26 April 2022
Freeman Law
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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.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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