Sidell v. Commissioner
| Decision Date | 09 September 1999 |
| Docket Number | Docket No. 10489-98. |
| Citation | 78 T.C.M. 423 |
| Parties | Chester F. and Faye L. Sidell v. Commissioner. |
| Court | U.S. Tax Court |
Respondent determined deficiencies and an accuracy-related penalty under section 6662(a) with respect to petitioners' Federal income taxes, as follows:
Penalty
Year Deficiency Sec. 6662(a)
1993 .................. $103,728 --
1994 .................. 41,621 $8,324
The deficiencies stem from respondent's recharacterizing the income Chester F. Sidell (Mr. Sidell) received from the rental of properties to his wholly owned C corporation from passive to nonpassive. Respondent now concedes the accuracy-related penalty under section 6662(a) for 1994.
The issues for decision are: (1) Whether respondent's recharacterization of the rental income Mr. Sidell received from his wholly owned C corporation was proper; and if so, (2) whether respondent properly disallowed the rehabilitation credits petitioners claimed for those years.
All section references are to the Internal Revenue Code as in effect for the years in issue.
Some of the facts have been stipulated and are so found. The stipulation of facts and the exhibits submitted therewith are incorporated herein by this reference.
Petitioners, husband and wife, resided in Framingham, Massachusetts, at the time they filed their petition contesting respondent's determinations. For both years in issue, petitioners filed joint Federal income tax returns.
Acquisition of Rental Properties.
Mr. Sidell was the sole beneficiary of five trusts: The Manche Realty Trust, CFS Realty Trust, FLS Realty Trust, GES Realty Trust, and RMS Realty Trust. All five trusts are nominee trusts under Massachusetts law and constitute grantor trusts for Federal income tax purposes. All income, deductions, and credits of these trusts were reported as pass-through items on petitioners' 1993 and 1994 Federal income tax returns.
On November 8, 1985, Manche Realty Trust acquired title to the land and building known as the Everett Mill Cotton Weaving House (the Everett Mill property), located at 181-183 Canal Street, Lawrence, Massachusetts. The Everett Mill property is located in a National Register historical district. Immediately after its purchase in 1985, the Everett Mill property was leased to KGR, Inc. (KGR), Mr. Sidell's wholly owned corporation. At the time of its acquisition, the Everett Mill property was in poor condition.
On July 6, 1992, Mr. Sidell executed an agreement for the acquisition of the land and building known as Kunhardt Mill, located at 60 Island Street, Lawrence, Massachusetts. The Kunhardt Mill property is a historic mill dating back to the late 1800's and is located across the street from the Everett Mill property in the same National Register historical district. On October 14, 1992, CFS Realty Trust (rather than Mr. Sidell) took title to the Kunhardt Mill property. At the time of its acquisition, the Kunhardt Mill property needed substantial repair. After its acquisition, the Kunhardt Mill property was leased to KGR. The property was subsequently renovated and thereafter used as KGR's corporate headquarters.
On February 23, 1993, FLS Realty Trust acquired the land and building located at Canal, Mill, and Methuen Streets, Lawrence, Massachusetts (the FLS Realty Trust property). This property was subsequently leased to KGR to alleviate a parking shortage around KGR's offices.
On July 14, 1993, and May 16, 1994, respectively, GES Realty Trust and RMS Realty Trust acquired properties located near the Everett Mill, Kunhardt Mill, and FLS Realty Trust properties. These properties were acquired in anticipation of future expansion of KGR's business; they were not rented to KGR during the years in issue.
KGR, incorporated in Massachusetts, has its principal place of business in Lawrence, Massachusetts. For Federal income tax purposes it is a subchapter C corporation. KGR is engaged in the business of manufacturing women's and children's apparel under private labels for such customers as Nordstrom, Talbots, and Dillards.
During the years in issue, petitioner was the president, treasurer, and sole director of KGR. With the exception of its retail sales operation, which was managed by Mrs. Sidell, Mr. Sidell managed every facet of KGR's day-to-day activities.
On May 16, 1986, Mr. Sidell submitted a historical preservation application to the U.S. Department of the Interior requesting certification that the Everett Mill property was a "certified historic structure". Certification was subsequently granted by the National Park Service (Park Service). Thereafter, in 1989 and 1990, substantial rehabilitation, repairs, and modifications were made to the Everett Mill property. Petitioners claimed rehabilitation credits for the rehabilitation expenditures in 1989 and 1990. The rehabilitation credits for these years were allowed and are not at issue in this case.
Seeking similar tax treatment for the Kunhardt Mill property, and concurrently with its acquisition, Mr. Sidell (on behalf of CFS Realty Trust) instituted a major rehabilitation project with respect to the property. After repairs and renovations had begun on the Kunhardt Mill property, Mr. Sidell submitted a historic preservation certification application on March 23, 1993, to the U.S. Department of the Interior seeking a determination that the work previously done on the property conformed with its "Standards for Rehabilitation". After Mr. Sidell completed the rehabilitation project, the Park Service preliminarily determined that the work performed on the Kunhardt Mill property was eligible for "certified rehabilitation" status. Subsequently, on September 23, 1994, Mr. Sidell submitted a "Historic Preservation Certification Application Request for Certification of Completed Work" to the Park Service. Rehabilitation costs totaling $1,701,988 in 1993 and $84,435 in 1994 were incurred with regard to the rehabilitated Kunhardt Mill property.1 An additional $200,000 was incurred in related costs associated with obtaining "qualified rehabilitation" status.
Petitioners timely filed their 1993 and 1994 Federal income tax returns. On their returns, petitioners reported the following net rental income:
Property Net Rental Income/(Loss
1993 1994
Manche/Everett Mill property ................................. $122,139 $ 45,936
CFS/Kunhardt Mill property ................................... 138,451 (5,335)
FLS property ................................................. (42,758) 57,894
GES property ................................................. (2,272) (25,315)
RMS property ................................................. N/A (11,855)
________ _________
Rental activities with net income ............................ 260,590 103,830
Rental activities with net loss .............................. (45,030) (42,505)
________ _________
Net rental income ............................................ 215,560 61,325
Petitioners also claimed rehabilitation credits of $85,361 in 1993 and $24,284 in 1994 with regard to the Kunhardt Mill property renovations.
In the notice of deficiency dated March 11, 1998, respondent recharacterized the positive 1993 income from the Everett Mill and Kunhardt Mill properties and the positive 1994 income from the Everett Mill and FLS Realty Trust properties from passive to nonpassive pursuant to section 1.469-2(f)(6), Income Tax Regs.; the recharacterization resulted in petitioners' 1993 and 1994 taxable income being increased by $45,030 and $42,505, respectively. In addition, as a consequence of respondent's recharacterization, respondent determined that petitioners' regular tax liability allocable to all passive activities for 1993 and 1994 was insufficient to enable them to use the rehabilitation credits claimed for those years. See sec. 469(d)(2).
OPINIONCentral to the dispute in this case is the validity of the so-called self-rented property rule contained in section 1.469-2(f)(6), Income Tax Regs., which provides:
Property rented to a nonpassive activity. — An amount of the taxpayer's gross rental activity income for the taxable year from an item of property equal to the net rental activity income for the year from that item of property is treated as not from a passive activity if the property —
(i) Is rented for use in a trade or business activity * * * in which the taxpayer materially participates * * * for the taxable year.
Pursuant to this rule, and by virtue of the attribution rule of section 1.469-4(a), Income Tax Regs.,2 respondent recharacterized the rental income Mr. Sidell received in 1993 and 1994 from the three properties leased to his wholly owned C corporation from passive to nonpassive.
As a consequence of this recharacterization, petitioners were neither able to reduce such rental income by the losses from other rental properties nor able to utilize certain rehabilitation credits.
Pursuant to section 469(a), in general, a taxpayer is denied both a passive activity loss and a passive activity credit for the taxable year in which they arise. A passive activity loss is defined as the amount by which the aggregate losses from all passive activities exceeds the aggregate...
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