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Eger v. United States

United States District Court, N.D. California

August 30, 2019

GREG A EGER and JULI A EGER, Plaintiffs,



         This case is about a tax dispute. Plaintiffs Greg and Juli Eger (“the Egers”) challenge the Internal Revenue Service's (“IRS”) decision to disallow an election they made on their federal income tax returns regarding three rental properties. They move for partial summary judgment. [Docket No. 43 (Pltfs' Mot.).][1] Defendant United States of America (“the Government”) opposes, cross-moves for summary judgment, and moves to dismiss one claim based on lack of standing. [Docket No. 50 (Def.'s Opp'n & X-Motions).] The court heard oral argument on August 1, 2019. Having considered the parties' arguments and submissions, the court denies the Egers' motion for partial summary judgment and grants the Government's cross-motion for summary judgment and motion to dismiss.


         A. Description of the Statutory Framework

         The facts of the case are described in detail below. In short, this dispute involves the Egers' 2007, 2008, and 2009 (the “Relevant Years”) federal income tax returns. During the Relevant Years, Greg Eger met the requirements to claim status as a Real Estate Professional (“REP”) under the tax code.[2] The Egers owned numerous rental properties, including the three at issue here. The Egers treated the three properties as “rental activity, ” which increased the total amount of business loss they sought to claim. The IRS disallowed this approach, and the Egers filed this lawsuit to challenge the IRS's decision.

         The parties' positions turn on a regulation promulgated under section 469 of the Internal Revenue Code. Section 469 captures the “Passive Activity Limitations” (“PAL”) rule, which limits a taxpayer's ability to deduct losses from businesses in which he or she does not materially participate, and from rental activities. See 26 U.S.C. § 469(a)(1) (1986). Thus, a passive activity is any activity that “involves the conduct of any trade or business . . . in which the taxpayer does not materially participate.” Id. § 469(c)(1). Rental activity from properties also is typically considered passive activity. Id. § 469(c)(2). However, if the taxpayer qualifies as an REP, rental activity generally is not considered passive, and can be applied as non-passive loss against non-passive income. Id. § 469(c)(7).

         Rental activity is “any activity where payments are principally for the use of tangible property.” Id. § 469(j)(8). The accompanying regulation defines “rental activity:” [A]n activity is a rental activity for a taxable year if-

(A) During such taxable year, tangible property held in connection with the activity is used by customers or held for use by customers; and
(B) The gross income attributable to the conduct of the activity during such taxable year represents . . . amounts paid or to be paid principally for the use of such tangible property (without regard to whether the use of the property by customers is pursuant to a lease or pursuant to a service contract or other arrangement that is not denominated a lease).

26 C.F.R. § 1.469-1T(e)(3)(i).

         The regulation also sets forth seven exceptions to the definition of “rental activity.” The parties agree that their dispute centers on one of the exceptions, which states that the activity is not rental activity if “[t]he average period of customer use for such property is seven days or less.” 26 C.F.R. § 1.469-1T(e)(3)(ii)(A). A “period of customer use” is further defined as “[e]ach period during which a customer has a continuous or recurring right to use [the property].” 26 C.F.R. § 1.469-1(e)(3)(iii)(D).

         The Government contends that this exception applies to the three properties at issue because the average period of customer use for each of them was seven days or less. See, e.g., Def.'s Opp'n & X-Motions at 4. Under the Government's approach, the customers are the end-user guests who stayed in the rental properties. According to the Government, the IRS correctly determined that the three properties do not constitute rental activity because the end-user guests stayed an average of less than seven days. For their part, the Egers assert that the customers are the three management companies with whom the Egers had a contractual relationship. See, e.g., Pltfs' Mot. at 12. Therefore, according to the Egers, the average period of customer use was far greater than seven days, which means that the exception does not apply, and they appropriately treated the three properties as rental activity in their tax returns.

         B. Stipulated Facts and Procedural History

         The parties submitted a Joint Statement of Undisputed Facts [Docket No. 42 (JS).] At the hearing, they confirmed that there are no disputed facts that are material to the adjudication of these motions.

         The Egers filed federal income tax returns for the Relevant Years. JS ¶ 2. During that time period, Greg Eger “render[ed] personal services solely in real property trades or businesses in which he materially participated, ” “devot[ing] more than 750 hours of services in each such year to such trades or businesses.” Id. ¶ 3. For purposes of these motions, it is undisputed that Greg Eger qualifies as a REP under the tax code. Def.'s Opp'n and X-Motions at 2, n.1 (“The United States will assume, without conceding, for purposes of the Motion only that Plaintiffs were in the ‘real property business' during the years at issue, and that they made a proper group election.”). During the Relevant Years, the Egers owned rental properties in Mexico, Colorado, and Hawaii (the “Resort Properties”). For each of these properties, the Egers entered into management agreements, which are described below.

         1. The Los Cabos, Mexico Property

         In 2005, the Egers purchased Villas del Mar # 371 (the “Mexico Property”) in Los Cabos, Baja California Sur, Mexico. JS ¶ 5. The Egers entered into a “2006 Consulting Agreement” with SH Consulting, LLC (“SH”) to rent out and manage the property (the “Mexico Agreement”), pursuant to which SH was granted the “exclusive right to market [the Mexico Property, hereinafter “the Unit, ”][3] to third parties for use.” [Docket Nos. 43 (2-7), 44-48 (Declaration of Smith (“Smith Decl.”)), Ex. 8 at ¶ 2.] As part of the agreement, the Egers elected to join a program called “Free Sell.” Under the Free Sell program, SH would “black out any and all dates that [the Egers] do not wish to offer the Unit for use.” Id. ¶ 3. The Egers could update the blackout dates at any time in writing, as long as there was not a conflicting confirmed reservation for the Unit. Id. SH agreed to use its efforts to market the Unit “for use by third parties on the Available Days, ” and was allowed to “enlist the services of one or more subcontractors or other third parties to assist SH in such efforts.” Id. ¶ 6. SH was also entitled to request up to five complimentary nights from the Egers. Id. ¶ 7. SH would execute a “Use Agreement” with third-party guests who wanted to rent the Mexico Property, and could make changes to the Use Agreement as SH “deemed appropriate, ” except that SH could not change the daily use fee without the Egers' consent. Id. ¶ 8. SH was authorized to collect payment from third-party guests and allocate 70% to the Egers and 30% to SH, after subtracting service fees. Id. ¶ 9. The Egers occupied the Mexico Property for 13 nights in 2007, 12 nights in 2008, and 12 nights in 2009. JS ¶ 24.

         2. The Avon, Colorado Property

         In 2007, the Egers purchased a unit in Bachelor Gulch Village in Avon, Colorado (the “Colorado Property”). JS ¶ 10. The Egers entered into a “Rental Program Agreement” (the “Colorado Agreement”) with Bachelor Gulch Operating Company, LLC, which was labeled as “Resort Owner” in the agreement. Smith Decl., Ex. 15. Pursuant to the Colorado Agreement, the Resort Owner owned the resort under the Ritz-Carlton name. Id. at 1. The Egers could elect to place their property into a “voluntary rental program” to rent the Unit to “guests of the Resort.” Id. By opting into the rental program, the Egers allowed the Resort Owner to “act as the sole and exclusive rental agent to offer the Subject Unit for rental.” Id. The Colorado Agreement granted the Resort Owner “the exclusive authority to rent, operate and manage the [] Unit as agent of Unit Owner.” Id. at 2. The rental program placed the Unit in a rotating unit reservation system “designed to fairly and equitably allocate Unit reservations and occupancy among Participating Units.” Id. The Resort Owner was responsible for “rent[ing] the [] Unit to Resort Guests on a transient basis for and on behalf Resort Owner (sic) and [the Egers], ” and for collecting the owed amounts from the guests. Id. at 3. The Resort Owner would also help market the Unit; provide a central reservation system for the entire Resort and process all reservations received through this system; and negotiate all terms and conditions including setting room rates, negotiating group rates, and offering incentives to prospective guests. Id. The Resort Owner was responsible for setting the rental rate for the Unit and could modify the rate at its “sole and absolute discretion.” Id. at 7. The Resort Owner was also entitled to seven complimentary nights, to be used at its discretion. Id. The Egers had the right to use the property subject to several restrictions. First, they were allowed to request the Unit for up to 56 nights in a calendar year. Id. at 8. Anything beyond the 56 nights would be subject to an additional fee owed to the Resort Owner. Id. at 5. The Egers could not reserve the Unit more than 365 days in advance. Id. at 8. If the Egers were to reserve their Unit, they would have to register at the Resort. Id. at 9. If any guests were to stay with them in their Unit, they would have to notify the Resort Owner of the names and occupancy dates of all guests no less than 15 days prior to the date of arrival of any such guest(s). Id. The Egers could not accept payment or other consideration for the use of the Unit during any nights on which they decide to use the Unit. Id. They could not enter the Unit without prior notification, approval from, or coordination with the Resort Owner, and could not make alterations to the Unit. Id. at 11-12. The Egers never occupied the Colorado Property during the Relevant Years. JS ¶ 25.

         3. The Maui, Hawaii Property

         In 2008, the Egers purchased a condominium unit in Maui, Hawaii (the “Hawaii Property”). JS ¶ 16. They entered into a “Rental Program Agreement” (the “Hawaii Agreement”) with Honolua Associates, LLC to rent out and manage the property for the Egers. Smith Decl., Ex. 28. Pursuant to the Hawaii Agreement, the management company became the exclusive rental agent, and agreed to “endeavor to offer for rent” the Unit “to Resort Guests on a transient basis for and on behalf of [the Egers].” Id. at 4. As with the Colorado Property, the management company was responsible for collecting room rental from guests and marketing the Unit under the Ritz-Carlton name. Id. at 5. Indeed, the Hawaii Agreement is substantially similar to the Colorado Agreement, with two notable differences. First, unlike the Colorado Property, there was no limit on the number of nights the Egers could reserve the Hawaii Property, except that in the initial six months the Egers were subject to a 30-night cap. Id. at ...

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