                         T.C. Memo. 2013-167



                   UNITED STATES TAX COURT



 GUILLERMO MERINO, JR., AND LISA MERINO, Petitioners v.
   COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 7518-11.                           Filed July 16, 2013.



        R determined a deficiency in Ps’ 2007 Federal income tax.
After Ps’ concession, the issues for decision are: (1) whether I.R.C.
sec. 469 limits Ps’ claimed losses from a real estate rental activity; (2)
whether Ps are liable for an I.R.C. sec. 6651(a)(1) addition to tax for
late filing; and (3) whether Ps are liable for an I.R.C. sec. 6662(a)
accuracy-related penalty.

       Held: P-H failed to prove that he spent more time performing
services for a real estate trade or business than he spent performing
services for other trades or businesses. Therefore P-H is not a real
estate professional. The losses attributable to P-H’s real estate rental
activity are subject to the passive activity limitations of I.R.C. sec.
469(a), and Ps do not qualify for the exception under I.R.C. sec.
469(i).

       Held, further, Ps are liable for the I.R.C. sec. 6651(a)(1)
addition to tax.
                                         -2-

[*2]          Held, further, Ps are liable for the I.R.C. sec. 6662(a) accuracy-
       related penalty.



       Guillermo Merino, Jr., pro se.1

       Sebastian Voth, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


       WHERRY, Judge: This case is before the Court on a petition for

redetermination of an income tax deficiency that respondent determined for

petitioners’ 2007 tax year. After a concession2 by petitioners, the issues for

decision are: (1) whether section 469 limits petitioners’ losses from a real estate

rental activity; (2) whether petitioners are liable for an addition to tax under

section 6651(a)(1); and (3) whether petitioners are liable for an accuracy-related

penalty under section 6662(a).3


       1
      At trial Mr. Merino submitted to the Court a letter of consent from Ms.
Merino informing the Court that she authorized Mr. Merino to act on her behalf.
       2
      Petitioners conceded the disallowance of $21,123 of their deduction for
home mortgage interest.
       3
      Unless otherwise noted, all section references are to the Internal Revenue
Code of 1986 as amended and in effect for the year in issue. All Rule references
                                                                      (continued...)
                                          -3-

[*3]                             FINDINGS OF FACT

       Some of the facts have been stipulated, and the stipulation of facts and

supplemental stipulation of facts with their accompanying exhibits are hereby

incorporated by reference into our findings. At the time they filed their petition,

petitioners resided in California.

       Lisa Merino was not a real estate professional during 2007. Guillermo

Merino, Jr., was the president and sole shareholder of One Stop Home Loans (One

Stop), an S corporation, in 2007. Mr. Merino organized One Stop in 2005 to

independently process loan applications for various lenders. A typical day at One

Stop for Mr. Merino consisted of supervising between two and four employees,

making calls, bringing borrowers or potential borrowers into the office, and

reviewing and processing files and loans. Mr. Merino was responsible for

monitoring the finances of One Stop, and all of the money went through his

account. In 2007 Mr. Merino received income of $112,489 reported on a Schedule

K-1, Shareholder’s Share of Income, Deductions, Credits, etc., and income of

$20,000 reported on a Form W-2, Wage and Tax Statement, from One Stop.4


       3
        (...continued)
are to the Tax Court Rules of Practice and Procedure.
       4
           Petitioners’ Form 1040, U.S. Individual Income Tax Return, reported a
                                                                        (continued...)
                                         -4-

[*4] Also in 2007 Mr. Merino operated a business listed as Mona Vie, Inc., on

petitioners’ Schedule C, Profit or Loss From Business, attached to their 2007 Form

1040. This business involved the sale and distribution of an acai berry drink. The

business was not associated with Mr. Merino’s mortgage business or his real estate

rental activity.

       Mr. Merino’s third income-producing activity in 2007, and the activity at

the center of the dispute in this case, is his real estate rental activity. He owned

seven properties in 2007, one in Colorado and six in Nevada. To handle the

Colorado property, Mr. Merino used a management company throughout 2007.

As consideration for the management company’s services in 2007, he paid $120

per month. The management company collected rent, leased or rented the

property, looked into problems with the property, and talked with the homeowners

association. For the six Nevada properties, Mr. Merino engaged the services of an

assistant at the rate of $50 to $75 per month per property who collected checks

from tenants and handled assigned tasks requested by Mr. Merino. Examples of

such requests included opening doors for locked-out tenants and arranging for

       4
        (...continued)
total of $199,015 in wage income. Presumably $179,015 of this income is
attributable to Mrs. Merino. Petitioners reported their adjusted gross income as
$293,297. Respondent’s adjustments resulted in adjusted gross income of
$362,406.
                                        -5-

[*5] delivery of rock for a property’s yard landscaping. In late 2007 or sometime

in 2008 Mr. Merino prepared a summary of the time he spent in connection with

the rental properties.

      On April 14, 2008, petitioners filed a request for an automatic extension of

time to file their tax return, which made their return due on October 15, 2008.

Petitioners did not file their 2007 tax return until March 14, 2010. On the return

petitioners reported losses from all seven rental properties on their Schedule E,

Supplemental Income and Loss, for the 2007 tax year. Respondent issued a notice

of deficiency, and petitioners timely petitioned this Court. A trial was held on

March 23, 2012, in Los Angeles, California.

                                     OPINION

I.    Burden of Proof

      The Commissioner’s determination of a taxpayer’s liability is generally

presumed correct, and the taxpayer bears the burden of proving that the

determination is improper. See Rule 142(a); Welch v. Helvering, 290 U.S. 111,

115 (1933). However, pursuant to section 7491(a), the burden of proof on factual

issues that affect the taxpayer’s tax liability may be shifted to the Commissioner

where the “taxpayer introduces credible evidence with respect to * * * such issue.”

Petitioners have not established that they meet the requirements under section
                                          -6-

[*6] 7491(a)(1) and (2) for such a shift. Consequently, the burden of proof

remains on them. Moreover, deductions are a matter of legislative grace, and

petitioners bear the burden of proving that they are entitled to any of the

deductions claimed. See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84

(1992).

II.   Real Estate Rental Activity

      Section 469 generally limits a taxpayer’s deductions attributable to “passive

activities” to the amount of the income generated by the taxpayer’s “passive

activities”. Madler v. Commissioner, T.C. Memo. 1998-112, slip op. at 6. A

“passive activity” includes: (1) any activity which involves the conduct of a trade

or business and in which the taxpayer does not materially participate, and (2)

except for the rental real estate activity of certain taxpayers engaged in the real

property trade or business as provided in section 469(c)(7), any rental activity

without regard to whether the taxpayer materially participates in the activity. Sec.

469(c)(1), (2), (4), (7). The parties do not dispute that the activity in question here

is rental activity that meets the definition of a real property trade or business.

Rather, the question is whether Mr. Merino was actively engaged in a real property

trade or business as provided in section 469(c)(7) (i.e., whether he was a real

estate professional).
                                           -7-

[*7] A taxpayer qualifies as a real estate professional, and his rental real estate

activity is not per se a passive activity, 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.

Sec. 469(c)(7)(B). In the case of a joint return, a spouse must separately satisfy

the requirements of section 469(c)(7) to qualify as a real estate professional. Id.

Further, unless the taxpayer elects otherwise, the taxpayer must satisfy the

requirements of material participation as applied separately to each property or

interest in rental real estate. Sec. 469(c)(7)(A). Without an election, in addition to

performing more than 750 hours of services in a real property trade or business,

the taxpayer must materially participate in each rental activity. Shaw v.

Commissioner, T.C. Memo. 2002-35, slip op. at 27-28.5

       Respondent contends that petitioners failed to prove that: (1) Mr. Merino

performed more than half of his services in real property trades or businesses and

       5
       Petitioners did not make such an election for the 2007 tax year. They
contend, however, that we should honor a late election. We need not decide this
issue because, as we find infra, petitioners do not meet the requirements of sec.
469(c)(7) without regard to such an election.
                                         -8-

[*8] (2) Mr. Merino performed more than 750 hours of services in a real property

trade or business. We agree. Petitioners presented no evidence of how many

hours Mr. Merino spent at One Stop and Mona Vie. Clearly, the time spent at One

Stop was significant as petitioner supervised between two and four employees, ran

the business as president, processed and reviewed files and loans, and monitored

finances. Because Mr. Merino failed to present evidence6 of the time spent on

non-rental-activity services, he failed to meet the first requirement of section

469(c)(7)(B). Because he failed to meet this requirement, the real estate rental

activity is a passive activity and the limitation on losses applies.

      Further, we find that petitioners failed to carry their burden of proof with

respect to section 469(c)(7)(B)(ii). Mr. Merino’s summary of hours is insufficient

to substantiate the 750 hours requirement. A taxpayer may establish the 750 hours

“by any reasonable means”. Sec. 1.469-5T(f)(4), Temporary Income Tax Regs.,

53 Fed. Reg. 5727 (Feb. 25, 1988). “Any reasonable means” does not require the

      6
        Mr. Merino’s statements in his briefs that he spent only 20 hours per week
on One Stop because he was staying at home caring for his wife and infant
daughter, however true or sympathetic, are not evidence. See Rule 143(c)
(“[S]tatements in briefs * * * do not constitute evidence.”). At trial Mr. Merino
rested without calling any witness. Respondent called Mr. Merino as a witness
and examined him at length. Mr. Merino, however, chose not to offer any cross-
examination. Consequently, he never testified about caring for his wife or infant
daughter. Had he done so, that testimony would have constituted admissible
evidence and would have been subject to cross-examination by respondent.
                                         -9-

[*9] taxpayer to have contemporaneous records compiled daily. Id. Rather, the

taxpayer may use methods including, but not limited to, “the identification of

services performed over a period of time and the approximate number of hours

spent * * * based on appointment books, calendars, or narrative summaries.” Id.

For the purposes of section 469, “the regulations do not allow a postevent

‘ballpark guesstimate.’” Moss v. Commissioner, 135 T.C. 365, 369 (2010) (citing

Bailey v. Commissioner, T.C. Memo. 2001-296, and Goshorn v. Commissioner,

T.C. Memo. 1993-578).

      Mr. Merino acknowledged that he prepared the summary using his estimates

and his memory as to how much time he spent on certain tasks with respect to the

real estate rental activity. Unfortunately, we found Mr. Merino’s summary to be

less of an approximation and more of a “ballpark guesstimate”. See Moss v.

Commissioner, 135 T.C. at 369. In Bailey v. Commissioner, T.C. Memo. 2001-

296, the taxpayer kept a calendar of visits to rental properties but did not track

hours spent on rental activities. We rejected the taxpayer’s narrative summary,

which she reconstructed before trial, as not a “reasonable” means because it was

uncorroborated and not reliable. Id., slip op. at 13. Mr. Merino credibly testified

that he created the summary in 2007 or 2008 shortly after a flood destroyed his

records. See Villarreal v. Commissioner, T.C. Memo. 1998-420, slip op. at 6
                                       - 10 -

[*10] (“When a taxpayer’s records are lost or destroyed through circumstances

beyond his control, he is entitled to substantiate deductions by reconstructing his

expenditures through other credible evidence. Malinowski v. Commissioner, 71

T.C. 1120, 1125 (1979).”).

      Mr. Merino’s summary was not created from contemporaneous

documentation, but rather it is a postevent reconstruction from memory. Compare

Pohoski v. Commissioner, T.C. Memo. 1998-17, slip op. at 13-14 (accepting the

taxpayers’ postevent narrative summary because it was compiled using

contemporaneous records and was supported by credible testimony and other

objective evidence), with Bailey v. Commissioner, slip op. at 13 (rejecting the

taxpayer’s uncorroborated summary in part because she assigned hours to tasks

“based solely on her judgment and experience as to how much time the activities

must have taken her”). Mr. Merino’s records are not contemporaneous; they must

therefore be a “reasonable means” of establishing the extent of his participation

and not a “postevent ballpark guesstimate”. Moss v. Commissioner, 135 T.C. at

369; sec. 1.469-5T(f)(4), Temporary Income Tax Regs., supra.

      Mr. Merino’s estimates, however well meaning, are unreliable and

uncorroborated. For instance, we are skeptical that Mr. Merino on average:

purchased and had delivered one appliance per month for at least one of his seven
                                         - 11 -

[*11] properties; received a notice of violations of homeowners association rules

requiring an hour of work at least once per week; or had a property with a problem

that required a contractor every week.

      Mr. Merino was unable to recall any specifics about any particular entry in

his narrative summary or otherwise provide evidence as to the reliability of the

summary. Furthermore Mr. Merino admitted an error in his chart, which

improperly ascribed four hours of work per week to check writing when it should

have been four hours per month. Correction of this error reduces the hours

reported by 160 (i.e. (52 weeks x 4 = 208 hours claimed) minus (12 months x 4 =

48 actual hours) = 160 fictitious hours). Mr. Merino also counted all of his travel

time when he went to visit his properties, including unrelated activities such as

meals with friends and time spent sleeping. Finally, the summary does not clearly

distinguish between or identify services Mr. Merino personally performed and

services the Colorado management company or the Nevada assistant may have

performed.

      On the basis of the facts and circumstances of the summary and the lack of

any corroborating evidence, such as invoices or letters to and from the

homeowners associations, other than Mr. Merino’s self-serving testimony, we find

that the summary does not fall within the regulation’s “any reasonable means”.
                                         - 12 -

[*12] See sec. 1.469-5T(f)(4), Temporary Income Tax Regs., supra; see also Hill

v. Commissioner, T.C. Memo. 2010-200, slip op. at 13 (finding that the excessive

hours claimed by the taxpayer on the noncontemporaneous reconstruction, relative

to the tasks performed, diminished the credibility of the taxpayer’s estimates),

aff’d, 436 Fed. Appx. 410 (5th Cir. 2011).

      Petitioners also do not qualify for the limited exception under section

469(i). This section allows a taxpayer to take into account up to $25,000 of the

passive activity loss attributable to rental real estate activity in which the taxpayer

actively participated for the year. Sec. 469(i)(1). This $25,000, however, begins

to phase out for a taxpayer with a modified adjusted gross income that exceeds

$100,000. Sec. 469(i)(3)(A). The exception is completely phased out when the

taxpayer’s modified adjusted gross income exceeds $150,000. Petitioners’

modified adjusted gross income for the 2007 taxable year exceeds $150,000, and

thus they cannot take advantage of this section.
                                        - 13 -

[*13] III.   Section 6651(a)(1) Addition to Tax7

      Respondent bears the burden of production with respect to the section

6651(a)(1) addition to tax. See sec. 7491(c); Higbee v. Commissioner, 116 T.C.

438, 446-447 (2001). To meet this burden, respondent must produce sufficient

evidence establishing that it is appropriate to impose the addition to tax. The

burden of establishing that the failure to timely file their 2007 tax return was due

to reasonable cause rather than willful neglect remains with petitioners. See

Higbee v. Commissioner, 116 T.C. at 447.

      As a general rule, “any person made liable for any tax * * * shall make a

return or statement according to the forms and regulations prescribed by the

Secretary.” Sec. 6011(a). Returns for calendar year individual taxpayers are due

on April 15 of the year following the tax year. Sec. 6072(a). If a taxpayer fails to

file a return on time, section 6651(a)(1) imposes an addition to tax of 5% of the


      7
        At trial respondent raised the possibility that the sec. 6651(a)(1) addition to
tax and the sec. 6662(a) accuracy-related penalty may have been discharged by
Mr. Merino’s bankruptcy proceeding. The Court lacks jurisdiction to determine
whether tax liabilities have been so discharged. Neilson v. Commissioner, 94 T.C.
1, 9 (1990) (citing Graham v. Commissioner, 75 T.C. 389, 399 (1980)). This lack
of jurisdiction over the issue of discharge in bankruptcy “does not, however, limit
our jurisdiction to redetermine those deficiencies and additions to tax.” McAlister
v. Commissioner, T.C. Memo. 1993-166, 1993 WL 114165, at *2. Nonetheless
respondent assures us that both the addition to tax and the accuracy-related penalty
are nondischargeable and that Mr. Merino’s bankruptcy did not discharge them.
                                         - 14 -

[*14] tax required to be shown on the return for each month or fraction thereof for

which there is a failure to file, not to exceed 25% in the aggregate. The penalty

will not apply if the taxpayer shows that the failure is due to reasonable cause and

not due to willful neglect. Sec. 6651(a)(1).

      The parties do not dispute that petitioners requested and received an

automatic extension, which extended the due date of the return to October 15,

2008. Sec. 6081(a). The parties also do not dispute that respondent did not

receive the return until March 14, 2010. Thus, respondent has met his burden of

production. Petitioner consequently bears the burden of proving either timely

filing or reasonable cause and lack of willful neglect. See Higbee v.

Commissioner, 116 T.C. at 446. Petitioners presented no evidence on this issue.8

We therefore hold for respondent on this issue.

IV.   Section 6662(a) Accuracy-Related Penalty

      Respondent also bears the burden of production for the determined penalty

and must produce sufficient evidence establishing that it is appropriate to impose




      8
       In their briefs petitioners for the first time argue that they reasonably relied
upon a tax professional. Petitioners did not present any evidence of reliance on a
professional at trial, and we cannot accept the statements in the briefs as evidence.
See Rule 143(c).
                                        - 15 -

[*15] the penalty. See id. However, the burden to establish that they acted with

reasonable cause remains with petitioners. See id. at 447.

      Section 6662(a) imposes an accuracy-related penalty equal to 20% of an

underpayment of tax attributable to one of five causes specified in subsection (b).

Respondent contends that petitioners are liable for the penalty because of

negligence or disregard of the rules or regulations or, alternatively, because the

underpayment is due to a substantial understatement of income tax. See sec.

6662(b)(1) and (2).

      For the purposes of the penalty, “‘negligence’ includes any failure to make a

reasonable attempt to comply with the provisions of this title”. Sec. 6662(c).

Under caselaw, “‘Negligence is a lack of due care or the failure to do what a

reasonable and ordinarily prudent person would do under the circumstances.’”

Freytag v. Commissioner, 89 T.C. 849, 887 (1987) (quoting Marcello v.

Commissioner, 380 F.2d 499, 506 (5th Cir. 1967), aff’g on this issue 43 T.C. 168

(1964) and T.C. Memo. 1964-299), aff’d, 904 F.2d 1011 (5th Cir. 1990), aff’d,

501 U.S. 868 (1991). A substantial understatement of income tax in the case of an

individual is (with certain modifications which do not apply in this case) an

understatement of income tax that exceeds the greater of (1) 10% of the tax
                                        - 16 -

[*16] required to be shown on the return for the taxable year or (2) $5,000. Sec.

6662(d)(1)(A).

       There is an exception to the section 6662(a) penalty when a taxpayer can

demonstrate that the taxpayer (1) had reasonable cause for the underpayment and

(2) acted in good faith with respect to the underpayment. Sec. 6664(c)(1).

Regulations promulgated under section 6664(c) further provide that the

determination of reasonable cause and good faith “is made on a case-by-case basis,

taking into account all pertinent facts and circumstances.” Sec. 1.6664-4(b)(1),

Income Tax Regs.

      Reliance on the advice of a tax professional may, but does not necessarily,

establish reasonable cause and good faith for the purpose of avoiding a section

6662(a) penalty. Sec. 1.6664-4(b)(1), Income Tax Regs.; see also United States v.

Boyle, 469 U.S. 241, 251 (1985) (reliance on an accountant or attorney as to a

matter of tax law may be reasonable); Canal Corp. v. Commissioner, 135 T.C. 199,

218 (2010) (“The right to rely on professional tax advice, however, is not

unlimited.”). To avoid liability for a section 6662(a) penalty based on reliance on a

tax professional, a taxpayer must meet the following three requirements: “(1) The

adviser was a competent professional who had sufficient expertise to justify

reliance, (2) the taxpayer provided necessary and accurate information to the
                                        - 17 -

[*17] adviser, and (3) the taxpayer actually relied in good faith on the adviser's

judgment.” Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000),

aff’d, 299 F.3d 221 (3d Cir. 2002); see also Charlotte’s Office Boutique, Inc. v.

Commissioner, 425 F.3d 1203, 1212 n.8 (9th Cir. 2005) (quoting with approval the

above three-prong test), aff’g 121 T.C. 89 (2003). In addition, the advice must not

be based on unreasonable factual or legal assumptions (including assumptions as to

future events) and must not unreasonably rely on the representations, statements,

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

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

      Respondent has met his burden of production. He has shown that the

understatement exceeds the greater of 10% of the tax required to be shown on the

return or $5,000, and we therefore need not decide whether petitioners were

negligent or disregarded rules or regulations. Petitioners bear the burden of

proving a defense to the penalty. See Higbee v. Commissioner, 116 T.C. at 447.

Petitioners failed to present any evidence at trial as to reasonable cause.9 We

therefore find for respondent on this issue.


       9
       Again petitioners attempted in their briefs to raise a reasonable cause
defense based on reliance on a tax professional, but petitioners presented no
evidence of such reliance at trial. Petitioners’ statements in the briefs are not
evidence. See Rule 143(c).
                                        - 18 -

[*18] The Court has considered all of petitioners’ contentions, argument, requests,

and statements. To the extent not discussed herein, we conclude that they are

meritless, moot, or irrelevant. To reflect the foregoing,



                                                       Decision will be entered

                                                 for respondent.
