                    IN THE COURT OF APPEALS OF IOWA

                                  No. 14-1144
                           Filed September 10, 2015

GEORGE M. LANCE and
PHYLLIS J. LANCE,
     Petitioners-Appellants,

vs.

IOWA STATE BOARD OF
TAX REVIEW,
     Respondent-Appellee.
________________________________________________________________

      Appeal from the Iowa District Court for Johnson County, Robert E.

Sosalla, Judge.



      Taxpayers appeal notice of assessment for additional tax, penalty, and

interest. AFFIRMED.



      Sean W. Wandro of Meardon, Sueppel & Downer, P.L.C., Iowa City, for

appellants.

      Thomas J. Miller, Attorney General, Hristo Chaprazov and Valencia Voyd

McCown, Assistant Attorneys General, and Donald D. Stanley Jr., Special

Assistant Attorney General, for appellee.




      Considered by Vogel, P.J., and Doyle and McDonald, JJ.
                                         2



MCDONALD, J.

       In this administrative appeal, George and Phyllis Lance challenge the

Notice of Assessment issued by the Iowa Department of Revenue after the

department disallowed a capital gain deduction for the taxpayers for the tax year

ending December 31, 2005. The Iowa State Board of Tax Review affirmed the

notice of assessment.     The district court affirmed the agency’s action.   We

conclude this appeal is largely resolved by the applicable standards of review,

and we affirm the judgment of the district court.

                                         I.

       In 1981 the Lances bought a rooming house in Iowa City locally known as

the Lindsay House, which they used as a rental property. From 1981 to 1994,

the Lances personally managed all aspects of the business. In 1994 the Lances

contracted with Lincoln Real Estate to manage the property, including advertising

vacancies, screening potential tenants, preparing lease agreements, collecting

rent and security deposits, arranging for basic cleaning and maintenance, and

serving as the first contact for tenants. Although Lincoln managed the day-to-day

operation of the Lindsay House, George continued to pay bills, performed some

maintenance, drove by to inspect the property, oversaw major repairs and

renovations, interfaced with city inspectors, and approved major expenditures.

George kept a record of the bills paid in an expense ledger. He did not keep

contemporaneous calendar, time, or activity logs.

       In 2005, the Lances sold the Lindsay House to River City Housing

Cooperative.   The Lances realized a capital gain and claimed a capital gain
                                         3



deduction on their Iowa individual income tax return for the tax year ending 2005.

The department disallowed the capital gain deduction.          In April 2009, the

department issued a Notice of Assessment for $40,742.33, which included

additional tax, penalty, and interest.       The Lances timely protested the

assessment.

       The fighting issue between the Lances and the department is the

interpretation and application of Iowa Code section 422.7(21) (2005) and Iowa

Administrative Code rule 701-40.38(1) (2005).        These provisions allow the

taxpayer to deduct net capital gain in computing the taxpayer’s adjusted gross

income under certain circumstances.

       Net capital gain from the sale of real property used in a business, in
       which the taxpayer materially participated for ten years, as defined
       in section 469(h) of the Internal Revenue Code, and which has
       been held for a minimum of ten years, or from the sale of a
       business, as defined in section 423.1, in which the taxpayer was
       employed or in which the taxpayer materially participated for ten
       years, as defined in section 469(h) of the Internal Revenue Code,
       and which has been held for a minimum of ten years. The sale of a
       business means the sale of all or substantially all of the tangible
       personal property or service of the business.

Iowa Code § 422.7(21)(a)(1). The department has interpreted this provision to

allow a deduction only when the taxpayer materially participated in the business

for at least the ten-year period immediately preceding the sale of the real

property at issue:

       Material participation in a business if the taxpayer has been
       involved in the operation of the business on a regular, continuous,
       and substantial basis for ten or more years at the time assets of the
       business are sold or exchanged. If the taxpayer has regular,
       continuous and substantial involvement in the operations of a
       business which meets the criteria for material participation in an
       activity under Section 469(h) of the Internal Revenue Code and the
                                             4



         federal tax regulations for material participation in 26 CFR §1.469-5
         and §1.469-5T, for the ten years prior to the date of the sale or
         exchange of the assets of a business, the taxpayer shall be
         considered to have satisfied the material participation requirement
         for this subrule.

Iowa Admin. Code r. 701-40.38(1).            The Lances contend the department’s

interpretation, as set forth in the regulation, is contrary to the statute, which only

requires the taxpayer materially participate in the business for any ten-year

period during the period of ownership. The Lances also contend that even if the

department’s interpretation is correct, they did materially participate in the

business during the ten-year period preceding the sale of the Lindsay House.

         The taxpayers’ protest came on for hearing before an administrative law

judge.      The administrative law judge considered both the challenge to the

department’s interpretation of Iowa Code section 422.7(21) and the Lances’

contention they participated materially in the business during the relevant time

period. The administrative law judge found in favor of the taxpayers, concluding:

                The taxpayers submitted sufficient evidence to prove that
         they participated in activity related to this business for more than
         100 hours each year and that no other individual spent more time in
         the business activity than they did. Therefore, the taxpayers have
         established that material participation during the ten years
         immediately before sale of the property. See 701 Iowa Admin.
         Code 701-40.38(1)(e)(3).[1] They were entitled the capital gain
         deduction for net proceeds from the sale that they claimed in 2005
         and the Department erred in disallowing the deduction.


1
    Iowa Administrative Code rule 701-40.38(1) provides, in relevant part:
                 e. Generally, an individual will be considered as materially
         participating in a tax year if the taxpayer satisfies or meets any of the
         following tests:
                 ....
                 (3) The individual participates in the business for more than 100
         hours in the tax year, and no other individual spends more time in the
         business activity than the taxpayer.
                                        5



Because the administrative law judge concluded the Lances materially

participated in the business in the ten years immediately preceding the sale of

the Lindsay House, the administrative law judge did not have to resolve the

challenge to the department’s interpretation of section 422.7(21).

      The department appealed the administrative ruling. The acting director

considered both the challenge to the department’s interpretation of the code and

the Lances’ contention they materially participated in the business for the

relevant time period.    Concerning the department’s interpretation of section

422.7(21), the acting director noted section 422.68(1) gives the director “the

power and authority to prescribe all rules not inconsistent with the provisions of

this chapter, necessary and advisable for its detailed administration and to

effectuate its purposes.” The acting director concluded “the authority to interpret

Iowa Code section 422.7(21)(a)(1) is clearly vested with the Department.”

Comparing federal law concerning material participation, the acting director

concluded:

      These sections provide for specific time periods when determining
      whether a taxpayer meets the material participation requirements
      for federal tax purposes. Under Internal Revenue Code section
      1.469-5T(a)(5), a taxpayer will be deemed to materially participate
      in the current tax year if he materially participated in the business
      for five of the last ten years. Under subsection 469(h) and the
      federal regulations for material participation in 26 CFR § 1.469-5T,
      the federal law does not generally look further than the ten years
      immediately preceding the current tax year.                Based on the
      foregoing, limiting the look back period to the immediate prior ten
      years is not irrational, illogical nor wholly unjustifiable.

(Emphasis added.) Concerning the hours of participation claimed by the Lances,

the acting director concluded:
                                         6



       Neither the taxpayer nor Lincoln maintained contemporaneous
       documentation of actual or estimated hours based upon the
       performance of services. While documentation can be established
       by other reasonable means an estimate based primarily upon
       recollection seems particularly unreliable. The taxpayers initially
       estimated 520 hours or participation annually and estimated the
       participation of the property manager at 312 hours annually. This
       was later changed to 194 hours and 111 hours respectively. This
       exceptionally wide range of estimated hours by itself significantly
       reduces the confidence level in the accuracy of the estimate and
       reasonably brings into question whether the management company
       or the taxpayer spent more time in the business activity. This is the
       sort of guesstimate prepared after the fact that courts have found to
       be insufficient to establish the hours of time required to meet the
       standard of material participation, and is not considered to be a
       reasonable means to establish an individual’s participation in an
       activity.

The acting director concluded both that the department “did not exceed its

authority in limiting the look back period to the ten years immediately prior to sale

of the property” and the taxpayers did not present sufficient evidence to show

they met the material participation requirement in section 422.7(21)(a)(1).

       The Lances appealed to the State Board of Tax Review.             The board

affirmed the acting director’s ruling. The board held the Lances failed to “meet

the burden of proof to show material participation according to Iowa Code

§ 422.7(21)(a)(1).”

       The Lances sought judicial review of the board’s ruling. The district court

concluded the phrase “materially participated for ten years” in section 422.7(21)

was “neither clear nor unmistakable”; the department had the authority and

expertise to interpret the statute; and the department’s interpretation was “not

irrational, illogical, or unjustifiable.” Concerning whether the Lances materially

participated in the business during the last ten years of ownership, the district

court concluded there was substantial evidence in the record to affirm the
                                         7



agency’s decision, there was a basis for the agency’s conclusion the Lance’s

method of approximating hours of participation was unreasonable, and George’s

“characterization of his activities on the rental properties provided a basis for the

agency to conclude that much of his participation was not related to the rental

business.” The Lances timely filed this appeal.

                                         II.

       Judicial review of agency decisions is governed by the Iowa Administrative

Procedure Act (“IAPA”), Iowa Code chapter 17A. See Iowa Med. Soc’y v. Iowa

Bd. of Nursing, 831 N.W.2d 826, 838 (Iowa 2013). We apply the standards set

forth in section 17A.19(10) and determine “whether our application of those

standards produce[s] the same result as reached by the district court.” See Auen

v. Alcoholic Beverages Div., 679 N.W.2d 586, 589 (Iowa 2004). If so, we affirm.

If not, we reverse.

                                         A.

       We first address the interpretive question presented. The parties dispute

whether Iowa Code section 422.7(21) requires material participation for any ten-

year period coinciding with ownership or whether it requires material participation

for the ten-year period immediately preceding the sale of the property at issue.

The Lances contend the language “materially participated for ten years” in

section 422.7(21)(a)(1) is clear and unambiguous and simply requires a taxpayer

to participate materially for any ten-year period coinciding with ownership. The

Lances contend the agency’s interpretation of the statute is not entitled to any

deference.     The department contends the language is not clear and
                                              8



unambiguous. The department further contends that it has been vested with

discretion to interpret the statute and that its interpretation is entitled to

deference.

        Where the question concerns whether the agency correctly interpreted a

statute, our level of scrutiny depends on whether the legislature has vested the

agency with interpretive authority.         Where the legislature has not vested the

agency with interpretive authority, we afford the agency no deference in its legal

interpretations. See NextEra Energy Res. L.L.C. v. Iowa Utils. Bd., 815 N.W.2d

30, 37 (Iowa 2012); Doe v. Iowa Dep’t of Human Servs., 786 N.W.2d 853, 857

(Iowa 2010). Where the legislature has given the agency authority to interpret a

statute, we review only to determine whether the agency’s interpretation is

“irrational, illogical, or wholly unjustifiable.” Iowa Code § 17A.19(10)(l), (m). Iowa

Code section 422.68 gives the department rulemaking authority “necessary and

advisable for [chapter 422’s] detailed administration and to effectuate its

purposes.” “Given the broad language of the enabling statute, the scope of the

department’s authority is expressly comprehensive.” City of Sioux City v. Iowa

Dep’t of Revenue & Fin., 666 N.W.2d 587, 589 (Iowa 2003). The department has

“clearly been vested with discretion to interpret chapter 422.” Ranniger v. Iowa

Dep’t of Revenue & Fin., 746 N.W.2d 267, 268 (Iowa 2008). Thus, “we will

reverse the department’s interpretation of section 422.7(21) only if it was

‘irrational,   illogical   or   wholly   unjustifiable.’”   Id.   (quoting   Iowa   Code

§ 17A.19(10)(l)).
                                         9



       We conclude the agency’s interpretation of the statute is not irrational,

illogical, or wholly unjustifiable. We begin our analysis with the language of the

statute. The goal when construing a statute is to determine legislative intent.

NextEra Energy Res. L.L.C., 815 N.W.2d at 39. If the statutory language is plain

and unambiguous, no construction is necessary. See Sierra Club v. Iowa Dep’t

of Transp., 832 N.W.2d 636, 644 (Iowa 2013). “A statute is ambiguous when

reasonable persons could disagree as to its meaning.” Naumann v. Iowa Prop.

Assessment Appeal Bd., 791 N.W.2d 258, 261 (Iowa 2010). Section 422.7(21)

allows for a deduction for the “[n]et capital gain from the sale of real property

used in a business, in which the taxpayer materially participated for ten years.”

While there is nothing in the statutory text requiring the taxpayer materially

participate in the business for the ten-year period preceding the sale, there is

also nothing in the statute precluding such an interpretation.       There is also

nothing in other sections of the code precluding the agency’s interpretation. The

phrase “for ten years” appears in thirteen sections of the Iowa Code. 2 In none of

those sections is the agency’s interpretation precluded. In short, there is no

contra definition in the text of the statute or other provisions of the code that

disallows the agency’s interpretation.

       Several other considerations support our conclusion. First, the agency’s

interpretation is in harmony with the Internal Revenue Code. See 26 U.S.C.

§ 469(h) (defining “material participation” as involvement “in the operations of the




2
  Iowa Code §§ 10A.108, 96.14, 124C.4, 256.44, 299.24, 303.3B, 321.18A, 422.7,
422.26, 424.11, 622.30, 650.10, 650.14.
                                         10



activity on a basis which is—regular, continuous, and substantial”); 26 C.F.R.

§§ 1.469-5T. Section 1.469-5T(a) provides a person

       shall be treated, for purposes of section 469 and the regulations
       thereunder, as materially participating in an activity for the taxable
       year if and only if— . . . (5) The individual materially participated in
       the activity (determined without regard to this paragraph (a)(5)) for
       any five taxable years (whether or not consecutive) during the ten
       taxable years that immediately precede the taxable year.

Second, tax exemptions are strictly construed against taxpayers and liberally in

favor of the department.      See Ranniger, 746 N.W.2d at 269 (affirming the

department’s construction of the phrase “sale of a business” in section

422.7(21)). Third, the legislature has acquiesced to the agency’s interpretation

for the statute for a long time.    See City of Sioux City, 666 N.W.2d at 592

(considering the legislature’s inaction as tacit approval of the department’s

interpretation). Here, the agency’s interpretation of the statute set forth in rule

701-40.38 was adopted in 1990. The legislature has not countermanded the

agency’s interpretation for twenty-five years.      See Marion v. Iowa Dep’t of

Revenue & Fin., 643 N.W.2d 205, 207-08 (Iowa 2002) (“Our views as to the

meaning of the statute are strengthened by the fact that the agency rule has

existed for nearly seventeen years.”).

       For the foregoing reasons, we conclude the agency’s interpretation of the

statute set forth in rule 701-40.38 was not irrational, illogical, or wholly

unjustifiable.

                                         B.

       The Lances contend even if the department’s interpretation is correct, they

met the material participation standard. Specifically, the Lances contend they
                                          11



spent more than 100 hours per year managing the property and no one else

spent more time.        See Iowa Admin. Code r. 701-40.38(c)(3) (providing an

individual is considered as materially participating if the individual “participates in

the business for more than 100 hours in the tax year and no other individual

spends more time in the business activity than the taxpayer”). We review the

agency’s findings to determine if they are supported by substantial evidence.

See Kohlhaas v. Hog Slat, Inc., 777 N.W.2d 387, 391 (Iowa 2009). “‘Substantial

evidence’ means the quantity and quality of evidence that would be deemed

sufficient by a neutral, detached, and reasonable person to establish the fact at

issue when the consequences resulting from the establishment of that fact are

understood    to   be    serious   and   of    great   importance.”      Iowa    Code

§ 17A.19(10)(f)(1).

       The department’s ruling contains two determinations pertinent to the

question presented. First, the agency concluded the Lances’ evidence of the

number of hours worked over the relevant time period was not credible. The

agency’s credibility determination was based largely on two key points. First, the

agency concluded the evidence presented in this particular case was not credible

because of the large revisions in the estimates. Second, the agency concluded

the type of guesstimate the Lances made here was not a “reasonable means” to

prove the number of hours worked over the relevant time period. See 26 C.F.R.

§ 1-469.5T(f)(4) (providing “reasonable means” to prove participation “may

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
                                        12



services during such period, based on appointment books, calendars, or

narrative summaries”); Goshorn v. Comm’r of Internal Revenue, T.C. Memo.

1993-578, 1993 WL 500167, at *3 (U.S. Tax Ct. 1993) (“[W]hile the regulations

are somewhat ambivalent concerning the records to be maintained, they by no

means allow the type of post-event ballpark guestimate that petitioner used.”).

We will not disturb the agency’s credibility determination. See Arndt v. City of

LeClaire, 728 N.W.2d 389, 394–95 (Iowa 2007) (noting it is the agency’s duty as

the trier of fact, not the reviewing court, to determine the credibility of the

witnesses, to weigh the evidence, and to decide the facts in issue).

      The agency also made a second finding of great importance. The agency

found that most of the Lances’ management activities were “investor-type

activities” and should thus not be counted for the purposes of determining

whether the Lances met the material participation requirement.

      Mr. Lance’s testimony reflects a complicated relationship with
      Lincoln. However, the “Management Agreement” executed on
      November 11, 1998 (Exhibit D) assigns the management role to
      Lincoln as the “owner’s exclusive agent to manage, rent, lease and
      operate the property known as 935 E. College St. Iowa City.” The
      contractual roles of the two parties clearly vest the day-to-day
      management and operation of the Lindsay House in Lincoln. In this
      light the financial records maintained by Mr. Lance, including the
      payment of bills presented by Lincoln or generated through
      Lincoln’s activities, the reconciliation of rent collected by Lincoln,
      and the maintenance of records for tax purposes represent
      investor-type activities.

(Emphasis added.)

      We conclude this finding is supported by substantial evidence.           Rule

1.469-5T(f)(2)(ii)(A) provides, “Work done by an individual in the individual’s

capacity as an investor in an activity shall not be treated as participation in the
                                          13



activity for purposes of this section unless the individual is directly involved in the

day-to-day management or operations of the activity.”            Work done by an

individual as an investor includes:

       (1) Studying and reviewing financial statements or reports on
       operations of the activity; (2) Preparing or compiling summaries or
       analyses of the finances or operations of the activity for the
       individual’s own use; and (3) Monitoring the finances or operations
       of the activity in a non-managerial capacity.

26 C.F.R. § 1.469-5T(f)(2)(B)(ii)(B)(1)-(3); see also Estate of Stangeland v.

Comm’r of Internal Revenue, T.C. Memo. 2010-1856, 2010 WL 3239191 (U.S.

Tax Ct. 2010).     In this case, the Lances’ activities, after entering into the

management agreement with Lincoln, largely consisted of paying bills and

maintaining financial records related to their investment in the property. Indeed,

the Lances’ contract with Lincoln explicitly vested the day-to-day management of

the property to Lincoln. While the evidence might support a different finding, on

substantial evidence review, we only review to determine if the evidence

supports the finding actually made. It does.

                                          III.

       For the foregoing reasons, we affirm the judgment of the district court.

       AFFIRMED.
