Tax Court - Passive activity exception satisfied by personal services performed by trustees for the trust  

March 27: The U.S. Tax Court today issued an opinion finding that a trust qualified for the exception under section 469(c)(7) because of the personal services performed by trustees on behalf of the trust with respect to the trust’s real estate business. In addition, the court found the trust materially participated in the real property trades or businesses. Hence, the trust’s losses from its real estate rental activities were not subject to the passive activity limitation rules. Frank Aragona Trust v. Commissioner, 142 T.C. No. 9 (March 27, 2014)

Read the court’s opinion [PDF 110 KB]


The trust is a complex residuary trust that owns rental real estate properties and is involved in other real estate business activities, such as holding real estate and developing real estate.

The trust was formed in 1979 by an individual, and he was the grantor and trustee and his five children were the beneficiaries. According to the trust instrument, the five children shared equally in the income of the trust. The grantor died in 1981, and was succeeded as trustee by six trustees. One of the six trustees was an independent trustee; the other five trustees were the five children.

Although the trustees formally delegated their powers to an executive trustee, the trustees acted as a management board for the trust and made all major decisions regarding the trust’s property.

The trust conducted some of its rental real estate activities directly, some through wholly owned entities, and the rest through entities in which it owned majority interests and in which certain of the children owned minority interests.

During the 2005 and 2006 tax years, the trust incurred losses from its rental real estate properties, and reported these losses on its income tax returns. The IRS, however, issued a notice of deficiency on the basis that the the trust’s rental real estate activities were passive activities (and thus increased the passive activity losses for 2005 and 2006).

Tax Court’s opinion

The Tax Court explained that the rental real estate activities of the trust would be considered as per se passive activities under section 469(c)(2) unless the trust qualified for the exception under section 469(c)(7)—i.e., if more than one-half of the personal services performed in trades or businesses by the trust are performed in real property trades or businesses in which the taxpayer materially participates and if the trust performs more than 750 hours of services during the year in real property trades or businesses in which it materially participates.

The Tax Court concluded that a trust can qualify for the section 469(c)(7) exception. As the court found:

  • A trust is capable of performing personal services within the meaning of section 469(c)(7).
  • Services performed by individual trustees on behalf of the trust may be considered personal services performed by the trust.

While the IRS argued that a trust is incapable of performing “personal services” because the regulation defines “personal services” to mean “any work performed by an individual in connection with a trade or business,” the Tax Court rejected this argument. As the court explained, if Congress had wanted to exclude trusts from the section 469(c)(7) exception, it could have done so explicitly by limiting the exception to “any natural person.”

The IRS conceded that the trust’s real estate operations qualified as real property trades or businesses. The Tax Court turned, therefore, to address whether the trust materially participated in its real estate operations. Here, the court held that the trust did materially participate in real property trades or businesses.

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