Recent Tax Court Case Takes on Section 469 Passive Activity Loss Limitations
Lucero v. Comm’r, T.C. Memo. 2020-136 | September 29, 2020 | Pugh, J. | Dkt. No. 588-18
Short Summary: The taxpayers owned short-term rental property in California. The taxpayers rented the property to tenants in 2014 and 2015. They paid a property management company to manage the property’s day-to-day rental operations, including advertising, cleaning, landscaping, and responding to tenant complaints. However, the taxpayer maintained control over the setting of rental rates and approving expenses over $100. The taxpayers reported losses from the rental property, and the IRS denied the losses.
Key Issue: Whether any of the taxpayers’ real estate losses reported on their Schedule E, Supplemental Income and Loss, are limited by Section 280A or Section 469 for the years at issue.
- (1) Section 280A does not limit any of the real estate loss deductions the taxpayers may claim with respect to the property. (2) However, the taxpayers’ loss deductions are limited under Section 469.
Key Points of Law:
- Ordinarily, the burden of proof in cases before the Court is on the taxpayer. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Under section 7491(a)(1), “[i]f, any court proceeding, a taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the liability of the taxpayer for any tax imposed by subtitle A or B, the Secretary shall have the burden of proof with respect to such issue.” Higbee v. Comm’r, 116 T.C. 438, 442 (2001).
- The Commissioner may bear the burden of proof with respect to “[a] new theory that is presented [by him] to sustain a deficiency.” Wayne Bolt & Nut Co. v. Comm’r, 93 T.C. 500, 507 (1989); see also Rule 142(a)(1).
- The new theory shifts the burden to the Commissioner if “it either alters the original deficiency or requires the presentation of different evidence”; it remains with the taxpayer if the new theory “merely clarifies or develops the original determination”. Wayne Bolt & Nut Co. v. Comm’r, 93 T.C. at 507; see also Shea v. Comm’r, 112 T.C. 183, 191-197 (1999).
- Ordinarily, no deduction is allowed with respect to a dwelling unit used by the taxpayer as a residence during the taxable year. 280A. A dwelling unit is considered to be a taxpayer’s residence if it its use for personal purposes exceeds the greater of 14 days or 10% of the days the unit is rented at a fair rental value in a taxable year. Sec. 280A(d)(1).
- A taxpayer is deemed to have used a dwelling unit for personal purposes when, for any part of a day, the taxpayer or any member of the taxpayer’s family uses the unit for personal purposes or any individual uses the unit unless a fair rent is charged for the use. 280A(d)(2)(A), (C). Days spent primarily repairing and maintaining the unit will not count toward personal use merely because other individuals on the premises are engaged in some other activity. Sec. 280A(d)(2); see also Rose v. Comm’r, T.C. Memo. 2019-173; Van Malssen v. Comm’r, T.C. Memo. 2014-236.
- A passive activity is any activity involving the conduct of a trade or business—or an income-producing activity—in which a taxpayer does not materially participate. 469(c)(1), (6). Section 469(c)(1), (6). Section 469 limits a taxpayer’s deductible loss from passive activities in a taxable year to the taxpayer’s income from passive activities. Sec. 469(d)(1). Any loss from passive activities exceeding the income from those activities constitutes a passive activity loss and any deduction is therefore disallowed for that taxable year; it may be carried over, however, to the next taxable year to offset passive activity income for that next year. Sec. 469(a), (b), (d)(1); Temp. Treas. Reg. § 1.469-2T(b)(1).
- Rental activity is ordinarily passive, regardless of whether the taxpayers materially participate in the activity. 469(c)(2), (4); Bailey v. Comm’r, T.C. Memo. 2001-296; Temp. Treas. Reg. § 1.469-1T(e)(1)(ii). However, an activity that involves the use of tangible property is not a rental activity if “[t]he average period of customer use for such property is seven days or less” in a taxable year (short-term rental). Temp. Treas. Reg. § 1.469-1T(e)(3)(ii)(A).
- Material participation requires that a taxpayer be involved in the activity on a regular, continuous, and substantial basis. 469(h)(1). A taxpayer is considered to have materially participated in an activity if he satisfies any one of seven regulatory tests. Temp. Treas. Reg. § 1.469-5T(a). Taxpayers may establish hours of material participation by any reasonable means. Temp. Treas. Reg. § 1.469-5T(f)(4). Contemporaneous reports, logs, or similar documentation are not required if the taxpayer can establish his qualification by other reasonable means. Id. Reasonable means may include identifying services performed over a period of time and the approximate time spent performing those services using appointment books, calendars, or narrative summaries. Id. “[P]ostevent ‘ballpark guestimate[s]’” of hours do not suffice. Moss v. Comm’r, 135 T.C. 365, 369 (2010)
Insight: As the Lucero decision shows, the Section 469 passive activity loss rules continue to be a trap for taxpayers who rent properties during any given tax year. Accordingly, taxpayers with rental activities and losses are wise to consult tax advisors regarding whether they may deduct their losses under Section 469.
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