                       T.C. Memo. 2010-198



                     UNITED STATES TAX COURT



                 WILLIAM J. DUNN, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 17290-06.           Filed September 13, 2010.



     Frank J. Yong and J. Ellsworth Summers, Jr., for

petitioner.1

     Jeffrey S. Luechtefeld, for respondent.




     1
      Petitioner was represented by Elizabeth Opalka when he
filed his petition. On Jan. 3, 2007, Donald W. Wallis was
substituted for Ms. Opalka as counsel for petitioner. On Sept.
21, 2009, Frank J. Yong was substituted for Mr. Wallis as counsel
for petitioner.
                                - 2 -

             MEMORANDUM FINDINGS OF FACT AND OPINION


     THORNTON, Judge:   Respondent determined the following

deficiencies in and penalties on petitioner’s Federal income

taxes:

                                Accuracy-Related Penalty
     Year      Deficiency             Sec. 6662(a)

     2002       $177,658                $35,532
     2003        140,820                 28,164
     2004        192,463                 38,493

     The issues for decision are:    (1) Whether petitioner is

entitled to deduct expenses, mostly relating to airplane rentals,

use, and maintenance, incurred by his wholly owned S corporation,

Dunn Property Management, Inc. (DPM); (2) whether petitioner’s

pass-through losses from DPM and his single-member limited

liability company, Dunn Equipment Leasing, L.L.C. (DEL), are

subject to the passive activity loss restrictions of section 469;

and (3) whether petitioner is liable for a section 6662(a)

accuracy-related penalty for each year at issue.2

                           FINDINGS OF FACT

     The parties have stipulated some facts, which we so find.

When he petitioned the Court, petitioner resided in Florida.




     2
      All section references are to the Internal Revenue Code
(Code) in effect for the years at issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
                                - 3 -

A.   Petitioner’s Background

     Petitioner is a 1976 graduate of the U.S. Air Force Academy

and a 1980 graduate of Georgetown University Medical School.

After serving some years as an Air Force flight surgeon, in 1988

he left active duty for the private practice of ophthalmology in

Bangor, Maine.    While working and living there with his family,

he commuted in his private plane to Cleveland, Ohio, for a

fellowship program in retina and vitreous surgery.    Since 1991 he

has been employed as a retinologist by the Florida Retina

Institute, P.A. (FRI), a Florida professional corporation of

which he is a vice president and shareholder.

     FRI has a number of offices throughout northeast Florida and

Georgia.    Petitioner’s medical practice is concentrated primarily

in FRI’s Daytona Beach office, which is in the general vicinity

of his residence, and in Palm Coast, a short distance away.

Petitioner typically works at FRI about 4-1/2 days each week and

takes 6 to 8 weeks of vacation each year.

     In addition to practicing medicine with FRI, petitioner

participates in drug treatment studies for two major drug

companies and serves on their advisory boards.    Sometimes he

travels to Miami or Atlanta to participate in these advisory

boards.    These companies pay petitioner consultant’s fees and

reimburse his travel expenses, typically on the basis of airline

coach fares.
                               - 4 -

     As described more fully below, during the years at issue

petitioner also pursued aviation interests and real estate

activities.

B.   Petitioner’s Aviation Interests

     Petitioner has been an aviation enthusiast since childhood.

At age 14 he took his first flying lesson, and at age 17--the

youngest age permitted by the Federal Aviation Administration

(FAA)--he obtained his private pilot’s license.   At the Air Force

Academy he frequently flew military aircraft, and he completed a

pilot indoctrination course.

     In 1986 petitioner purchased his first airplane, a 1969 Aero

Commander, which he flew for training and attending medical

meetings.   In 1990 he traded up to a 1968 Mooney M20F, which he

used for, among other things, attending medical meetings,

commuting between Bangor, Maine, and Cleveland, Ohio, and taking

his family on trips.   Because the Mooney was only a four-seater,

he decided he needed a larger aircraft that would allow him to

“take everybody on a trip” with greater safety, range, and speed.

Consequently, in 1996 he traded up to a Cessna 414, which he used

for, among other things, “flying my children around and business

associates” and for trips from his Florida home to his Air Force

reserve duty station in Washington, D.C.
                                 - 5 -

     In 2000 petitioner and his wife divorced.   She got the

Cessna 414.   Petitioner decided to replace it with a Mitsubishi

MU-2.

C.   Dunn Equipment Leasing, LLC

     The Mitsubishi dealer referred petitioner to Louis M.

Meiners, Jr. (Meiners), for advice about placing the new airplane

in a holding company for asset and liability protection and to

minimize State taxes.   Meiners was a certified public accountant

(C.P.A.) and attorney with his own CPA firm in Indianapolis,

Indiana (the Meiners firm), that specialized in tax-planning

services.   Meiners was also president of Advocate Aircraft

Taxation Consulting Co. (Advocate), an aviation consulting

business with about 35 employees including CPAs, attorneys,

paralegals, and support staff.    Advocate assists its clients in

complying with Treasury regulations, FAA regulations, and State

aviation-related regulations.

     In 2000 petitioner engaged Advocate for advice about income

taxes and about acquiring an aircraft in such a manner as to

reduce sales or use taxes.   Following Advocate’s advice,

petitioner formed DEL, a limited liability company organized

under Indiana law.   During the years at issue, petitioner was

DEL’s only member and employee.    DEL paid petitioner no salary.
                                - 6 -

D.   DEL’s Purchase and Lease of the Mitsubishi to Petitioner

     On or about July 1, 2000, DEL purchased a Mitsubishi MU-2

aircraft (the Mitsubishi) for about $630,000.   The purchase was

financed by a loan that petitioner personally guaranteed.     On

July 20, 2000, DEL, as owner, and petitioner, as operator,

entered into an aircraft lease.   Pursuant to the lease,

petitioner agreed to lease the Mitsubishi from DEL for a term

ending December 31, 2004, and to make the following fixed rental

payments:    $5,000 on July 20, 2000; $225,000 by August 19, 2000;

and $5,000 at yearend 2000, 2001, 2002, and 2003.3   In addition,

petitioner was responsible for all maintenance, service, and

insurance on the Mitsubishi.

     Petitioner’s Florida residence is in a “fly-in/fly-out”

community; i.e., one with a private airport for use by its

residents.    An airplane hangar adjoins petitioner’s residence.

The Mitsubishi was stored in this hangar.

E.   Dunn Property Management

     In September 2001 petitioner incorporated DPM under the laws

of Nevada.   The articles of incorporation list DPM’s purpose as

“PROPERTY MANAGEMENT”.   Petitioner was DPM’s sole officer,


     3
      Petitioner testified that the $225,000 payment was made to
“maximize state tax savings by doing a large prepayment of the
lease payment”. Other than this testimony, there is no evidence
that petitioner actually made any of the scheduled lease payments
to DEL.
                               - 7 -

director, and shareholder.   DPM elected for Federal income tax

purposes to be treated as an S corporation.

F.   DEL’s Lease of the Cessna Citation to Petitioner and DPM

     In July 2002, in a reverse like-kind exchange facilitated by

Advocate, DEL sold the Mitsubishi for about $545,000 and

purchased a Cessna Citation aircraft (the Citation) for about

$810,000.   The purchase was financed with a loan that petitioner

personally guaranteed.   The Citation, like the Mitsubishi before

it, was kept at petitioner’s home in Florida.

     The parties amended the preexisting aircraft lease between

DEL and petitioner to substitute the Citation for the Mitsubishi.

Also, on July 3, 2002, DEL, as owner, and DPM, as operator,

entered into aircraft rental agreement, whereby DEL rented to DPM

the nonexclusive right to use and operate the Citation.    The DPM

rental agreement stated that DPM was renting the Citation in

furtherance of its “primary, non-transportation business and its

employee benefits.”   DPM agreed to pay DEL rent of $175 per hour

of flight time.   In 2002, 2003, and 2004, DPM paid DEL aggregate

rents of $54,400, $26,968, and $26,058, respectively.   DPM also

paid costs of using and maintaining the aircraft.

     On November 1, 2004, DEL, as owner, and petitioner, as

operator, entered into another rental agreement whereby DEL
                                - 8 -

granted petitioner nonexclusive rights to use and operate the

Citation for a rental rate of $700 per hour of flight time.4

G.   Real Estate Owned by Petitioner Directly

     During the years at issue petitioner owned in his own name,

in addition to his Florida residence, interests in the following

three real properties.

     1.   Mountain Air Country Club Residence

     In 1996 petitioner and his wife purchased this residential

unit for about $380,000.   It is near Burnsville, North Carolina,

in Mountain Air Country Club, an exclusive “fly-in/fly-out”

community with its own landing strip and amenities such as golf,

swimming, and tennis.    Pursuant to his divorce agreement in 2000,

petitioner gained outright ownership of the property.   Petitioner

typically used the property about six to eight times each year

with family and friends.   Generally, he and his family or friends

would fly there in the Mitsubishi or, later, in the Citation.

     2.   Mountain Air Country Club Building Lot

     In 2001 petitioner purchased this unimproved lot, also in

Mountain Air Country Club, for $319,000.

     3.   Miami Beach Condominium

     In 2004 petitioner and his girlfriend purchased this

property for $539,500.   She lived in the condominium while


     4
      Apart from petitioner’s testimony, there is no evidence
that petitioner paid DEL such rents in 2004.
                                - 9 -

attending school in Miami.    Petitioner would visit using the

Citation.

H.   Property Management Agreement Between DPM and Petitioner

     On January 1, 2003, DPM and petitioner entered into an asset

management agreement, which stated that petitioner retained DPM

to manage designated assets for annual compensation calculated as

the sum of 1 percent of the asset value of non-income-producing

properties and 10 percent of the income on income-producing

properties.    The annual payment was due no later than June 30 of

the year following the year in which the management services were

rendered.5    The asset management agreement indicates that it

covers petitioner’s two North Carolina country club properties.

I.   Real Property Owned by DPM

     During the years at issue, DPM purchased ownership interests

in the following four real properties, all of which it still

possessed at the end of 2004.

     1.   Ormond Beach, Florida, Apartment

     In May 2002 DPM purchased this property for $72,500.    For an

undisclosed period during the years at issue, DPM leased this

apartment to tenants for $875 per month under a monthly rental

agreement.    DPM employed a property management company to collect



     5
      The record indicates that in May 2004 petitioner wrote DPM
a $15,000 check for 2003 management fees. The record does not
indicate whether petitioner paid DPM any management fees for
2004.
                               - 10 -

rent and handle day-to-day management duties and routine

maintenance.   DPM paid the property management company 10 percent

of the rental income generated by the property.      Petitioner drove

to the Ormond Beach property about once a month in his Lexus

automobile, which DPM leased from him.

     2.    Key Largo, Florida, Condominium

     In August 2002 DPM purchased this condominium for $749,900.

The property includes amenities such as a pool, a spa, tennis

courts, and a deepwater marina.    DPM employed property management

companies, which marketed the property for rent, collected the

rent for the property, and enforced the rental agreements with

tenants.    The property managers were authorized to handle minor

repairs, but DPM handled major repairs.      The property managers

were also responsible for day-to-day duties such as changing

linens, booking reservations, and handling the arrival and

departure of guests.    For its services DPM paid the property

management companies 30 to 40 percent of total rental revenues.

     Petitioner flew to the Key Largo property four to six times

each year in the Citation.    According to his testimony, he would

engage in “global oversight” of the property to make sure it was

being maintained and marketed according to the management

agreements.    On these visits, which typically lasted from Friday

night through Sunday night, he would stay in DPM’s condominium if
                                - 11 -

it was vacant.   Otherwise he would stay in another unit on the

property for a discounted rate.

     3.   Lake Mary, Florida, Property

     In June 2003 DPM and one of petitioner’s professional

colleagues purchased, as 50-50 coowners, an unimproved parcel of

land in Lake Mary, Florida, adjacent to one of FRI’s properties.

Petitioner visited the property four to six times each year in

his Lexus automobile, which DPM leased from him.

     4.   Telluride, Colorado, Condominium

     In June 2004 DPM purchased this unit in a resort hotel with

amenities such as ski-in/ski-out access, a spa, restaurants, a

swimming pool, and a gym.     DPM engaged a property management

company which handled day-to-day duties such as changing the

linens, housekeeping, marketing the property for rent, booking

reservations, and collecting rent.       As payment for its services

DPM paid the property management company 50 percent of total

rental revenues.     DPM’s responsibilities for the property

included making decisions regarding the marketing, occasionally

inspecting the property, and staying apprised of the current real

estate market.   In 2004 petitioner flew to this property twice in

the Citation.

J.   Tax Reporting

     The Meiners firm prepared DPM’s Form 1120S, U.S. Income Tax

Return for an S Corporation, for each year at issue.      On these
                                   - 12 -

returns DPM reported net losses from rental real estate

activities (hereinafter sometimes referred to as rental losses)

and, separately, net losses from nonrental activities, which it

labeled “ordinary” income losses (hereinafter sometimes referred

to as nonrental losses), as follows:

     Year           Nonrental Losses1       Rental Losses2

     2002               $173,912               $36,123
     2003                150,478                65,393
     2004                160,502               141,872
            1
           In calculating these nonrental losses, DPM
     reported no gross receipts for 2002 or 2003. For 2004
     DPM reported gross receipts of $15,000, representing
     “management fees” that petitioner paid to DPM. In
     calculating its nonrental losses, DPM reported
     deductions as shown in appendix A. Most of these
     deductions appear to be aviation related.
            2
           In calculating these rental losses, DPM claimed
     deductions shown in appendix B.

On Schedules K-1, Shareholder’s Share of Income, Credits,

Deductions, etc., DPM reported these losses as passing through to

petitioner.

     CPA firms other than the Meiners firm prepared petitioner’s

Forms 1040, U.S. Individual Income Tax Return, for the years at

issue, although the Meiners firm helped prepare certain schedules

relating to airplane expenses and also prepared grouping

elections.      For 2002, on Schedule E, Supplemental Income and

Loss, of his Form 1040 petitioner claimed the aggregate $210,035

of DPM pass-through losses (i.e., $173,912 of nonrental losses

plus $36,123 of rental losses) as nonpassive losses which he
                                - 13 -

offset against other income, principally wages, to report

adjusted gross income of $897,451.       For 2003 and 2004 on

Schedules E petitioner claimed the DPM pass-through nonrental

losses as nonpassive losses, which he offset against other

income, principally wages, to report adjusted gross income of

$793,448 for 2003 and $702,654 for 2004. For 2003 and 2004 he

treated the DPM rental losses as passive losses and deducted them

only to the extent of other real estate rental income that he

received from FRI ($5,808 in 2003 and $3,995 in 2004).

     On Schedules C, Profit or Loss From Business, attached to

his Forms 1040, petitioner also claimed net losses from DEL as

follows:

                                     2002         2003          2004
     Expenses:
       Depreciation               $174,701      $167,313   $286,863
       Insurance                    36,600         --         --
       Interest                     17,114        31,601     28,051
       Hangar                        1,100         --         --
       Taxes and licenses            --               28        603
       Legal and professional        --            5,000      5,000
         services
           Total expenses          229,515       203,942    320,517
     Gross receipts                 54,400        26,968     26,058
     Net loss                      175,115       176,974    294,459

The Meiners firm provided petitioner’s tax return preparer the

information used to prepare the Schedules C relating to DEL’s

leasing activities.

     Petitioner, on his 2003 Form 1040, and DPM, on its 2003 and

2004 Forms 1120S, elected to group the activities of DPM and DEL

for purposes of the section 469 passive activity loss limitations
                              - 14 -

and for purposes of section 183.6   The Meiners firm prepared

these grouping elections for petitioner.

K.   Notice of Deficiency

     In the notice of deficiency, respondent disallowed the DPM

pass-through losses and petitioner’s DEL Schedule C losses on

grounds that it had not been established that any amounts were

incurred and paid for ordinary and necessary business purposes or

in an activity entered into for profit or with respect to

property held for the production of income.    Alternatively,

respondent determined that DPM’s pass-through losses and the DEL

Schedule C losses were attributable to passive activities and

subject to the section 469 limitations.    More particularly,

respondent made separate adjustments for DPM’s rental and

nonrental pass-through losses and for the DEL Schedule C losses

as more fully described below.

     1.   DPM Rental Pass-Through Losses

     Respondent disallowed in their entirety the DPM rental

losses that petitioner claimed ($36,123 for 2002, $5,808 for

2003, and $3,995 for 2004) and determined that petitioner should

have reported pass-through rental income equal to DPM’s gross

rents ($4,361 for 2002, $28,752 for 2003, and $29,269 for 2004).


     6
      As related to the sec. 469 grouping, the elections on these
various returns stated identically: “Taxpayer hereby elects to
group equipment rental activity identified as Dunn Equipment
Leasing, Inc., with Dunn Property Management, Inc., its lessee in
the original grouping as an appropriate economic unit pursuant to
Regulation § 1.469-4(d)(1)(C).”
                                 - 15 -

As a result of these adjustments, respondent determined that

petitioner’s taxable income should be increased $40,484 for 2002,

$34,560 for 2003, and $33,264 for 2004; i.e., the sum of the

disallowed losses and the unreported gross rents.   For 2002

respondent further determined that the DPM pass-through rental

losses, which petitioner had claimed as nonpassive losses on his

2002 Form 1040, should be recharacterized as passive losses for

purposes of section 469.   For 2003 and 2004 respondent determined

that no such recharacterization was required, because

petitioner’s 2003 and 2004 Forms 1040 properly showed the DPM

pass-through rental losses as passive.

     2.   DPM Nonrental Losses

     Respondent disallowed in their entirety the DPM nonrental

pass-through losses ($173,912 for 2002, $150,478 for 2003, and

$160,502 for 2004) and determined that petitioner should have

reported as income the gross amount of DPM’s nonrental income

(zero for 2002 and 2003, and $15,000 for 2004).   As a result of

these adjustments, respondent determined that petitioner’s

taxable income should be increased by $173,912 for 2002, $150,478

for 2003, and $175,502 for 2004; i.e., the sum of the disallowed

losses and the unreported gross income.   Respondent further

determined that all the DPM nonrental pass-through losses were

subject to the section 469 passive activity loss limitations.
                              - 16 -

     3.   DEL Schedule C Losses

     On grounds that petitioner had failed to establish that any

amounts were paid for ordinary and necessary business purposes or

in an activity entered into for profit or with respect to

property held for the production of income, respondent disallowed

in their entirety the Schedule C business expense deductions that

petitioner claimed with respect to his DEL activity, resulting in

corresponding increases to his taxable income ($229,515 for 2002,

$203,942 for 2003, and $320,517 for 2004).    Respondent further

determined that any profits or losses allowable with respect to

his DEL activity were attributable to a passive activity.

     4.   Section 6662(a) Penalty

     Respondent determined that for each year at issue petitioner

was liable for a section 6662(a) accuracy-related penalty for

substantial understatement of income tax.

                              OPINION

I.   Introduction

     Petitioner, a retinologist and a licensed pilot, claims

substantial losses attributable to airplanes that DEL, his

single-member LLC, owned and that he flew, allegedly on behalf of

DPM, his wholly owned S corporation.    More particularly,

petitioner claims Schedule C losses from DEL’s activity of

leasing the airplanes to DPM and petitioner.    Petitioner also

claims substantial pass-through losses from DPM.    They comprise:
                               - 17 -

(1) Rental losses, attributable to DPM’s expenses of renting real

estate that it owned, and (2) nonrental losses, attributable

mainly to DPM’s leasing, using, and maintaining at least one of

the airplanes.

       As previously described, in the notice of deficiency

respondent disallowed all the Schedule C deductions for DEL

business expenses and DPM pass-through losses on various

alternative grounds.    In this proceeding, respondent has modified

his positions.    Respondent now concedes that DEL and DPM paid the

disputed expenses.    Respondent continues to maintain, however, as

he did in the notice of deficiency, that the aviation-related

expenses giving rise to the DPM nonrental losses were not

ordinary and necessary expenses incurred in a trade or business.

He no longer presses this contention, however, with regard to the

DPM rental activity or with regard to DEL’s activity.    Respondent

continues to assert that DEL was not engaged in an activity for

profit, but he no longer presses this argument with regard to

DPM.    As in the notice of deficiency, respondent maintains that

any allowable losses from either petitioner’s DEL activity or his

DPM activities are subject to the passive activity loss

restrictions of section 469.    But respondent now concedes the

adjustments of $34,560 and $33,264 for 2003 and 2004,

respectively, with respect to the DPM pass-through losses

attributable to its rental activities, noting that petitioner
                              - 18 -

correctly reported these pass-through losses as passive for 2003

and 2004.7

II.   Burden of Proof

      The taxpayer generally bears the burden of proving the

Commissioner’s determinations erroneous.    Rule 142(a).   In

particular, the taxpayer bears the burden of substantiating the

amount and purpose of each item claimed as a deduction.    See

Higbee v. Commissioner, 116 T.C. 438, 440 (2001); Hradesky v.

Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam 540 F.2d

821 (5th Cir. 1976).

      Section 7491(a)(1) provides that if, in any court

proceeding, a taxpayer introduces credible evidence with respect

to any factual issue relevant to ascertaining the taxpayer’s

proper tax liability, the Commissioner shall have the burden of

proof with respect to that issue.   Credible evidence is evidence

the Court would find sufficient upon which to base a decision on

the issue in the taxpayer’s favor, absent any contrary evidence.

See Higbee v. Commissioner, supra at 442.    Section 7491(a)(1)

applies, however, only if the taxpayer complies with all


      7
      The notice of deficiency similarly determined that
petitioner had correctly reported the 2003 and 2004 DPM rental
losses as passive but nevertheless determined an increase in
petitioner’s tax liabilities resulting from the disallowance of
the DPM rental losses for failure to establish that they
represented ordinary and necessary business or investment
expenses. In conceding this issue, respondent has waived any
issue as to whether the DPM rental expenses should be disallowed
entirely.
                              - 19 -

substantiation and recordkeeping requirements under the Code and

cooperates with the Commissioner’s reasonable requests for

witnesses, information, documents, meetings, and interviews.

Sec. 7491(a)(2)(A) and (B).

     As discussed infra, our decision turns primarily on two

issues:   (1) Whether DPM’s airplane expenses were ordinary and

necessary; and (2) whether petitioner’s DPM and DEL pass-through

losses are subject to the passive activity loss restrictions of

section 469.   As to the first issue, respondent concedes that

petitioner has substantiated the amounts of the disputed expenses

but contends, and we agree, that petitioner has failed to

substantiate business purposes independent of substantial

personal purposes for the flights.     Whether petitioner’s failure

in this regard be viewed as failure to satisfy the substantiation

prerequisite of section 7491(a)(2)(A) or as failure to present

credible evidence sufficient for the Court to render a decision

in his favor, the result is the same--the burden of proof remains

with petitioner.

     The passive loss issue involves mixed questions of law and

fact.   With respect to critical factual issues, particularly as

to the number of hours petitioner might have engaged in his DPM

and DEL activities, petitioner has, again, failed to substantiate

these matters or to present credible evidence sufficient for the
                                  - 20 -

Court to render a decision in his favor.      The burden of proof as

to this issue also remains with petitioner.

     Respondent bears the burden of production with respect to

penalties.    See sec. 7491(c).    We discuss this matter infra.

III. Deductibility of DPM’s Airplane Expenses

     A.   The Parties’ Contentions

     Respondent contends that the DPM nonrental losses (i.e., the

losses attributable to DPM’s activities other than renting its

real estate properties) are nondeductible under section 162(a)

because they are not attributable to the conduct of any trade or

business.    Alternatively, respondent contends that the DPM

nonrental losses are nondeductible under either section 162(a) or

section 212 because they do not represent ordinary and necessary

business expenses but rather primarily personal expenses.8

     Characterizing respondent’s discussion of the trade or

business requirement of section 162(a) as “inapposite” and

thereby implicitly conceding that the DPM nonrental activity was

not a trade or business, petitioner contends on brief that DPM’s

deduction of the disputed expenses was based not upon section

162(a) but upon section 212(2).9      Petitioner contends that DPM’s


     8
      Respondent argues alternatively that even if DPM’s
aircraft-related expenses were ordinary and necessary business
expenses, petitioner’s deduction of these expenses would be
limited by the sec. 469 passive activity loss limitations. We
address these arguments in pt. IV, infra.
     9
      Petitioner’s contentions are inconsistent with the manner
                                                   (continued...)
                              - 21 -

main activity was holding real estate for appreciation.    He

contends that the disputed expenses represent ordinary and

necessary travel expenses that were integral to DPM’s managing,

conserving, and maintaining properties that it owned during the

years at issue and were also necessary for DPM’s investigating

prospective investment properties.     He contends that his need to

travel on DPM’s behalf by private plane was “obvious” because

otherwise it would have been inefficient or infeasible for him to

pursue his far-flung real estate investment activities while at

the same time conducting his full-time medical practice.    Thus,

he contends, the disputed expenses are deductible under section

212(2) as DPM’s ordinary and necessary expenses.

     B.   General Legal Principles

     An eligible small business corporation that elects S

corporation status is generally exempt from corporate income tax.

See sec. 1363(a).   Instead, the S corporation’s shareholders must


     9
      (...continued)
in which he treated the disputed expenses on his tax returns for
the years at issue. On his returns petitioner treated these
items not as miscellaneous itemized deductions under sec. 212 but
as reductions in arriving at adjusted gross income, presumably
pursuant to sec. 162(a). If we were to agree with petitioner’s
argument that the disputed expenses are deductible as
miscellaneous itemized deductions under sec. 212 (which we do
not), collateral computational effects (i.e., subjecting them
under sec. 67(a) to the 2-percent floor of adjusted gross income
and under sec. 68 to reduction for high-income individuals) would
likely reduce the value of these miscellaneous itemized
deductions to petitioner. See infra text accompanying note 11.
Because we conclude, for reasons discussed infra, that the
disputed expenses are not ordinary and necessary, we need not
consider these issues further.
                              - 22 -

report pro rata shares of the S corporation’s taxable income,

losses, deductions, and credits.    Sec. 1366(a)(1)(A); sec.

1.1366-1(a), Income Tax Regs.10    An S corporation item generally

retains its character for the shareholder.    Sec. 1366(b).    With

certain exceptions, an S corporation’s taxable income is computed

in the same manner as an individual’s.    Sec. 1363(b).

     Unless expressly provided in the Code, no deduction is

allowed for personal expenses.    Sec. 262(a).   Section 162(a)

allows a deduction for “all the ordinary and necessary expenses

paid or incurred during the taxable year in carrying on any trade

or business”.   Section 212(1) and (2) provides that an individual

may deduct ordinary and necessary expenses paid or incurred for

the production or collection of income or for the management,

conservation, or maintenance of property held for the production

of income.

     Generally, sections 162(a) and 212 provide, with respect to

the respective classes of activities to which they pertain,

“coextensive” deductions.   Trust of Bingham v. Commissioner, 325

U.S. 365, 374 (1945) (discussing statutory predecessors of

sections 162(a) and 212(1) and (2)).    In some circumstances,

however, a section 212 deduction might be less beneficial than a


     10
      The shareholder may not take into account S corporation
losses and deductions for any taxable year in excess of the
shareholder’s adjusted basis in the S corporation’s stock and
debt. Sec. 1366(d)(1). Respondent does not contend that
petitioner’s basis in DPM was insufficient to support the pass-
through losses in question.
                              - 23 -

section 162(a) deduction.   For instance, as miscellaneous

itemized deductions, section 212 deductions, unlike section

162(a) deductions, are deductible only to the extent they exceed

2 percent of the taxpayer’s adjusted gross income and for high-

income individuals are subject to reduction.11   Secs. 67(a), 68;

see 1 Bittker & Lokken, Federal Taxation of Income, Estates and

Gifts, par. 20.5.1, at 20-115 through 20-117 (3d ed. 1999)

(discussing various other circumstances in which deductibility

under section 212 may be less beneficial than under section

162(a)).

     To be deductible under either section 162(a) or 212,

expenses must be ordinary and necessary.   Under the section 212

regulations, this means that the expenses must be “reasonable in

amount and must bear a reasonable and proximate relation to the

production or collection of taxable income or to the management,

conservation, or maintenance of property held for the production

of income.”   Sec. 1.212-1(d), Income Tax Regs.; see Trust of



     11
      For reasons such as these, to effect flowthrough of
deductions from an S corporation to a shareholder, itemized
deductions under sec. 212, unlike deductions under sec. 162(a),
must be separately stated rather than aggregated with the S
corporation’s other items of income, deductions, losses, and
credits. See secs. 1363(b)(2) (disallowing in the computation of
an S corporation’s taxable income deductions referred to in sec.
703(a)(2), which includes, in subpar. (E) thereof, itemized
deductions under sec. 212), 1366(a)(1); sec. 1.1366-1(a)(2)(vi),
Income Tax Regs. The character of such separately stated items
is determined in the hands of the shareholder as if they were
“incurred in the same manner as incurred by the corporation.”
Sec. 1366(b).
                               - 24 -

Bingham v. Commissioner, supra at 373 (articulating a

substantially identical standard with respect to the statutory

predecessor of section 212).   If substantial business and

personal motives exist for owning and maintaining property, it is

necessary to allocate the expenditures.12   Internatl. Artists,

Ltd. v. Commissioner, 55 T.C. 94, 105 (1970); Richardson v.

Commissioner, T.C. Memo. 1996-368.

     C.   Analysis

     During 2002 and 2003, of the three real properties in which

DPM held ownership interests, only one--the Key Largo

condominium--was a destination to which petitioner flew himself

in one of the airplanes in question.    He made these trips, he

testified, four to six times a year on DPM’s behalf, staying

weekends.   In 2004 DPM also acquired a resort property in

Telluride, Colorado; in 2004 petitioner flew there twice and



     12
      Pursuant to sec. 274(d)(4), stringent substantiation is
required for deductions with respect to “listed property”, which
includes passenger automobiles and “any other property used as a
means of transportation”; e.g., airplanes. Sec. 280F(d)(4)(A)(i)
and (ii). These rules require the taxpayer to maintain adequate
records or sufficient corroborating evidence to establish each
element of an expenditure, including business purpose. See sec.
274(d); sec. 1.274-5T(b)(6), (c)(2)(i), Temporary Income Tax
Regs., 50 Fed. Reg. 46016, 46017 (Nov. 6, 1985). If the listed
property is used for both personal and business purposes, no
deduction is allowed unless the taxpayer establishes the business
purpose. Kinney v. Commissioner, T.C. Memo. 2008-287; sec.
1.274-5T(b)(6)(i)(B), Temporary Income Tax Regs., 50 Fed. Reg.
46016 (Nov. 6, 1985). Although these rules would seem germane to
the deductibility of DPM’s airplane expenses, respondent has not
cited or relied upon the sec. 274(d) substantiation rules.
Accordingly, we likewise do not rely upon them in our analysis.
                              - 25 -

stayed for periods undisclosed in the record.   For the years at

issue DPM claimed airplane expenditures ranging from $150,478 to

$175,502.13

     Clearly, these large airplane expenditures were not wholly

attributable to the approximately 20 flights that petitioner made

during the years at issue to DPM’s Key Largo and Telluride

properties.   In fact, according to petitioner’s flight logs,

which are in evidence, during the years at issue petitioner made

over 350 flights in the airplanes.14   He has offered into

evidence a redacted version of his flight logs that, according to

his testimony, omits “personal trips” and includes only “business

trips”.   These redacted flight logs show about 250 flights that



     13
      Respondent characterizes these expenses as being
“predominately related to petitioner’s aircraft”. Appearing to
agree with this characterization, petitioner states that “the
bulk” of these expenses are expenses related to airplane travel.
The disputed expenses appear to include some relatively small
nonaviation items; e.g., “Auto and truck expense”. See app. A.
On the basis of petitioner’s testimony and in the absence of
other evidence, we infer that “Auto and truck expense” includes
the expense of DPM’s purportedly leasing petitioner’s Lexus from
him, so that he could drive it, allegedly on DPM’s behalf, to the
Ormond Beach and Lake Mary, Fla., properties. Petitioner has not
advanced independent arguments with respect to such nonaviation
items but, like respondent, has contented himself with treating
all the disputed expenses as being aviation related.
     14
      DPM reported as “Rent expense” $54,400, $27,607, and
$32,058, for 2002, 2003, and 2004, respectively. See app. A.
Although the record is not explicit on this point, it would
appear that these are the amounts that DPM paid DEL as rent for
the airplanes. The record does not establish the reasonableness
of such rents between these related entities. As discussed
infra, it appears that a substantial portion of the rents
represents petitioner’s personal use of the airplanes.
                               - 26 -

he took in the airplanes.    According to petitioner’s own

reckoning, then, at least 100 of his flights were for personal

purposes.   Insofar as we can tell from the record, however (and

petitioner does not contend otherwise), all the flights,

including those that petitioner concedes to have been personal,

are included in the aviation expense deductions that DPM claimed

for the years at issue.   The record does not reflect that

petitioner reimbursed DPM for any of these flights.

     Another problem brought to light by these flight logs is

that petitioner is claiming as part of DPM’s airplane

expenditures the cost of 22 flights that he made between January

1 and June 16, 2002, in the Mitsubishi, before DEL acquired the

Citation in July 2002.    DEL and DPM entered into the lease

agreement for the Citation on July 3, 2002.    Insofar as the

record shows, DEL never leased the Mitsubishi to DPM.    Petitioner

has not explained why any of the Mitsubishi expenses represent

expenses of DPM rather than of petitioner.

     Furthermore, it appears that petitioner has counted as

“business flights” numerous flights, both in the Mitsubishi and

in the Citation, that he made to the North Carolina country club

in which he owned a vacation home and a building lot.    In the

flight logs the purpose of these flights is generally described,

without elaboration, as “Inspect Property” or as

“Training/Inspect Property”.    Apparently, petitioner
                                 - 27 -

characterizes these as business flights partly because of the

asset management agreement whereby DPM purportedly agreed to

manage these properties on petitioner’s behalf.     The asset

management agreement, however, was executed on January 1, 2003,

and so has no bearing on flights petitioner made before then.

More fundamentally, we do not perceive any significant purpose,

apart from hoped-for tax benefits, in petitioner’s purportedly

arranging for DPM to manage his properties.     Because petitioner

was the sole officer, director, and shareholder of DPM, which had

no employees, this agreement was tantamount to petitioner’s

agreeing, for a fee, to “manage” his properties for himself.      Nor

are we impressed with petitioner’s suggestion that he should be

allowed to deduct the expenses of flying to his vacation home

because he hoped someday to sell it at a profit.15

     In the redacted flight logs the purpose of many of the so-

called business trips is listed simply as “Training”.     For many

years before forming DPM and DEL, petitioner had regularly taken

training flights to acquire flying licenses and to satisfy

insurance standards.     We are unconvinced that the “Training”

flights were not primarily for personal purposes.16     See Noyce v.


     15
      Similarly, we see no DPM-related purpose to a July 30,
2004, flight, included in petitioner’s redacted flight logs, in
which petitioner flew with his girlfriend and his daughter to
make an offer on the Miami Beach condominium that he and his
girlfriend would eventually coown in their own names.
     16
          In some instances, the flight logs manifest personal
                                                       (continued...)
                              - 28 -

Commissioner, 97 T.C. 670, 693 (1991) (treating training flights

as personal).

     Indeed, we do not believe that even the 20 or so flights

that petitioner made to two of the properties that DPM owned were

devoid of substantial personal motivations.   After all, these

were resort properties managed by professional management

companies.   Although petitioner testified that he performed

“global oversight” at these properties, his description of this

activity (“looking at the big picture, taking care of maintenance

items, et cetera, that type of thing”) does not persuade us that

any such activity would have much interfered with his personal

motives for his frequent weekends at the Key Largo condominium or

for his two trips to the Telluride, Colorado, condominium during

2004.

     Petitioner suggests that in evaluating whether the disputed

expenses were ordinary and necessary, we should take into account

not only the airplane trips he made to the two properties that

DPM owned but also the more numerous airplane trips he claims to

have made to investigate other prospective real estate



     16
      (...continued)
purposes for the “Training” flights. For instance, a “Training”
trip to Miami, Fla., on Aug. 14, 2002, is described in the
unredacted version of the flight logs as having the purpose of
“pick up daughter”. A “Training” trip to Chapel Hill, N.C., on
Sept. 27, 2002, is described in the unredacted version of the
flight logs as having the purpose of “visit Lisa”. Even in
instances where a personal purpose is not made manifest, however,
we are not convinced that personal motives were absent.
                                - 29 -

investments, allegedly on DPM’s behalf.    He has failed to

substantiate, however, that any such investigatory expenses

relating to new investment opportunities rather than to the

maintenance of existing investments qualify for deduction under

section 212.   See Bick v. Commissioner, T.C. Memo. 1978-390 (and

cases cited therein).

     In Noyce v. Commissioner, supra, this Court held that Intel

Corp.’s vice chairman, a licensed pilot, was entitled to deduct

unreimbursed expenses of using his private airplane in the course

of his employment with Intel.    The Court held that these were

ordinary and necessary expenses incurred in the taxpayer’s trade

or business as a corporate official, finding that he had not

voluntarily assumed the travel expenses, that his official duties

required extensive and frequent travel, that his access to the

airplane enabled him to significantly reduce his travel time,

that he traveled by aircraft only when there was business

advantage in doing so, and that the cost of replicating his

travel schedule and time savings via commercial charter carrier

would have exceed the costs of operating his airplane.    Id. at

685-688; see also Richardson v. Commissioner, T.C. Memo. 1996-368

(holding that the taxpayer was entitled to deduct airplane

expenses incurred by his S corporation as ordinary and necessary

expenses that contributed to the efficiency and productivity of

the corporation’s trade or business).
                              - 30 -

     Unlike the taxpayers in Noyce and Richardson, petitioner

does not contend that the disputed expenses were incurred in the

conduct of any trade or business.17    More fundamentally, unlike

the taxpayers in Noyce and Richardson, petitioner has failed to

identify business purposes independent of substantial personal

purposes for any of the flights in question.18    Rather, the

evidence convinces us that for all the flights in question

petitioner had substantial personal motives emanating from his

lifelong interest in flying airplanes.    From this perspective,

this case bears some similarity to Henry v. Commissioner, 36 T.C.

879 (1961).   In that case, a lawyer sought to deduct, as ordinary

and necessary business expenses, the costs of acquiring and

maintaining his yacht.   He claimed that he used the yacht to


     17
      Moreover, petitioner has not claimed, and the evidence
does not suggest, that he incurred the disputed expenses in the
conduct of his trade or business of being an employee of FRI.
The evidence does not show that petitioner used the airplane as
part of his FRI employment or that any such use would not have
represented his voluntary assumption of FRI’s expenses, rendering
them nondeductible to him. Cf. Noyce v. Commissioner, 97 T.C.
670, 683-685 (1991) (concluding that the taxpayer personally
incurred airplane expenses pursuant to Intel’s written travel
reimbursement policy requiring its officers to incur certain
expenses for Intel’s benefit without reimbursement).
     18
      In Noyce v. Commissioner, supra at 681-682, the taxpayer’s
personal use of the airplane was 45.6 hours out of a total 147.4
hours, and the taxpayer claimed no deduction for this personal
use. The Court in Noyce also disallowed expenses for flight
hours attributable to maintenance, training, and delivery on the
grounds that these flight hours did not represent business use.
Id. at 693. Similarly, in Richardson v. Commissioner, T.C. Memo.
1996-368, the taxpayer’s use of the airplane is described as
“minor”, and the taxpayer paid the actual cost associated with
this personal use.
                              - 31 -

promote his business.   In disallowing the expenses the Court

noted the taxpayer’s strong personal interest in yachting and

stated:

     In determining that which is “necessary” to a
     taxpayer’s trade or business, the taxpayer is
     ordinarily the best judge on the matter, and we would
     hesitate to substitute our own discretion for his with
     regard to whether an expenditure is “appropriate and
     helpful,” in those cases in which he has decided to
     make the expenditure solely to serve the purposes of
     his business. * * * But where, as in this case, the
     expenditures may well have been made to further ends
     which are primarily personal, this ordinary constraint
     does not prevail; petitioner must show affirmatively
     that his expenses were “necessary” to the conduct of
     his professions. * * * We do not think petitioner has
     shown that the expenses of acquiring and maintaining a
     yacht were “necessary” to the conduct of his
     professions. [Id. at 884.]

     Petitioner has failed to show that the disputed expenses

were ordinary and necessary expenses of DPM rather than his

personal expenses.   Accordingly, petitioner is not entitled to

deduct the claimed DPM nonrental pass-through losses pursuant to

section 212 or otherwise.19




     19
      On reply brief, petitioner appears to concede that some of
the flights for which he claimed deductions were personal and
states that “these expenses, at a minimum, would have to be
allocated based on the use”. He also acknowledges that “if it
were true” (and we find that it is true) that DPM deducted the
total airplane expenses without allocating any portions to
petitioner’s personal use, this “oversight or error should be
corrected.” Petitioner suggests that this “oversight or error”
should be corrected “as part of the computations that will be
made under Rule 155(b) * * * in accordance with the findings and
conclusions of this Court.” We disagree. In accordance with our
findings and conclusions supra, no allocation of the disputed
expenses is warranted.
                                 - 32 -

IV.     Passive Activity Limitations

        A.   The Parties’ Contentions

        Respondent contends that during the years at issue DPM’s

only activity was renting real estate and that DEL’s only

activity was leasing airplanes.     Accordingly, respondent contends

that under section 469(c)(2) petitioner’s activities with respect

to DEL and the DPM rental activity were per se passive activities

and his claimed losses therefrom are subject to the section

469(a) passive activity loss restrictions.20    Respondent further

argues that whether or not these rental activities are deemed per

se passive, all petitioner’s DPM and DEL activities were in fact

passive because petitioner failed to materially participate in

them.

      Petitioner contends that all his activities--including his

medical professional activities, his medical research activities,

his real estate investment activities, and the ownership and use

of airplanes--should be regarded as a “single activity” for

purposes of section 469.     From this perspective, he suggests,

DPM’s rental activities were merely “incidental” to its

investment activities, and DEL’s airplane rental activities

should be disregarded altogether, since “no one other than

Petitioner ever used the aircraft in connection with any


        20
      As previously noted, respondent concedes the adjustments
with respect to the 2003 and 2004 DPM rental losses, on the
ground that petitioner correctly treated these losses as passive
on his 2003 and 2004 returns. See supra note 7.
                                  - 33 -

activity.”     Accordingly, he contends, neither DEL’s nor DPM’s

activities should be treated as per se passive rental activities.

He further contends that he meets the material participation test

for these various activities, whether viewed separately or as a

group, and that accordingly the disputed losses are not subject

to the section 469 restrictions.

     B.   General Legal Principles

     Section 469(a)(1) disallows any deduction for a “passive

activity loss”, defined generally as the amount each year by

which the aggregate losses from all passive activities exceed

aggregate income from all passive activities.21     Sec. 469(d)(1).

Generally, a passive activity is one involving the conduct of a

trade or business in which the taxpayer does not materially

participate.    Sec. 469(c)(1).    Subject to certain exceptions, a

“rental activity” is treated as a per se passive activity without

regard to whether the taxpayer materially participates.     Sec.

469(c)(2), (4).    A “rental activity” is one in which payments are

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

      Generally, one or more trade or business activities or

rental activities may be treated as a single activity if the


     21
       By its terms, sec. 469 applies to individuals and various
specified entities but not to conduits such as partnerships and S
corporations. See sec. 469(a)(2). For purposes of sec. 469, the
character of each item of gross income and deduction allocated to
a taxpayer from a partnership or S corporation is determined by
reference to the taxpayer’s participation in the activity. Sec.
1.469-2T(e)(1), Income Tax Regs., 53 Fed. Reg. 5718 (Feb. 25,
1988).
                                - 34 -

activities constitute an appropriate economic unit for the

measurement of gain or loss for purposes of section 469.     Sec.

1.469-4(c)(1), Income Tax Regs.    As an exception to this general

rule, however, an activity involving the rental of real property

and an activity involving the rental of personal property

generally may not be treated as a single activity.    Sec. 1.469-

4(d)(2), Income Tax Regs.

     C.   Analysis

          1.     Petitioner’s Grouping Arguments

     On their 2003 returns petitioner and DPM elected to group

DPM’s and DEL’s activities for purposes of section 469.      Insofar

as the record shows, no grouping election was made before 2003.

And contrary to petitioner’s assertions on brief, no election was

ever made, for any year, to group these activities with his

medical practice employment or his medical research activities.

Indeed, such an election would have been inappropriate for a

variety of reasons.

     In the first instance, petitioner does not contend and the

record does not show that during the years at issue his medical

research activities constituted a “trade or business” so as to be

eligible for grouping with his other activities under the

regulations.22    See sec. 1.469-4(c)(1), Income Tax Regs.   As


     22
      Although petitioner testified that he reported
consultant’s fees from his medical research activities as
additional income on his tax returns, we find no such additional
                                                   (continued...)
                                - 35 -

previously discussed, we have also concluded that petitioner, by

insisting that DPM has claimed its nonrental expenses under

section 212 and by characterizing as “inapposite” respondent’s

complaint that DPM did not meet the trade or business requirement

of section 162(a), has effectively conceded that DPM’s nonrental

activities did not constitute a trade or business during the

years at issue.    Accordingly, petitioner’s medical research

activities and DPM’s nonrental activities are ineligible for

grouping with petitioner’s other activities.

     But even if we were to assume, for the sake of argument,

that all the activities which petitioner seeks to group

constituted either trades or businesses or rental activities, we

would nevertheless conclude that these activities do not

constitute an “appropriate economic unit” within the meaning of

the regulations.    Id.   The regulations provide that whether

activities constitute an appropriate economic unit for grouping

depends upon all the relevant facts and circumstances, with these

five factors receiving the greatest weight:

          (i) Similarities and differences in types of
     trades or businesses;


     22
      (...continued)
income reported on his returns for the years at issue.
Petitioner’s generalized testimony about his medical research
activities leaves us in doubt as to the exact periods during
which he might have been involved in these activities. But even
if we were to assume, for the sake of argument, that he was
involved in these activities during the years at issue, the
record does not establish that they would have constituted a
trade or business.
                               - 36 -

            (ii) The extent of common control;

            (iii) The extent of common ownership;

            (iv) Geographical location; and

            (v) Interdependencies between or among the
       activities (for example, the extent to which the
       activities purchase or sell goods between or among
       themselves, involve products or services that are
       normally provided together, have the same customers,
       have the same employees, or are accounted for with a
       single set of books and records). [Sec. 1.469-4(c)(2),
       Income Tax Regs.]

       Petitioner conducted his medical practice as an employee of

FRI.    Being an employee may be a trade or business.   Putoma Corp.

v. Commissioner, 66 T.C. 652, 673 (1976), affd. 601 F.2d 734 (5th

Cir. 1979).    Petitioner has made no showing, however, that his

trade or business of being an employee of FRI or any putative

trade or business involving his medical research satisfies any of

these grouping factors, with the possible exception of the

geographical factor.    It is not apparent to us that petitioner

used the airplanes to any significant degree in his medical

practice, based a short distance from his residence, or to what

extent he might have used the airplanes in any medical research

activities during the years at issue.    His central argument, as

we understand it, is that using the airplanes was helpful to his

medical employment and his medical research because it minimized

the time he would lose from these activities while pursuing other

activities, such as real estate activities (and, we infer,

vacations).    But any such connection does not suffice to make his
                                 - 37 -

various activities an “appropriate economic unit”.    We reject

petitioner’s suggestion that all his activities should be grouped

for purposes of section 469.23

          2.   DEL’s Rental Activity

     Apart from his grouping argument, which we have rejected,

petitioner has advanced no reason for us to conclude that DEL’s

activity was not in fact, as petitioner and DPM expressly

characterized it in their grouping elections, an “equipment

rental activity”.    Petitioner has not shown that respondent erred

in treating DEL’s rental activity as per se passive under section

469(c)(2) and (4).   Consequently, we hold that the Schedule C

losses petitioner claimed with respect to DEL’s activities are

subject to the passive activity loss limitations.24


     23
      Consequently, we also reject as without legal or factual
basis petitioner’s argument that “as a result of the grouping
pursuant to the elections, it is appropriate to merge together,
and to ignore the separateness of, the aircraft rental income
received and the aircraft rental expense paid.” Taken to its
logical conclusion, petitioner’s argument might suggest that the
transactions or entities in question should be collapsed or
disregarded and viewed, in substance, as signifying nothing more
than petitioner’s attempt to garner tax deductions by renting his
airplanes to himself. But because respondent has not pursued
this precise argument, neither do we.
     24
      We note that this holding will result in a smaller
increase to petitioner’s taxable income with respect to this item
than respondent determined in the notice of deficiency, which
disallowed petitioner’s Schedule C DEL deductions entirely for
failure to establish that any amounts had been paid or incurred
for ordinary and necessary expenses. In this proceeding,
respondent concedes that the DEL expenses were paid or incurred
and has not argued that the DEL expenses were not ordinary and
necessary. Rather, respondent has sought only to limit the DEL
                                                   (continued...)
                               - 38 -

            3. DPM’s Rental Activity

       For 2003 and 2004 petitioner reported the DPM rental losses

as passive, and respondent has conceded any adjustment with

respect to these items for these years.    Respondent continues to

challenge, however, petitioner’s treating the 2002 DPM rental

losses as nonpassive.    Respondent contends that the 2002 DPM

rental activity was per se passive under section 469(c)(2) and

(4).    Petitioner disagrees, contending that, at least for 2002

(the only year for which petitioner reported the DPM rental

activity as nonpassive), DPM’s rental activity was incidental to

its primary activity of holding investment properties for future

appreciation.25   We need not decide whether DPM’s rental activity


       24
      (...continued)
deductions on the grounds that they represent passive activity
losses under sec. 469 and, alternatively, that the DEL activity
was an “activity not engaged in for profit” within the meaning of
sec. 183(c). If respondent’s alternative sec. 183 contention
were sustained, the result would be to limit petitioner’s DEL
deductions to DEL’s gross income for each year at issue. See
sec. 183(a) and (b). As discussed in more detail infra, in
petitioner’s circumstances this result is functionally equivalent
to applying the sec. 469 restrictions to petitioner’s DEL losses.
Consequently, we need not and do not address respondent’s
alternative sec. 183 contentions.
       25
      Under temporary regulations, an activity involving the use
of tangible property is not treated as a rental activity for a
taxable year if rental of the property is treated as incidental
to a nonrental activity. Sec. 1.469-1T(e)(3)(ii)(D), Temporary
Income Tax Regs., 53 Fed. Reg. 5702 (Feb. 25, 1988). Rental of
property is treated as incidental to an activity of holding the
property for investment only if the principal purpose of holding
the property is to realize gain from the appreciation of the
property and the gross rental income from the property is less
than 2 percent of the lesser of (i) the unadjusted basis of the
                                                   (continued...)
                                 - 39 -

was “incidental”, because even if it were, to avoid the section

469 restrictions petitioner would still need to show that he

materially participated in this activity.     As discussed below,

petitioner has not shown that he materially participated in any

of the DPM activities (or for that matter, the DEL activities)

for any year, whether they be considered singly or together.

          4.    Lack of Material Participation

     Material participation is defined generally as regular,

continuous, and substantial involvement in the business

operations.    Sec. 469(h)(1).   The regulations identify these

seven situations in which an individual will be treated as

materially participating in an activity:

          (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 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 (within the meaning of paragraph (c) of this
     section) for the taxable year, and the individual’s


     25
      (...continued)
property, or (ii) the fair market value of the property. Sec.
1.469-1T(e)(3)(vi)(B)(2), Temporary Income Tax Regs., 53 Fed.
Reg. 5703 (Feb. 25, 1988).
                             - 40 -

     aggregate participation in all significant participation
     activities during such year exceeds 500 hours;

          (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;

          (6) The activity is a personal service activity (within
     the meaning of paragraph (d) of this section), and the
     individual materially participated in the activity for any
     three taxable years (whether or not consecutive) preceding
     the taxable year; or

          (7) Based on all of the facts and circumstances (taking
     into account the rules in paragraph (b) of this section),
     the individual participates 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. 5725-5726 (Feb. 25, 1988).]

The regulations also provide that the last-described “facts and

circumstances” test requires that the individual’s participation

in the activity exceed 100 hours during the taxable year.26   Sec.

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

5726 (Feb. 25, 1988).

     On brief petitioner claims that he meets the third, fourth,

sixth, and seventh of these tests.    He has directed us, however,

to no evidence or proposed findings to show that he meets the



     26
      Although the regulations permit a taxpayer to establish
the extent of his participation by “any reasonable means”, sec.
1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727
(Feb. 25, 1988), a postevent “ballpark guesstimate” does not
suffice, see Lee v. Commissioner, T.C. Memo. 2006-193; Bailey v.
Commissioner, T.C. Memo. 2001-296; Carlstedt v. Commissioner,
T.C. Memo. 1997-331; Speer v. Commissioner, T.C. Memo. 1996-323;
Goshorn v. Commissioner, T.C. Memo. 1993-578.
                               - 41 -

quantitative requirements for the third, fourth, or seventh test,

as applied to his activities separately.    Petitioner’s reliance

on all four tests appears to be partly or (in the case of the

sixth test) wholly premised on the notion that all his activities

should be grouped together so as to constitute, in the aggregate,

a personal service activity.   For the reasons discussed above, we

reject this premise.

     D.   Summary of Conclusions

     We conclude and hold that petitioner’s DEL and DPM

activities were passive.   Consequently, pursuant to section

469(d), for each year at issue he may not deduct losses from

these passive activities to the extent that his aggregate losses

from all his passive activities exceed his aggregate income from

these activities.   Application of this rule in calculating

petitioner’s tax liability requires some consideration of the

interplay among petitioner’s various activities in the light of

our holdings.

     For each year at issue, petitioner engaged in three passive

activities:   (1) The DPM nonrental activity; (2) the DPM rental

activity; and (3) the DEL activity.     We have disallowed the DPM

nonrental losses for failure to show that the disputed expenses

were ordinary and necessary.   Consequently, petitioner is allowed

no loss, passive or otherwise, with respect to the DPM nonrental

activity.   For 2002 and 2003 petitioner reported no income from
                              - 42 -

the DPM nonrental activity.   For 2004, however, petitioner

reported $15,000 of income from the DPM nonrental activity;

pursuant to our earlier holding, petitioner is allowed no

deductions against this income.   For 2004, then, the result of

our holding DPM’s nonrental activity to be passive is partly to

“free up” $15,000 of passive income to be added to petitioner’s

aggregate income from all passive activities and thereby to

increase by $15,000 the aggregate losses petitioner is allowed to

claim with respect to all his passive activities for 2004.27

V.   Accuracy-Related Penalties

     Respondent determined that for each year at issue petitioner

is liable for an accuracy-related penalty pursuant to section

6662(a) and (b)(2) for substantial understatement of income tax.

Respondent bears the burden of production with respect this


     27
      As previously noted, we have declined to address
respondent’s alternative argument under sec. 183 that
petitioner’s DEL activity was not engaged in for profit. Our
reason for declining to address this alternative argument was
that, even if it were sustained, it would not affect petitioner’s
tax liabilities in any way different from our holding that the
DEL losses were subject to the sec. 469 restrictions. In the
light of the discussion supra, that conclusion requires some
further elaboration. If we had held that the DEL losses were
subject to the sec. 183 limitation, those losses would have been
allowable only to the extent of DEL’s gross income for each year
and consequently would not have been available to absorb the
$15,000 of “freed up” passive income from the DPM nonrental
activity in 2004. But because the DPM rental activity generated
more than $15,000 of losses in excess of income from that
activity, those losses are available to offset the $15,000 of
“freed up” passive income from the DPM nonrental activity,
independent of any effect that our treatment of the DEL losses,
as being limited by either sec. 183 or 469, might have upon the
calculation.
                                  - 43 -

penalty.    Sec. 7491(c).    To meet this burden, respondent must

produce evidence establishing that it is appropriate to impose

this penalty.    Once respondent has done so, the burden of proof

is upon petitioner.    See Higbee v. Commissioner, 116 T.C. at 449.

     Section 6662(a) and (b)(2) imposes a 20-percent

accuracy-related penalty on any portion of a tax underpayment

that is attributable to any substantial understatement of income

tax, defined in section 6662(d)(1)(A) as an understatement that

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

on the return or $5,000.      The exact amount of petitioner’s

understatement will depend upon the Rule 155 computation, taking

into account respondent’s concessions and in accordance with our

findings and conclusions.      To the extent that those computations

establish, as seems almost certain, that petitioner has a

substantial understatement of income tax, respondent has met his

burden of production.       See Prince v. Commissioner, T.C. Memo.

2003-247.

     The accuracy-related penalty does not apply with respect to

any portion of the underpayment if it is shown that the taxpayer

had reasonable cause and acted in good faith.      Sec. 6664(c)(1).

Petitioner contends that he had reasonable cause and acted in

good faith because in reporting his taxes for the years at issue

he relied in good faith on advice from the Meiners firm, which

prepared DPM’s Forms 1120S and numerous schedules and tables that
                                - 44 -

were incorporated into petitioner’s Forms 1040.    He also contends

that he relied upon Advocate, which advised him in forming DEL

and DPM and in preparing necessary documents.

     Reliance on a professional tax adviser’s advice may

demonstrate reasonable cause and good faith if, taking into

account all the facts and circumstances, the reliance was

reasonable and the taxpayer acted in good faith.    Sec. 1.6664-

4(b)(1), (c)(1), Income Tax Regs.    Reliance on a tax adviser may

be reasonable and in good faith if the taxpayer establishes:      (1)

The adviser was a competent professional with sufficient

expertise to justify reliance; (2) the taxpayer provided

necessary and accurate information; and (3) the taxpayer actually

relied in good faith on the adviser’s judgment.    Neonatology

Associates, P.A. v. Commissioner, 115 T.C. 43, 99 (2000), affd.

299 F.3d 221 (3d Cir. 2002).    The advice must not be based on

unreasonable factual or legal assumptions and must not

unreasonably rely on representations, statements, findings, or

agreements of the taxpayer or any other person.    Sec. 1.6664-

4(c)(1)(ii), Income Tax Regs.

     Our determinations regarding petitioner’s tax deficiencies

turn on two key issues:   (1) Whether DPM’s nonrental expenses

were ordinary and necessary expenses; and (2) whether his DPM and

DEL activities were passive activities.    Petitioner has not shown

that he provided his tax advisers necessary and accurate
                               - 45 -

information as to certain critical matters regarding these

issues.   Moreover, it appears that his advisers unreasonably

relied on certain of his representations.

     More particularly, the disputed airplane expenses, reported

as ordinary and necessary expenses of DPM, emanate from the

flight logs that petitioner maintained.    Meiners testified that

these flight logs were a “logbook format that we provide to our

clients as an example of what they can use to meet the

documentation requirements.”    It appears, however, that the

Meiners firm accepted at face value petitioner’s characterization

of all his flights as business related.

     Similarly, the evidence indicates that it was petitioner,

not his tax advisers, who decided whether to characterize his

activities as passive or nonpassive.    Meiners testified:   “The

client would tell us whether or not it was passive or nonpassive.

* * * We would have to ask the client.    We would have no way of

knowing without. * * * If the client told us it was passive,

fine.   It was passive.   If the client tells us -- you know, we

don’t know unless the client tells us.”    Judging from this

testimony, it appears that on this critical issue the tax

advisers relied upon petitioner, rather than the other way

around.

     As petitioner acknowledges on brief, he is “highly educated

and sophisticated and possesses extensive business experience.”
                             - 46 -

Accordingly, as petitioner concedes, “the standard of care that

must have been exercised by the Petitioner is a high one.”    We

are not convinced that petitioner met that high standard of care.

We hold that for each year at issue petitioner is liable for a

section 6662(a) penalty insofar as the Rule 155 calculations show

a substantial understatement of income tax.

     To reflect the foregoing and respondent’s concessions,


                                        Decision will be entered

                                   under Rule 155.
                             - 47 -

                           APPENDIX A

                  DPM Nonrental Loss Deductions

                                 2002        2003       2004

Repairs & maintenance              --       $22,506    $54,591
Rent expense                    $54,400      27,607     32,058
Taxes & licenses                    600          25        125
Depreciation                       --         1,056      1,353

Other deductions:
  Auto & truck expense            2,038       3,075      3,075
  Avionics                        2,630        --         --
  Fuel                           57,567      55,210     53,143
  Landing fees permits            3,092        --         --
  Maintenance Aircraft           30,575        --         --
  Real estate fees                  160        --         --
  Training                       22,850       1,724      1,794
  Charts & maps                    --           279          81
  Dues & subscriptions             --         1,045       --
  Flight planning fees             --           162       --
  Hanger rent                      --         6,000       --
  Insurance                        --        24,310     20,910
  Legal & professional             --           375      1,300
  Management fees                  --         1,800      1,800
  Meals & entertainment            --           526        261
  Miscellaneous                    --           488        430
  Oil                              --             58      --
  Other rent                       --           213       --
  Ramp & landing fees              --           179        106
  Postage                          --          --          339
  Supplies                         --             46     1,307
  Telephone                        --           788        725
  Tie down parking                 --           543        770
  Transportation                   --           200        200
  Travel                           --         2,263      1,134
Total                          173,912      150,478    175,502
                           - 48 -

                         APPENDIX B

                 DPM Rental Loss Deductions

                                2002      2003      2004

Advertising                     $196       --        --
Auto & travel                  1,414       $319      --
Cleaning & maintenance           692       --        --
Commissions                      261      4,858      --
Insurance                      4,027      1,773    $1,965
Interest                       4,578     21,837    66,883
Repairs                         --        1,118     6,082
Taxes                          1,382     14,863    13,529
Utilities                        503      1,183     2,087
Depreciation                  20,829     33,685    67,228
Other deductions               6,602     14,509    13,367
  Total                       40,484     94,145   171,141
