                          T.C. Summary Opinion 2015-47



                         UNITED STATES TAX COURT



 RICHARD D. ESCALANTE AND BARBARA J. ESCALANTE, Petitioners v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 17675-12S.                         Filed August 10, 2015.



      Richard Allen Block, for petitioners.

      Christopher J. Richmond, for respondent.



                              SUMMARY OPINION


      CARLUZZO, Special Trial Judge: This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code in effect when the

petition was filed.1 Pursuant to section 7463(b), the decision to be entered is not


      1
      Unless otherwise indicated, section references are to the Internal Revenue
Code of 1986, as amended, in effect for the years in issue. Rule references are to
                                                                      (continued...)
                                          -2-

reviewable by any other court, and this opinion shall not be treated as precedent

for any other case.

      In two separate notices of deficiency both dated April 10, 2012 (notices),

respondent determined deficiencies in, and penalties with respect to, petitioners’

Federal income tax for 2005, 2006, and 2007 as follows:

                                                                  Penalty
          Year                   Deficiency                      sec. 6662(a)

          2005                     $2,666                           $533.20
          2006                      1,483                            296.60
          2007                     18,828                          3,765.60

      The issues for decision for each year are: (1) whether petitioners are

entitled to a deduction for a loss from their rental real estate activity, the resolution

of which depends upon whether section 469(c)(7) applies to Mr. Escalante

(petitioner); and (2) whether petitioners are liable for a section 6662(a)

accuracy-related penalty.

                                      Background

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

petition was filed, petitioners resided in California.




      1
       (...continued)
the Tax Court Rules of Practice and Procedure.
                                         -3-

      Except for a leave of absence noted below, beginning in 1996 and

continuing through each year in issue petitioner was employed as a full-time

teacher by the Los Angeles Unified School District (LAUSD).2

      As a member of the United Teachers Los Angeles teacher’s union (UTLA),

petitioner was covered by the terms of the union contract between UTLA and the

LAUSD then in effect (contract). According to article XIV, section 1.1, of the

contract: “For compensation purposes only, full-time basic assignments shall be

the number of hours per working day as shown below or the pay period equivalent

thereof. Such basic assignment hours are not to affect or reduce the actual hours

of service and duties as required under Article IX.” For purposes of section 1.1,

the class of employees covered by the contract of which petitioner is a member is

designated to have a six-hour working day.

      Article IX, section 1.0, of the contract states: “It is agreed that the

professional workday of a full-time regular employee requires no fewer than eight

hours of on-site and off-site work, and that the varying nature of professional

duties does not lend itself to a total maximum daily work time of definite or

uniform length.” In addition to petitioner’s classroom teaching responsibilities, he


      2
       Barbara J. Escalante was also employed as a teacher by the LAUSD during
the years in issue.
                                        -4-

was required to attend monthly faculty meetings and an open house once every

semester.

      Petitioner took a leave of absence from teaching from July 2005 through

July 2006. During his leave of absence petitioner began dedicating more time to

investing in rental real estate.

      During 2005 petitioners (or at least one of them) owned two rental

properties in Los Angeles, one in Las Vegas, one in Henderson, Nevada, and one

in Orem, Utah. In 2006 petitioners purchased two additional rental properties in

Henderson, and in 2007 petitioners purchased another rental property in

Henderson. In total, petitioners incurred approximately $1,978,000 in mortgage

indebtedness to finance the acquisition of the rental properties.

      As between the two of them, petitioner was primarily responsible for

managing and maintaining the rental properties although Mrs. Escalante

contributed as well. Among other things, petitioner met with prospective tenants,

corresponded regularly with tenants, negotiated and prepared leases, collected

rent, reviewed mortgage statements and made mortgage payments, researched

housing markets, and developed and maintained income and expense statements

for each rental property. Petitioner made repairs himself to his various rental
                                        -5-

properties but also occasionally hired others to do so. An independent

management company managed some of the properties.

      Petitioner prepared multiple logs showing hours he claims to have spent on

petitioners’ rental real estate activity and on his employment as a teacher for each

year in issue.

      On jointly filed Federal income tax returns for 2005, 2006, and 2007

petitioners reported rental property income and expenses on Schedules E,

Supplemental Income and Loss. The Schedules E show losses of $35,819,

$137,157, and $98,905 for the years 2005, 2006, and 2007, respectively.

      In the notices respondent determined that the losses reported on the

Schedules E are subject to the section 469 passive loss limitations. Respondent

also imposed an accuracy-related penalty under section 6662(a) for each year in

issue upon various grounds.

                                     Discussion

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

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

preponderance of the evidence that the determination is erroneous. See Rule
                                            -6-

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).3 Furthermore, deductions

are a matter of legislative grace, and a taxpayer bears the burden of proving that

the taxpayer is entitled to any deductions claimed. Rule 142(a); see INDOPCO,

Inc. v. Commissioner, 503 U.S. 79, 84 (1992).

I. Real Estate Activity

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

producing expenses. Secs. 162, 212. Section 469(a) generally disallows for the

taxable year any passive activity loss. A passive activity loss is the excess of the

aggregate losses from all passive activities for the taxable year over the aggregate

income from all passive activities for that year. Sec. 469(d)(1). A passive activity

is any trade or business, or any income-producing activity, in which the taxpayer

does not materially participate. Sec. 469(c)(1)(6).

      Rental activity is generally treated as per se passive regardless of whether

the taxpayer materially participates. Sec. 469(c)(2). However, the rental activity

of a taxpayer is not treated as per se passive if the taxpayer satisfies the

requirements of section 469(c)(7)(B).4 Sec. 469(c)(7)(A)(i). If a taxpayer is


      3
      Under the circumstances, we are satisfied that the provisions of sec.
7491(a) are not applicable.
      4
          There is an additional exception for rental real estate activity losses of a
                                                                            (continued...)
                                          -7-

described in that section (sometimes that taxpayer is referred to as a “real estate

professional”), then section 469(c)(2) does not apply and the taxpayer’s rental real

estate activity, if conducted as a trade or business or for the production of income,

is not treated as a passive activity if the taxpayer materially participates in the

activity. Sec. 469(c)(1); Fowler v. Commissioner, T.C. Memo. 2002-223; sec.

1.469-9(e), Income Tax Regs.

      Because respondent concedes that petitioner materially participated in the

rental real estate activity,5 we need not get into the complicated definition of the

term “material participation” set forth in section 469(h) and its corresponding

regulations. Instead, the disagreement between the parties focuses on whether

petitioner is a taxpayer described in section 469(c)(7).6 According to petitioners,

he is; according to respondent, he is not.




      4
       (...continued)
natural person(s). See sec. 469(i). In the notices respondent allowed petitioners to
deduct $25,000 for 2006, $25,000 for 2007, and, because of the phaseout
provisions, $19,000 for 2005. See sec. 469(i)(3)(A).
      5
        The parties proceeded as though petitioner had aggregated his various
interests in real property. See sec. 469(c)(7)(A)(ii).
      6
          Mrs. Escalante does not claim to be a taxpayer so described.
                                         -8-

      Section 469(c)(7) contains two tests that a taxpayer must satisfy to be

described in that section. One requires that the taxpayer perform 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)(ii). The other

requires that “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”. Sec.

469(c)(7)(B)(i).

      Petitioners’ rental real estate activity constituted a real property trade or

business during each of the years in issue. See sec. 469(c)(7)(C). The dispute

between the parties regarding petitioner’s status as a person described in section

469(c)(7) is resolved by an examination of the amount of time he spent performing

services in his real estate rental activity during each year in issue. According to

petitioners: (1) the logs petitioner maintained show the time he spent as a teacher

as well as the time he spent performing services in connection with his rental real

estate activity; and (2) those logs further show that for each year in issue,

petitioner has satisfied the two tests mentioned above.

      There are no specific requirements as to the manner by which a taxpayer can

establish the time spent performing services in connection with a particular
                                         -9-

activity. Section 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727

(Feb. 25, 1988), provides:

      The extent of an individual’s participation in an activity may be
      established by any reasonable means. 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 for purposes of this paragraph 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.

Although the above regulation is less than precise regarding the records to be

maintained by taxpayers, it does not allow for a noncontemporaneous “ballpark

guesstimate”. Hill v. Commissioner, T.C. Memo. 2010-200, aff’d, 436 Fed. Appx.

410 (5th Cir. 2011); 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 logs show the hours petitioner claims to have spent on petitioners’

rental real estate activity and as a teacher during each year in issue, as follows:
                                            - 10 -

             Activity                     2005             2006                2007
                                      1
Hours spent on rental real estate         4,000           1,989                1,353
Hours spent as teacher                      618             390                  932

         1
        On the second page of the 2005 log, petitioner reported that he worked
2,450 hours on his real estate activity as opposed to the 4,000 hours reported on
the first page. According to petitioner the 4,000 hours worked were the hours
“available for me to work” and the real number worked was 2,450.

         The logs reflect six hours for each day petitioner worked as a teacher, which

was the minimum time required under the contract for compensation purposes

only. The logs show no time for “off-site” activities, such as preparation for class,

independent reading, faculty meetings, parent-teacher meetings and/or

consultations, or attending his school’s open house functions.

         We understand from petitioner’s testimony that the total of these “off-site”

hours might be considerably less than the hours for which he was paid, but his

failure to record this time in the logs undermines their reliability. We are reluctant

to rely upon the logs to establish the total amount of time petitioner spent as a

teacher; and absent that information, we cannot determine whether petitioner spent

more time in his real estate activity than he did as a teacher for any of the years in

issue.

         In addition to the obvious understatement in the logs of hours petitioner

spent as a teacher for each year in issue, the reliability of the logs is also called
                                       - 11 -

into question by what appear to be exaggerated amounts of time shown for

relatively routine, recurring events, such as check writing. During petitioner’s

cross-examination respondent’s counsel pointed out numerous instances of entries

showing one to several hours for such activities. The Court does not exist in a

vacuum, and we cannot divorce ourselves from our own experiences of daily life,

such as the time it takes to review a mortgage statement and/or bill and pay the

item by check. We reject petitioner’s claim that the dozens, if not hundreds, of

checks that he wrote over the years in issue each took at least an hour to prepare.

      Other entries pointed out by respondent’s counsel during petitioner’s cross-

examination add to our concerns. Rather than point out each one, however, suffice

it to note the following exchange during petitioner’s cross-examination after

respondent’s counsel totaled the hours shown in the logs for time spent on various

activities on a particular day:

      MR. RICHMOND [respondent’s counsel]: And on November 30th
      [2007], you worked a 25-hour day on your rental properties?

      WITNESS [petitioner]: Well, I guess it was a big day.

      MR. RICHMOND: I guess it was.

More than 24 hours of activities are shown on the logs for other days as well.

Furthermore, some of the entries in the logs are attributable to services performed
                                          - 12 -

by Mrs. Escalante; petitioner now concedes that her activities should not be taken

into account. See sec. 469(c)(7)(B)(2). Finally, other entries in the logs are

simply improbable given the activities described and the locations of petitioner’s

various properties where the activities are shown to have occurred.

      Simply put, the logs are insufficient to show that petitioner has satisfied the

tests set forth in section 467(c)(7)(B), and his testimony in that regard was,

understandably, too generalized to otherwise do so. Because petitioners have

failed to establish that petitioner satisfied these tests for any of the years in issue,

petitioner is not a taxpayer described in section 469(c)(7) for any of those years.

That being so, petitioners’ rental real estate activity is treated as a passive activity

for each of those years. It follows that respondent’s disallowance of deductions

for the rental property losses attributable to that activity are sustained.

II. Section 6662(a) Accuracy-Related Penalty

      Section 6662(a) and (b)(1) imposes a penalty of 20% of the portion of an

underpayment of tax attributable to the taxpayer’s negligence or disregard of rules

or regulations. Respondent bears the burden of production with respect to the

imposition of the section 6662(a) accuracy-related penalty. See sec. 7491(c);

Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). According to
                                        - 13 -

respondent, the underpayment of tax7 for each year is due to petitioners’

negligence. “Negligence” includes any failure to make a reasonable attempt to

comply with the Internal Revenue Code, including any failure to keep adequate

books and records or to substantiate items properly. See sec. 6662(c); sec. 1.6662-

3(b)(1), Income Tax Regs.

      Petitioners’ challenge to the section 6662(a) penalty was ancillary to their

challenge to the deficiency for each year in issue. That challenge, in turn, hinged

upon the accuracy of the logs. Although the regulation cited above does not

require a taxpayer’s participation in an activity to be established by any specific

type of record, it assumes that the “reasonable means” relied upon by the taxpayer

was accurate. We have concluded that the logs are neither accurate nor reliable.

Accordingly, petitioners are liable for a section 6662(a) penalty for each of the

years in issue.

      To reflect the foregoing,


                                                       Decision will be entered

                                                 for respondent.


      7
      In this case the deficiency, understatement of income tax, and underpay-
ment of tax are all computed in the same manner. See secs. 6211, 6662(d)(2),
6664(a).
