioner, T.C. Memo. 2010-126; Fowler v. Commissioner, T.C. Memo.

2002-223; sec. 1.469-9(e)(1), Income Tax Regs.4

      To qualify as a real estate professional, a taxpayer must (among other

things) “perform[] more than 750 hours of services during the taxable year in real

property trades or businesses in which * * * [she] materially participates.” Sec.

469(c)(7)(B)(ii). If a taxpayer is married, activity by the taxpayer’s spouse counts

in determining “material participation” by the taxpayer. See sec. 1.469-5T(f)(3),

Temporary Income Tax Regs., supra. But spousal attribution may not be used for

the purpose of satisfying the 750-hour annual service requirement. Oderio v.

Commissioner, T.C. Memo. 2014-39, 107 T.C.M. (CCH) 1214, 1215. Thus, at

least one spouse must individually perform more than 750 hours of service in a

real property trade or business.

      Petitioners assert in their post-trial brief that “they spend more than 750

hours” annually on AAM’s rental real estate activities. As noted above, however,

at least one spouse must individually satisfy the 750-hour requirement. Consis-


      4
        A taxpayer who is not a real estate professional, but who actively partici-
pates in a rental real estate activity, may deduct against ordinary income up to
$25,000 of losses from that activity if adjusted gross income (AGI) is less than
$150,000. Sec. 469(i)(1), (2), and (3). Because petitioners’ AGI substantially ex-
ceeded $150,000 for each year at issue, they were ineligible to deduct losses under
these provisions.
                                          - 14 -

[*14] tently with the trial testimony, petitioners state in their post-trial brief that

Mrs. Syed “undertook primary responsibility” for AAM’s rental real estate activi-

ties. We accordingly consider whether petitioners have proven that she met the

750-hour requirement.

      A taxpayer may substantiate the required 750 hours of participation by any

reasonable means, but a mere “ballpark guesstimate” will not suffice. Moss v.

Commissioner, 135 T.C. 365, 369 (2010); sec. 1.469-5T(f)(4), Temporary Income

Tax Regs., supra. In the absence of “[c]ontemporaneous daily time reports, logs,

or similar documents,” the extent of participation may be established by “the iden-

tification of services performed over a period of time and the approximate number

of hours spent performing such services * * * based on appointment books, calen-

dars, or narrative summaries.” Sec. 1.469-5T(f)(4), Temporary Income Tax Regs.,

supra. The credibility of a taxpayer’s records is diminished if the number of hours

reported appears excessive in relation to the tasks described. Hill v. Commission-

er, T.C. Memo. 2010-200, aff’d, 436 F. App’x 410 (5th Cir. 2011).

      Mrs. Syed worked for Dr. Syed’s medical practice as a full-time employee

during 2009-2011. Although she had ceased functioning as the office manager,

she accompanied Dr. Syed to work virtually every day and was paid for a 40-hour

work week. Many of her hours at the office were “soft,” but she was physically
                                        - 15 -

[*15] present there most of the day. Dr. Syed fondly described their life-long

partnership as “still going strong,” noting how much it helped him to have her at

the office “opposite me.”

      Petitioners’ son Nabeel testified that Mrs. Syed was generally in the office

whenever Dr. Syed was there. Although her substantive duties were limited,

Nabeel wanted her there “to keep company for my dad and to see old patients.”

The onsite office manager confirmed that on most days petitioners arrived and left

together, typically in the same car because Mrs. Syed did not drive. Her status as a

full-time employee of the medical practice and her inability to drive a car signifi-

cantly limited the number of hours she could devote to rental real estate activities.

      The trial testimony established that Mrs. Syed performed several tasks relat-

ing to the two rental properties, such as handling the bank account, writing a few

checks each month, and occasionally meeting with contractors. But petitioners

produced no contemporaneous records to substantiate the number of hours these

tasks entailed. The tenant of the commercial property credibly testified that he had

never met Mrs. Syed or Dr. Syed during the four years of his tenancy. This fact

alone suggests that their personal involvement was not great.

       The evidence showed that most of the required work was in fact done by

other people. For the commercial property, AAM paid property management fees
                                        - 16 -

[*16] (ranging from 16% to 54% of gross receipts) to petitioners’ son Hisham,

who devoted 16 hours a week to that property annually. Mrs. Syed hired a land-

scape company to maintain the outdoor premises of the commercial property, and

she hired contractors to do cleaning and make required repairs for both properties.

      For the residential property, a single-family home, AAM reported minimal

rent receipts, suggesting long periods of vacancies. (Rental income did not exceed

$2,200 for any year at issue.) Mrs. Syed testified that she had advertised the pro-

perty and tried to find tenants, but petitioners provided no documentation to sub-

stantiate the volume of her appointments or actual showing dates.

      Petitioners submitted at trial a spreadsheet listing various real-estate-related

tasks they supposedly performed, allegedly consuming in excess of 1,000 hours

per year. But this list was supported by no contemporaneous records, and we did

not find it credible; it is the sort of uncorroborated “ballpark guesstimate” that we

have found inadequate on prior occasions. See Lee v. Commissioner, T.C. Memo.

2006-193; Goshorn v. Commissioner, T.C. Memo. 1993-578. Petitioners created

this list during the IRS examination or before trial with an end result in mind: to

show a certain number of hours of time devoted to rental properties. We have

previously found such lists unpersuasive, and our conclusion is the same here.
                                        - 17 -

[*17] See, e.g., Mowafi v. Commissioner, T.C. Memo. 2001-111; Goshorn, T.C.

Memo. 1993-578.

      Both Mrs. Syed and Dr. Syed were full-time employees of the medical prac-

tice during the tax years at issue. We conclude that neither of them has substant-

iated, for 2009, 2010, or 2011, the performance of more than 750 hours of services

in connection with AAM’s rental real estate activities. Petitioners have thus failed

to establish their status as real estate professionals under section 469(c)(7). The

losses passed through to them from AAM are therefore passive losses that cannot

be used to offset their ordinary income.5

      C. Flowthrough Losses From SFLP

      Through SFLP petitioners owned a ranch in Hunt County, Texas, about 50

miles from their residence. Dr. Syed testified that he raised goats, emus, and other

animals on the ranch, but he was unable to specify in which tax years he began

      5
        Even if petitioners were “real estate professionals,” they would still have to
establish that they “materially participated” in AAM’s rental real estate activity.
Where (as here) multiple rental properties are involved, material participation is
tested separately with respect to each property unless the taxpayer has elected to
treat all of the properties as a single activity. Sec. 469(c)(7)(A); Aragona Tr. v.
Commissioner, 142 T.C. 165, 181 n.17 (2014). A taxpayer makes this election by
filing a statement with his original tax return for the first year he elects to treat
multiple rental properties as one. See sec. 1.469-9(g)(3), Income Tax Regs. Peti-
tioners concede that they did not make this election. Given their lack of credible
time records, they could not possibly establish material participation with respect
to the two properties separately.
                                        - 18 -

[*18] raising those animals. SFLP’s tax returns for 2009-2011 do not list any

livestock as assets, and petitioners introduced no documentary evidence to sub-

stantiate the purchase or sale of livestock. At one point, Dr. Syed indicated that

livestock activity on the ranch did not occur until 2012 or 2013.

       For 2009-2011 SFLP attached to its Forms 1065 Schedules F, Profit or Loss

From Farming. These schedules showed net farm losses, which flowed through to

petitioners and were reported on their Schedules E. Through two other pass-

through entities, SFLP also seems to have held rental real estate, at least in 2011.

But petitioners introduced no evidence concerning the nature of that activity or

their role in it.

       Petitioners assert that Dr. Syed was able to “materially participate” in the

ranch activity because he had largely wound down his medical practice by 2009.

But his employment contract designated him a full-time employee during the tax

years at issue and required that he maintain an office schedule of at least 32 hours

a week. A senior official of the practice’s management company, upon a review

of billing data, concluded that Dr. Syed saw an average of 200 patients a month in

2009, 155 patients a month in 2010, and 150 patients a month in 2011. Petition-

ers’ son Nabeel, who had been with the practice for a decade, provided roughly
                                         - 19 -

[*19] consistent testimony, estimating that his father saw up to 35 patients a week

and spent 30 to 40 minutes with each.

      The onsite office manager for the medical practice characterized Dr. Syed’s

schedule during the tax years at issue as “tough,” testifying that it was rare for him

to leave the office before 4:30 p.m. She credibly testified that he did not cut back

his hours until 2013 or 2014, when he neared retirement. His wage income from

the practice--$193,261 in 2009, $232,967 in 2010, and $179,185 in 2011--is con-

sistent with a relatively full-time schedule. Dr. Syed’s full-time employment as a

doctor makes us skeptical that he could have “materially participated” in SFLP’s

ranch activity.

      In any event, petitioners produced no contemporaneous records to substan-

tiate the extent of Dr. Syed’s ranch activity participation. Virtually all of the ac-

tual work on the ranch was performed by laborers and hired contractors. Dr. Syed

testified that he did research before embarking on raising livestock, but this type

of work does not count as direct involvement in the day-to-day operations of a

trade or business and thus does not count toward satisfying the material participa-

tion requirement. See, e.g., Serenbetz v. Commissioner, T.C. Memo. 1996-510;

Goshorn, T.C. Memo. 1993-578. He also claimed to have taken part in the brand-

ing and registration of cattle. But there is no evidence in the record that SFLP’s
                                         - 20 -

[*20] ranch had any registered cattle brand during the tax years at issue. The

ranch did register a brand for its cattle in Hunt County, but that was not until

January 2016, well after the tax years at issue.

         Petitioners argue that they materially participated in SFLP’s ranch opera-

tions under the last two of the seven disjunctive regulatory tests. See sec. 1.469-

5T(a)(1) through (7), Temporary Income Tax Regs., supra. We therefore deem

petitioners to have conceded any argument based on the first five tests. See Rybak

v. Commissioner, 91 T.C. 524, 566 n.19 (1988). The sixth regulatory test relates

to “personal service” activities, and the seventh test mandates a “facts and circum-

stances” inquiry. See sec. 1.469-5T(a)(6) and (7), Temporary Income Tax Regs.,

supra.

         A “personal service activity” encompasses certain enumerated activities and

any “other trade or business in which capital is not a material income-producing

factor.” Id. para. (d). Capital is a material income-producing factor if a substan-

tial portion of the gross income from the activity is attributable to the employment

of capital. See, e.g., Moore v. Commissioner, 71 T.C. 533 (1979). When it comes

to ranching, “the quality of the land, the efficiency of the machinery, and the de-

velopment of the cattle [a]re critical to its success.” Woodbury v. Commissioner,
                                         - 21 -

[*21] 49 T.C. 180, 191 (1967). Because capital is a material income-producing

factor for a ranching business, it is not a “personal service activity.”6

      Under the “facts and circumstances” test, an individual will be regarded as

materially participating in an activity if, “[b]ased on all of the facts and circum-

stances * * * , the individual participates in the activity on a regular, continuous,

and substantial basis during such year.” Sec. 1.469-5T(a)(7), Temporary Income

Tax Regs., supra. Generally speaking, “[a]n individual’s services performed in the

management of an activity shall not be taken into account in determining whether

such individual is treated as materially participating.” Id. para. (b)(2)(ii). In no

event shall an individual be deemed to materially participate if he “participates in

an activity for 100 hours or less during the taxable year.” Id. subdiv. (iii).

      We find that petitioners, under all the facts and circumstances, did not par-

ticipate in the ranch activity “on a regular, continuous, and substantial basis” dur-

ing 2009, 2010, or 2011. Id. para. (a)(7). At trial they submitted an exhibit listing

SFLP-related tasks they supposedly performed, coming up with bottom-line num-

bers of 10 to 15 hours per week. These estimates were supported by no contem-

      6
       Even if the ranch activity were deemed a “personal service activity,” the
regulations (subject to an exception not applicable here) require the taxpayer to
have participated in it for three years before the year at issue. Sec. 1.469-5T(a)(6),
Temporary Income Tax Regs., supra. Petitioners introduced no evidence about
material participation for years before 2009.
                                        - 22 -

[*22] poraneous records, and we did not find them credible. See Bartlett v. Com-

missioner, T.C. Memo. 2013-182. Both petitioners were full-time employees of

the medical practice; they visited the ranch on weekends, chiefly for personal rea-

sons. Dr. Syed was 75 years old by 2009. He conceded that most of the time he

devoted to the ranch consisted of reading, talking, and thinking, whereas all the

actual ranch and farm work was done by laborers and contractors.

       Upon a careful review of all the facts in the record, we conclude that neither

petitioner materially participated in the ranch activity under the “facts and circum-

stances” test. The losses passed through to them from SFLP are therefore passive

activity losses that cannot be used to offset their ordinary income.7

III.   Accuracy-Related Penalties

       The Code imposes a 20% penalty upon the portion of any underpayment of

income tax that is attributable (among other things) to “negligence” or any “sub-

stantial understatement of income tax.” Sec. 6662(a) and (b)(1) and (2). “Negli-

gence” is defined as “any failure to make a reasonable attempt to comply” with the

provisions of the Code. See sec. 6662(c). An understatement of income tax is

       7
        Petitioners offered no testimony or documentary evidence concerning the
rental real estate activities that SFLP allegedly conducted through two subsidiary
passthrough entities. We have determined that petitioners were not “real estate
professionals,” and we deem them to have conceded that they did not materially
participate in any rental real estate activity conducted through SFLP.
                                        - 23 -

[*23] “substantial” if it exceeds the greater of $5,000 or 10% of the tax required to

be shown on the return. See sec. 6662(d)(1)(A). Invoking both grounds in the

alternative, the notice of deficiency determined an accuracy-related penalty on the

full amount of the deficiency for each year.

      Under section 7491(c) the Commissioner bears the burden of production

with respect to the liability of an individual for any penalty. See Higbee, 116 T.C.

at 446. Respondent has carried that burden here: He has shown that petitioners

were not real estate professionals; that they did not materially participate in any

loss-generating activities; and that all claimed loss deductions were in fact passive.

      No penalty is imposed with respect to any portion of an underpayment if the

taxpayer acted with reasonable cause and in good faith with respect thereto. Sec.

6664(c). The taxpayer bears the burden of proving reasonable cause and good

faith. Higbee, 116 T.C. at 444-447. Reasonable cause can be shown by good-

faith reliance on the advice of a qualified tax professional. Sec. 1.6664-4(b)(1),

(c), Income Tax Regs. Whether the taxpayer actually relies on the advice and

whether such reliance is reasonable present questions of fact. Neonatology

Assocs., P.A. v. Commissioner, 115 T.C. 43, 98 (2000), aff’d, 299 F.3d 221 (3d

Cir. 2002); sec. 1.6664-4(c)(1), Income Tax Regs. For reliance to be reasonable,
                                       - 24 -

[*24] the taxpayer must prove (among other things) that he provided “necessary

and accurate information to the adviser.” Neonatology Assocs., P.A., 115 T.C. at

99.

      Petitioners have failed to establish that they made a good-faith effort to de-

termine their Federal income tax liabilities correctly. Although they hired a tax re-

turn preparer, they presented no credible evidence regarding what (if any) records

they provided to their preparer to substantiate the nonpassive character of their

flowthrough losses. See Bartlett, T.C. Memo. 2013-182. Nor have they shown

that their return preparer was competent. They did not call her as a witness, and

her unquestioning acceptance of their losses as nonpassive, in the absence of any

contemporaneous participation records, does not inspire confidence.

      We therefore conclude that all of the underpayments (as redetermined) are

attributable to negligence. Alternatively, if the Rule 155 computations show that

the various understatements of income tax exceed the greater of $5,000 or 10% of

the amounts required to be shown on the respective returns, we conclude that

those underpayments are attributable to substantial understatements of income tax

for which reasonable cause has not been shown.
                                  - 25 -

[*25] To reflect the foregoing,


                                           Decision will be entered under

                                  Rule 155.
