                          T.C. Memo. 2005-14



                      UNITED STATES TAX COURT



         ASSAF F. AL ASSAF AND REHAB ASSAF, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 770-03.                   Filed January 31, 2005.



     Rehab R. Assaf, for petitioners.

     William F. Castor, for respondent.


              MEMORANDUM FINDINGS OF FACT AND OPINION


     KROUPA, Judge:   Respondent determined deficiencies of $8,940
for 1999 and $12,486 for 2000 in petitioners’ Federal income
taxes.   The issue to be decided is whether the passive loss rules
of section 4691 preclude petitioners from deducting leasing



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

activity losses incurred by their wholly owned limited liability
company.    We hold that they do not.
                          FINDINGS OF FACT
     Some of the facts have been stipulated and are so found.
The stipulation of facts and the accompanying exhibits are
incorporated by this reference.    Petitioners resided in Oklahoma
City, Oklahoma, at the time they filed the petition.
     Petitioner wife was a partner in the law firm of Assaf &
Cohlmia, PLLC (the law firm), in Oklahoma City, Oklahoma, during
the years at issue.    During the same time, petitioner husband was
a medical doctor and worked full-time as a professor at the
University of Oklahoma Health Sciences Center in Oklahoma City,
Oklahoma.
     Petitioner husband also provided consulting services to his
wife’s law firm, other attorneys, and health maintenance
organizations.    The services he provided included reviewing
medical-malpractice cases, serving as an expert witness,
performing mock surveys, and providing training in quality
assurance programs.    Petitioner husband engaged in the consulting
activity as a part of a professional practice plan within the
University of Oklahoma Health Sciences Center, which allowed its
professors to pursue business activities outside the University
relating to their area of expertise.
     Petitioners conducted their respective practices in the same
office building (the office building).    The office building was
owned by AGI Consulting, LLC (AGI), in which petitioners were
each 50-percent shareholders.    Petitioner husband’s consulting
activities were conducted through AGI, while petitioner wife’s
                                - 3 -

law practice was conducted apart from AGI.2   AGI’s principal
activity was providing legal support services to attorneys to
whom it leased space.    AGI therefore engaged in three kinds of
activities.    It provided legal support services, leased office
space, and offered consulting services.
     AGI employed an office staff consisting of at least three
clerical support personnel to provide legal support services.
Services included client intake, answering phones, taking
messages, filing documents at the courthouse and State capitol,
process serving, express mailing, binding briefs, conducting
legal research, typing briefs and legal memoranda, taking
dictation, managing a file room, and photocopying.    AGI also
maintained an updated law library and conference facilities for
its tenants.   AGI provided other services including a security
service, trash removal, janitorial services, coffee service, and
general utilities.    AGI owned the office equipment it leased to
the law firm and “nine or ten” other tenant attorneys.    AGI was
reimbursed by the law firm, other attorneys, and petitioner
husband for their shares of payroll and office expenses.    AGI
also offered petitioner husband’s consulting services to its
tenants.   Tenant attorneys leased space in the office building
principally to obtain these services that AGI offered.
     Petitioner wife exclusively managed AGI’s leasing activities
and legal support services during the years at issue.    This
involved supervising AGI’s office staff, procuring supplies,



     2
      The law practice leased space from AGI and used AGI’s
services.
                                - 4 -

performing or overseeing repairs and maintenance of the office
building and office equipment, paying AGI’s bills and payroll,
depositing AGI’s checks, filing related employment tax returns,
remaining on call 7 days a week with the security service, and
overseeing tenants moving in and out of the office building on
weekends.
       AGI incurred losses during the years at issue from the
leasing activities and the legal support services, both of which
it classified as nonpassive and netted with its consulting
activity income on its partnership returns.    AGI had net losses
of $34,090 in 1999 and $34,207 in 2000.    AGI issued Schedule K-1,
Partner’s Share of Income, Credits, Deductions, Etc., each year
to petitioners reflecting their distributive share of the losses,
which they shared equally.    Petitioners each reported their
distributive share of the losses in each year at issue on
Schedule E, Supplemental Income and Loss.    Petitioner wife’s
Schedule E losses from AGI for 1999 and 2000 reduced her self-
employment income from the law practice.
       Respondent determined in the statutory notice of deficiency,
dated December 11, 2002, that AGI’s leasing activities were per
se passive and limited by the passive activity rules.    In making
that determination, respondent cited petitioner wife’s law
practice gross income of $175,505 in 1999 and $220,974 in 2000 as
evidence that she could not have devoted the necessary time to
AGI.    Respondent determined, consequently, that petitioners did
not qualify for an exception to the passive loss rules and should
not have netted income from AGI’s consulting services with losses
from its leasing activities and legal support services.
                                 - 5 -

     Petitioners timely filed a petition contesting respondent’s
determination, arguing that they qualified for an exception to
the passive loss rules because of the nature of the services AGI
provided and because of the number of hours petitioner wife spent
managing AGI.   Petitioner wife also disputes respondent’s claim
that she worked full-time in her law practice, claiming that the
law practice income was mostly attributable to income earned on a
flat-fee basis or for work performed in prior years.
                                OPINION
     Passive activity losses that exceed passive activity income
are generally disallowed.     Sec. 469(a)(1), (d)(1).   Passive
activities include the conduct of any trade or business
activities in which the taxpayer does not materially participate
and rental activities without regard to whether the taxpayer
materially participates.    Sec. 469(c)(1), (2), (4); see also sec.
469(j)(8); sec. 1.469-1T(e)(1), Temporary Income Tax Regs., 53
Fed. Reg. 5702 (Feb. 25, 1988).3    A rental activity is any
activity where payments are principally for the use of tangible
property.   Sec. 469(j)(8).
     There are several exceptions to the definition of “rental
activity”, one of which petitioners assert applies.4     Sec. 1.469-

     3
      The Commissioner is given authority under sec. 469(l) to
prescribe regulations to carry out the provisions of the section.
As relevant here, this statutory authority was carried out in
sec. 1.469-1T, Temporary Income Tax Regs., 53 Fed. Reg. 5701
(Feb. 25, 1988), sec. 1.469-5T, Temporary Income Tax Regs., 53
Fed. Reg. 5725 (Feb. 25, 1988), and sec. 1.469-9, Income Tax
Regs. See also sec. 7805.
     4
      Petitioners also argued that the leasing activity was
nonpassive because petitioner wife qualified as a real estate
                                                   (continued...)
                               - 6 -

1T(e)(3)(ii), Temporary Income Tax Regs., supra.     Respondent
counters that AGI’s leasing activities are per se passive in
nature and that petitioners do not qualify for any exception.
Instead, respondent claims the losses by petitioners should have
been suspended until a future date when petitioners had gains
from passive activities.   See sec. 469(b).
     We address, first, whether petitioners produced evidence
sufficient to shift the burden of proof to respondent under
section 7491.   We address, second, whether one of the exceptions
to the definition of a “rental activity” applies and whether
petitioners materially participated in that activity.
Burden of Proof
     Determinations of the Commissioner in a notice of deficiency
are presumed correct, and the taxpayer bears the burden of
proving otherwise.   Rule 142(a); Welch v. Helvering, 290 U.S.
111, 115 (1933).   Deductions are generally a matter of
legislative grace, and the taxpayer bears the burden of proving
entitlement to claimed deductions.     INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v.
Helvering, 292 U.S. 435, 440 (1934).


     4
      (...continued)
professional under sec. 469(c)(7)(B). If a taxpayer qualifies as
a real estate professional, the rental activities of the real
estate professional are exempt from classification as a passive
activity under sec. 469(c)(2). Instead, the real estate
professional’s rental activities are treated as a passive
activity under sec. 469(c)(1) unless the taxpayer materially
participated in the activity. Sec. 1.469-9(e)(1), Income Tax
Regs. Because we find that petitioners qualified for the
extraordinary personal services exception, petitioners are not
engaged in a rental activity, and we need not address whether
petitioners qualify for the real estate professional exception.
                               - 7 -

      This burden, however, may shift to the Commissioner to
disprove entitlement to a claimed deduction if the taxpayer
introduces “credible evidence” complete with the necessary
substantiation and documentation sufficient to fulfill the
requirements of section 7491(a).5   To shift the burden, the
taxpayer must also have complied with requirements to cooperate
with reasonable requests by the Commissioner for witnesses,
information, documents, meetings, and interviews.     Id.   The
taxpayer bears the burden of proving that these requirements have
been met.   Snyder v. Commissioner, T.C. Memo. 2001-255 (citing H.
Conf. Rept. 105-599, at 240-241 (1998), 1998-3 C.B. 747, 994-
995).
      In the context of the passive loss rules under section 469,
a taxpayer’s participation in an activity may be established by
any reasonable means.   Sec. 1.469-5T(f)(4), Temporary Income Tax
Regs., supra at 5727; see Shaw v. Commissioner, T.C. Memo. 2002-
35.   Contemporaneous daily time reports are not required if the
extent of participation may be established by other reasonable
means.    Sec. 1.469-5T(f)(4), Temporary Income Tax Regs., supra.
Reasonable means may include identifying services performed over
a period of time and the approximate number of hours spent
performing the services during that period based on appointment
books, calendars, or narrative summaries.    Id.   Although the




      5
      Sec. 7491 applies to examinations commencing after July 22,
1998, and therefore applies here. See Internal Revenue
Restructuring and Reform Act of 1998, Pub. L. 105-206, sec. 3001,
112 Stat. 726.
                               - 8 -

regulations are vague, they do not allow a post-event “ballpark
guesstimate”.   Fowler v. Commissioner, T.C. Memo. 2002-223.
     In testimony and exhibits, petitioner wife produced credible
evidence to establish that she met the requisite time
requirements.   Higbee v. Commissioner, 116 T.C. 438, 442 (2001).
Petitioner wife did not comply, however, with respondent’s
reasonable request to view redacted law practice time sheets.
Accordingly, we find that section 7491 does not shift the burden
of proof to respondent.   Petitioners therefore bear the burden of
proving by a preponderance of the evidence that they qualified
for an exception to the definition of a rental activity.
Extraordinary Personal Services
     We address next whether petitioners qualify for the
extraordinary personal services exception.   To qualify for the
extraordinary personal services exception, petitioners must prove
that the activity was not a “rental activity” under section
469(j)(8).   In so doing, petitioners must prove that the use by
customers of AGI’s real property was incidental to their receipt
of AGI’s services.6   Sec. 1.469-1T(e)(3)(ii)(C), Temporary Income
Tax Regs., supra at 5702.
     Very little guidance exists on the meaning of
“extraordinary” personal services, and no reported case by this



     6
      The extraordinary personal services exception is separate
from another exception, not at issue here, where the rental of
property is “incidental to” a nonrental activity. See sec.
1.469-1T(e)(3)(ii)(D), Temporary Income Tax Regs., 53 Fed. Reg.
5702 (Feb. 25, 1998). Unlike the extraordinary personal services
exception, this exception involves a computational analysis. See
sec. 1.469-1T(e)(3)(vi); compare sec. 1.469-1T(e)(3)(v),
Temporary Income Tax Regs., supra.
                                - 9 -

Court has addressed the extraordinary personal services exception
with facts similar to ours.    Two cases involved equipment leasing
activities that are distinguishable from the facts here.      Kessler
v. Commissioner, T.C. Memo. 2003-185; Hairston v. Commissioner,
T.C. Memo. 2000-386.   Neither case is dispositive.
     Both cases concerned equipment leasing activities, while we
are addressing real property leasing activities in conjunction
with legal support services.   Moreover, the taxpayers in both
Hairston and Kessler personally owned the equipment they leased
to their wholly owned companies, which in turn leased the
equipment to third-party end users.     In each case, the lease
provided that the taxpayers’ company would perform equipment
maintenance.   The taxpayers therefore performed maintenance
services not in their role as owners of the equipment but rather
in their role as corporate officers or employees.     The Court
consequently found that the services performed were unrelated to
the taxpayers’ leasing activities.      Kessler v. Commissioner,
supra; Hairston v. Commissioner, supra.      Here, AGI owned the real
property that it leased to tenants, not petitioners, and AGI
provided the services.   AGI was therefore the lessor and service
provider.
     Moreover, the services provided in Hairston and Kessler were
minimal in comparison with the legal support services AGI
provided to its attorney-tenants.    While the services in Hairston
                                - 10 -

and Kessler involved maintaining and servicing equipment, AGI
provided extensive services.7
     Only one case has previously determined that the services
provided were extraordinary.    Welch v. Commissioner, T.C. Memo.
1998-310.   Welch involved personal service contracts in which the
taxpayer, a carpenter, contracted with movie production companies
to construct movie sets.   The taxpayer also leased tools and
equipment to the production companies.   The Court found that the
movie company’s primary motivation was to obtain the taxpayer’s
services and not to lease his equipment.    Id.   Similarly, we find
that AGI’s attorney-tenants leased from AGI primarily to obtain
its legal support services and not to lease its office space.
     The regulations provide examples regarding when the
extraordinary personal services exception might apply.    Two
examples concern the use by patients of a hospital’s boarding
facilities and the use by students of a boarding school’s
dormitories.8   See sec. 1.469-1T(e)(3)(v), Temporary Income Tax
Regs., supra at 5702.   In each, the use of the premises was


     7
      Further, the Court in Hairston v. Commissioner, T.C. Memo.
2000-386, stated that no credible evidence supported taxpayers’
contention that extraordinary services were performed. The Court
found, rather, that the taxpayers individually had “little or no
responsibility” for maintaining the equipment under the lease,
and that the taxpayers merely “serviced and maintained” equipment
they rented. In contrast, the record supports petitioners’
contention that petitioner wife was continuously engaged in
providing extensive legal support services.
     8
      Additional examples in the regulations address the
extraordinary personal services exception in the context of
leasing photographic equipment, leasing tractor trailers, and
leasing a taxi. See sec. 1.469-1T(e)(3)(viii), Examples (1),
(3), (9), Temporary Income Tax Regs., supra at 5703-5704. We do
not find these examples analogous to our facts.
                                - 11 -

incidental to the services offered.      Id.   The facts in our case
are more akin to those services offered by a hospital or school,
where the prime concern of the tenants is the receipt of
services, whether medical, teaching, or, in our case, legal.
While the space leased may have factored into the attorney-
tenants’ determination, it was incidental to the services they
received.
     AGI provided substantial support services to its tenants,
and AGI’s tenants leased space exclusively so that they would
have the benefit of those services.      Specifically, AGI provided
its attorney-tenants with a paralegal, a legal intern, a law
clerk, an up-to-date law library, a computer with legal research
capabilities, and two conference rooms.9       AGI’s employees
performed client intake, answered phones, took messages, filed
documents at the courthouse and State capitol, typed briefs, took
dictation, referred cases, scheduled depositions and court
reporters, arranged travel, managed a file room and file storage,
and performed legal research.    AGI also offered petitioner
husband’s expert consulting services, as well as referrals for
medical-related cases.
     Witnesses for petitioners testified that AGI’s services to
its tenants were unique in the area close to the courthouse, and
that they would not have moved onto the premises if the support
services were not provided.     We find of particular significance
that AGI performed legal research for its attorney-tenants.



     9
      After the years at issue, AGI also provided tenants with
video-conferencing equipment.
                                  - 12 -

Overall, testimony established that the services were the crucial
determinant in attorneys’ choosing to lease from AGI, and we
found the testimony on behalf of petitioners credible and
compelling.    See Anderson v. City of Bessemer City, 470 U.S. 564,
575 (1985).    We therefore find the payments to AGI were
principally for the services provided and not for the space
leased.   Consequently, the leasing activity is not a rental
activity.
Material Participation
     Finally, to qualify the losses as nonpassive, petitioners
must carry their burden to prove not only that the extraordinary
personal services exception applies, but also that petitioners
materially participated in the activity.
     Material participation is defined as involvement in the
operations of an activity that is regular, continuous, and
substantial.    Sec. 469(h)(1).    A taxpayer may also satisfy the
material participation requirement if the individual satisfies
any one of seven regulatory tests.         See sec. 1.469-5T(a),
Temporary Income Tax Regs., supra at 5725; see also Lapid v.
Commissioner, T.C. Memo. 2004-222 (citing Mordkin v.
Commissioner, T.C. Memo. 1996-187, which upheld the regulatory
“safe harbor” tests letting taxpayers prove material
participation by showing they spent a certain number of hours on
an activity).    The test most applicable in this case is whether
petitioner wife participated in the nonrental activity for more
than 500 hours during the year.      See Harrison v. Commissioner,
T.C. Memo. 1996-509; sec. 1.469-5T(a)(1), Temporary Income Tax
                                - 13 -

Regs., supra at 5725.     “Participation” generally means any work
done in an activity by an individual who owns an interest in the
activity.     Sec. 1.469-5(f)(1), Income Tax Regs.
     Petitioner wife has shown, through exhibits and testimony,
that she provided regular and substantial services to AGI’s
tenants.     Petitioner wife was daily onsite and in charge of AGI’s
leasing activities and legal support services during the years at
issue.     She estimated, in retrospect, that her total time spent
on office leasing activities was approximately 1,340 hours per
year.     As the onsite manager of AGI’s legal support services,
petitioner wife supervised the office staff, met the business and
legal needs of “nine to ten” tenant attorneys and other non-
tenant attorneys.     Petitioner wife also performed payroll,
accounts payable, and accounts receivable services, and
maintained the law library.
     Respondent argues that, while petitioner wife provided a
good faith estimate of her time spent in AGI’s activities, it was
not based on any objective measure, and the lack of
contemporaneous logs or calendars cast doubt on her pretrial
estimate of time spent in the activities.10    As a result,


     10
      It is not clear whether respondent disputes that
petitioner wife materially participated in the activity. For
example, respondent discusses Shaw v. Commissioner, T.C. Memo.
2002-35, which held that a taxpayer had not materially
participated in a passive activity. Respondent also claimed that
petitioner wife did not adequately document the extent of time
she spent on the activity. Respondent’s arguments, however,
focused primarily on the number of hours petitioner wife worked
in relation to the real estate professional exception, which
requires, among other things, that petitioner wife spend in
excess of 750 hours on the activity. Because our holding does
                                                   (continued...)
                              - 14 -

respondent contends that petitioner wife’s estimate was neither
reasonable nor reliable.   Petitioner wife counters that she still
performs the same activities, which are at issue in this case, so
the computations of time were not based on distant memories.
Based on testimony regarding petitioner wife’s onsite management
of AGI’s employees, petitioner wife contends she has adequately
satisfied the requirement that she materially participated in the
nonrental activity.
     We have no doubt that petitioner wife spent substantial time
on the leasing activities and legal support services.   Although
this Court has not always accepted a post-event narrative of
participation, we find petitioner wife’s description of her
participation, when combined with witness testimony and the
objective evidence in the record, to be credible, and we
therefore conclude that petitioner wife materially participated
in the activity by participating for more than 500 hours during
the year.   See Harrison v. Commissioner, T.C. Memo. 1996-509.
Accordingly, petitioners have satisfied their burden of showing




     10
      (...continued)
not require an analysis under the real estate professional
exception, we apply respondent’s argument to whether petitioner
wife materially participated in the nonrental activity.
Moreover, Shaw is distinguishable from the present case because
many of the hours the taxpayer alleged to have spent materially
participating in the passive activity in Shaw were in fact
“investor type activities”, which are not includable unless the
individual is directly involved in the day-to-day management or
operations of the activity. Sec. 1.469-5T(f)(2)(ii)(A),
Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988).
As we have shown, petitioner wife daily participated in the
management and operations of the activity.
                              - 15 -

petitioner wife materially participated in the nonrental
activity.   See sec. 469(c)(1), (h)(1).
     In conclusion, we find that the payments the attorney-
tenants paid to AGI were principally for the use of the
extraordinary personal services, and that the property leasing
was incidental to the services AGI offered.    Having also
determined that petitioners materially participated in the
leasing activity, we find that AGI’s activities are not passive
activities.   AGI’s losses therefore are nonpassive and may be
netted with AGI’s other income.
     In reaching our holding, we have considered all arguments
made, and, to the extent not mentioned, we conclude that they are
moot, irrelevant, or without merit.
     To reflect the foregoing,


                                          Decision will be entered


                                      for petitioners.
