Carlos v. Comm'r of Internal Revenue, 5512–03.

• Decision Date: 20 September 2004
• Docket Number: No. 5512–03.,5512–03.
• Citation: 123 T.C. No. 16,123 T.C. 275
• Parties: Tony R. CARLOS and Judith D. Carlos, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

123 T.C. 275
123 T.C. No. 16

Tony R. CARLOS and Judith D. Carlos, Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 5512–03.

United States Tax Court.

Sept. 20, 2004.

[123 T.C. 275]

Ps owned and actively engaged in the conduct of two S corporations, B and J. B rented real property BB from Ps, and J rented real property JJ from Ps. Ps grouped the two rentals together to make up a single passive “activity” for purposes of sec. 469, I .R.C. B paid its rent on BB according to its lease with Ps, resulting in income to Ps. J did not pay its rent on JJ under its lease

[123 T.C. 276]

with Ps, resulting in a loss to Ps. Ps netted the income and loss from the two rentals, claiming nonpassive net rental income. R, however, determined that the income and loss items could not be netted, that the income from renting BB was nonpassive and the loss from renting JJ was passive, and that Ps could not offset the nonpassive BB income with the passive JJ loss.

Held: Sec. 1.469–2(f)(6), Income Tax Regs., recharacterizes rental income from the taxpayer's active business as nonpassive, thereby removing such income from the calculation of passive loss for a sec. 469, I.R.C. activity, despite the proper grouping of such income with an item of passive loss against which such income would otherwise be offset.

Murray H. Falk, for petitioners.

Paul L. Dixon, for respondent.

OPINION WELLS, J.

Respondent determined deficiencies in petitioners' Federal income taxes for 1999 and 2000 as follows: ¹

+----------------+
                ¦Year¦Deficiency ¦
                +----+-----------¦
                ¦ ¦ ¦
                +----+-----------¦
                ¦1999¦$17,011 ¦
                +----+-----------¦
                ¦2000¦1 14,443 ¦
                +----+-----------¦
                ¦ ¦ ¦
                +----------------+
                

The issue to be decided is whether losses from petitioners' rental activity constitute passive activity losses pursuant to section 469.²

Background

The parties have submitted the instant case fully stipulated, without trial, pursuant to Rule 122. The parties' stipulations of fact are incorporated herein by reference and are found as facts in the instant case.

[123 T.C. 277]

Petitioners are husband and wife. At the time of filing their petition, petitioners resided in Apple Valley, California.

During the years in issue, petitioners owned two commercial real estate properties in Apple Valley, California. One property was located at 22040 Bear Valley Road (Bear Valley Road property), and the other was located at 13685/13663 John Glenn Road (John Glenn Road property). Collectively, the Bear Valley Road property and the John Glenn Road property are referred to as the rental properties. Petitioners also owned all of the stock of two S corporations—Bear Valley Fabricators & Steel Supply, Inc. (steel company), and J & T's Branding Company, Inc. (restaurant).

During 1999 and 2000, petitioners leased the Bear Valley Road property to the steel company and leased the John Glenn Road property to the restaurant.

The steel company agreed to pay rent of $120,000 per year to petitioners for the Bear Valley Road property. The steel company paid the rent, which, after taxes, depreciation, and bank charges, resulted in net rental income to petitioners for the Bear Valley Road property of $102,646 in 1999 and $102,045 for 2000.

The restaurant agreed to pay rent of $60,000 per year to petitioners for the John Glenn Road property. The restaurant failed to pay its designated rent in 1999 and 2000, which, after mortgage interest, taxes, depreciation, and amortization incurred by petitioners, resulted in a net loss to petitioners for the John Glenn Road property of $41,706 in 1999 and $40,169 in 2000.

Petitioners grouped the rental properties together to constitute a single “activity”. On Schedules E, Supplemental Income and Loss, of their 1999 and 2000 income tax returns, petitioners netted the income from the Bear Valley Road property and the loss from the John Glenn Road property. For 1999, petitioners subtracted the $41,706 net loss on the John Glenn road property from the $102,646 net income on the Bear Valley Road property, resulting in net rental income of $60,940. Similarly, for 2000, petitioners subtracted the $40,169 net loss on the John Glenn Road property from the $102,045 net income on the Bear Valley Road property, resulting in net rental income of $61,876. Petitioners reported the net rental income as not from a passive activity and reported no passive activity loss.

[123 T.C. 278]

Respondent disallowed petitioners' net losses on the John Glenn Road property under section 469(a) as passive activity losses.

Discussion

Section 469(a) disallows the passive activity loss of an individual taxpayer.³ The Internal Revenue Code defines “passive activity” as an activity involving the conduct of a trade or business in which the taxpayer does not materially participate.⁴ “Passive activity”, however, generally includes any rental activity, regardless of material participation. Sec. 469(c)(2).

Section 469 does not define “activity”. See Schwalbach v. Commissioner, 111 T.C. 215, 223, 1998 WL 567814 (1998). The Secretary, however, has prescribed regulations pursuant to section 469(1) that specify what...