Shri G. & Sudha Agarwal, Petitioner

T .C . Summary Opinion 2009-2 9

UNITED STATES TAX COUR T

SHRI G . AND SUDHA AGARWAL, Petitidners .v . COMMISSIONER OF INTERNAL REVENUE, Responden t .Docket No . 12670-07S . Filed March 2, 2009 .

.Shri G . and Sudha Agarwal, pro sese .

Kris H . An , for respondent .

DEAN, Special Trial Judge : This case was heard pursuant,to the provisions of section 7463 of the Internal Revenue Code (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 a s precedent for any other case . Unless otherwise indicated , subsequent section references . are-to the Code in effect for the years in'issue, and all Rule references are to the Tax Court Rules of Practice and Procedure .

Respondent determined deficiencies of $15,066 and $6,649 in petitioners' 2001 and 2002 Federal income taxes, respectively .

Respondent4also determined accuracy-related penalties under section 6662(a) of $3,013 .20 and $1,329 .80 for 2001'and 2002, respectively .

After concessions by the parties,' the issues remaining-for decision are whether petitioners are : (1) Entitled to deduct on Schedule E, Supplemental Income and Loss, losses of $40,104 and $19,656 for 200 1.and 2002, respectively,,-as qualifying taxpayer s in real property trades or businesses ; and (2) liable for the accuracy-related penalty for each year .

Background Some of the facts have been stipulated : and are so found ., The stipulation of facts and the exhibits received into evidence are incorporated herein by reference . When the petition was filed, petitioners resided in California .

, -In a "Stipulation of Settled Issues " the parties agree that : (1) Petitioners are entitled to a net capital loss of $856 (rather than $5,988 .16) for 2001 ; (2) they are not entitled' to a' self-employed, . health insurance deduction of $2,332 for 2001 ; (3) they are not entitled to additional exemptions of $9,048 and $1,920 for 2001 and 2002, respectively ; and (4 ) itemized deductions adjustments for 2001 and 2002 are computational .

During 2001 and 2002 Shri Agarwal (Mr . A4arwal) worked full time as an engineer . During 2001 and 2002 Sudha Agarwal (Mrs .

Agarwal) worked full time as a real estate agent at "Century 21 Albert Foulad Realty':. (brokerage firm) :_ .2 During 2001 and 2002 Mrs . Agarwal was licensed as a real estate agent under, California law ; she was not a licensed as a broker .3 She worked for a brokerage firm pursuant to an "Independent Contractor Agreement (Between Broker and Associate Licensee)" . . The contract provided that she was an independent contractor, not and employee of the brokerage firm : Consistent with Mrs . Agarwal','s independent contractor status, the brokerage firm issued a Form 1099 to her for each year, andit did not pay-her a salary ; rather, she received commissionsf The contract .also required . Mrs .- Agarwal to sell, exchange, lease, or rent properties and solicit additional listings, clients, and--customers diligently and with .her best efforts .

During 2001 and 2002 petitioners .-owned two rental properties . Together they spent approximately 170 hours managing the "Wanda Property" and approximately 170 hours managing the "Mohave Property" during 2001 and 2002 . They were the only persons who managed their rental properties . Mrs . Agarwal spen t 'The brokerage firm is a licensed broker under California law . The brokerage firm is franchised by a broker, Albert Foulad .

'Mrs . Agarwal became'a licensed broker in,~December 2007 .

a total of 1,400 and 1,600 hours managing petitioners' rental properties and selling real estate,in 2001 and 2002, respectively .

For 2001 Mrs ."Agarwal reported commissions of $13,912 as gross receipts on Schedule C, Profit :or=Loss From Business . She, also reported : total expenses of $14,084 for a $172 loss with respect to her Schedule C real estate business .- For 2002 she reported'commissions of $14,119 .,as gross receipts .. on Schedule C and total expenses of $13,401 fora profit of $718 :

For 2001-petitioners reported total,rents of $36 ;367 on Schedule E . They also reported total expenses .of .$76,471 .78 for ., a $40,104 .'78 loss (which they rounded down to $40,104) . For 2002 they reported . total rents of $451-521 on Schedule .E and tota l expenses of $65,177 for a $19,656 loss .

In the notice of deficiency issued,-to-petitioners, respondent disallowed their Schedule E losses for each year because : (1) Passive losses .are allowed only, to the extent,that they'.quali-fy for the special allowance for rental real estate and the transitional,phase-in rule ; and (2) petitioners' losses were in excess of their passive income, the special allowance, and the phase-in rule .

I .

Burden of Proo f Discussio n The Commissioner ' s (cid:127) determinations in a notice of deficiency are presumed correct , and the taxpayer bears the burden to prove that the determinations are in error .

See Rule . 142(a ) ; Welch v .

Helvering , 290 U . S . 111 , 115 (1933) . But the : burden of proof'on factual issues that affect the taxpayer ' s tax liability may be shifted to the Commissioner where the "taxpayer introduce s credible evidence with respect to * * * suchriissue ." See sec .

7491(a)(1) . Petitioners have not alleged that section 7491(a) applies ; however, the Court need not decide whether the burden shifted to respondent since there is no dispute as to any factual issue . Accordingly, the case is decided by the application of law to the undisputed facts, and section 7491(a) is inapplicable .

II .

Petitioners' Losses and Application of Section 46 9 Section 469(a) generally disallows any passive activity loss . A passive activity loss is defined as the excess of the aggregate losses over the-aggregate income from all passive activities . Sec . 469(d)(1) . A passive activity is any trade or business or an activity engaged in for the production of income in which the taxpayer'does not materially participate . Sec .

469(c) (1) , - (6) . ~ Material participation means ~11that the taxpaye r is involved in the activity's operations on a, .regular , continuous,-and substantial basis . Sec . 469(h) ; see also sec .

1 .469-5T(a), Temporary Income Tax Reg,s ., 53 Fed . Reg . 5725 (Feb .

25, 19 .88) (an individual is treated as materially . participating, if the .:indiv:idual satisfies any, one ofthe seven enumerate d tests) .

The general rule is that a rental activity- is as,,a per se passive activity regardless of .whether the taxpayer materially participates ., . Sec . 469(c)"(2), (4) . But under . section 469(c)(7),, rental activities of a qualifying taxpayer in a real property trade or business are not a"per se passive activity under sedtion 469(c)(2) .

Kosonen v . Commissioner , T .C . Memo .- 2000-107 .

Rather, the qualifying'taxpayer's ..'rental'activities are treated .as a trade or business--subject to the material participation requirements of section 469(c)(1) .

Fowler v .

Commissioner ;,-T .C . Memo . 2002-223 ; sec . 1 .469-9(e)(1), Income Tax Regs . And in determining whether a . taxpayer materially, participates, the participation .'of the taxpayer's . spouse is taken into account . Sec . .469(h) .(5) .

A taxpayer may qualify,for the .real,property trade or business . exception 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 ;,an d (2) the taxpayer performs more than-750 hours of services during the taxable-year in : real property trades or businesses in which .

7 - the taxpayer materially participates .

Sec . 469 ( c)(7)(B)(i) and (ii) . In the case of a joint return either spouse must satisfy both requirements ..

Sec . 469 ( c)(7) .(B)' .

Section 469(c)(7)(C) defines the term "real property trade or business" as "any real property development, redevelopment , construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business . " [Emphasis added . ] A .

The Parties' .Argiument s Petitioners argue that real estate agents should be considered real estate professionalis because real estate agents are engaged in a 'real property brokerage business in that rea l estate agents "bring together buyers and sellers" .

In reply, respondent argues that Mrs . Agarwal was a license d real estate agent,-not a licensed real estate broker . Thus, under California law, according to-respondent,-Mrs . Agarwal could not be engaged in a brokerage trade or business, and therefore , she was not engaged in a real property trade or. business . as defined by -section 469 (c) (7) (C ) B .

Brokerage Define d The term "brokerage" is not defined in section 46 .9, within the legislative history of section 469, or by any court decision .

Thus, the Court turns to principles of statutory construction to determine its meaning .

See Baker v . Wash . Group Intl ., Inc . , No .

1 :06-CV-1874 (M .D . Pa . Mar . 14, 2008,) ; Sierra Club v . Leavitt , .

355 F . Supp . 2d 544, 555 (D .D .C . 2005,) ;. Weber v . Heitkamp (In re , Hopson) , 324 Bankr . 284, 287 (S .D . Tex . 2005 ) "Statutory words are uniformly presumed, unless the contrary appears, to be-used in their : ordinary, and usual sense, and with the meaning . commonly attributed to ..them ."

Caminetti v . United > States ; 242 U .S . 470, .485-486 (1917) ., In addition, a statutory term is construed "in its context and in light of the terms , surrounding it ."

Leocal v . Ashcroft ,, 543 .U .S . 1 ., 9 .(2004) ; see also Jarecki v . G . D . Searle &LL.Co . , :367 U .S . 303,,307 (1961) ("a word . is known by the company it-keeps") . Legislatures are , presumed-to have intended that .a statute's terms "`be given a reasonable construction'," . --Hazlett v . Evans , 943 .F -`Supp 785, 788 (E .D . Ky . .1996) (quoting D .L .C .-v . Walsh , 908 S .W .2d .791 (Mo .

Ct . App . 1995)) ; see also Beck v . N .'Natural Gas Co . , 170 F :3d 1018 ; 1024 .(10th Cir .,1.999) ; . In re Nofziger , 925 F .2d 428,,435 (D .C . Cir . 1991 ) A term's :common or approved usage'may be established by a dictionary .

Rousey v . Jacoway , 544 .U .S : 320 (2005) ; Smith v .

United States , 508 U .S . 223, 228-229 (1993) . Webster's Third New International'sDictionary 282 (2002) defines,-the term "brokerage" as "the b,usiness ,of a broker" or "the fee'or commission fo r transacting business as a bro .ker .. [Emphasis added .] .

The Court concludes that Congress is presumed to have defined the term "brokerage" in its common ori! .ordinary meaning .

The Court further concludes that for purposes of section 469, the "business" of a real estate broker includes, but is not limited to : (1) Selling, exchanging,, purchasing, renting, or leasing ,_ real property ; (2) offering to do those activities ; (3) negotiating the terms-of a real estate contract ; (4) listing of real property for sale, lease, or exchange ; :or (6) procuring prospective sellers,,,-purchasers, lessors, or ll~essees . . See Hoope r v . California , 155 U .S . 648,, 657 (1895) ; I;awre'nce Gas Co . v .

Hawkeye Oil Co . , 165-N .W .(cid:127)445, 447 (Iowa 1917 .) ; Schmidt'v .

Maples, 289 N .W . 140,"143 (Mich . 1939) ; Commonwealth v . Jones & Robins, Inc . , 41 . S .E .2d 720, 727 .-'(Va . 1947) ; In re `Pipes , .748 A .2d 118, 121 (N .J . Super . Ct . App . Div . 2000) ; Commonwealth v . :

Fahnestock , 15 Pa . C . 598 (Pa . Quar . Sess . 189.5) ; see also Ky .

Rev . Stat . Ann . sec . 324 .010(1) . (LexisNexis 2007) (defining "Real estate brokerage"') ;-Md . Code Ann . Bus . Occ &11Prof . sec .

17-101(1)(cid:127)(LexisNexis 2004 & Supp . 2008) .(defining-Provide real estate brokerage services") Wis . Stat . .Ann . sec . 452 .01(3e) (West 2006) (defining "Brokerage service") .

.

C .

Application of the Definition to Mrs . Acarwal's Activitie s As is relevant here, California law defines the term "rea l estate broker" as a person who does, or negotiates to do, any on e of the enumerated activities for compensation . Cal . Bus . & Prof .

II Code sec . 10131 (West 2008) . Similarly,- California law also defines the,'term ."real -estate ksalesman" ° 'as a , person who is employed by a broker and who-does any one of the . enumerated activities . Cal . . .Bus . & Prof . „Code sec . 10132 (West 2008) . - . :But{ ; whether Mrs . Agarwal is characterized as ;a broker or a salesperson for State'law-purposes isr=irrelevant'for Federal, .

income tax purposes--the test is whether she . was engaged in "brokerage" .within,the meaning of section 469, as defined supra . .

Consistent with . her real estate-salesman's license and, pursuant, .

to her contract with the brokerage firm,"Mrs . Agarwal was engaged , in "brokerage" ; i .e ., she sold ;`exchanged, leased, or ..rented rea l property and solicited,listings .- Therefore, Mrs ._Agarwal was engaged in a "brokerage" trade or business within the meanin g section 469 (c) (7) (C) .

Because .Mrs .'Agarwal owned an interest, in a rental property, performed more .than one-half of 'her personal : services; in real-- .property trades or businesses in which she materially participated, and , performed more than 750'hours of services-in real .property trades or businesses in .which .she materially participated, she is a qualifying-taxpayer . .See sec . 469(c)(7) ; t sec . 1 .469-9(b)(6), (c)(1), Income Tax Regs . .Because Mrs .

Agarwal is a qualifying taxpayer and she materially participate d a with respect to each property,4 petitioners are entitled to deduct their 2001 and 2002 Schedule E'losses . See sec ; 469(c)(7) ; sec . 1 .469-9(e)(1), (3), (4) Example ( .i) , Income Tax Regs . ; sec . 1 .469-5T(a), Temporary Income Tax Regs ., supra (defining material participation) ; see also, Fowler .v .

Commissioner , T .C . Memo . 2002-223 ; Shaw v . Commissioner , T .C .

Memo . 2002-35 .

III .

Accuracy-Related Penalt y Initially, .the .Commissioner has the burden of production ; with respect to any penalty, addition to tax, or additioal amount . Sec . 7491(c) . The Commissioner satisfies this burden of production by coming forward with sufficient evidence that indicates that it is appropriate to impose the penalty . See Higbee v . Commissioner , 116 T .C . 4381' 446 (2001) .- Once the Commissioner satisfies this burden of producti!on,- the-taxpaye r must persuade the Court that the Commissioner's determination i s 41f the taxpayer is a qualifying taxpayer, then each interest in rental real estate is treated as a separate activity unless the taxpayer elects to treat all interests in rental real estate as one activity . Sec . 469(c)(7)(A) ; Fowler v . Commissioner , T .C . Memo . 2002-223 . And the determination of whether the qualifying taxpayer materially participated pursuant to sec . 469(c)(1) must be met with respect to each rental activity, unless the taxpayer elected to treat all of the taxpayer's rental activities as-a single activity . Sec . 469(c)(7)(A) ; Fowler v . Commissioner , supra ; Shaw v . Commissioner , T .C . Memo . 2002-35 ; sec . 1 .469-9(e)(1), (4) Example Jj , Income Tax Regs - 1 2 in error by supplying sufficient evidence of . reasonable cause , substantial authority, or a similar provision .

I d In pertinent part, section-6662(a), and (b)(1) and (2) imposes an accuracy-related penalty equal to,20 percent of .the underpayment that is attributable to : (1),Negligence or, disregard of rule^s .or regulations ; or (2) a substantial understatement of income tax .' Section 6662(c) defines the term, "negligence" to include "any failure to make a reasonable-attempt to comply with the provisions of .this,title," and'the~term "disregard. " -to , include "any, careless,, reckless, or intentional disregard ." Negligence also includes any,failure by the-taxpayer to keep adequate books and records or to substantiate item s properly . Sec . 1 .6662 7 3 (b)..(i),, Income Tax Regs . , IY Section~6664(c)(1) provides .an exception to the section 66 6.2(a) penalty : no'penalty is, .,imposed with respect to any .

portion,of . an° underpayment if it ,is shown 'that .,there wa s reasonable cause. therefor and the taxpayer acted in good faith .

Section 1 .6664-4(b)(1), Income .Tax Regs ., incorporates a facts and circumstances test to determine whether the taxpayer acte d with' reasonable cau'seand in good faith . The most important factor is the extent-of the taxpayer's°effort` to-assess hi s 'Because the Court finds that,petitioners :were negligent or.

disregarded rules or regulations the Court need not discuss whether there is-a substantial-understatement of income tax . See sec . 6662(b) ; Fields v . Commissioner , T .C . Memo . 2008-207. .

proper tax liability .

Id .

"Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light o f * * * the experience, knowledge, and education; of the taxpayer . " Id .

Because petitioners concede that they are' not entitled`to certain deductions, see supra note 1, the Court finds that respondent has met his burden of production and that petitioners were negligent . Petitioners did not establish a defense for their noncompliance with the Code's requirements . See sec . 6001 (requiring taxpayers to keep records sufficient to establish the amounts of the items required to be shown on their Federal income tax returns) . Respondent's determination is sustained .

To reflect the foregoing, Decision will be entered under Rule 155 .

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