                       T.C. Memo. 1996-56



                     UNITED STATES TAX COURT


          B. THEODORE AND WENDY CHAPIN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket No. 12106-94.       Filed February 14, 1996.


          Ps own a beach condominium that is rented for an
     average period of 7 days or less during the June to
     September rental season. A rental agent handles all leasing
     arrangements, cleaning between tenants, and routine repairs
     and maintenance. Ps allege that they spend more than 170
     hours during the nonrental season on cleaning and
     maintaining the condominium. Held: For purposes of sec.
     469, I.R.C., Ps' participation in the activity does not
     constitute participation on a regular, continuous, and
     substantial basis. Accordingly, the losses incurred are
     subject to the passive loss rules of sec. 469, I.R.C.


     E. Gregory Lardieri and E. Newton Steely, Jr. (specially

recognized), for petitioners.

     John C. Donovan, for respondent.
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              MEMORANDUM FINDINGS OF FACT AND OPINION

     POWELL, Special Trial Judge:     This case was assigned

pursuant to the provisions of section 7443A(b)(3) and Rules 180,

181, and 182.1

     Respondent determined deficiencies in petitioners' Federal

income taxes in the following amounts:

                     Year        Deficiency

                     1987         $1,694
                     1988          8,337
                     1989          9,930
                     1990          9,511
                     1991          2,089

     The issue is whether deductions related to the expenses of

renting a beach condominium owned by petitioners are limited by

the passive activity loss limitations of section 469.

                            FINDINGS OF FACT

     During the years 1987 through 1991, and at the time of

filing the petition, petitioners resided in Silver Spring,

Maryland.   Petitioner B. Theodore Chapin (Mr. Chapin) worked full

time as vice president of American Digital Systems Corp. until

December of 1990, at which time he organized and began working

full time for his own corporation, Applied Software, Inc.

Petitioner Wendy Chapin (Mrs. Chapin) is a housewife/artist who


     1
         Unless otherwise indicated, 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.
                               - 3 -


specializes in copying paintings that are displayed in the

National Gallery of Art in Washington, D.C.   She does not

generally sell these reproductions.

     During the years at issue, petitioners owned various rental

properties.   In 1987, petitioners owned properties in Apopka,

Florida, and Silver Spring, Maryland.   In 1988, petitioners

acquired another property in Silver Spring, Maryland.    In 1989,

petitioners purchased property in Takoma Park, Maryland, and a

third property in Silver Spring, Maryland.    These properties were

generally leased for 1 year terms.

     Petitioners also own a condominium apartment (the

condominium) in Ocean City, Maryland.   The condominium was

purchased in 1986 and consisted of two bedrooms, two full

bathrooms, a kitchen, a living room/dining room area, a

laundry/utility room, and a balcony.    The condominium was rented

to tenants between June and September (the rental season).     The

average rental term was 7 days or less for each of the years at

issue.

     Petitioners left the day-to-day management of the property

in the hands of O'Conor, Piper & Flynn (the rental agent).     The

rental agent's duties included advertising the property for rent,

receiving calls from prospective tenants, showing the condominium

to prospective tenants, dispensing and collecting keys,

collecting rent and deposits from tenants, hiring a cleaning
                                - 4 -


service to clean between rentals, hiring maintenance people to

perform repairs on the premises, and preparing owner's reports

detailing the income and expenses of the rental.

     Petitioners testified that they spent between 170.5 and

193.5 hours every year in various activities relating to the

condominium.   This alleged participation consisted of:   Cleaning

(39.5-50.5 hours), shopping (8 hours), general maintenance (29-31

hours), travel to and from Ocean City (70-80 hours),2 and

repainting (24 hours).    Petitioners purportedly spent an

additional 24 hours in both 1988 and 1990 painting the entire

condominium, and Mrs. Chapin spent 32 hours in 1987 and an

additional 35 hours painting copies of paintings to hang on the

walls of the condominium.3

     Petitioners did not maintain a log or other record of their

hours of participation.    Petitioners introduced credit card

receipts from restaurants and other commercial enterprises in

Ocean City or the vicinity to corroborate their testimony that

they were in the area seven to eight times a year between the end

of one commercial rental season in September and the beginning of




     2
         Travel time consisted of seven to eight trips per year
at 5 hours per round trip for both petitioners.
     3
         Mrs. Chapin was uncertain as to the years in which this
participation occurred.
                               - 5 -


the next in June.4   The driving time from Silver Spring to Ocean

City is approximately 2-1/2 hours.

     Petitioners filed joint Federal income tax returns claiming

a business loss on Schedule C from the rental of the condominium

for each of the taxable years at issue.        The claimed losses,

after agreed-upon adjustments, were in the following amounts:

                     Year               Loss

                     1987            $25,341
                     1988             26,861
                     1989             23,953
                     1990             22,493
                     1991             21,056

     In the notice of deficiency, respondent determined that the

rental of the condominium was a passive activity, and, therefore,

petitioners' claimed losses for each year were suspended pursuant

to section 469.

                              OPINION

     Section 162 allows deductions for all the ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on a trade or business.   Section 212 allows deductions

for all the ordinary and necessary expenses paid or incurred

during the taxable year for the production of income or the

management or maintenance of property held for the production of




     4
         The receipts showed that petitioners were in Ocean City,
or the vicinity, between five and eight times per year.
                               - 6 -


income.   Section 469, however, limits the deductions for losses

from a "passive activity".   A passive activity means any activity

          (A) which involves the conduct of any trade or
     business, and

          (B) in which the taxpayer does not materially
     participate. [Sec. 469(c)(1).]

     Generally, an activity in which payments are received

principally for the use of tangible property by customers is a

"rental activity".   Sec. 469(j)(8); sec. 1.469-1T(e)(3)(i)(A),

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

All rental activities are deemed passive.     Sec. 469(c)(2), (4);

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

5702 (Feb. 25, 1988).   However, if the average period of customer

use of the property is 7 days or less, the activity is not

considered to be a "rental activity".     Sec. 1.469-

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

(Feb. 25, 1988).   Nonetheless, an activity falling outside the

definition of a rental activity will be passive if the taxpayer

does not materially participate in the activity.     Sec. 469(c)(1);

sec. 1.469-1T(e)(1), Temporary Income Tax Regs., supra.

     An individual materially participates in an activity when

involved in the operations of the activity on a regular,

continuous, and substantial basis.     Sec. 469(h)(1).   Pursuant to

section 469(l)(1), the Secretary has issued regulations that

specify what constitutes material participation.     Section 1.469-
                               - 7 -


5T(a)(2), (3), and (7), Temporary Income Tax Regs., 53 Fed. Reg.

5725-5726 (Feb. 25, 1988), provides, in relevant part, that an

individual shall be treated as materially participating if the

individual meets any of the following tests:

           (2) The individual's participation in the
      activity for the taxable year constitutes substantially
      all of the participation in such activity of all
      individuals (including individuals who are not owners
      of interests in the activity) for such year;

           (3) The individual participates in the activity
      for more than 100 hours during the taxable year, and
      such individual's participation in the activity for the
      taxable year is not less than the participation in the
      activity of any other individual (including individuals
      who are not owners of interests in the activity) for
      such year;

                *    *    *    *       *   *   *

           (7) Based on all of the facts and circumstances
      (taking into account the rules of paragraph (b) of this
      section), the individual participates in the activity
      on a regular, continuous, and substantial basis during
      such year.

      The "material participation standard identifies an important

distinction between different types of taxpayer activities."    S.

Rept. 99-313, at 716 (1986), 1986-3 C.B. (Vol. 3) 1, 716.   The

focus of section 469 is directed to suspending the so-called tax

preferences unless there is "substantial and bona fide

involvement in the activities to which the preferences relate."

Id.   It is necessary "to examine the materiality of a taxpayer's

participation in an activity in determining the extent to which
                                - 8 -


such taxpayer should be permitted to use tax benefits from the

activity."   Id.

     It is important, therefore, to define the activity subject

to the limits of section 469.   For income tax purposes there are

generally two economic interests involved in the ownership of

real estate--the value of the asset as an investment, and if

rented, the value of the rental income.   As to the first, the

value of the asset may appreciate or depreciate, and, the

resulting gain or loss is generally recognized as a capital

transaction when the property is sold even though the economic

gain or loss was realized over the years that the property was

owned.   See sec. 1001.   On the other hand, the leasing activity

gives rise to gross income and deductions, and the net income or

loss generally is realized and recognized during each taxable

year that the property is rented.   See secs. 61, 441.   When

section 469 applies to rental real estate, it operates to suspend

losses from the leasing activity.   Accordingly, we will use the

terms "activity" and "leasing activity" interchangeably.

     In this case, the average lease period of the condominium

was 7 days or less during the years at issue, and, therefore, the

leasing activity is not a "rental activity" for purposes of

section 469(c)(2).   Sec. 1.469-1T(e)(3)(ii)(A), Temporary Income

Tax Regs., supra.    While the leasing activity falls outside the

definition of a "rental activity", section 469 nonetheless
                                 - 9 -


applies if petitioners did not materially participate in the

activity.   Sec. 469(c)(1).

     Petitioners assert that they meet the so-called safe harbor

requirements of section 1.469-5T(a)(2), Temporary Income Tax

Regs., supra.     That section provides that the taxpayer's

participation must constitute "substantially all of the

participation in such activity of all individuals" during the

years at issue.    But the rental of the condominium required

continual involvement in the leasing and day-to-day management of

the property.   The rental agent had complete responsibility for

these activities, and, therefore, petitioners' participation did

not constitute "substantially all of the participation" in the

activity.

     Petitioners also assert that they meet the "safe harbor"

requirements of section 1.469-5T(a)(3), Temporary Income Tax

Regs., supra.     To satisfy this test, petitioners must establish

that (1) they participated in the activity for more than 100

hours each year, and (2) no other individual's participation

exceeded petitioners' participation during each year.    Regardless

whether petitioners satisfy the first requirement, they have not

established that no other participation exceeded their

participation in the activity.    The rental agent not only

advertised, showed, and rented the property, but was also

routinely available to handle complaints, repairs, etc.       Further,
                               - 10 -


after each tenant, a cleaning service cleaned the property.

While we do not know how much time these services took, they

involve a substantial amount of time.     It is petitioners' burden

to show that they satisfy the requirements of section 1.469-

5T(a)(3), Temporary Income Tax Regs., supra, and they have failed

to meet that burden.5

     Petitioners alternatively contend that, if they fail the so-

called safe harbor provisions of paragraphs (a)(2) and (3) of

section 1.469-5T, Temporary Income Tax Regs., supra, they

nonetheless satisfy the requirements of section 1.469-5T(a)(7),

Temporary Income Tax Regs., supra.      Section 1.469-5T(a)(7),

Temporary Income Tax Regs., supra, mirrors the statutory

definition of "material participation" set out in section

469(h)(1) and requires that petitioners show they participated in

the activity on a regular, continuous, and substantial basis

during each year.   As an initial matter, petitioners'

participation must exceed 100 hours each year.     Sec. 1.469-

5T(b)(2)(iii), Temporary Income Tax Regs., 53 Fed. Reg. 5726

(Feb. 25, 1988).    Measuring participation in terms of time may be

useful in setting minimum requirements and in defining safe


     5
         No witness from the rental agency testified. Mr. Chapin
attempted to testify as to his estimate of the hours spent by the
rental agent in connection with the rental and maintenance of the
condominium. Respondent objected on the ground that Mr. Chapin
did not have personal knowledge of that fact. The objection was
sustained.
                              - 11 -


harbors, but the deductibility of a loss under section 469(h)(1)

depends also on regular and continuous participation in the

activity.

     While we have grave doubts concerning the time allegedly

spent by petitioners,6 even if that time would satisfy the

minimum requirement of the regulation, the work performed by

petitioners in connection with the leasing activity was not

regular and continuous participation.   We reemphasize here, the

activity with which we are concerned is the rental of the

property.   As we have already outlined, the rental of the

condominium to many different tenants over the course of the

rental season required substantial work and time.   The rental

agent advertised, showed the condominium, collected rent and

deposits from tenants, collected and dispensed keys, hired a

cleaning service to clean the condominium between tenants, hired

maintenance people to perform repairs on the premises, and

maintained an office to receive calls from tenants and

     6
         We are not persuaded that the time allegedly spent by
petitioners is an accurate reflection of what transpired.
Petitioners claim to have spent 5 to 6 hours cleaning two
bathrooms, 8 hours cleaning a kitchen, and 5 hours "refreshing"
plastic floral arrangements. We are left with the conclusion
that much of the total time allegedly spent was exaggerated or,
if not, was spent primarily for the purposes of avoiding the
limitations of sec. 469. See sec. 1.469-5T(f)(2), Temporary
Income Tax Regs., 53 Fed. Reg. 5726-5727 (Feb. 25, 1988). As set
out above, however, time is not the only measure of an
individual's participation. We, therefore, do not find it
necessary to determine the amount of time that petitioners spent
on the rental activity.
                              - 12 -


prospective tenants.   A cleaning service cleaned the condominium

after each tenant vacated the premises throughout the rental

season.   Maintenance workers performed repairs to the

condominium.   The performance of this work constituted the

regular and continuous participation in the activity, and notably

absent was any participation by petitioners.   Petitioners'

contribution to the activity consisted of a single, albeit

thorough, cleaning of the condominium after each rental season.

They may have extended this participation over six or eight

weekends during the nonrental seasons, but their contribution to

the activity did not constitute participation on a basis that was

regular and continuous.7

     Based on the foregoing, we find that petitioners did not

materially participate in this activity.



     7
          The report of the Finance Committee notes:

           Another factor that may be highly relevant in
     showing regular, continuous, and substantial
     involvement in the operations of an activity, and
     thereby establishing material participation, is
     whether, and how regularly, the taxpayer is present at
     the place or places where the principal operations of
     the activity are conducted. For example, in the case
     of an employee or professional who invests in a horse
     breeding activity, if the taxpayer lives hundreds of
     miles from the site of the activity, and does not often
     visit the site, such taxpayer is unlikely to have
     materially participated in the activity. * * * [S.
     Rept. 99-313, at 733 (1986), 1986-3 C.B. (Vol. 3) 1,
     733.]
- 13 -


     Decision will be entered

for respondent.
