Real Estate Agents are Same as Brokers for "Real Estate Professional Rule" for
By Ron Cohen, CPA, MST
Greenstein, Rogoff, Olsen & Co., LLP
Taxpayer victory in Tax Court
Real estate agents can claim the real estate professional exception to the
passive loss limitations.
The I.R.S. tried to argue that the taxpayer needs to be a “Broker” not a just an
“Agent” to meet the 750 hour per year material participation test.
The Tax Court said: “The
Court concludes that Congress is presumed to have defined the term “brokerage”
in its common or 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” and therefore, an “agent” is the same as a “broker” for purposes of
Comment from Ron Cohen: We agree with the tax court and can’t imagine why the
I.R.S. even troubled this taxpayer by arguing an “agent” did not qualify,
imposing back taxes and penalties…making them suffer through an audit on this
issue and the need to appeal into court. Had the Tax Court found that the
activities of an agent did not qualify for the Real Estate Professional Rule,
many, many thousands of well advised taxpayers would have been in a tough spot
having to decide whether they must amend their returns and pay-up. This is
another example of the I.R.S. trying to turn the clear meaning of a law against
the taxpayers. One must wonder: Is the I.R.S. enforcing the law, or coming up
with their own unintended theories of what the law should be?... just because
they have the power to do so.
By the way, somewhat related to this issue, that for California taxpayers,
the "Real Estate Professional" exception to the Passive Loss Limitation, does
California intentionally did not conform to the federal rule, so a taxpayer
will often have a substantial Passive Loss limitation within their California
income tax return even though they have no Passive Loss limitation within
their federal income tax return... which can often come as a shock to the
taxpayer because their California income tax return may show a substantial
amount of tax due (or a much lower refund than expected) in this situation.
Shri G. Agarwal, et ux. v. Commissioner, TC Summary Opinion 2009-29
SHRI G. AND SUDHA AGARWAL, Petitioners v. COMMISSIONER OF INTERNAL
REVENUE, Respondent .
Official Tax Court Syllabus
PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b),THIS OPINION MAY
NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE.
Shri G. and Sudha Agarwal, pro sese.
Kris H. An, for respondent.
Opinion by DEAN
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 as 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. Respondent also 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,
1 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 2001 and 2002, respectively, as qualifying taxpayers in
real property trades or businesses; and (2) liable for the accuracy-related
penalty for each year.
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.
(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. Agarwal) 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 an 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, and it did not pay
her a salary; rather, she received commissions. 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 spent 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 for a 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 $45,521 on Schedule E
and total 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 qualify 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 Proof
The Commissioner's 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 [12 AFTR 1456] (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 introduces credible evidence with respect to *** such issue.” 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 469
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 that the taxpayer 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 Regs., 53 Fed. Reg. 5725 (Feb. 25,
1988) (an individual is treated as materially participating if the individual
satisfies any one of the seven enumerated tests).
The general rule is that a rental activity is treated 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
Kosonen v. Commissioner, T.C. Memo. under section 469(c)(2). 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 [TC 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.
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; and (2) the taxpayer
performs more than 750 hours of services during the taxable year in real
property trades or businesses in which 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' Arguments
Petitioners argue that real estate agents should be considered real estate
professionals because real estate agents are engaged in a real property
brokerage business in that real estate agents “bring together buyers and
In reply, respondent argues that Mrs. Agarwal was a licensed 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 Defined
The term “brokerage” is not defined in section 469, 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 & Co., 367 U.S. 303, 307
[7 AFTR 2d 1585] (1961) (”a word is known by the company it keeps”).
Legislatures are presumed to have intended that a statute's terms “be given a
Hazlett v. Evans, 943 F. Supp. 785, reasonable construction”. 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. 1999); 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 [95 AFTR 2d 2005-1716] (2005); Smith v. United States, 508
U.S. 223, 228-229 (1993). Webster's Third New International Dictionary 282
(2002) defines the term “brokerage” as “the business of a broker” or “the fee or
commission for transacting business as a broker.” [Emphasis added.]
The Court concludes that Congress is presumed to have defined the term
“brokerage” in its common or 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 (5) procuring prospective sellers, purchasers, lessors, or lessees.
See Hooper v. California, 155 U.S. 648, 657 (1895); Lawrence Gas Co. v. Hawkeye
Oil Co., 165 N.W. 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. 1895); see also Ky.
Rev. Stat. Ann. sec. 324.010(1) (LexisNexis 2007) (defining “Real estate
brokerage”); Md. Code Ann. Bus. Occ. & Prof. sec. 17-101(l) (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. Agarwal's Activities
As is relevant
here, California law defines the term “real estate broker” as a person who does,
or negotiates to do, any one of the enumerated activities for compensation. Cal.
Bus. & Prof. Code sec. 10131 (West 2008). Similarly, California law also defines
the term “real estate salesman” as a person who is employed by a broker and who
does any one of the enumerated Cal. Bus. & Prof. Code sec. 10132 (West 2008).
But activities. whether Mrs. Agarwal is characterized as a broker or a
salesperson for State law purposes is 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 real
property and solicited listings. Therefore, Mrs. Agarwal was engaged in a
“brokerage” trade or business within the meaning of 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); , sec. 1.469-9(b)(6), (c)(1), Income
Tax Regs. Because Mrs. Agarwal is a qualifying taxpayer and she materially
participated 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
[TC Memo 2002-223]; Shaw v. Commissioner, T.C. Memo. 2002-35 [TC Memo 2002-35].
Accuracy-Related Penalty III.
Initially, the Commissioner has the burden of production with respect to any
penalty, addition to tax, or additional 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. 438, 446 (2001). Once the Commissioner satisfies this
burden of production, the taxpayer must persuade the Court that the
Commissioner's determination is (i), Income Tax Regs. in error by supplying
sufficient evidence of reasonable cause, substantial authority, or a similar
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 rules or regulations; or (2) a
substantial understatement of income tax.
5 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 items properly. Sec.
1.6662-3(b)(1), Income Tax Regs.
Section 6664(c)(1) provides an exception to the section 6662(a)
penalty: no penalty is imposed with respect to any portion of an underpayment if
it is shown that there was 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 acted with reasonable cause
and in good faith. The most important factor is the extent of the taxpayer's
effort to assess his 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 of *** 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.
1 In a “Stipulation of Settled Issues” the parties agree that: (1)
Petitioners are entitled to a net capital loss of $856
2 The brokerage firm is a licensed broker under California law. The
brokerage firm is franchised by a broker, Albert Foulad.
3 Mrs. Agarwal became a licensed broker in December 2007.
4 If 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 [TC 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 [TC Memo 2002-35]; , sec. 1.469-9(e)(1), (4)
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 [TC Memo 2008-207].