                  T.C. Memo. 1997-90



                UNITED STATES TAX COURT



            DOUGLAS E. KAHLE, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 19712-94.               Filed February 20, 1997.



     P, an individual, owned rental real estate, which
produced passive losses under sec. 469, I.R.C. P was
also a partner in partnership A, which had nonpassive
losses from a nonrental real estate operation. Held, P
could not combine the rental operation and nonrental
operation into a single undertaking, and thus could not
deduct passive losses as active losses, because the
resultant undertaking would not pass the common
location/ownership test of sec. 1.469-4T(c)(2),
Temporary Income Tax Regs., 54 Fed. Reg. 20544 (May 12,
1989), and because the de minimis exception of sec.
1.469-4T(d), Temporary Income Tax Regs., 54 Fed. Reg.
20547 (May 12, 1989), is not satisfied. Held, further,
P was liable for additions to tax under secs. 6653(a)
and 6661(a), I.R.C., and for a penalty under sec.
6662(b), I.R.C.


Douglas E. Kahle, pro se.

Veena Luthra, for respondent.
                                  - 2 -

                            MEMORANDUM OPINION

       TANNENWALD, Judge:    Respondent determined the following

additions to tax and penalty for petitioner's Federal income

taxes1:

Year             Additions to Tax I.R.C. Secs.             Penalty

            6651(a)(1)2     6653(a)(1)(A)        6661       6662

1988        $9,398.75        $2,950.20       $14,751.00       --

1989         4,978.25            --                --     $4,985.80

After concessions, the issue before us is whether petitioner's

rental operations may be combined with a nonrental partnership

operation, so that petitioner may deduct losses from the rental

operation as nonpassive losses.       Based on our decision on this

issue, we shall have to decide whether petitioner is liable for

additions to tax for delinquent filing, negligence, and

substantial understatement, and an accuracy-related penalty for

negligence.




       1
        There are no deficiencies due, because of net operating
loss carrybacks to the years 1988 and 1989 from the taxable year
1990. However, it is necessary to determine whether deficiencies
would otherwise have been due (if not for such carrybacks), in
order to determine whether additions to tax are proper. Auerbach
Shoe Co. v. Commissioner, 21 T.C. 191, 196 (1953), affd. 216 F.2d
693 (1st Cir. 1954), and cases cited thereat; see also Wentz v.
Commissioner, 105 T.C. 1, 2 (1995).
       2
        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.
                                 - 3 -

Background

     This case was submitted fully stipulated under Rule 122.

The stipulation of facts and attached exhibits are incorporated

herein by this reference and found accordingly.

     Petitioner is an individual residing, at the time the

petition in this case was filed, in Virginia Beach, Virginia.

The returns for the periods here involved were filed with the

Internal Revenue Service at Norfolk, Virginia.    Petitioner's

individual return for the taxable year 1988 was filed

delinquently on July 24, 1991.    Petitioner's individual return

for the taxable year 1989 was filed delinquently on January 16,

1992.

     Petitioner was general partner of the Pilot House Associates

II partnership (Associates).   Associates built the Pilot House

condominium project (Project), and the condominium units were

owned by Associates until sold.    Associates constituted, for

purposes of section 469, a nonpassive activity of petitioner for

the taxable years 1988 and 1989.    Associates reported the

following gross receipts and cost of goods sold for the years at

issue.

                                     1988             1989

     Gross receipts                $469,281         $297,239
     Cost of goods sold             477,473          302,000
     Gross income                   $(8,192)        $ (4,761)

   Petitioner's shares of Associates' nonpassive losses were as

follows:
                                     - 4 -

                   Year                Loss


                   1988               $18,232
                   1989                12,231

     In 1987, Associates sold two units of the Project, Pilot

House 206 (unit 206) and Pilot House 405 (unit 405), to

petitioner.    During 1988 and 1989, petitioner rented out these

units.   He owned and rented out other units that are not the

subject of this dispute.      We shall refer to petitioner's rental

of units 206 and 405 as the Rental Operation.           Petitioner's gross

income with respect to the Rental Operation was as follows:

           Unit                1988                    1989

           206                $5,166                    -0-
           405                 7,200                    -0-

Petitioner incurred losses with respect to the Rental Operation

as follows:

           Unit               1988              1989

           206               $22,947                   $26,703
           405                23,115                    30,966

In 1989, petitioner sold unit 405.



Statutory and Regulatory Framework

     The issue before us is whether petitioner's Rental Operation

should be classified as a nonpassive activity for purposes of

section 469.      That section was designed to limit deductions of

losses from passive activities.        S. Rept. 99-313 (1986), 1986-3

C.B. (Vol. 3) 713, 716-718.      To this end, taxpayers generally may
                                  - 5 -

not deduct passive activity losses, except against passive

activity income.   Sec. 469(a).    Rental activities are generally

passive.   Sec. 469(c)(2).   The passive loss rules involve three

terms of art: "operations" are the most basic business unit under

the regulations; "undertakings" consist of one or more

"operations"; "activities" consist of one or more "undertakings".

Application of the rules hinges on a determination of whether the

taxpayer's "operations" can be combined into "undertakings" and

then into "activities" for the purpose of aggregating passive

income and passive losses, and active income and active losses.

This determination is made according to the rules set out in

section 1.469-4T, Temporary Income Tax Regs., 54 Fed. Reg. 20542-

20565 (May 12, 1989).   This section is made applicable to the tax

years at issue by section 1.469-11(a)(2), Income Tax Regs.

     The initial determination is whether each operation involved

is a separate undertaking.   Each undertaking owned by a taxpayer

is usually then a separate and distinct activity.    Sec.

1.469-4T(a)(4), (b)(1), Temporary Income Tax Regs., 54 Fed. Reg.

20542, 20543.   In certain cases, however, a taxpayer may

aggregate its separate undertakings into a single activity.    Sec.

1.469-4T(f),(k), Temporary Income Tax Regs., 54 Fed. Reg. 20552,

20561.

     Operations that constitute a separate source of income are

treated as a single undertaking only if the operations are: (1)

conducted at the same location, and (2) owned by the same person.
                                - 6 -

Sec. 1.469-4T(c)(2), Temporary Income Tax Regs., 54 Fed. Reg.

20544.   Operations are separate undertakings if one of these two

prongs is not met.    Sec. 1.469-4T(a)(3)(ii), (c)(2)(i), Temporary

Income Tax Regs., 54 Fed. Reg. 20542, 20543.   Operations are

owned by the same person "if and only if one person (within the

meaning of section 7701(a)(1)) is the direct owner of such

operations."   Sec. 1.469-4T(c)(2)(v), Temporary Income Tax Regs.,

54 Fed. Reg. 20544.   The term "person" includes an individual,

partnership, association, company, or corporation.   Sec.

7701(a)(1).

     Even if two operations are considered the same undertaking

under the foregoing location/ownership test, rental operations

and nonrental operations are still considered to be separate

undertakings, unless "Less than 20 percent of the gross income of

the paragraph (c) undertaking is attributable" to either the

rental or nonrental operation (the de minimis exception).    Sec.

1.469-4T(d)(1), (2)(ii) and (iii), Temporary Income Tax Regs., 54

Fed. Reg. 20547.

     A combination undertaking is then subject to the

"predominant character rule".   Under section 1.469-4T(d)(1)(iii),

Temporary Income Tax Regs., supra, with reference to section

1.469-1T(e)(3), Temporary Income Tax Regs., 53 Fed. Reg. 5702

(Feb. 25, 1988), a combined rental-nonrental undertaking has the

character of the rental operation only if the gross income from

the combined operation represents amounts paid "principally" for
                                - 7 -

the rental of property.    That is, the entire undertaking is

treated as rental or nonrental depending on the predominant

character of the income.

     If a rental operation is classified as a separate

undertaking, it may be combined, under certain circumstances,

only with another rental undertaking into a single activity.

Sec. 1.469-4T(k), Temporary Income Tax Regs., 54 Fed. Reg. 20561.

There is no possibility under the regulations for a rental

undertaking to be combined with a nonrental undertaking into one

activity.    Thus, if rental and nonrental operations cannot be

combined into one undertaking under the regulations, they cannot

be combined at all.



Discussion

     Combination of Operations into One Undertaking

     Petitioner incurred losses with respect to the Rental

Operation.   Rental real estate losses would normally be passive.

Sec. 469(c)(2).   Petitioner seeks to deduct those losses as non-

passive losses.   This may only be accomplished if the Rental

Operation is combined with petitioner's share of the nonpassive

Project into one undertaking.    Neither party contends that

petitioner's Rental Operation is not a rental real estate

operation.   Also, both parties agree that Associates' Project is

a nonpassive, nonrental operation.      It is the possible
                               - 8 -

combination of this rental operation with this nonrental

operation upon which the parties do not agree.

     The combination of operations into undertakings occurs using

the two-pronged test found in section 1.469-4T(c)(2), Temporary

Income Tax Regs., supra.   Applying the first prong, it is clear

that petitioner's Rental Operation and Associates' Project are

conducted at the same location.   Sec. 1.469-4T(c)(2)(i)(A),

Temporary Income Tax Regs., 54 Fed. Reg. 20544.

     But, the combination fails the second prong of the test

because the two operations are not owned by the same person.       Id.

Section 1.469-4T(c)(2)(v), Temporary Income Tax Regs., supra, is

clear that operations are owned by the same person "if and only

if one person (within the meaning of section 7701(a)(1)) is the

direct owner of such operations." (Emphasis added.)    Units 206

and 405 are owned by petitioner, a natural person, whereas the

Project is owned by the Associates partnership, a separate legal

person.   See Wiseman v. Commissioner, T.C. Memo. 1995-203.

     Petitioner points to section 1.469-4T(j), Temporary Income

Tax Regs., 54 Fed. Reg. 20559, and argues that effective control

is the measure of ownership under section 1.469-4T(c)(2),

Temporary Income Tax Regs., supra.     Section 1.469-4T(f)(2),

Temporary Income Tax Regs., 54 Fed. Reg. 20552, makes common

control, as defined in section 1.469-4T(j), Temporary Income Tax

Regs., supra, a precondition to the aggregation of trade or

business undertakings into a single activity, not the combination
                               - 9 -

of operations into a single undertaking.   Furthermore, by its

plain language, this provision does not apply to rental

operations.3   Moreover, the reference to direct ownership in

section 1.469-4T(c)(2)(v), Temporary Income Tax Regs., supra,

makes it clear that ownership, not control, is the relevant

factor in determining combinability under this section.

     Thus, because we find that the ownership test of section

1.469-4T(c)(2), Temporary Income Tax Regs., supra, has not been

met, we hold that petitioner may not combine the Rental Operation

and his share in Associates' nonpassive operations into a single

undertaking.   See Wiseman v. Commissioner, supra; see also 5

Mertens, Law of Federal Income Taxation, sec. 24C.11 (1990); cf.

Moore v. United States, 943 F. Supp. 603, 615-617 (E.D. Va.

1996).

     In any event, petitioner cannot succeed herein because he

cannot satisfy the de minimis exception of section 1.469-4T(d),

Temporary Income Tax Regs., supra.



     3
        Sec. 1.469-4T(f)(1)(i) and (ii)(A), Temporary Income Tax
Regs., 54 Fed. Reg. 20552 (May 12, 1989), provides:

     (1) Applicability. (i) In general. This paragraph (f)
     applies to a taxpayer's interests in trade or business
     undertakings (within the meaning of paragraph
     (f)(1)(ii) of this section).
          (ii) Trade or business undertaking. For purposes of
     this paragraph (f), the term "trade or business undertaking"
     means any undertaking in which a taxpayer has an interest,
     other than --
               (A) A rental undertaking * * * [Emphasis added.]
                               - 10 -

     For both years at issue, the Project had no gross income,

because Associates' cost of goods sold exceeded its gross

receipts on Project sales.   See Beatty v. Commissioner, 106 T.C.

268, 273 (1996); supra pp. 3-4.    Because the Project had no gross

income, the gross income from the Rental Operations cannot be

less than 20 percent of the Project's gross income, and the

Rental Operation cannot be combined into the active Project

operation.

     In 1989, neither operation had any gross income, so the

exception cannot be applied.   In 1988, when the Rental Operation

had gross income of $11,366, the Project operation could be

combined, via the de minimis exception and the predominant

character rule of section 1.469-1T(e)(3), Temporary Income Tax

Regs., supra, into the Rental Operation, a result neither party

seeks.   Although petitioner attempts to rely upon the de minimis

exception, it would work only to his detriment in this case.     Cf.

Moore v. United States, supra at 617.



     Additions to Tax and Penalties

     For the 1988 taxable year, respondent has determined

additions to tax for delinquency, negligence, and substantial

understatement under sections 6651(a)(1), 6653(a)(1), and 6661.

For the 1989 taxable year, respondent has determined an addition

to tax for delinquency under 6651(a)(1) and a penalty for

negligence under section 6662.    Petitioner has the burden of
proof, which is not lessened in a fully stipulated case.    Rule

142(a); Tippin v. Commissioner, 104 T.C. 518, 533 (1995);

Borchers v. Commissioner, 95 T.C. 82, 91 (1990), affd. 943 F.2d

22 (8th Cir. 1991).   Petitioner has conceded that the returns for

both years at issue were filed delinquently and has offered no

other evidence on the issues of additions to tax and penalties,

which he did not address in his brief.   Accordingly, we sustain

respondent's determinations.

     To reflect the foregoing, and concessions of the parties,

                                    Decision will be

                                entered under Rule 155.
