## Facts

- Jose Franco and Linda Anne Franco (California residents) filed a 2013 federal income tax return reporting rental real estate income and expenses on Schedule E.
- The Commissioner issued a notice of deficiency determining a $7,068 deficiency after disallowing $42,882 of reported rental loss as a passive activity loss under I.R.C. § 469.
- Jose Franco was a licensed architect and performed approximately 649 hours of non-real-estate work in 2013 for two clients.
- The Francos owned and rented two properties: a four-unit apartment building and a single-family home, both in Burlingame, California.
- Jose Franco personally managed the rentals, including weekly trips related to trash handling, tenant communications, rent collection and deposits, minor repairs, coordinating major repairs, purchasing materials, paying bills, maintaining insurance, and keeping books and records.
- In 2013, two tenants moved out of the four-unit property, requiring additional time for move-out coordination, repairs, advertising, and lease-up activities.
- Franco supported his claimed time with a log and documents (e.g., receipts and emails) and testified to spending about 1,137 hours on rental management during 2013.
- The IRS allowed a $25,000 rental loss under § 469(i) but treated the remaining loss as nondeductible passive loss; the IRS did not dispute an election to treat all rentals as a single activity for § 469(c)(7) purposes.

## Issues

1. Whether the Francos’ 2013 rental real estate loss was limited by the passive activity loss rules of I.R.C. § 469.
2. Whether Jose Franco satisfied the “real estate professional” requirements of I.R.C. § 469(c)(7), including the “more-than-one-half” personal services test and the 750-hour test.
3. Whether Jose Franco materially participated in the aggregated rental real estate activity, making the rental loss non-passive.

## Decision

- The Tax Court held that Jose Franco satisfied both prongs of I.R.C. § 469(c)(7)(B) and materially participated in the aggregated rental activity.
- The court found that Franco performed more hours in real property trades or businesses (rental management) than in his architectural work and exceeded 750 hours of qualifying services.
- The court concluded that Franco’s participation exceeded 500 hours, satisfying a regulatory material participation test for the aggregated rental activity.
- The court ruled that the $42,882 disallowed portion of the Schedule E loss was not a passive loss and was fully deductible; the deficiency determination based on that disallowance was not sustained.

## Legal Principles

- Rental activities are generally passive under I.R.C. § 469, and passive losses are generally not deductible against non-passive income, subject to statutory exceptions.
- Under I.R.C. § 469(i), qualifying taxpayers may deduct up to $25,000 of rental real estate loss if they actively participate and meet applicable limitations.
- Under I.R.C. § 469(c)(7), rental real estate losses are not treated as passive if the taxpayer (1) performs more than one-half of personal services in real property trades or businesses in which the taxpayer materially participates and (2) performs more than 750 hours of services in those real property trades or businesses during the year.
- Material participation may be established through regulatory tests, including participation exceeding 500 hours in the activity for the year.
- The court may credit time estimates for § 469(c)(7) and material participation when supported by logs, corroborating documents, and credible testimony; routine management tasks can qualify if they constitute participation in the rental real estate activity.

## Conclusion

The Tax Court allowed the Francos’ full claimed rental loss because Jose Franco proved, through credible records and testimony, that he qualified as a real estate professional and materially participated in the aggregated rental activity, removing the loss from the passive activity loss limitations.


Franco v. Commissioner, T.C. Summ. Op. 2018-9 (2018)