                        T.C. Memo. 2006-193



                      UNITED STATES TAX COURT



             KAI H. and SUSANNA LEE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

             ULYSSES K. and JANE LEE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 16601-04, 16602-04.    Filed September 11, 2006.



     Roger Adams, for petitioners.

     John D. Faucher, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     HOLMES, Judge:   In 1999 and 2000, Ulysses Lee was a full-

time employee of the IRS; his brother, Kai, worked as a doctor

and professor and ran several other businesses.   One of these

businesses was Lee Brothers Investments, a real estate investment
                                - 2 -

partnership that Kai and Ulysses ran together and which owned a

house and two small apartment buildings.     In 1999 and 2000, Lee

Brothers Investments and the brothers’ other real estate

investments ran up big, albeit noncash, losses.    The Commissioner

argues that these losses were passive, and so may not be used by

the Lees to offset their other income.

                          FINDINGS OF FACT

     The Lee brothers were born in China, and moved to Honolulu

in 1961.   Both later moved to the mainland (they were California

residents when they filed their petitions) and started families

of their own.   The Lees are well educated:   Ulysses earned a

bachelor’s degree in accounting and a master’s in business

administration.   Kai earned bachelor’s and master’s degrees in

nuclear engineering, and another master’s degree and a doctorate

in medical physics.

     During 1999 and 2000, Kai worked full time as a professor of

radiology under a joint appointment at the University of Southern

California and the Los Angeles County Medical Center.    Kai also

co-owned and operated (beginning in 2000) 101 Positron Emission

Tomography Management Services LLC, a medical diagnostic

facility; Kai Lee, Ph.D., Inc., a consulting service; and

invested in a few real estate ventures with members of his

family.    Ulysses Lee was a full-time examiner at the IRS, and he

also invested in real estate.
                                 - 3 -

     The brothers are equal partners in Lee Brothers Investments,

a partnership that owned three rental properties--one single-

family home and a five-unit apartment building in southern

California, and another small apartment building in Hawaii.

Outside this partnership, Kai Lee owns three other rental

properties (two single-family homes and a three-unit apartment

building); and Ulysses owns one other rental property, a four-

unit apartment building.    These properties produced losses,

largely from depreciation, which the Lees reported on their

returns.

     The Commissioner disallowed the losses, and added accuracy-

related penalties to the resulting deficiencies, for both years

and both brothers.    The Lees filed timely petitions, and the

cases were consolidated and tried together in Los Angeles.

                                OPINION

A.   Passive Activity Losses

     The focus of the trial was on whether the challenged losses

were deductible.     The Code allows taxpayers to deduct most

business and investment expenses under sections 162 and 212;1

however, section 469 limits these deductions when they arise from

“passive” activities.    Section 469(c)(2) defines passive


     1
       Unless otherwise indicated, section references are to the
Internal Revenue Code as in effect for the years at issue, and
the Rule reference is to the Tax Court Rules of Practice and
Procedure.
                               - 4 -

activities as including rental activities.   The notice of

deficiency that the Commissioner sent the Lees disallowed their

losses from Lee Brothers Investments and their other real estate

ventures because the Commissioner concluded that they were all

“rental real estate activities,” and so per se passive.      The

Commissioner also reduced the size of the depreciation expenses

that the Lees had taken on two of their properties, because they

had used a 10-year useful life rather than the 27.5-year life

clearly required by law.   The Lees had no good reason for having

done this, and conceded the issue before trial.

     The trial focused on whether the brothers’ work on their

rental real estate qualified them for an exception to the Code’s

characterization of rental activities as passive.   The exception

that they aimed for is section 469(c)(7)(B), and it applies if:

               (i) more than one-half of the personal
          services performed in trades or businesses by
          the taxpayer during such taxable year are
          performed in real property trades or
          businesses in which the taxpayer materially
          participates, and

               (ii) such taxpayer performs more than
          750 hours of services during the taxable year
          in real property trades or businesses in
          which the taxpayer materially participates.

     In the case of a joint return, the requirements of the
     preceding sentence are satisfied if and only if either
     spouse separately satisfies such requirements. * * *

     There are a few elements to this exception about which there

is no dispute.   First, for both years and in both cases, this
                                  - 5 -

exception will either be met or not by the services performed by

the brothers themselves--both filed joint returns, but their

wives did no work in the real estate business.    And there is

likewise no dispute that Lee Brothers Investments and their other

properties qualify as a “real property trade or business”--

renting to tenants is included in the statutory definition of the

term.    See sec. 469(c)(7)(C).   Finally, we assume that both the

brothers Lee were “material participants” in their real estate

ventures.

     That distills the case into one that turns on a single issue

--whether or not each Lee brother worked more than half his total

time providing “personal services performed in trades or

businesses” on their real estate business.

     The burden of proof on this issue lies with the Lees.2      The

method of proof, set out in section 1.469-5T(f)(4), Temporary

Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988), is quite

lenient, letting taxpayers prove their time spent by “any

reasonable means.”    Reasonable means are not limited to

“Contemporaneous daily time reports, logs, or similar documents,”



     2
       The Lees argued that the burden of proof should be shifted
to the Commissioner under section 7491. We find, however, that
they failed to cooperate fully with the IRS during the audit and
IRS appeals process by failing to cooperate with the IRS’s
reasonable requests for information, interviews, and documents.
See sec. 7491(a)(2)(B). We also decide this case after weighing
the evidence, using a preponderance-of-the-evidence standard, not
on the basis of the initial allocation of proof.
                               - 6 -

but include “the identification of services performed over a

period of time and the approximate number of hours spent

performing such services during such period, based on appointment

books, calendars, or narrative summaries.”     Id.; see Mowafi v.

Commissioner, T.C. Memo. 2001-111.     But despite its apparent

leniency, this section of the regulations does not require us to

believe a “ballpark guesstimate” of the time spent on different

activities.   Carlstedt v. Commissioner, T.C. Memo. 1997-331;

Speer v. Commissioner, T.C. Memo. 1996-323; Goshorn v.

Commissioner, T.C. Memo. 1993-578.

     The Lees tried to prove their cases with time logs.    These

were not contemporaneous logs, though, but reconstructions based

on each brother’s personal experience and a smattering of the

partnership’s records from 1999 and 2000.    According to the Lees,

they worked enormously long hours on their real estate business.

Kai claimed to rack up 2,087 hours in 1999 and 2,226 hours in

2000.   And Ulysses worked only a little less--reporting on his

logs that he spent 2,063 hours in 1999 and 2,102 hours in 2000,

working with his brother on these small properties.

     We do not find these logs, or the testimony accompanying

them, credible.   The credibility problems begin with the fact,

which we already noted, that both brothers had full-time salaried

jobs during 1999 and 2000--Kai as a professor of radiology, and

Ulysses as an IRS examiner.   Kai also worked for his own
                               - 7 -

corporation as a consultant; and in 2000 founded, and began

working for, 101 Positron.

      The credibility problems grew when the Commissioner

introduced time logs that each brother produced to the IRS during

audit and pretrial preparation.   Kai submitted his first 1999 log

at his appeals conference with the IRS; Ulysses produced logs for

both years at his IRS audit.   A side-by-side comparison shows:

           First log to IRS            Log introduced at trial

Kai          1999 - 1125                    1999 - 2087
             2000 - N/A                     2000 - 2226

Ulysses      1999 - 994                     1999 - 2063
             2000 - 875                     2000 - 2102

      If the brothers are to be believed, they each discovered

more than a thousand missing hours for each year between the time

of the audit and the time of trial.     But the logs introduced at

trial are packed with too much exaggeration to be believed.      Here

are a few examples from Ulysses’:

      !    280 hours each year to close the books and prepare
           information about the partnership for he and his
           brother to use in completing their tax returns.

      !    80 hours in 2000 preparing for an IRS audit because the
           partnership’s records were in such disarray, despite
           his 280 hours of work in closing the books. (The audit
           of the 2000 returns, of course, did not actually take
           place in 2000.)

      !    24 hours to replace four miniblinds in one of the
           apartments, 42 hours to paint another, and 56 hours to
           install a new toilet in a third.
                               - 8 -

     And here are a few from Kai’s:

     !    186 hours in 1999 to show a single vacant apartment to
          prospective tenants.

     !    200 hours of answering calls from prospective tenants
          in both years.

     !    48-50 hours to wrap coins from laundry machines in one
          of the apartment buildings.

     But because the brothers had to show not only the time they

spent on partnership business, but that it was greater than the

time they spent on other jobs, the exaggeration in their logs of

real estate work was matched by understatements of time spent at

their full-time jobs.   Ulysses calculated his hours spent working

for the IRS by deducting his sick leave and vacation from a full-

time schedule.   But the Commissioner introduced time and

attendance records from the IRS, showing that Ulysses hadn’t used

all his available sick and annual leave.   This forced him to take

the dubious position that he routinely filled in his own time-

and-attendance records inaccurately.

     Kai Lee’s testimony on this point was no better.   He swore

that he worked for the corporation that he owned--a corporation

that produced more than $60,000 in gross receipts for both years

--only 37 hours in 1999, and 3 hours in 2000.   He likewise

claimed to have spent only 135 hours working for 101 Positron

(the diagnostic facility that he owned and operated).   But when,

during the exam process, he argued that 101 Positron was not a

passive activity, he told the appeals officer that he spent “at
                               - 9 -

least 20 hours each week” on that job.   (And he must have been

convincing--the Commissioner conceded this issue.)

     The credibility of the brothers’ testimony was undermined

even when it touched on other areas.   For instance, when asked on

cross-examination whether he knew anything about what an IRS

appeals officer does, Kai Lee responded:   “I don’t know any IRS

people.”   His brother Ulysses, who had just retired from his

career as an IRS examiner, was sitting at petitioners’ table with

him at the time.

     We conclude from all this that the Lee brothers’ claims

about the number of hours they worked are not credible.   They are

nothing more than “post-event ballpark guesstimates,” and in

these cases, not really in the ballpark at all.   We must find

neither Lee met the test for either year for being considered a

real estate professional.   Their real estate losses were passive.

B.   Section 6662

     The brothers also contest the Commissioner’s determination

to impose an accuracy-related penalty under section 6662.   The

Commissioner gives two reasons to support his determination.     The

first is negligence.   The regulation defines negligence as not

making

     a reasonable attempt to comply with the provisions of
     the internal revenue laws or to exercise ordinary and
     reasonable care in the preparation of a tax return.
     “Negligence” also includes any failure by the taxpayer
     to keep adequate books and records or to substantiate
                               - 10 -

     items properly. * * * Negligence is strongly indicated
     where--

                       *   *   *   *   *   *   *

          (ii) A taxpayer fails to make a reasonable
          attempt to ascertain the correctness of a
          deduction * * * on a return which would seem
          to a reasonable and prudent person to be “too
          good to be true” under the circumstances;

Sec. 1.6662-3(b)(1), Income Tax Regs.

     Our finding on reasonableness is strongly influenced by the

experience, knowledge, and education of the taxpayers involved.

See Pratt v. Commissioner, T.C. Memo. 2002-279.         Considering that

Ulysses worked as an IRS examiner, and his brother Kai was highly

educated and a long-time real estate investor, the Lees can

hardly argue that they made a reasonable attempt to comply with

the Code or exercise ordinary and reasonable care in preparing

their returns--either in picking a depreciable life for two of

the properties out of thin air, or in figuring out whether they

met the definition of real estate professional in section

469(c)(7) before they filed their returns.         Ulysses could have

easily sought advice on passive activities or the taxation of

rental activities from one of his colleagues if he didn’t feel

confident in his own knowledge of the Code and regulations.         The

brothers--remarkably sophisticated in tax law and business, and

quite well educated--were also unable to point to any substantial

authority or evidence of good faith reliance on the advice of an
                              - 11 -

attorney or accountant.   Cf. United States v. Boyle, 469 U.S.

241, 251 (1985).

     Section 6662(d)(1)(A) provides another ground for sustaining

the penalty.   It penalizes a substantial understatement, defined

as one that is the greater of ten percent of the tax required to

be shown on the return or $5,000.   The understatements on the

brothers’ returns meet this definition for both years.     To

reflect concessions and settlements on other issues, though,



                               Decisions will be entered

                          under Rule 155.
