The Tax Court in Brief – April 18th- April 22nd, 2022

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Tax Litigation:  The Week of April 18th, 2022, through April 22nd, 2022

Sezonov. Comm’r, TC Memo. 2022-40| April 20, 2022 | Marvel, J. | Dkt. No. 26650-17

Opinion

Short Summary: The Sezonovs (“Petitioners”) had their primary residence in Ohio during 2013 and 2014. Mr. Sezonov was the only member of a single-member LLC. Petitioners owned two properties that they rented out through the LLC during those years (the “Rental Properties”). Petitioners performed various activities with regard to the Rental Properties, including communicating with prospective renters and preparing the properties for new renters.

Petitioners kept records of the hours they worked on the Rental Properties for these years:

Mrs. Sezonov Mr. Sezonov
2013 2014 2013 2014
Hours 476:20 80:20 405:30 26:40

 

 

 

 

Petitioners jointly filed their 2013 and 2014 Forms 1040, U.S. Federal Income Tax Returns, reporting the income, expenses, and losses associated with the Rental Properties on Schedule E, Supplemental Income and Loss. The IRS issued a statutory notice of deficiency disallowing the loss deduction that Petitioners claimed on their Schedules E for 2013 and 2014.

Key Issues

  • Were Petitioners’ activities with respect to the Rental Properties during 2013 and 2014 passive activities?

Primary Holdings

  • Yes, Petitioners’ activities with respect to the Rental Properties during 2013 and 2014 were passive activities. Therefore, the losses from those activities were not deductible. The evidence that Petitioners presented did not show that either spouse performed more than 750 hours of services in real property trades or businesses during either of those years.

Key Points of Law

  • A deficiency determination generally is presumed correct, with the taxpayer bearing the burden of proving that the determination is in error. Tax Court Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
  • Deductions are a matter of legislative grace, and the taxpayer bears the burden of proving they are entitled to any claimed deduction. INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992).
  • Taxpayers must maintain records to adequately substantiate the nature, amount, and purpose of a claimed deduction. R.C. § 6001; Higbee v. Comm’r, 116 T.C. 438, 440 (2001)
  • Taxpayers may deduct ordinary and necessary expenses paid or incurred in the ordinary course of business. R.C. § 162.
  • However, individual taxpayers are not allowed to deduct “passive activity losses.” I.R.C. § 469(a)(1), (b).A “passive activity loss” is the excess of the aggregate losses from all of a taxpayer’s passive activities for a taxable year over the aggregate income from all of that taxpayer’s passive activities during that taxable year. § 469(d).
  • A “passive activity” is any trade or business in which a taxpayer does not materially participate or any rental activity (regardless of whether the taxpayer materially participates in the rental activity). I.R.C. § 469(c)(1), (2).
  • While most rental activity is passive, there is an exception for rental activities of a taxpayer engaged in a real property trade or business. See I.R.C. § 469(c)(2), (7).
  • If a taxpayer is engaged in a real property trade or business, the material participation requirements apply. I.R.C. § 469(c)(7)(A)(i).
  • A taxpayer is engaged in a real property trade or business during a given taxable year if half of the personal services in trades or businesses that the taxpayer performs in the taxable year are performed in real property trades or business in which the taxpayer materially participates and the taxpayer performs more than 750 hours of services in real property trades or businesses in which the taxpayer materially participates. I.R.C. § 469(c)(7)(B). When taxpayers file joint returns, the two requirements are satisfied only if either spouse satisfies both requirements.

Insights:  This case is another illustration of the (frustrating) principle that deductions can be hard to come by—taxpayers need to be able to prove them up in order to get them.

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