Monday, February 2, 2009

L.A. Dean

February 2, 2009

Code Sec. 469

Code Sec. 1211

Appeal of a district court's grant of summary judgment in favor of the IRS. Dean sued to recover on his claim for a refund for 1996 based on the carryback of his partnership share of Dean Securities' loss for 1998. Taxpayer that summary judgment was improper because he raised a triable issue of fact as to whether he worked for Dean Securities for at least 500 hours during the 1998 tax year. Had Taxpayer worked at least 500 hours, he would be deemed to have "materially participated" in Dean Securities activities, and the passive loss limitations in 26 U.S.C. § 469 would not apply. See 26 U.S.C. § 469 ; 26 C.F.R. § 1.469-5T(f)(4) .

LOREN A. DEAN, Plaintiff - Appellant v. INTERNAL REVENUE SERVICE, Department of Treasury, Defendant - Appellee.

UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT. No. 07-35341 D.C. No. CV-05-05352-FDB. Submitted August 28, 2008 ** Seattle, Washington.

Appeal from the United States District Court for the Western District of Washington Franklin D. Burgess, District Judge, Presiding

Before: HAWKINS, McKEOWN, and BYBEE, Circuit Judges.


While Dean correctly asserts that § 1.469-5T(a)(1) allows him to establish "by any reasonable means" that he worked at least 500 hours, Dean's evidence does not amount to such reasonable means, and no reasonable factfinder could find that he met his burden of proof. See F.T.C. v. LLC , 453 F.3d 1196, 1201 (9th Cir. 2001). While "this temporary regulation is somewhat vague regarding the records that a taxpayer must maintain to prove hours of participation, [the tax court] uniformly has held that the regulations do not permit a post-event 'ballpark guesstimate'." See, e.g. , D'Avanzo v. United States , 67 Fed. Cl. 39, 42 (Ct. Fed. Cl. 2005) (citing cases). Dean's tepid assertion at his deposition that he "[m]ight well have [worked at the brokerage for more than 500 hours], but [he] can't say for sure," and his brother's declaration that it is his "recollection that Loren Dean spent more than 500 hours in the Dean Securities office," are just such ballpark estimates, at best.

Neither did the district court abuse its discretion in denying Dean's motion for reconsideration. Dean's illness at the time the opposition to the motion for summary judgment was prepared does not amount to exceptional circumstances requiring the court to invoke FED. R. CIV. P. 59(e)'s "extraordinary remedy." See Kona Enters., Inc. v. Bishop , 229 F.3d 877, 890 (9th Cir. 2000). The cases cited by Dean are distinguishable on their facts, but more importantly involve default judgments, which do not implicate the same interest in judicial finality as judgments such as this one on the merits. See, e.g. , TCI Group Life Ins. Plan v. Knoebber , 244 F.3d 691, 698 (9th Cir. 2001). Finally, because Dean's two substantive claims fail, so too does his claim that the district court erred in awarding costs.


** The panel unanimously finds this case suitable for decision without oral argument. See Fed. R. App. P. 34(a)(2).

* This disposition is not appropriate for publication and is not precedent except as provided by 9th Cir. R. 36-3.

A boat owner was denied a deduction for losses incurred in the operation of a boat charter business because he did not show that he materially participated in the business, under the facts and circumstances test, for more than 100 hours during the tax year at issue. Marina employees spent more time performing chartering activities than did the owner. Further, it was not clear that the owner spent the required 100 hours in management activity because much of the time claimed actually constituted investment activity. Finally, the owner's records were "post-event ballpark guesstimates" that were inadequate to establish the facts asserted.

W.A. Goshorn, 66 TCM 1499, Dec. 49,453(M), TC Memo. 1993-578.

A chiropractor and his wife were required to characterize certain losses on an investment in the S corporation that owned the marina where they docked their boat as passive activity losses because they did not materially participate in the management of the S corporation's business. The husband's testimony that as a one-twentieth owner of the S corporation, as a boat owner, and as a 99-year leaseholder of a slip in the marina, he was active was not sufficient evidence. Further, the taxpayers' contention that they materially participated was contradicted by the Schedule K-1 (Form 1120S) that they received from the S corporation. It specifically stated that the losses were from a passive activity and that the taxpayers should file Form 8582, Passive Activity Loss Limitations, with their return.

R.J. Dougherty, 68 TCM 1347, Dec. 50,274(M), TC Memo. 1994-597.

The taxpayers could not offset losses from a horse racing partnership against their non-passive income in a second horse racing partnership because they did not materially participate in the first partnership. They offered no evidence, except their uncorroborated testimony, regarding their participation in the partnership. Accordingly, the taxpayers did not meet their burden of proof, and the Code Sec. 469 passive activity loss rules applied.

J.E. Machado, 70 TCM 1165, Dec. 50,983(M), TC Memo. 1995-526. Aff'd, CA-9 (unpublished opinion), 97-2 USTC ¶50,593.

Rents received by a wife from her husband's personal service corporation (PSC) pursuant to an office lease were properly recharacterized by the IRS as nonpassive income that could not be used to offset the couple's passive losses. Because the husband materially participated in the PSC's dental activity, the recharacterization rule of Reg. §1.469-2(f)(6) applied during the tax years at issue.

M.F. Connor, CA-7, 2000-2 USTC ¶50,560.

The IRS properly applied Reg. §§1.469-2(f)(6) and 1.469-4(a) in order to recharacterize rental income of a dentist who leased real estate to his personal service corporation for use in a dentistry practice in which he materially participated. Thus, because the the rental income was recharacterized as nonpassive income, the taxpayers could not offset the income with the passive losses.

S. Schwalbach, 111 TC 215, Dec. 52,861.

Rents received by the sole shareholder of two C corporations from his lease of an office building to one of the corporations, a law firm in which he was a partner, were properly recharacterized by the IRS as nonpassive income that could not be used to offset his losses on the lease of another building to the other corporation. The taxpayer materially participated in the law firm's business, and his challenge to the validity of the recharacterization rule was rejected because the legislative rule was not arbitrary, capricious, or manifestly contrary to Code Sec. 469.

T.P. Krukowski, CA-7, 2002-1 USTC ¶50,219, 279 F3d 547.

A married couple's claimed losses with respect to their investment in two S corporations were passive activity losses and were not deductible. The couple failed to prove that the husband materially participated in the businesses. He did not keep a diary of the amount of time he devoted to the businesses, and they did not offer any records similar to those described in Reg. §1.469-5T(f)(4).

L. Speer, 72 TCM 125, Dec. 51,450(M), TC Memo. 1996-323.

Taxpayers who rented out a beach condominium were engaged in a passive activity and could not currently deduct losses. Although the undertaking was not considered a rental activity because the average rental term for the condominium was seven days or less, it was still subject to the PAL limitations. The time spent by the taxpayers in cleaning and refurbishing the property at the end of the vacation season did not amount to material participation in the business activity because the bulk of the property maintenance, management, and leasing functions were handled through a leasing agent. Since they did not materially participate in the activity and since their involvement did not constitute "substantially all of the participation" in the activity, the taxpayers did not meet the safe harbor requirements of Temporary Reg. §1.469-5T(a)(2) and (3).

B.T. Chapin, 71 TCM 2027, Dec. 51,159(M), TC Memo. 1996-56.

A condominium owner and part-time member of the management team of a ski lodge did not materially participate in the lodge's business. His argument that Temporary Reg. §1.469-5T(a)(1) was invalid was rejected because the regulation implemented a congressional mandate in a reasonable manner by focusing on the amount and extent of time spent on the activity. The taxpayer also failed to prove that his rental activity was a personal service activity and that he materially participated in that activity for the three tax years preceding each of the tax years at issue. His activity did not involve the performance of personal services in the fields that are specifically identified in Temporary Reg. §1.469-5T(a)(6), and the activity necessarily employed capital as a substantial, material income-producing factor. Nor did the taxpayer materially participate under the facts and circumstances test of Temporary Reg. §1.469-5T(a)(7). Other persons were compensated for performing management services, and they performed those services for more hours than the taxpayer performed management services.

A.P. Mordkin, 71 TCM 2796, Dec. 51,301(M), TC Memo. 1996-187.

An owner of three trucking and waste removal businesses who engaged in treasure hunting activity for profit was entitled to deduct losses related to that activity. The losses were not disallowed pursuant to the Code Sec. 469 passive activity loss limitations because the owner materially participated in the treasure hunting activity. He and one of his treasure hunting associates credibly testified that he transported heavy equipment, operated machinery, manned water pumps, negotiated contracts and purchased equipment for the venture.

F.G. Harrison, Sr., 72 TCM 1258, Dec. 51,653(M), TC Memo. 1996-509.

A married couple could not deduct rental activity losses involving an out-of-state condominium partnership because the losses arose with respect to passive activities in which the taxpayers did not materially participate. Since the day-to-day rental operation was run and managed by a full-time, on-site staff of condominium association employees, the taxpayers' activities of preparing income tax returns, reviewing budgets, attending partnership meetings, and paying bills were considered investor activities, not participation in a trade or business. Since the taxpayers' participation was less than that of the on-site employees, they did not come within the safe harbor requirements of Reg. §1.469-5T(a)(3) for material participation. Further, the regulation did not permit computation of participation by the employees on a per-unit basis.

R. Serenbetz, 72 TCM 1264, Dec. 51,654(M), TC Memo. 1996-510.

A professor who invested in a condominium hotel and who was a member of its board of directors did not establish material participation relating to the condominium rental activities, and thus, the activities' losses were passive activity losses. Her activities under Reg. §1.469-5T(a)(3) did not constitute material participation because the participation of the full-time staff of the hotel's management company exceeded the professor's participation. Also, the professor did not establish material participation under Reg. §1.469-5T(a)(7) because the management company's onsite staff provided management services and were compensated for their services. Further, under Reg. §1.469-5T(a)(4), the aggregate participation in significant participation activities of the professor who was a partner in an accounting firm during the years at issue did not exceed 500 hours.

B.H. Scheiner, 72 TCM 1532, Dec. 51,700(M), TC Memo. 1996-554.

A shareholder in an S corporation that operated an automobile dealership did not materially participate in the management of the business. Testimony that the shareholder worked for as many as 500 hours during the year was not credible. He was living out of the country during the tax years in question. However, under the phase-in of the PAL rules, he could deduct a portion of the dealership's losses for two tax years plus the excess loss carryover for one tax year.

C.N. Bohannon, 73 TCM 2446, Dec. 51,962(M), TC Memo. 1997-153.

The president and majority shareholder of a general contracting company, which was part of a related group of real estate partnerships, materially participated in company activities because he failed to prove that he spent less than 500 hours on company activities. The methods he used to approximate the amount of time allocated to each of the closely integrated entities were not reasonable and did not account for the fact that activities performed for a specific enterprise produced a general benefit that flowed to all of the entities. Moreover, he understated the amounts of time allocated to activities that only benefited the company and attributed no time to his wife's activities for the company. The president's self-serving testimony was insufficient to show that he was not involved in the company's operations on a regular, continuous, and substantial basis.

W.N. Carlstedt, 74 TCM 170, Dec. 52,159(M), TC Memo. 1997-331.

Losses sustained in the operation of one vacation condominium operated by married taxpayers were deductible; however, losses sustained in the operation of another vacation condominium were nondeductible passive activity losses. The activity was a trade or business and not rental activity because the average period of customer use was seven days or less during the year. The taxpayers established the extent of their participation with respect to the rental of the condominiums through testimony regarding contemporaneous records, a management contract, and a narrative summary. The taxpayers proved that they spent over 100 hours participating in the rental of the first condominium and that the management company's participation did not exceed the number of hours that they devoted to the activity. Under their agreement with the company, the taxpayers performed the majority of services, and the mere availability of front desk personnel did not count as participation. However, the taxpayers failed to show that they had materially participated in the rental of the second condominium because the record did not support their contention that they spent over 100 hours participating in its rental. Further, since the taxpayers failed to offer any evidence as to whether they performed more hours of service in the rental of the second condominium than management company personnel, the taxpayers did not materially participate in the business and their activity was passive.

G. Pohoski, 75 TCM 1574, Dec. 52,520(M), TC Memo. 1998-17.

A married couple was not allowed to deduct losses attributable to their yacht-chartering activity because they failed to establish that they materially participated in the activity. The couple contracted with a charter broker to handle all day-to-day management responsibilities and did not devote 100 or more hours annually to the activity, as required by Temp. Reg. §1.469-5T(b)(2)(iii), during the months the yacht was available for charter. Moreover, even if the time they spent maintaining the yacht had met the 100 hours requirement, they failed to establish that their participation was greater than that of the broker.

T.C. Oberle, 75 TCM 2204, Dec. 52,678(M), TC Memo. 1998-156.

Married taxpayers who failed to prove that they participated in the activity of renting their condominium unit for more than 100 hours during any of the tax years in issue were denied business loss deductions for costs incurred with respect to the unit. Documents that purportedly summarized the taxpayers' hours of participation were not prepared contemporaneously; the taxpayers' monthly calendars merely corroborated the dates of their trips to the condominium and the husband's attendance at meetings; and their records and testimony regarding their involvement in the unit's management did not prove that their combined hours of participation exceeded 100 hours for each of the tax years. Accordingly, absent proof of material participation in the rental activity, the taxpayers' expenses gave rise to passive activity losses that were deductible only to the extent of their passive activity income.

S.D. Rapp, 78 TCM 175, Dec. 53,475(M), TC Memo. 1999-249.


W.A. Barniskis, 78 TCM 226, Dec. 53,486(M), TC Memo. 1999-258.

Losses realized by a logging company employee with respect to his aircraft leasing activity were subject to the passive activity limitations of Code Sec. 469 because the leasing venture qualified as a rental activity. The tangible property held in connection with the activity was used or held for use by customers and the gross income attributable to the conduct of the activity represented amounts paid for the use of the tangible property. Because all rental activities are generally passive regardless of whether the taxpayer materially participates in the undertaking, the fact that the taxpayer spent at least 500 hours annually in conjunction with the venture did not exempt the activity from the passive loss rules.

W.W. Kelly, 79 TCM 1427, Dec. 53,733(M), TC Memo. 2000-32.

A couple did not materially participate in a hotel condominium business in which the couple and other condominium owners entered into an agreement with a company to manage and rent their condominiums to third parties. Therefore, the activity constituted a passive activity. The average period of customer use of the condominium units did not exceed seven days; therefore the activity was a trade or business rather than a rental activity. Since the management company employed personnel who performed more hours of service in the business activity than the couple performed, they did not qualify as materially participating in the company.

IRS Letter Ruling 9543003, July 10, 1995.

Married taxpayers who sought to characterize the husband's ratable share of an LLC's medical consulting, marketing, and management flow-through losses as ordinary losses were entitled to a refund of taxes and penalties paid. By grouping the husband's participation in the LLC with his previous participation in a C corporation that engaged in a significantly similar line of business, he showed material participation in the activity of a trade or business; thus, the loss could properly be characterized as ordinary.

S.A. Gregg, DC Ore., 2001-1 USTC ¶50,169.

A scientist who incurred losses in equipment leasing activities that were deemed "incidental" to the nonrental activity of his partnership was permitted business loss deductions because he materially participated in the leasing activity by maintaining records, personally purchasing equipment, and conducting transactions on a regular basis.

U. Tarakci, 80 TCM 727, Dec. 54,129(M), TC Memo. 2000-358.

A taxpayer could not deduct losses involving a fast food restaurant business for which he served as secretary because the losses arose with respect to passive activities. The individual failed to prove that he materially participated in the restaurant business under Temp. Reg. §1.469-5T(a)(1). His testimony regarding his participation in the business was questionable and not credible in certain material respects. Moreover, materials he provided documenting his alleged duties and activities at the restaurant were inconsistent and vague.

J.B. Newhart, 82 TCM 832, Dec. 54,534(M), TC Memo. 2001-289.

Married attorneys were not entitled to all claimed deductions for rental losses because they did not qualify as real estate professionals for one of the tax years at issue. The wife's uncorroborated estimates of time spent on rental activities were not reasonable and did not reflect the hours that she devoted to the activities. Moreover, the taxpayers did not materially participate in the operation of the excluded property because they did not spend the requisite amount of hours in the activity.

B. Bailey, 82 TCM 868, Dec. 54,541(M), TC Memo. 2001-296.

The IRS's reclassification of losses claimed by an individual as losses from nonpassive activities was upheld because the activities generating the losses were actually passive activities subject to the loss limitations of Code Sec. 469. The individual did not prove that he participated in one activity for more than 500 hours during the years at issue; therefore, the level of his participation did not qualify as material participation.

S.C. Shaw, 83 TCM 1194, Dec. 54,640(M), TC Memo. 2002-35.

The "material participation" of a testamentary trust in a ranching business had to be determined by addressing the activities of the trust through its fiduciaries, employees, and agents, and could not be decided by evaluating only the activities of the trustee. The plain meaning of Code Sec. 469 dictates that the trust itself was the taxpayer, and its participation in the ranch operations had to be evaluated by reference to the persons who conducted the business on its behalf, including the trustee. Because the collective activities of those persons were regular, continuous, and substantial, the material participation requirement was satisfied. Moreover, the trustee's activities, standing alone, constituted material participation. Thus, the trust's ranching loss deductions were improperly disallowed as passive activity losses and it was entitled to a refund of the overpaid taxes, with interest.

K. Carter Trust, DC Tex., 2003-1 USTC ¶50,418, 256 FSupp2d 536.

The real estate activities of married taxpayers that constituted a trade or business and rental activity generated only nondeductible passive losses. The trade or business involved owning four units in hotels whose day-to-day operations were managed by hotel management companies. Because the taxpayers failed to establish material participation, their activity with the units was passive. Though there was evidence that the wife spent many hours every night studying and tracking their investments, this monitoring activity was deemed to be "investment activity," and did not count toward material participation. As a result, the taxpayers did not fall within the safe harbors in Temporary Reg. §§1.469-5T(a)(1), 1.469-5T(a)(3), or 1.469-5T(a)(4), which require participation in the activity for a set number of hours. Taxpayers also could not rely on the safe harbor provided by Temporary Reg. §1.469-5T(a)(7). Because the taxpayers compensated the hotels for management services, with some of the taxpayers' revenues withheld as payment for services like cleaning and check-ins, time that the taxpayers spent on managerial functions was discounted under Temporary Reg. §1.469-5T(b)(2)(ii)(A).

Z. Lapid, 88 TCM 313, Dec. 55,764(M), TC Memo. 2004-222.

The passive activity loss rules of Code Sec. 469 did not preclude a married couple from deducting leasing activity losses incurred by their limited liability company (LLC). The wife spent a substantial amount of time on the leasing activities of the LLC and provided legal support services to the tenants and, therefore, materially participated in the LLC's activities.

A.F. Al Assaf, 89 TCM 694, Dec. 55,915(M), TC Memo. 2005-14.

An individual failed to satisfy the material participation requirements of Code Sec. 469(c)(7) to qualify as a real estate professional and was, therefore, not entitled to deduct unlimited real estate losses. The taxpayer did not offer a contemporaneous written record to prove the number of hours he spent working on his five rental properties.

A.M. D'Avanzo, FedCl 2005-2 USTC ¶50,497, 67 FedCl 39. Aff'd per curiam, CA-FC (unpublished opinion), , 2007-1USTC ¶50,371.

If an individual, through a subchapter S corporation of which she or he is the sole owner, leases an aircraft for another's use, supplying neither pilot nor crew, then the dominant element of the relationship is a rental activity and, therefore, a passive activity.However, if the S corporation provides a pilot and crew to operate and maintain the aircraft, and food and fuel for travel, then the S corporation has provided extraordinary personal services in connection with the use of the aircraft and the aircraft rental is incidental to the customers' receipt of services. Even though providing air transportation services is not a rental activity, it may still be a passive activity if the individual/sole owner of the S corporation does not to materially participate in the activity. If the owner does materially participate, the provision of air transportation services is not a passive activity and losses are not subject to the Code Sec. 469 limitations.

Rev. Rul. 2005-64, I.R.B. 2005-39, 600.

A married couple was precluded from applying losses from their various rental properties to offset rental income derived from leases of their property as office space to their wholly owned lessee corporations. The IRS properly recharacterized the couple's rental income as nonpassive income under the self-rental rule of Reg. §1.469-2(f)(6) because they materially participated in the business activities of the lessee corporations. Therefore, the rule was applicable to couple even if their motive was not to avoid tax and even if the arrangement did have a bona fide purpose.

G. Beecher, CA-9, 2007-1 USTC ¶50,379, aff'g Cal Interiors, Inc., 87 TCM 1226, Dec. 55,614(M), TC Memo. 2004-99.

A testamentary trust did not materially participate in a business for purposes of the passive activity loss limitation because the trustee's involvement in the business operations was not regular, continuous and substantial. Since special trustees hired to operate the business had only limited power under the contract, they could not be considered fiduciaries of the trust for purposes of counting their time managing or operating the business as material participation. Because the special trustees were not fiduciaries of the trust for purposes of Code Sec. 469, only the activities of the trustees counted toward the material participation requirement for the trust. Since the limited number of hours the trustees spent on the management and operations of the business did not constitute a regular, continuous and substantial involvement in the business, the trust did not satisfy the material participation requirement.

TAM 200733023, August 17, 2007

Symbol: TAM-100421-07

Uniform Issue List No. 0469.00-00

[Code Sec. 469]
Passive activity losses and credits limited.


(1) How does a trust establish material participation for purposes of the passive activity loss limitation of § 469 of the Internal Revenue Code?

(2) Under the circumstances described below, did Trust materially participate in Business during Year 3 for purposes of § 469?


(1) A trust materially participates in an activity for purposes of § 469 if the fiduciaries of the trust participate in the operations of the activity on a basis which is regular, continuous, and substantial.

(2) Under the circumstances below, Trust did not materially participate in Business during Year 3 because Special Trustees in this case are not fiduciaries for purposes of § 469 and Trustees' involvement in the operations of Business for Year 3 was not regular, continuous, and substantial.


Trust is a testamentary trust established in Year 1. The trustees of Trust are Trustees. In Year 2, Trust acquired an interest in P, a state law limited liability company (LLC) that is classified as a partnership for federal tax purposes. P engages in Business.1 According to Trust, between Year 2 and Year 3, Trustees provided services to P that encompassed a range of administrative and operational activities relating to Business, including direct participation in operations, oversight of bond financings and borrowing activities, and approval of operating budgets.

The will establishing Trust provides for the appointment of a special trustee "as to part or all of the trust property." The will also states that, except as specifically limited by the appointing instrument, the special trustee "shall have all of the rights, titles, powers, duties, discretions, and immunities of the trustees. ..."

For Year 3, Trustees contracted with Special Trustees to perform a number of tasks related to Business. The contract entered into between Trust and Special Trustees for Year 3 explicitly states that Special Trustees are being appointed as special trustees pursuant to the will and that their involvement in Business is intended to satisfy the material participation standard of § 469(h)(1). The contract also provides that Special Trustees "will not possess the capacity to legally bind or commit the Trust to any transaction or activity" and that "[Trust] acknowledges that it retains all decision making responsibilities related to [Trust's] financial, tax, or business matters."

Time logs submitted by Trust indicate that Special Trustees spent most of their work hours during Year 3 reviewing operating budgets, analyzing a tax dispute that arose among the partners, and preparing and analyzing other financial documents. The logs evidence repeated contacts with Trustees relating to these issues. In addition, Special Trustees appear to have spent a considerable number of hours negotiating the sale of Trust's interests in P to a newly-admitted partner. Consistent with the contractual provisions described above, Trust submits that, while Trustees relied heavily upon the recommendations of Special Trustees, ultimate decision-making authority remained vested solely with Trustees. During Year 3, Special Trustees spent approximately #a hours performing services under the contract.

Additional time logs submitted by Trust indicate that Trustees spent approximately #b hours during Year 3 on matters related to Business. Approximately #c of these hours were spent on issues related to the proposed sale of Trust's interests in P to the newly-admitted partner. The remaining hours appear to have been spent reviewing and analyzing operating budgets and other financial documents related to Business.

For its tax return filed for Year 3, Trust reported a loss from P in the amount of $X. Trust did not treat the loss as a passive loss on its tax return.


Issue 1: How does a trust establish material participation for purposes of the passive activity loss limitation of § 469?

Section 469(a)(1) disallows the passive activity loss for any taxable year to any individual, estate or trust, any closely held C corporation, and any personal service corporation. The passive activity loss for a given year is the amount, if any, by which the passive activity deductions for the taxable year exceed the passive activity gross income for the taxable year. Temp. Treas. Reg. § 1.469-2T(b)(1). As relevant here, § 469(c)(1) defines the term "passive activity" to include any activity which involves the conduct of any trade or business in which the taxpayer does not materially participate.

Section 469(h)(1) provides that a taxpayer materially participates in an activity only if the taxpayer is involved in the operations of the activity on a basis which is regular, continuous, and substantial. The legislative history to § 469 contains significant discussion of the concept of material participation. Embodied throughout the discussion is a general notion that in order for a taxpayer to materially participate, the taxpayer must be involved in the day-to-day operations of the trade or business: "Even an intermittent role in management, while relevant, does not establish material participation in the absence of regular, continuous, and substantial involvement in operations." S. Rep. No. 99-313, 99th Cong., 2d Sess. 734 (May 26, 1986), Vol. 3 1986-3 C.B. 734.

For individuals, the qualitative test of § 469(h)(1) has largely been replaced by the more quantitative regulatory tests of Temp. Treas. Reg. §§ 1.469-5T(a)(1)-(7) of the Income Tax Regulations. The Treasury Department has not yet issued regulations addressing the material participation requirement for trusts and estates. See Treas. Reg. §§ 1.469-5(T)(g), 1.469-8. Until regulations are promulgated, § 469(h)(1) remains the sole standard for determining whether a trust or estate satisfies the material participation requirement of § 469. Cf. Hillman v. IRS, 263 F.3d 338 (4th Cir. 2001) (while the government's authority to issue regulations exempting certain self-charged fees from the ambit of § 469 was clearly contemplated by Congress, the failure to do so did not obviate the basic statutory rule that the fees in question were passive activity deductions). The statutory standard for material participation can be applied in the absence of regulations. See Housing Pioneers v. Commissioner, 58 F.3d 401 (9th Cir. 1995) [95-1 USTC ¶50,126] (applying statutory requirement of regular, continuous, and substantial involvement to a tax-exempt entity in a case where an unrelated statute explicitly borrows the language of § 469.)

As noted above, other than the "regular, continuous, and substantial" language of § 469(h)(1), there is an absence of explicit statutory or regulatory guidance regarding how a trust establishes material participation. Nonetheless, the legislative history of § 469 provides important insight into how Congress intended for the material participation standard to apply to trusts: "Special rules apply in the case of taxable entities that are subject to the passive loss rule. An estate or trust is treated as materially participating in an activity...if an executor or fiduciary, in his capacity as such, is so participating." S. Rep. No. 99-313, at 735.2

Trust submits that the opinion in Mattie K. Carter Trust v. United States, 256 F.Supp.2d 536 (N.D. Tex. 2003) [2003-1 USTC ¶50,418], provides the appropriate standard for evaluating material participation for trusts. In Mattie K. Carter, the court held that in determining material participation for trusts, the activities of the employees of the trust should be included in determining whether the trust's participation is regular, continuous, and substantial. In rejecting the government's position that the determination should be made solely with reference to the activities of the trustee, the court stated:

Such a contention is arbitrary, subverts common sense, and attempts to create ambiguity where there is none. The court recognizes that [the] IRS has not issued regulations that address a trust's participation in a business ... and that no case law bears on the issue. However, the absence of regulations and case law does not manufacture statutory ambiguity.

Id. at 541.

Determining the proper focus in § 469 for the activities of Trust is a question of federal tax law and must include an examination of the treatment of trusts under Subchapter J. The taxation of trusts under Subchapter J is a hybrid regime involving an entity-level tax as well as the pass-through of income to the beneficiaries. While a trust is sometimes required to pay tax on its own income under § 641, it may also generally deduct under § 661 income that is passed through to its beneficiaries under § 662. Although the beneficiaries of a trust do not generally participate in the activities of the trust, the designated trustee acts on behalf of, and in the interests of, the beneficiaries.

The focus on a trustee's activities for purposes of § 469 accords with the general policy rationale underlying the passive loss regime. As a general matter, the owner of a business may not look to the activities of the owner's employees to satisfy the material participation requirement. See S. Rep. No. 99-313, at 735 (1986) ("the activities of [employees]...are not attributed to the taxpayer."). Indeed, because an owner's trade or business will generally involve employees or agents, a contrary approach would result in an owner invariably being treated as materially participating in the trade or business activity. A trustee performs its duties on behalf of the beneficial owners. Consistent with the treatment of other business owners, therefore, it is appropriate in the trust context to look only to the activities of the trustee. An interpretation that renders part of a statute inoperative or superfluous should be avoided. Mountain States Tele. & Tele. Co. v. Pueblo of Santa Ana, 472 U.S. 237, 249 (1985).

Therefore, notwithstanding the decision in Mattie K. Carter, the Service believes that the standard annunciated in the legislative history is the proper standard to apply to trusts for purposes of § 469. Thus, the sole means for Trust to establish material participation in Business for Year 3 is if its fiduciaries are involved in the operations of Business on a regular, continuous, and substantial basis.

Issue 2: Did Trust materially participate in Business during Year 3 for purposes of § 469?

Trust asserts that Special Trustees are fiduciaries for purposes of § 469 and, therefore, the activities of both Trustee and Special Trustees should be taken into account in determining whether Trust materially participated in Business for Year 3.

Section 7701(a)(6) defines "fiduciary" as a "guardian, trustee, executor, administrator, receiver, conservator, or any person acting in any fiduciary capacity for any person." The regulations further provide that "fiduciary" refers to "persons who occupy positions of peculiar confidence toward others, such as trustees, executors, and administrators." Treas. Reg. § 301.7701-6. To date, the Service has issued only limited guidance expounding upon the definition of fiduciary under § 7701(a)(6).

In Revenue Ruling 69-300, 1969-1 C.B. 167, a bank was appointed by court order to serve as the custodian of shares in a land trust. Among the powers granted to the bank was the power to vote at any stockholders' meeting, retain legal counsel, exercise or sell conversion or subscription rights, and petition the court to make any disposition concerning the property that it considered to be in the best interests of the owner. In holding that a trust was formed, the ruling notes that "where the bank or individual is vested with broad discretionary powers of administration and management, a fiduciary relationship exists within the meaning of § 7701(a)(6) of the Code."

In contrast, Revenue Ruling 82-177, 1982-2 C.B. 365, as modified by Revenue Ruling 92-51, 1992-2 C.B. 102, holds that a fiduciary relationship does not exist for purposes of § 7701(a)(6) where a bank merely holds money for an estate and pays interest on the account, but performs no administrative duties.

The case law is generally consistent with these rulings. United States v. Anderson, 132 F.2d 98 (6th Cir. 1942) [42-2 USTC ¶9786], a pre-7701(a)(6) case, involved the issue of whether an agreement between the taxpayer and a bank created a trust or an agency relationship. In that case, the bank could not invest or dispose of any corpus without the consent of the settlor and was relieved of all liability for any decline in the value of the corpus. The settlor had the power to vote any corporate stock held by the bank and could remove the bank and select a successor at any time. The court stated that while an agent undertakes to act on behalf of his principal and is subject to his control, a trustee usually has discretionary powers and acts for a term. Accordingly, because the bank did not have discretionary powers, the court held that the agreement created an agency relationship rather than a trust. See also City Nat'l Bank & Trust Co. v. United States, 109 F.2d 191 (7th Cir. 1940) [40-1 USTC ¶9171] (holding that no trust was formed where bank's investment decisions could be overridden by settlor and other evidence of managerial power was lacking).

What is apparent from the line of authority in this area is that a fiduciary must be vested with some degree of discretionary power to act on behalf of the trust. Although Trust represents that Special Trustees were heavily involved in the operational and management decisions of Business, Special Trustees --like the banks in Revenue Ruling 82-177 and Anderson --were ultimately powerless to commit Trust to any course of action or control Trust property without the express consent of Trustees. The contract between Trust and Special Trustees is explicit on this point, and Trust itself has acknowledged that Trustees retained final decision-making authority with regard to all facets of Business. The services performed by Special Trustees appear to be indistinguishable from those that would be expected of other non-fiduciary business personnel. If advisors, consultants, or general employees can be classified as fiduciaries simply by attaching different labels to them, the material participation requirement of § 469 as applied to trusts would be meaningless.

Trust cites the state law case of Matter of Will of Rubin, 540 N.Y.S.2d 944 (N.Y. Sur. Ct. 1989) to argue that, under the laws of many states, a trustee's powers may be "split" among more than one co-trustee or special trustee. However, Rubin and the cases cited therein involved actual delegations of discretionary power; specifically, the case involved whether one co-executor could be delegated the exclusive power to manage realty held by the estate. In the case of Trust, no such powers were delegated to Special Trustees. Trustees' ultimate power to control Trust property was unaffected by the appointment of Special Trustees, and Special Trustees could exercise no power over Trust property without first obtaining the permission of Trustees.

Citing Revenue Ruling 61-102, 1961-1 C.B. 245, Trust argues that the Service's own rulings rely heavily upon the language of the trust instrument to determine whether someone is a fiduciary. The ruling, however, appears limited to its facts and cannot be read to create a presumption that a named trustee will be recognized as such for federal tax purposes. Consistent with the Service's position that substance, not form, governs the tax consequences of purported trust arrangements, the courts have repeatedly refused to recognize the status of appointed "trustees" who lack any indicia of discretionary power. See City Nat'l Bank & Trust Co. v. United States, 109 F.2d 191 (7th Cir. 1940) [40-1 USTC ¶9171]; Dunham v. Commissioner, 35 T.C. 705 (1961) [CCH Dec. 24,638].

In light of the limited power vested with Special Trustees under the contract, we conclude that Special Trustees were not fiduciaries of Trust during Year 3 for purposes of § 469. Moreover, even if Special Trustees were fiduciaries of Trust, a review of the time logs submitted by Trust indicates that many of the duties performed by Special Trustees had a questionable nexus to the conduct of Business. As noted above, the legislative history of § 469 indicates that Congress was insistent that the material participation standard be satisfied through participation in the operations and management of the activity. See also Treas. Reg. § 1.469-5T(f)(2)(ii) (prohibiting "individuals" from counting certain "investor" hours toward the material participation requirement unless the individual is also involved in the day-to-day management or operations of the activity). Some of the hours reflected in the time logs of Special Trustees - particularly those spent negotiating the sale of Trust's interests in P as well as those spent resolving a tax dispute with another partner - were not spent managing or operating Business. Thus, even if Special Trustees were fiduciaries of Trust, a number of hours reflected in the time logs of Special Trustees would be disregarded for purposes of analyzing Trust's involvement in Business.

Because Special Trustees are not fiduciaries of Trust for purposes of § 469, only the activities of Trustees count toward the material participation requirement for Trust. According to the time logs submitted by Trust, Trustees spent approximately #b hours in Year 3 on activities related to Business. As noted above, however, many of these hours must be disregarded. In particular, the hours that Trustees spent negotiating the sale of Trust's interests in P (approximately #c) are not hours that should count toward Trust's involvement in Business for purposes of § 469. The limited number of hours that arguably do constitute participation in the management or operations of Business do not constitute involvement in Business that is regular, continuous, and substantial. Thus, we conclude that Trust did not materially participate in Business for Year 3.


A copy of this technical advice memorandum is to be given to the taxpayer(s). Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

No opinion is expressed herein as to any other issues raised in the technical advice request or that may be raised based on the facts of this case.

1 This memorandum assumes that Trust is a testamentary trust and not a business entity. See Bedell Trust v. Commissioner, 86 T.C. 1207 (1986) [CCH Dec. 43,116].

2 The legislative history is somewhat complicated by subsequent comments in the Bluebook to the 1986 Act. "No special rule is provided for determining material participation by a trust." See Staff of Joint Comm. on Tax'n, 100th Cong., 1st Sess., General Explanation of the Tax Reform Act of 1986 at 242, n. 33. However, the Bluebook is not legislative history. In addition, the discussion in the Bluebook is based on the assumption that trusts would rarely (if ever) materially participate in a trade or business activity.

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