                   T.C. Summary Opinion 2011-82



                      UNITED STATES TAX COURT



    ARIS VALDIS JENDE AND MARILYN JANE JENDE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 21304-09S.             Filed July 6, 2011.



     Aris Valdis Jende and Marilyn Jane Jende, pro sese.

     Emly B. Berndt, for respondent.



     DEAN, Special Trial Judge:   This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect when the petition was filed.    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.   Unless otherwise indicated, subsequent section references

are to the Internal Revenue Code in effect for the years at
                               - 2 -

issue, and Rule references are to the Tax Court Rules of Practice

and Procedure.

     Respondent determined deficiencies in petitioners’ Federal

income tax of $10,330 for 2005 and $8,403 for 2006.   Respondent

also determined under section 6662(a) accuracy-related penalties

of $2,066 for 2005 and $1,680.60 for 2006.

     The parties agree that petitioners are entitled to deduct

rental real estate losses on Schedule E, Supplemental Income and

Loss, incurred in connection with the Vandalia, Ohio, vacation

home in 2005 and the Cape Coral, Florida, vacation home for 2005

and 2006.1   The issues remaining for decision are whether

petitioners are entitled to deduct real estate losses on Schedule

E in excess of those determined or agreed to by respondent and

whether petitioners are liable for accuracy-related penalties

under section 6662(a) for 2005 and 2006.2

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the exhibits received in evidence

are incorporated herein by reference.   Petitioners resided in

Ohio when the petition was filed.


     1
      Respondent determined in the notice of deficiency that
pursuant to sec. 469(c)(7) petitioners are entitled to deduct for
2006 losses of $13,685 in connection with the Vandalia, Ohio,
vacation property, and $297 in connection with the Fort Myers,
Florida, timeshare.
     2
      Adjustments to petitioners’ itemized deductions are
computational and will be resolved consistent with the Court’s
opinion.
                                 - 3 -

                             Background

     Petitioners, Aris Jende (petitioner) and Marilyn Jende (Mrs.

Jende), are retired educators.    Petitioner retired as a school

superintendent, and Mrs. Jende retired as an assistant

superintendent of schools.    They have invested in real estate for

over 30 years, including the years at issue.    In 2005 and 2006,

in addition to their personal residence, petitioners owned

interests in six residential properties.

     Properties in Vandalia, Ohio, and Cape Coral, Florida, are

homes that were unfurnished and rented to long-term tenants in

2005 and 2006.   Petitioners owned a timeshare in Fort Myers,

Florida, and condominiums in Gatlinburg, Tennessee, Pigeon Forge,

Tennessee, and Destin, Florida.    Petitioners deducted losses of

$44,613 for 2005 and $45,131 for 2006 on their Schedules E in

connection with the six residential rental properties.

     The average stay in the Fort Myers timeshare and the

condominium units in Gatlinburg and Pigeon Forge was less than 7

days in 2005.    The average rental stay for the condominium unit

in Destin was more than 7 days in 2005.    The average stay for all

three condominium units was less than 7 days in 2006.

Petitioners maintained for 2005 and 2006 a Web site advertising

the Gatlinburg and Pigeon Forge, Tennessee, condominiums that

instructed interested persons to contact a “firm” to schedule

reservations at the condominiums.
                               - 4 -

The Destin Condominium

     Petitioners made one trip to the Crystal Sands condominium

in Destin in 2005 and one in 2006.     In both 2005 and 2006

petitioners were members of the Crystal Sands Owners Association

(CSOA).   The manager of CSOA was responsible for 277 condominium

units (including petitioners’ Destin, Florida, unit) in five

different complexes in Destin, Florida.     The CSOA manager spent

several hours a week at petitioners’ complex, but her main office

was at another complex in Destin.

     In connection with the condominium in Destin, petitioners

entered into a seasonal property management agreement in 2004

with Abbot Resorts, Inc. (Abbot).    Under the agreement, Abbot was

to receive 28 percent of “base rental income” as a fee for its

services, which included acquiring tenants, collecting rents, and

managing the property.   Abbot conducted a semiannual inspection

in order to determine the maintenance condition and appearance of

the units under its management.   In addition to its normal

housekeeping services, Abbot conducted a semiannual “deep,

general interior housecleaning” of the units.

     In 2005 and 2006 CSOA contracted with Resort Quest to secure

renters for the Crystal Sands complex, including petitioners’

unit.   A Resort Quest representative was present part time at the

complex in which petitioners’ unit was located.
                                 - 5 -

     Petitioners reported management fees paid to either or both

Abbot and Resort Quest of $5,551 for 2005 and $7,841 for 2006 in

connection with the Destin property.      Petitioners reported income

from the Destin unit of $20,661 in 2005 and $29,081 in 2006.

The Gatlinburg Condominium

     Petitioners made two trips to the Highlands condominium in

Gatlinburg in 2005 and one in 2006.      During the years at issue

petitioners were members of the Highlands Owners Association

(HOA).    HOA is responsible for maintaining the exterior of the

condominium complex in which petitioners’ Gatlinburg condominium

is located.    During 2005 and 2006 HOA contracted with Werner

Enterprises, Inc., to “operate” the 78-unit complex in which

petitioners’ unit was located.    Petitioners deducted management

fees of $6,069 for 2005 and $5,945 for 2006 in connection with

the Highlands unit.    Petitioners reported rental income from the

unit of $17,341 for 2005 and $16,985 for 2006.

The Pigeon Forge Condominium

     Petitioners visited the Whispering Pines condominium in

Pigeon Forge three times in 2005 and once in 2006.      During the

years in issue petitioners were members of the Whispering Pines

Owners Association (WPOA).    WPOA hired Werner Enterprises, Inc.

(Werner), to receive rental requests, assign renters, and assist

owners.    On December 12, 2006, petitioners signed an exclusive
                               - 6 -

rental management agreement with Resort Properties Management,

LLC (Resort) regarding the Pigeon Forge condominium.

     The agreement provided that Resort would receive 40 percent

of petitioners’ gross monthly receipts from rental income in

return for their services.   Among other provisions of the

agreement, Resort received the exclusive right to:    (1) Rent the

property at rates it set; (2) make repairs at the owners’

expense; (3) use the property for marketing through advertisement

and promotional stays; (4) collect and remit rent less

deductions; (5) provide maid service and supply paper products

and cleaning products; (6) provide maintenance and security

services; (7) actively promote and advertise the units within the

development; and (8) operate and maintain a reservation system to

process rental reservations for the premises.

     Petitioners deducted management fees in connection with the

Pigeon Forge condominium of $5,922 for 2005 and $6,066 for 2006.

They reported rental income from the property of $13,797 for 2005

and $15,318 for 2006.

                             Discussion

     Generally, the Commissioner’s determinations in a notice of

deficiency are presumed correct, and the taxpayer has the burden

of proving that those determinations are erroneous.    See Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).    In some

cases the burden of proof with respect to relevant factual issues
                                  - 7 -

may shift to the Commissioner under section 7491(a).     Petitioners

argue that the burden of proof has shifted to respondent because

they have met the requirements of section 7491.     The Court,

however, as discussed below, finds that petitioners have not met

the requirements of section 7491(a) and the burden of proof does

not shift to respondent.

Section 469 Passive Activity Losses

     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

income.

     If a taxpayer is an individual, however, the “passive

activity loss” for the taxable year shall not be allowed.     Sec.

469(a).3   The term “passive activity loss” means the amount by

which “the aggregate losses from all passive activities” exceeds

“the aggregate income from all passive activities” for the

taxable year.   Sec. 469(d)(1).    For purposes of section 469(a),

“passive activities” are, with certain exceptions, activities

involving a trade or business in which the taxpayer does not


     3
      A loss disallowed under sec. 469(a) shall be treated as a
loss allocable to the activity in the next taxable year. Sec.
469(b).
                                    - 8 -

“materially participate”.     Sec. 469(c)(1).    The term “passive

activity” generally includes any rental activity.       Sec.

469(c)(2).   Rental activity is any activity “where payments are

principally for the use of tangible property.”       Sec. 469(j)(8).

      An activity involving an average period of customer use of

tangible personal property for 7 days or less is not treated as

rental activity.     Sec. 1.469-1T(e)(3)(ii)(A), Temporary Income

Tax Regs., 54 Fed. Reg. 20535 (May 12, 1989).       The average stay

in the Fort Myers timeshare and the condominium units in

Gatlinburg and Pigeon Forge was less than 7 days in 2005.       Those

activities are treated as nonrental trades or businesses.

     The average rental stay for the condominium unit in Destin

was more than 7 days in 2005 and was therefore a rental activity

and a passive activity regardless of petitioners’ level of

participation.4    The loss suffered in 2005 for the Destin

condominium is a passive activity loss to which section 469(a)

applies.   The average rental stay for all three condominium units

was less than 7 days in 2006.       These activities are treated as

non-rental trades or businesses for the year.      Petitioners’ trade

or business activities are passive activities if they are trades

or businesses in which petitioners did not “materially

participate”.     Sec. 469(c)(1).


     4
      Petitioners, however, have argued that they are covered by
the real property trade or business exception under sec.
469(c)(7). See discussion infra pp. 16-20.
                               - 9 -

     Respondent alleges that petitioners did not materially

participate in their trade or business activities with respect to

the Destin condominium and the Fort Myers timeshare in 2005 and

the condominium units in Destin, Gatlinburg, and Pigeon Forge in

2006.   Petitioners argue that they have materially participated

in each real estate activity and that they have elected under

section 469(c)(7) to treat all their interests in rental real

estate as one activity.

     Material Participation

     Material participation means that the taxpayer is involved

in the operations of the activity on a regular, continuous, and

substantial basis.   Sec. 469(h).   Temporary regulations relating

to the meaning of the term “material participation” in section

469(h)(1) provide that, in general, an individual 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:   (1) The individual participates in

the activity for more than 500 hours during such year; (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
                               - 10 -

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; (4) the activity is a “significant participation”

activity for the taxable year, and the individual’s aggregate

participation in all significant participation activities during

such year exceeds 500 hours; (5) the individual materially

participated in the activity for any 5 taxable years (whether or

not consecutive) during the 10 taxable years that immediately

precede the taxable year; (6) the activity is a personal service

activity, and the individual materially participated in the

activity for any 3 taxable years preceding the taxable year; or

(7) based on all of the facts and circumstances, the individual

participated in the activity on a regular, continuous, and

substantial basis during such year.     Sec. 1.469-5T(a), Temporary

Income Tax Regs., 53 Fed. Reg. 5725 (Feb. 25, 1988).

     In determining whether a taxpayer materially participated in

an activity, the participation of a spouse shall be taken into

account.   Sec. 469(h)(5).   In general, work done by an individual

in connection with an activity in which he owns an interest is

treated as participation in the activity.    Sec. 1.469-5(f),

Income Tax Regs.

     According to petitioners, their condominium fees paid for

hiring the resort manager, hiring the maintenance workers,
                               - 11 -

maintaining the common areas and exterior, maintaining the

swimming pool, any kind of “replacements”, and utilities and

insurance for the complex, “not the individual units.”

     The parties have stipulated that petitioners compiled 2005

and 2006 “time logs” and narrative “trip activity logs” related

to their activities in connection with the condominiums.     At

trial respondent suggested that petitioners’ compilations may not

be contemporaneous.   Petitioner testified that they kept

receipts, records, documentation activity, and “hour logs” that

they “consolidate during tax time” and at a “later date”

transferred to a formal log.

     The time logs purport to provide a summary of the number of

hours each petitioner spent on various activities in connection

with five of their properties, including the three condominiums

but excluding the timeshare in Fort Myers.     The trip activity

logs purport to give for the condominiums a date and description

of each category of activity for which hours are listed in the

time logs for petitioner:   (1) Bank deposits, (2) phone log, (3)

post office, (4) recordkeeping and tax preparation, (5)

maintenance and repairs, (6) travel time, and (7) Web site

maintenance and Internet research.      For Mrs. Jende the time logs

and trip activity logs list hours for:     (1) Recordkeeping and tax

preparation, (2) maintenance and repairs, and (3) travel time.
                                - 12 -

     Work done by an individual in his capacity as an investor in

an activity is not treated as participation in the activity for

purposes of section 469 unless the individual is involved in the

day-to-day management or operations of the activity.    Sec. 1.469-

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

25, 1988).   Investor activity includes but is not limited to

studying and reviewing financial statements or reports on the

operations of the activity; preparing or compiling summaries of

the finances of the activity for the use of the individual; and

monitoring the finances or operations of the activity in a

nonmanagerial capacity.   Id.

     Petitioners were not involved in the day-to-day management

of their condominiums as they paid substantial fees under

contracts to Abbot and Werner or others for such services.      The

Court concludes that petitioners may not treat the hours they

devoted to “Bank Deposits”, “Post Office” and “Record Keeping &

Tax preparation” as participation for purposes of section 469.

     Petitioners treated all of their time traveling to and from

the condominiums as “work” for purposes of determining their

material participation in the condominium activities.    The Court

recognizes that travel in some circumstances can be “work” done

in connection with a trade or business.   The legislative history

of section 469 suggests, however, that only participation that is

integral to the operation of the business is to be counted for
                               - 13 -

purposes of the material participation test.    S. Rept. 99-313, at

732 (1986), 1986-3 C.B. (Vol. 3) 1, 732.    The Court finds that

petitioners’ travel to their properties was not integral to their

operation and will not be considered work for purposes of

determining their material participation in the condominium

activities.   See Toups v. Commissioner, T.C. Memo. 1993-359.

     The Court’s examination of the time logs leads to the

conclusion that the hours listed for “maintenance and repairs”

are exaggerated.    The hours listed for maintenance and repairs

for 2005 by each petitioner are exactly the same for two of the

properties and differ by only 1 hour for the third.    For 2006

there is somewhat more divergence, but the hours remain

substantially similar.    The duplication of hours by petitioners

in this category appears to result in large part from the

excessive number of hours the trip activity logs attribute to

shopping for, designing with, discussing, viewing, and

considering for the three condominiums various household items

including:    Furniture, pictures, fabrics, decorations, kitchen

appliances, dinnerware, and other items.

     For example, in entries for March 5, 2005, each petitioner

claims to have shopped for 11 hours related to the Pigeon Forge

unit.   The following day, Sunday, March 6, 2005, time log entries

show each petitioner spending 15-1/2 hours, not including lunch
                               - 14 -

or dinner, looking for decorations or pictures for the Gatlinburg

condominium.

     In another set of entries, for the Destin unit, petitioners

claim that on June 4 each of them shopped for 6 hours.   Each

petitioner claims to have shopped on Sunday, June 5, 2005, for

11-1/2 hours followed by another 11-1/2 hour shopping day on

Monday, June 6, 2005.    According to petitioners’ time logs, the

June 6 marathon shopping day was followed by a day, June 7, in

which each of them shopped for 9 hours.    The time log indicates

that on June 8 each petitioner shopped for 5-1/2 hours and on

June 9 for 10 hours.    That is a lot of shopping.

     Petitioners did not submit any of the receipts, records, or

documentation on which they say the logs were based to verify

their stated extended shopping efforts.    Petitioners’ exaggerated

claims of hours spent shopping cast doubt on the hours listed in

the other entries in their time logs, and the Court finds them

unreliable.

          Material Participation Test 1

     Petitioners do not claim to have participated in any of the

trade or business activities at issue for more than 500 hours for

either 2005 or 2006.
                               - 15 -

          Test 2

     Petitioners’ participation in the activities for the years

at issue do not constitute substantially all of the participation

of all individuals in the activities for the years at issue.

          Test 3

     The Court has determined that petitioners may not include as

hours of material participation time spent on investor activities

and travel.   Petitioners’ excessive claims of time spent on

maintenance and repairs has rendered the claims unreliable, and

therefore petitioners have not shown that they participated in

each of their trade or business activities for more than 100

hours in 2005 and 2006.5   Even if petitioners’ participation

exceeded 100 hours for each trade or business, they have not

shown that it equaled or exceeded the participation of any other

individual, including the management firms who ran the day-to-day

operations of the units.   See Barniskis v. Commissioner, T.C.

Memo. 1999-258; Chapin v. Commissioner, T.C. Memo. 1996-56; sec.

1.469-5T(b)(2)(ii), Temporary Income Tax Regs., 53 Fed. Reg. 5725

(Feb. 25, 1988).

          Test 4

     Because petitioners cannot show that their participation

with respect to each activity equaled or exceeded 100 hours for


     5
      Destin was a rental, and thus passive, activity in 2005.
Petitioners offered no evidence on their material participation
in the operations of the Fort Myers timeshare for 2005 or 2006.
                              - 16 -

each year, they cannot meet the test 4 requirements.   See sec.

1.469-5T(c), Temporary Income Tax Regs., 53 Fed. Reg. 5725 (Feb.

25, 1988).

          Tests 5 and 6

     The record contains no evidence that would support a finding

that petitioners meet test 5 or 6 for their trade or business

activities.

          Test 7

     Petitioners cannot meet test 7 requirements for any of their

trade or business activities because they have not shown that

their participation in each activity exceeded 100 hours.   See

sec. 1.469-5T(b)(2)(iii), Temporary Income Tax Regs., 53 Fed.

Reg. 5725 (Feb. 25, 1988).

     Real Estate Professionals

     Petitioners argue that even if they do not meet the

requirements for material participation for each property at

issue separately, they are real estate professionals and are

entitled to group their real estate activities for purposes of

the material participation test.

     The general rule is that a rental activity is treated as a

per se passive activity regardless of whether the taxpayer

materially participates.   Sec. 469(c)(2), (4).   But under section
                                  - 17 -

469(c)(7), the rental activities of a qualifying taxpayer6 in a

real property business, which includes rental activities, is not

a per se passive activity under section 469(c)(2).       Kosonen v.

Commissioner, T.C. Memo. 2000-107; sec. 1.469-9(b)(6), Income Tax

Regs.       Rather, the qualifying taxpayer’s rental activities are

treated as a trade or business--subject to the material

participation requirements of section 469(c)(1).       Fowler v.

Commissioner, T.C. Memo. 2002-223; sec. 1.469-9(e)(1), Income Tax

Regs.

      A taxpayer qualifies for the real property business election

if:   (1) More than one-half of the personal services performed in

trades or businesses by the taxpayer during the taxable year are

performed in real property trades or businesses in which he

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 he materially participates.          Sec.

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

requirements must be satisfied by the same spouse.       Sec.

469(c)(7)(B).

        For purposes of the 750-hour threshold, the Court looks at

all of the taxpayer’s rental activities to determine whether that

requirement is satisfied.       See DeGuzman v. United States, 147 F.


        6
      A qualifying taxpayer is one who owns at least one interest
in real estate and is in the real property business as described
in sec. 469(c)(7)(C).
                              - 18 -

Supp. 2d 274 (D.N.J. 2001); see also Fowler v. Commissioner,

supra; Bailey v. Commissioner, T.C. Memo. 2001-296.   If the

taxpayer does not materially participate in that activity, then

that activity does not count towards the 750-hour threshold.

DeGuzman v. United States, supra.

     If the taxpayer is a qualifying taxpayer, then the general

rule is that each interest in rental real estate is treated as a

separate activity unless the taxpayer elects to treat all

interests in rental real estate as one activity.   Sec.

469(c)(7)(A); Fowler v. Commissioner, supra.   The determination

of whether the taxpayer materially participated in his real

property business pursuant to section 469(c)(1) must be made with

respect to each rental activity unless the taxpayer made the

election to treat all of his rental activities as a single

activity.   Fowler v. Commissioner, supra; Shaw v. Commissioner,

T.C. Memo. 2002-35; sec. 469(c)(7)(A); sec. 1.469-9(e)(1), Income

Tax Regs.

     With respect to the real property business election, section

1.469-9(g), Income Tax Regs., provides that a qualifying taxpayer

makes the election to aggregate his activities by filing a

statement with the taxpayer’s original income tax return for the

taxable year.   The statement must contain a declaration that the

taxpayer is a qualifying taxpayer for the taxable year and is
                              - 19 -

making the election pursuant to section 469(c)(7)(A).     Sec.

1.469-9(g)(3), Income Tax Regs.

     The Court has determined that a taxpayer must clearly inform

the Commissioner of his intent to make the real property business

election.   See Kosonen v. Commissioner, supra (citing

Knight-Ridder Newspapers Inc. v. United States, 743 F.2d 781, 795

(11th Cir. 1984)).   To make the election, “‘the taxpayer must

exhibit in some manner * * * his unequivocal agreement to accept

both the benefits and burdens’” of section 469.     Id. (quoting

Young v. Commissioner, 83 T.C. 831, 839 (1984), affd. 783 F.2d

1201 (5th Cir. 1986)).   A taxpayer has not made the election if

it is not clear from the return that the election has been made.

See id. (citing Young v. Commissioner, supra at 1206).    The Court

has also stated that a taxpayer’s intent to make the election is

irrelevant when he has failed to do so.   See id.

     Petitioner testified that in 1998 petitioners discussed with

their accountant the desirability of treating all their rental

properties as “one entity” or a group.    According to petitioner,

they agreed to file an election to be so treated.    Petitioners

stated in their pretrial memorandum, however, that they believe

the election was made by their accountant in 2001.    Respondent

represented that he searched his records back to 2000 and was

unable to find an election.   Petitioners were unable to produce

any documentary evidence of making the election.
                                  - 20 -

     If petitioners could show that they made a proper election,

it might affect the treatment of the Destin property for 2005.

It would not, however, affect the treatment of the timeshare and

the other condominiums for 2005 or any of the properties for

2006.       The average stay in the Fort Myers timeshare and the

condominium units in Gatlinburg and Pigeon Forge was less than 7

days in 2005.       The average rental stay for all three condominium

units was less than 7 days in 2006.        These activities were trades

or businesses and not rental activities.       See sec. 1.469-

1T(e)(3)(ii)(A), Temporary Income Tax Regs., 54 Fed. Reg. 20535

(May 12, 1989).       Because they were not rental activities,

petitioners cannot properly include them in an election under

section 469(c)(7) to treat all interests in rental real estate as

a single rental real estate activity.       See Bailey v.

Commissioner, supra; sec. 1.469-9(e)(3), Income Tax Regs.7

        The Court concludes that petitioners’ losses from the named

properties are passive activity losses.

        Offset for Rental Real Estate Activities

     Section 469(i), with respect to rental real estate

activities in which an individual actively participates, provides

that the section 469(a) disallowance will not apply to a portion


        7
      Petitioners did not treat their contested activities as
trade or business activities and therefore did not elect to group
their trade or business activities for purposes of sec. 469 and
sec. 1.469-4, Income Tax Regs. Cf. Krukowski v. Commissioner,
279 F.3d 547, 552 (7th Cir. 2002), affg. 114 T.C. 366 (2000).
                                - 21 -

of the individual’s passive activity losses.     An annual maximum

of one $25,000 offset is allowed for all of a taxpayer’s rental

real estate activities.   Sec. 469(i)(2), (5).     This exemption

begins to phase out where the taxpayer’s adjusted gross income

(AGI) exceeds certain levels.    Sec. 469(i)(3).    The phaseout in

petitioners’ case is 50 percent of the amount by which their AGI

(computed without regard to passive activity losses) exceeds

$100,000.   See sec. 469(i)(3)(A), (F)(iv).

     For 2005 petitioners’ AGI computed without regard to passive

activity losses was $143,381 ($98,768 + $44,613).      Their AGI so

computed was $43,381 in excess of $100,000.    Reducing the $25,000

offset by 50 percent of $43,381, or $21,690.50, resulted in an

allowance by respondent of a $3,310 loss.

     The parties have since agreed, however, that petitioners are

entitled to the losses from the Cape Coral property of $5,435 and

the Vandalia property of $1,684.    The agreement of the parties

reduces petitioners’ passive activity losses from $44,613 to

$37,494 ($44,613 - $7,119).   Under the agreement, petitioners’

adjusted AGI computed without regard to passive activity losses

is $136,262.   Their AGI so computed is $36,262 in excess of

$100,000.   Reducing the $25,000 offset by 50 percent of $36,262,
                               - 22 -

or $18,131.50, results in an allowable loss under section 469(i)

for 2005 of $6,869.8

     All of the losses at issue in 2006 were from petitioners’

nonrental trades or businesses and therefore do not qualify for

the offset for rental real estate activities under section

469(i).

Accuracy-Related Penalty

     Section 7491(c) imposes on the Commissioner the burden of

production in any court proceeding with respect to the liability

of any individual for penalties and additions to tax.    Higbee v.

Commissioner, 116 T.C. 438, 446 (2001); Trowbridge v.

Commissioner, T.C. Memo. 2003-164, affd. 378 F.3d 432 (5th Cir.

2004).    In order to meet the burden of production under section

7491(c), the Commissioner need only make a prima facie case that

imposition of the penalty or the addition to tax is appropriate.

Higbee v. Commissioner, supra at 446.

     Respondent determined that for 2005 and 2006 petitioners

underpaid a portion of their income taxes due to negligence or

disregard of rules or regulations or a substantial understatement

of income tax.

     Section 6662(a) imposes a 20-percent penalty on the portion

of an underpayment of tax attributable to any one of various



     8
      In 2005 the Destin condominium was rental real estate and
accounted for a loss of $19,025.
                              - 23 -

factors, including negligence or disregard of rules or

regulations and a substantial understatement of income tax.    See

sec. 6662(b)(1) and (2).   Negligence includes any failure to make

a reasonable attempt to comply with the provisions of the

Internal Revenue Code, including any failure to keep adequate

books and records or to substantiate items properly.     See sec.

6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.

      A substantial understatement includes an understatement of

income tax that exceeds the greater of 10 percent of the tax

required to be shown on the return or $5,000.    See sec. 6662(d);

sec. 1.6662-4(b), Income Tax Regs.

      Section 6664(c)(1) provides that the penalty under section

6662(a) shall not apply to any portion of an underpayment if it

is shown that there was reasonable cause for the taxpayer’s

position and that the taxpayer acted in good faith with respect

to that portion.   The determination of whether a taxpayer acted

with reasonable cause and in good faith is made on a case-by-case

basis, taking into account all the pertinent facts and

circumstances.   Sec. 1.6664-4(b)(1), Income Tax Regs.   The most

important factor is the extent of the taxpayer’s effort to assess

his proper tax liability for the year.   Id.

      Petitioners have a substantial understatement of income tax

for   each of the years in issue since the understatement amount

exceeds the greater of 10 percent of the tax required to be shown
                              - 24 -

on the return or $5,000.   The Court concludes that respondent has

produced sufficient evidence to show that the accuracy-related

penalties under section 6662(a) are appropriate for both years.

     The accuracy-related penalties will apply unless petitioners

demonstrate that there was reasonable cause for the underpayments

and that they acted in good faith with respect to the

underpayments.   See sec. 6664(c).   Section 1.6664-4(b)(1), Income

Tax Regs., specifically provides:    “Circumstances that may

indicate reasonable cause and good faith include an honest

misunderstanding of fact or law that is reasonable in light of

all the facts and circumstances, including the experience,

knowledge, and education of the taxpayer.”

     Petitioners did not show that there was reasonable cause

for, and that they acted in good faith with respect to, the

underpayments.

      Respondent’s determination of the accuracy-related

penalties under section 6662(a) for 2005 and 2006 is sustained.

     To reflect the foregoing,

                                          Decision will be entered

                                     under Rule 155.
