                         T.C. Summary Opinion 2013-108



                         UNITED STATES TAX COURT



   JOSE C. BALLESTEROS AND LINDA S. BALLESTEROS, Petitioners v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 27880-11S.                         Filed December 23, 2013.



      Jose C. Ballesteros and Linda S. Ballesteros, pro sese.

      Kim-Khanh Thi Nguyen, for respondent.



                              SUMMARY OPINION


      COHEN, Judge: This case was heard pursuant to the provisions of section

7463 of the Internal Revenue Code in effect when the petition was filed. Pursuant

to section 7463(b), the decision to be entered is not reviewable by any other court,

and this opinion shall not be treated as precedent for any other case.
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      Respondent determined deficiencies and section 6662(a) penalties as

follows:

                                                                  Penalty
           Year                   Deficiency                    sec. 6662(a)

           2008                    $16,187                        $3,237.40
           2009                     15,749                         3,149.80
           2010                     12,666                         2,533.20

After concessions, the issues for decision are whether section 469 precludes

petitioners’ deductions for rental losses claimed and whether petitioners are liable

for the penalties. Unless otherwise indicated, all section references are to the

Internal Revenue Code in effect for the years in issue, and all Rule references are

to the Tax Court Rules of Practice and Procedure.

                                     Background

      Petitioners resided in California when they filed their petition. During the

years in issue, Linda S. Ballesteros (petitioner) was a full-time nurse for the

County of Los Angeles, regularly working in 12-hour shifts three days a week.

Her base salary was between $90,000 and $100,000 per year. Because she worked

substantial overtime hours, she earned wages of at least $143,454 in 2008,

$134,096 in 2009, and $139,912 in 2010. Jose C. Ballesteros was a full-time

employee of MAG Aerospace Industries.
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        Petitioners owned two rental properties in Florida and one in Georgia. They

also owned an investment property in Georgia. Tenants for petitioners’ rental

properties were usually obtained by travel agencies or realty companies. Tenants

usually made needed repairs by themselves and were reimbursed by petitioners. A

friend of petitioner was asked to check on the properties in Florida from time to

time.

        On their tax returns for 2007 through 2010, petitioners elected to group their

rental properties as a single rental real estate activity, representing that they were

real estate professionals. They deducted rental losses for each year in issue.

        Petitioners prepared logs of the hours allegedly spent on their real estate

activity, recording that petitioner spent 2,199 hours in 2008, 3,025 hours in 2009,

and 2,248 hours in 2010, and Jose C. Ballesteros spent 901 hours in 2008, 1,005

hours in 2009, and 851 hours in 2010 on their rental activity.

        Because petitioners lived in California and the properties were in Florida

and Georgia, most of the hours recorded in the logs were for telephone calls,

writing checks and delivering the checks to the post office, and other

administrative tasks. Petitioners recorded a recurring time, usually two hours, to

make a phone call or to pay bills and go to the post office, sometimes charging the

same hours to each of their properties. Appointments were regularly recorded as
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lasting four hours. Often each petitioner recorded the same hours for the same

tasks. Many of the hours recorded on the logs related to their investment property

in Georgia. Petitioners included hours related to social events during which they

recruited friends to join in their investment plans for the property. Overall, the

hours recorded in the logs were improbable and not credible in view of the

described activities and petitioners’ full-time employment.

      Petitioners’ rental losses were disallowed in the statutory notice of

deficiency. Recomputed deficiencies taking into account the settled issues exceed

the greater of 10% of the tax shown on their returns or $5,000 for each year.

                                     Discussion

      Taxpayers are allowed deductions for certain business and investment

expenses under sections 162 and 212. Section 469(a), however, generally

disallows any passive activity loss. A passive activity loss is defined as 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 in which the taxpayer does not materially

participate. Sec. 469(c)(1). For the purposes of section 469 and to the extent

provided in regulations, a trade or business includes any activity with respect to

which expenses are allowable as a deduction under section 212. Sec.
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469(c)(6)(B). Rental activity is generally treated as a per se passive activity

regardless of whether the taxpayer materially participates. Sec. 469(c)(2), (4).

Material participation is defined as involvement in the operations of the activity

that is regular, continuous, and substantial. Sec. 469(h)(1).

      An exception to the rule that a rental activity is per se passive is found in

section 469(c)(7), which provides that the rental activities of certain taxpayers in

real property trades or businesses are not per se passive activities under section

469(c)(2), but are treated as a trade or business subject to the material participation

requirements of section 469(c)(1). See sec. 1.469-9(e)(1), Income Tax Regs. A

taxpayer may qualify as a real estate professional if: (1) more than one-half of the

personal services performed in trades or businesses by the taxpayer during the

taxable year are performed in real property trades or businesses in which the

taxpayer materially participates and (2) the 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). In the case of a

joint tax return, either spouse must satisfy both requirements. Sec. 469(c)(7)(B).

Thus, if either spouse qualifies as a real estate professional, the rental activities of

the real estate professional are not per se passive under section 469(c)(2).
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       Although petitioners have asserted that each of them was a real estate

professional, only petitioner appeared and testified at trial. She insisted that what

was recorded in her logs represented what she did during the years in issue. At the

Court’s direction, respondent filed a memorandum brief addressing the reliability

of petitioner’s testimony and the logs she presented. Petitioners did not file a

responsive brief. They presented no evidence or argument with respect to the

activities of Jose C. Ballesteros other than the uncorroborated logs.

       We need not accept petitioner’s testimony and may and do reject it because

of the many indicia of unreliability. See Fleischer v. Commissioner, 403 F.2d 403,

406 (2d Cir. 1968), aff’g T.C. Memo. 1967-85; Tokarski v. Commissioner, 87 T.C.

74, 77 (1986). Petitioner’s logs are unreliable because the hours she recorded for

specific tasks, such as telephone calls and writing and mailing checks, were

improbable in that they were excessive, apparently duplicative (charging the same

hours to each rental property), and always the same. The total hours recorded are

unrealistic in view of petitioners’ full-time employment. On consideration of the

entire record, we do not accept petitioners’ claims as to the hours devoted to the

rental activity.

       Because we are not persuaded that petitioner spent more time on her rental

activity during the years in issue than she spent working as a nurse, she has not
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established that she is a real estate professional. We also cannot rely on the logs to

prove that either petitioner spent more than 750 hours on their rental activity.

Thus, we need not analyze whether they materially participated in management of

the rental properties. Petitioners’ rental activity, therefore, is per se passive, and

they may not offset the losses against their other income.

      Respondent also contends that petitioners’ rental losses were not

substantiated. Petitioners did not produce to respondent or present at trial

evidence of actual expenses incurred in relation to their rental properties. Because

we hold that petitioners are not entitled to deduct the losses, we need not address

the substantiation issue.

Section 6662(a) Penalty

      Section 6662(a) and (b)(2) imposes a 20% accuracy-related penalty on any

underpayment of Federal income tax which is attributable to a substantial

understatement of income tax. An understatement of income tax is substantial if it

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

$5,000. Sec. 6662(d)(1)(A).

      Under section 7491(c), the Commissioner bears the burden of production

with regard to penalties and must come forward with sufficient evidence

indicating that it is appropriate to impose penalties. Higbee v. Commissioner, 116
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T.C. 438, 446-447 (2001). If the understatement of income tax for the year in

issue, after recomputation to reflect the stipulation of settled issues, is substantial,

respondent has satisfied the burden of producing evidence that the penalty is

appropriate. Respondent has recomputed the deficiencies taking into account the

settled issues, and the understatements are still in excess of 10% of the tax

required to be shown on petitioners’ returns, which is greater than $5,000 for each

year. Thus respondent’s burden of going forward has been satisfied.

      Once the Commissioner has met the burden of production, the taxpayer

must come forward with persuasive evidence that the penalty is inappropriate

because he or she acted with reasonable cause and in good faith. Sec. 6664(c)(1);

Higbee v. Commissioner, 116 T.C. at 448-449. The decision as to whether a

taxpayer acted with reasonable cause and in good faith is made on a case-by-case

basis, taking into account all of the pertinent facts and circumstances. See sec.

1.6664-4(b)(1), Income Tax Regs.

      We conclude that the exaggerated logs negate the good faith of petitioners

in claiming rental losses against their earned income. Petitioner testified that she

confirmed her status as a real estate professional with her tax preparer by

completing a checklist of questions as to qualifications for that status. Because

she knew what was required, she is chargeable with knowledge that she did not
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satisfy those requirements. The preparer did not testify. Thus we have no

evidence as to the competence and expertise of the preparer, and it appears that the

preparer relied solely on petitioners’ representations as to their activities relating

to the rental properties. If the representations to the tax preparer were the same as

the contentions in this Court, the preparer was not provided with accurate

information. Under those circumstances, petitioners were not entitled to rely on

the preparer. See Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99

(2000), aff’d, 299 F.3d 221 (3d Cir. 2002). They are liable for the section 6662(a)

penalty for substantial understatements of income tax for each year.

      We have considered the other arguments of the parties, and they are not

material to our conclusions.

      To reflect the foregoing,


                                                      Decision will be entered

                                                under Rule 155.
