                         T.C. Summary Opinion 2015-38



                         UNITED STATES TAX COURT



          JEROME PADILLA AND MARGIE PADILLA, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 30807-12S.                          Filed June 29, 2015.



      Jerome Padilla and Margie Padilla, pro sese.

      Emerald G. Smith, for respondent.



                              SUMMARY OPINION


      GERBER, Judge: This case was heard pursuant to the provisions of section

7463 of the Internal Revenue Code in effect when the petition was filed.1


      1
      Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the year in issue, and all Rule references are to the Tax
                                                                       (continued...)
                                         -2-

Pursuant to section 7463(b), the decision to be entered is not reviewable by any

other court, and this opinion shall not be treated as precedent for any other case.

Respondent determined a $6,378 income tax deficiency for petitioners’ 2010

taxable year. After concessions2 the issue for our consideration is whether the

losses from petitioners’ rental real estate activity may be deducted from

nonpassive income under the provisions of section 469.

                                    Background

      Petitioners resided in California when their petition was filed. Petitioners

were employed during 2010 and, together, earned wages totaling $131,368. They

owned five single-family rental properties, one of which was in San Francisco,

California, and two each of which were in Round Rock and Pflugerville, Texas,

respectively.

      On their 2010 Schedule E, Supplemental Income and Loss, petitioners

reported: gross rental income totaling $72,790, expenses totaling $81,693, and

depreciation totaling $21,243, all of which resulted in a net loss of $30,146.



      1
      (...continued)
Court Rules of Practice and Procedure.
      2
        Petitioners conceded that they are not entitled to deduct $3,629 of mortgage
interest and that they failed to report $562 of qualified dividend income on their
2010 joint income tax return.
                                        -3-

Petitioners deducted the $30,146 reported net loss from their wage and other

income. Respondent, in a notice of deficiency dated September 26, 2012, among

other adjustments, disallowed $28,694 of the claimed rental activity loss

deduction, because, according to respondent, the losses were passive activity

losses.

      Jerome Padilla (petitioner) was a finance professional who managed

companies’ budgets and financial reporting. He purchased a single-family

residence during 2000 and four additional single-family residences during 2005-

06. During 2006 when the real estate market was good, petitioner decided to

pursue a rental real estate activity.

      The company petitioner worked for was restructuring and downsizing

during 2009, and in April 2010 petitioner lost his job. Petitioner worked

approximately 676 hours for the company during 2010 until his employment was

terminated. The loss of his job coupled with an overall economic downturn in the

real estate market caused petitioner to spend more time in trying to refinance and

in other activity related to his rental properties. He also spent time considering

alternatives, including opening a self-storage business, acquiring more single-

family homes, and opening a wine bar.
                                          -4-

      During 2010 petitioners’ four rental houses in Texas were managed by

Gaynor Property Management Co., LLC (Gaynor). Gaynor provided complete

management of the Texas properties and would consult with petitioners regarding

any needed repairs or maintenance or other aspects involving the rental activity. If

a repair or maintenance was agreed upon, Gaynor would hire the contractor to do

the work. Petitioner was more involved in the San Francisco rental property but

also hired a real estate company to handle the rental activity and to oversee

repairs.

      Petitioner prepared a summary document that purported to reflect 764 hours

worked in his rental activity. Several of the items in the summary related to 37

spent hours researching new business investment opportunities, including opening

a wine bar and a self-storage facility. Numerous hours were spent “Research[ing]

Existing Property Locations”, which included searching for new real estate

investments near the five rental properties. Numerous hours were spent

considering “Refinance” of existing properties.

                                      Discussion

      The primary dispute in this case is whether petitioner was engaged for at

least 750 hours as a real estate professional in his rental real estate activity.

Respondent contends that petitioners fail to meet the test to be entitled to use
                                          -5-

losses from a rental real estate activity against nonpassive income, for the

following reasons: (1) the 750-hour test was not met because the log included

nonrental activity and/or investor activity; (2) petitioners did not properly elect to

treat all rental activity as one activity; and (3) petitioners failed to adequately

substantiate the number of hours spent in the activity.

      Generally, the taxpayer bears the burden of proving entitlement to any

deductions claimed. See Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S.

79, 84 (1992). This burden may shift to the Commissioner if the taxpayer

introduces credible evidence with respect to any relevant factual issue and meets

other conditions, including maintaining required records. See sec. 7491(a)(1).

Petitioners have not established their compliance with section 7491(a).

Accordingly, petitioners bear the burden of proof. See Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933).

      Taxpayers are allowed deductions for certain business and investment

expenses; however, section 469(a) generally disallows any passive activity loss.

Passive activity losses can be deducted only to the extent of passive activity gains

in a particular tax year, and the remaining passive activity losses are suspended

and may be carried forward to subsequent tax years. Sec. 469(b). Passive activity

losses can be deducted from passive activity gains and ordinary income when the
                                         -6-

underlying passive activity property is disposed of. See generally St. Charles Inv.

Co. v. Commissioner, 232 F.3d 773, 776 (10th Cir. 2000), rev’g 110 T.C. 46

(1998); Veriha v. Commissioner, 139 T.C. 45, 47 (2012).

      A passive activity loss is defined as the excess of the aggregate losses from

all passive activities for the taxable year over the aggregate income from all

passive activities for that year. Sec. 469(d)(1). A passive activity is any trade or

business in which the taxpayer does not materially participate, sec. 469(c)(1), or to

the extent provided in regulations, any activity with respect to which expenses are

allowable as a deduction under section 212, sec. 469(c)(6)(B). Rental activity is

generally treated as a per se passive activity regardless of whether the taxpayer

materially participates. Sec. 469(c)(2), (4). Material participation is defined as

involvement in the operations of the activity that is regular, continuous, and

substantial. Sec. 469(h)(1).

       An exception to the rule that a rental activity is per se passive is found in

section 469(c)(7), which provides that the rental activities of a taxpayer in real

property businesses are not per se passive activities under paragraph (2) but are

treated as a business subject to the material participation requirements of

paragraph (1). See sec. 1.469-9(e)(1), Income Tax Regs. A taxpayer may qualify

as a real estate professional if: (1) more than one-half of the personal services
                                          -7-

performed in trades or businesses by the taxpayer during the taxable year are

performed in real property trades or businesses in which the taxpayer materially

participates and (2) the taxpayer performs more than 750 hours of services during

the taxable year in real property trades or businesses in which the taxpayer

materially participates. Sec. 469(c)(7)(B)(i) and (ii). In the case of a joint return,

either spouse must satisfy both requirements. Sec. 469(c)(7)(B). Thus, if either

spouse qualifies as a real estate professional, the rental activities of the real estate

professional are not per se passive under section 469(c)(2).

      For purposes of determining whether a taxpayer is a real estate professional,

a taxpayer’s material participation is determined separately with respect to each

rental property unless the taxpayer makes an election to treat all interests in rental

property as a single rental real estate activity. Sec. 469(c)(7)(A); sec. 1.469-

9(e)(1), Income Tax Regs. Petitioners did not show that they made an election to

treat their five rental properties as a single activity. See sec. 1.469-9(g)(3),

Income Tax Regs.

      Section 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727

(Feb. 25, 1988), provides guidelines for showing the number of hours spent in an

activity, as follows:
                                         -8-

      The extent of an individual’s participation * * * may be established
      by any reasonable means. Contemporaneous daily time reports, logs,
      or similar documents are not required if the extent of such
      participation may be established by other reasonable means.
      Reasonable means * * * include but are not limited to the
      identification of services performed over a period of time and the
      approximate number of hours spent performing such services during
      such period, based on appointment books, calendars, or narrative
      summaries.

      Petitioner presented a log to respondent and the Court that purports to

reflect a total of 764 hours spent engaged in his rental real estate activity during

2010. A log, coupled with petitioner’s testimony, would generally suffice to meet

the standards in section 1.469-5T(f)(4), Temporary Income Tax Regs., supra, to

show the number of hours spent in an activity. Further, petitioner spent only 676

hours at his job during the first four months of 2010 before he lost that position.3

Accordingly, if petitioner spent 764 hours, as per his log, engaged in services

during 2010 in a rental real estate activity within the meaning of section

469(c)(7)(B)(i) and (ii), petitioners would be entitled to deduct the losses that

respondent disallowed.

      We reviewed petitioner’s log coupled with his testimony to determine

whether the activities listed constituted “material participation”. Petitioner spent

      3
       Respondent contends that petitioner spent 686.5 hours according to his pay
slips. Ultimately, whether the number of hours was 676 or 686.5 is irrelevant to
the outcome of this controversy.
                                          -9-

at least 37 hours researching new business investment opportunities, including

opening a wine bar and a self-storage facility. The other categories of monthly

activities included property and rental management representing less than one-half

of the hours for each month. Most of the hours for each month were in the

following generic categories: research properties near properties already owned;

refinance research; foreclosure research (which appears to be considering

properties that could be purchased); and researching new businesses.

      Petitioner hired a management company to manage the four Texas

properties. Additionally, he hired a real estate company to find tenants and lease

the San Francisco property. Accordingly, petitioner had relatively little personal

involvement in the operation of the rental real estate activity that was regular,

continuous, and substantial. Work done by an individual in the capacity of an

investor in an activity is not generally treated as participation in the activity. Sec.

1.469-5T(f)(2)(ii)(A), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25,

1988). Most of the items listed in petitioner’s log are more in the nature of work

done by an individual in the capacity of an investor. For example, researching

properties near the existing properties and foreclosure research to acquire new

properties were investor activities. They were not activities involving petitioner in
                                         - 10 -

the operation of his existing rental real estate activity, such as finding tenants,

making or overseeing repairs, etc.

      Accordingly, petitioners’ argument must fail because they have not shown

that at least 750 hours were spent involved in the rental real estate activity, as

opposed to investor activities.

      We accordingly hold that petitioners have failed to show entitlement to

deduct their passive losses from nonpassive income and/or that respondent’s

determination was in error.

      To reflect the foregoing and to account for concessions of the parties,


                                                        Decision will be entered

                                                  for respondent.
