                           T.C. Memo. 2014-40



                     UNITED STATES TAX COURT



TALBOT MATTHEW ALMQUIST AND RULA ALMQUIST, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



  Docket No. 15082-11.                       Filed March 10, 2014.



         Ps claimed a deduction for rental real estate losses on their
  2008 Schedule E, Supplemental Income and Loss, for two rental real
  estate properties. R determined that Ps were not real estate
  professionals and issued a notice of deficiency disallowing a current
  deduction for the claimed rental real estate losses. R also determined
  an I.R.C. sec. 6662 accuracy-related penalty.

         Held: Ps are unable to currently deduct their 2008 losses from
  their rental real estate activity pursuant to I.R.C. sec. 469 because
  they did not meet the passive activity loss exception for a rental real
  estate professional.

         Held, further, Ps are liable for the I.R.C. sec. 6662 accuracy-
  related penalty.
                                          -2-

[*2] Talbot Matthew Almquist and Rula Almquist, pro se.

      Kris H. An, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


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

redetermination of a deficiency in income tax respondent determined for

petitioners’ 2008 tax year. Petitioners timely filed a joint Federal income tax

return for the 2008 tax year that was prepared for them by their certified public

accounting firm of Marks & Devine. Respondent issued a notice of deficiency on

April 13, 2011, for the 2008 tax year disallowing a deduction for petitioners’

losses from their rental real estate activity as passive and determining an accuracy-

related penalty under section 6662(a).1




      1
       Unless otherwise indicated, all section references are to the Internal
Revenue Code of 1986 (Code), as amended and in effect for the taxable year at
issue. All Rule references are to the Tax Court Rules of Practice and Procedure.
                                         -3-

[*3] After concessions by the parties,2 the only issues for decision are (1)

whether petitioners’ real estate loss of $154,835 reported on Schedule E,

Supplemental Income and Loss, for the tax year 2008 is subject to the passive loss

limitation under section 469 and (2) whether petitioners are liable for the section

6662(a) accuracy-related penalty.

                               FINDINGS OF FACT

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

the parties with accompanying exhibits are incorporated herein by reference. At

the time the petition was filed, petitioners resided in Encino, California.

General Background

       Talbot Matthew Almquist worked as an executive at Oakwood Worldwide

(Oakwood) a.k.a. R&B Realty Group for over 15 years including the 2008 tax

calendar year. While working for Oakwood Mr. Almquist managed 15 rental

buildings and oversaw 300 employees. Since 2001 Mr. Almquist and Rula

Almquist have owned and managed from one to three rental properties of their

own.

       2
        The parties agree that petitioners did not receive the unreported capital gain
of $744 that was determined in the notice of deficiency, petitioners incurred a
capital loss of $656 for the taxable year 2008, and petitioners are entitled to a
mortgage interest deduction of $76,591 reported on Schedule A, Itemized
Deductions, for the taxable year 2008.
                                           -4-

[*4] Petitioners’ Occupations

      In 2008 Mr. Almquist worked as the vice president of operations for

Oakwood and received a salary of $180,748.3 In 2008 Mr. Almquist estimated

that he spent no more than 20 hours a week working for Oakwood and that over

the course of the year he worked between 885 and 980 hours. Petitioners did not

provide any paperwork from Oakwood or other documents supporting Mr.

Almquist’s claim that he worked no more than 885 to 980 hours in 2008 for

Oakwood. Mr. Almquist continued to work for Oakwood until 2010 when his job

was terminated and he was provided with a severance check for $180,799.

      In 2008 Mrs. Almquist worked as an operations manager for Archstone

Communities, LLC (Archstone). Mrs. Almquist oversaw Archstone’s properties,

buildings, and apartments.

Rental Properties

      In 2008 petitioners owned two rental real estate properties. One of their

rental properties is in Indio, California (Indio property). Petitioners’ home in

Oakwood, California, is approximately 130 miles from Indio, California. The

Indio property is an approximately 2,700-square-foot residence purchased new in

2006. Petitioners rented the Indio property out to Beverly Humphrey in 2007 and

      3
          All dollar amounts are rounded to the nearest dollar.
                                         -5-

[*5] renewed the lease from January 9 through April 9, 2008, for $3,000 a month.

Mr. Almquist maintained the Indio property, which, although purchased new, did

not come with the amenities needed to rent it as a furnished apartment.

Accordingly, he spent considerable time preparing it for potential renters. Some

of the preparation activities included replacing the air conditioner condenser,

landscaping the yard, posting ads, and making sure the property had sufficient

furnishings.

      The other rental property is in Naples, Florida (Naples property). The

Naples property was constructed in 1993 and is approximately 1,500 square feet in

size. On May 29, 2007, petitioners hired Naples Realty Services, Inc. (Realty), to

find possible renters for the Naples property. In 2008 petitioners did not visit the

Naples property. Petitioners rented out the Naples property to one renter starting

January 28, 2008, for one year. Realty collected the $1,500 per month rent from

the renter, withheld its 10% fee, and then forwarded the remaining rent to

petitioners.

      Both of petitioners’ properties were furnished and were intended to be

rented out as fully furnished units. Generally, renting furnished residential

property requires more upkeep and time than renting unfurnished residential
                                         -6-

[*6] property because the furnished property should be equipped with reasonable

appliances, furnishings, and necessities for the renters.

      Renters and potential renters faxed correspondence to an electronic fax

number; then the correspondence was automatically forwarded to Mrs. Almquist’s

email address. Mr. Almquist had access to Mrs. Almquist’s email, and he worked

on the rental property business using her email.

Documentation of the Hours Worked

      Petitioners provided one calendar and two different logs describing the

hours worked on the rental properties. At the start of respondent’s examination of

petitioners’ 2008 tax return petitioners created the calendar from very brief cryptic

notes in Mr. Almquist’s personal spiral notebook daily records. He did this about

a year after the fact, long after the asserted work was completed. The calendar’s

short notes about the days Mr. Almquist worked on the rental properties

occasionally included the hours worked as respondent’s revenue agent requested

that this information be included when petitioners prepared the calendar. Mr.

Almquist contends that the calendar was created on the advice of petitioners’

certified public accountant and was, as noted, purportedly based on Mr.

Almquist’s daily record handwritten notes. Petitioners did not provide the

purported supporting handwritten notes to the Court.
                                         -7-

[*7] More than a year after the work was completed petitioners also created the

first log purportedly based on the calendar, documents, and emails. The first log

listed the hours Mr. Almquist spent working on the properties and a brief

description of the type of work he performed. That log indicated that Mr.

Almquist worked 486 hours on the Indio property and 188 hours on the Naples

property. The first log also indicated that Mr. Almquist spent another 101 hours

looking for investment properties and attending open houses. Other than the

calendar prepared after the audit started, petitioners did not provide any of the

purported supporting documents or emails to the Court. Mr. Almquist explained:

“[W]e’ve moved twice since then, so I can’t find the original spiral, but, you

know, it was transferred to this, which then was transferred to the final document.”

      After a meeting with a revenue agent, petitioners created a second log

listing additional time allocated to the activity. Mr. Almquist contends that the

second log lists more hours because it included additional activities, such as

craigslist ads and emails he did not previously include, as well as additional hours

for his drive to the Indio property. Petitioners contend the 280-mile round trip

takes on average as much as six to seven hours because of Los Angeles traffic and

gas stops. This second greatly expanded log containing many more entries

indicated that Mr. Almquist worked 759 hours on the Indio property and 84 hours
                                        -8-

[*8] on the Naples property. Among the changes from the first log to the second

log was a modification for November 2008 where the first log reported that Mr.

Almquist spent 25 hours on the Indio property, but the second log reported that

Mr. Almquist spent a little over 135 hours on the Indio property. Petitioners did

not provide the Court with any of the purported new supporting documents or

other emails for the later log.

                                    OPINION

      As a general rule, the Commissioner’s determination in the notice of

deficiency is presumed correct, and the taxpayer bears the burden of proving by a

preponderance of the evidence that the determination is improper. See Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Although section 7491(a)

may shift the burden of proof to the Commissioner in specified circumstances,

petitioners have not established that they meet the requirements under section

7491(a)(1) and (2) for such a shift. Consequently, the burden of proof remains on

petitioners.

      Deductions are a matter of legislative grace, and taxpayers bear the burden

of proving that they are entitled to any claimed deductions. Rule 142(a); see

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Taxpayers are required

to identify each deduction, maintain adequate records, substantiate each deduction,
                                         -9-

[*9] and show that they have met all requirements.4 Sec. 6001; Roberts v.

Commissioner, 62 T.C. 834, 836-837 (1974); sec. 1.6001-1(a), Income Tax Regs.

I. Real Estate Activity

      A taxpayer is generally allowed deductions for certain business and profit-

seeking investment expenses. See secs. 162, 212. Section 469 disallows a

taxpayer’s deductions attributable to a passive activity loss for the taxable year.

Section 469(d)(1) defines “passive activity loss” as “the amount (if any) by

which--(A) the aggregate losses from all passive activities for the taxable year,

exceed (B) the aggregate income from all passive activities for such year.”

Passive activity is defined as any activity “which involves the conduct of any trade

or business, and * * * in which the taxpayer does not materially participate.” Sec.

469(c)(1)(A) and (B). The Code specifically provides that the term “passive

activity” also includes any rental activity. Sec. 469(c)(2). The Code then provides

an exception from that rule for rental real estate activity of a taxpayer who is

engaged in a real property trade or business. See sec. 469(c)(7).5


      4
       Strict substantiation rules for deductions other than those subject to sec.
274(d) scrutiny may, in some situations not present here, be relaxed by the Cohan
rule. See Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930).
      5
       There is an additional exception for rental real estate activity losses of a
natural person(s); however, that exception does not apply here because the
                                                                         (continued...)
                                         -10-

[*10] Consequently, the first issue is whether Mr. Almquist was actively engaged

in a real property trade or business (real estate professional) as provided in section

469(c)(7). A taxpayer qualifies as a real estate professional 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)(i) and (ii). Unless the taxpayer timely elects otherwise, the

taxpayer must satisfy the requirement of material participation as applied

separately to each rental real estate interest. Sec. 469(c)(7)(A).6



      5
       (...continued)
exception is completely phased out for taxpayers whose adjusted gross income
(AGI) equals or exceeds $150,000. See sec. 469(i)(3)(A). Petitioners do not
contend their AGI was less than $150,000 for 2008 or that any special phaseout
rule applies. Therefore this exception does not apply.
      6
        In order for a taxpayer to make this election, the taxpayer is required to
attach a statement to his or her original Federal income tax return stating an
intention to make this election. See sec. 469(c)(7)(A); sec. 1.469-9(g)(3), Income
Tax Regs. Petitioners asserted at trial and in their opening brief that they elected
in their 2008 income tax return to combine their rental real estate properties as one
activity. Respondent, however, did not respond or separately raise this issue in the
notice of deficiency, at the trial, or in his opening brief. Rather, respondent waited
until his reply brief to bring up this matter. We discuss infra why the Court need
not resolve this issue.
                                         -11-

[*11] In determining whether a taxpayer performs more than 750 hours of service

in a real property trade or business, any time spent as an employee performing real

estate activities is ignored, except if the employee is also a 5% owner as defined in

section 416(i)(1)(B). See sec. 469(c)(7)(D)(ii). Mr. Almquist does not contend

that he was a 5% owner of Oakwood; therefore, any time spent managing property

as Oakwood’s employee is not included in determining whether Mr. Almquist is a

real estate professional.

      Petitioners do not contend that Mrs. Almquist qualifies as a real estate

professional. 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. See sec.

469(c)(7)(B). Petitioners do not allege, nor does the record support, that Mrs.

Almquist spent any time on the rental properties that should be included in

determining whether there was material participation. Therefore, any time Mrs.

Almquist spent working on the rental properties is not included in determining

whether Mr. Almquist qualifies as a real estate professional.

      All of a taxpayer’s real property trade or business activity is taken into

account in determining whether the 750-hour requirement is satisfied. See Fowler

v. Commissioner, T.C. Memo. 2002-223, slip op. at 13. A real property trade or

business is defined in section 469(c)(7)(C) as “any real property development,
                                        -12-

[*12] redevelopment, construction, reconstruction, acquisition, conversion, rental,

operation, management, leasing, or brokerage trade or business.” This list does

not include any research or other preparatory activities.

      The regulations provide that “the extent of an individual’s participation in

an activity may be established by any reasonable means.” Sec. 1.469-5T(f)(4),

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

             Contemporaneous daily time reports, logs, or similar
      documents are not required if the extent of such participation may be
      established by other reasonable means. Reasonable means * * * may
      include but are not limited to the identification of services performed
      over a period of time and the approximate number of hours spent
      performing such services during such period, based on appointment
      books, calendars, or narrative summaries.

Id. Although “reasonable means” may be interpreted broadly, “a postevent

‘ballpark guesstimate’” will not suffice. 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).

      Petitioners introduced a calendar containing cryptic brief notes about the

work completed on the two rental properties. The calendar occasionally stated

some of the hours Mr. Almquist purportedly worked. Petitioners purportedly

created the first log using the calendar, supporting documents, and emails.
                                        -13-

[*13] However, other than the calendar, petitioners did not supply the Court with

any of the purported supporting documents or emails.

      Even if this Court were to accept petitioner’s calendar and first log as

accurate, Mr. Almquist would still not qualify as a real estate professional because

the first log shows that Mr. Almquist spent only 486 hours on the Indio property,

188 hours on the Naples property, and 101 hours on investment property.

Combined, these would account for 775 hours worked on real estate property,

which would only be enough for the 750 hour requirement. Petitioners have not

shown that Mr. Almquist spent more than one-half of his trade or business

personal service time in a real property trade or business in which he materially

participates as required by section 469(c)(7)(B)(i).

      Mr. Almquist estimated that he spent somewhere between 885 and 980

hours working at Oakwood. If this Court were to accept Mr. Almquist’s assertion

and generously place him at the low end of his estimate of 885 hours worked at

Oakwood, Mr. Almquist would still not qualify as a real estate professional.

      Petitioners contend that this Court should look past the fact that petitioners

did not provide any supporting documentation of the hours Mr. Almquist worked,

should ignore petitioners’ calendar and first log, and should look only to the

second log in determining whether Mr. Almquist is a real estate professional. We
                                         -14-

[*14] again emphasize that the Court was not provided any of the purported

supporting documentation or email and was provided only petitioners’ self-serving

testimony.

      We are not required to accept such self-serving testimony, and we are not

willing to rely on that testimony to establish petitioners’ position. See Tokarski v.

Commissioner, 87 T.C. 74, 76-77 (1986); see also Chapman Glen Ltd. v.

Commissioner, 140 T.C. __ (slip op. at 45 n.24) (May 28, 2013). Without any

supporting documentation, the second log, created by petitioners over a year after

the work was completed, is nothing more than “a postevent ‘ballpark

guesstimate’”. See Moss v. Commissioner, 135 T.C. at 369.

      Therefore, Mr. Almquist does not meet the minimum requirements for a

qualified real estate professional. Accordingly, petitioners’ rental real estate

activity shall be treated as passive and the claimed deduction relating to the

passive activity losses is disallowed for the 2008 tax year.7

      7
        Petitioners’ disallowed deduction is “treated as a deduction or credit
allocable to such activity in the next taxable year.” See sec. 469(b). At trial
petitioners made a motion for attorney’s fees. Sec. 7430(a) provides relief for a
taxpayer seeking attorney’s fees if among other requirements the taxpayer is the
prevailing party. We need not address the other requirements of sec. 7430 because
petitioners are not the prevailing party. Sec. 7430(c)(4) generally provides that a
taxpayer may qualify as a prevailing party only if either (1) the taxpayer “has
substantially prevailed with respect to the amount in controversy, or * * * has
                                                                        (continued...)
                                         -15-

[*15] II. Accuracy-Related Penalty

      Respondent bears the burden of production with respect to the section

6662(a) accuracy-related penalty. See sec. 7491(c); Higbee v. Commissioner, 116

T.C. 438, 446-447 (2001). In order to meet the burden of production under

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

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

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

underpayment of tax. Respondent contends that petitioners are liable for the

accuracy-related penalty because of their negligence or, alternatively, because the

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

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

      Negligence includes any failure to make a reasonable attempt to comply

with the provisions of the Code, including any failure to keep adequate books and

records or to substantiate items properly. See sec. 6662(c); sec. 1.6662-3(b)(1),

      7
        (...continued)
substantially prevailed with respect to the most significant issue or set of issues
presented” or (2) the taxpayer has made a qualified offer to settle more favorable
to the Commissioner than what the Commissioner actually achieved in certain
circumstances (qualified offer rule). See Knudsen v. Commissioner, T.C. Memo.
2013-87, at *12-*13. Petitioners do not allege they qualify for the qualified offer
rule. This Court has found that petitioners are not able to currently deduct the
disputed deduction. See Rule 143(c). Accordingly, petitioners are not entitled to
attorney’s fees.
                                         -16-

[*16] Income Tax Regs. A substantial understatement is an understatement of

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

return or $5,000. See sec. 6662(d); sec. 1.6662-4(b), Income Tax Regs.

      Respondent has met his burden of production. Respondent showed that the

understatement exceeds 10% of the tax required to be shown on the return, which

is greater than $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.

      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); sec.

1.6664-4(a), Income Tax Regs. A determination of whether a taxpayer acted with

reasonable cause “is made on a case-by-case basis, taking into account all

pertinent facts and circumstances.” Sec. 1.6664-4(b), Income Tax Regs. The most

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

proper tax liability.” Id. Circumstances indicating that a taxpayer acted with

reasonable cause and in good faith include “an honest misunderstanding of fact or

law that is reasonable in light of all of the facts and circumstances, including the

experience, knowledge, and education of the taxpayer.” Id.
                                        -17-

[*17] 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 on the basis of

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 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.
                                         -18-

[*18] The fact that petitioners had an accountant prepare their returns does not, in

and of itself, prove that they acted with reasonable cause and in good faith. See

Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 99-100. Additionally,

petitioners’ failure to properly document the time spent performing rental activity

was detrimental to their ultimate effort to substantiate all of the time they spent on

their rental property activity. See sec. 6001; sec. 1.6001-1, Income Tax Regs.

This made it impossible for their accountant to have all the accurate information

necessary to make an informed tax decision. Id. The accountant relied on

petitioners for an accurate representation of the amount of hours worked on their

rental activity; however, petitioners were unable to prove the purported hours

worked. Petitioners have not proven reasonable cause for their underpayment.

Thus, this Court concludes petitioners are liable for the section 6662 accuracy-

related penalty.

      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 under

                                        Rule 155.
