Charles Gragg; Delores Gragg v. United States of America; Internal Revenue Service Commissioner

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
CHARLES GRAGG; DELORES
GRAGG,
Plaintiffs-Appellants,
v.
UNITED STATES OF AMERICA;
INTERNAL REVENUE SERVICE
COMMISSIONER,
Defendants-Appellees.
No. 14-16053
D.C. No.
4:12-cv-03813-YGR
OPINION
Appeal from the United States District Court
for the Northern District of California
Yvonne Gonzalez Rogers, District Judge, Presiding
Submitted May 10, 2016*
San Francisco, California
Filed August 4, 2016
Before: Jerome Farris, Diarmuid F. O’Scannlain,
and Morgan Christen, Circuit Judges.
Opinion by Judge Christen
* The panel unanimously concludes this case is suitable for decision
without oral argument. See Fed. R. App. P. 34(a)(2).

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GRAGG V. UNITED STATES 2
SUMMARY**
Tax
The panel held that Internal Revenue Code § 469 allows
real estate professionals to deduct rental losses from their
taxable income, but only if they materially participate in
rental activities.
Under IRC § 469(c)(1), the general rule is that any
activity in which a taxpayer does not materially participate is
passive. Under § 469(c)(2), rental activity is per se passive,
regardless of whether the taxpayer materially participates.
Under § 469(c)(7), the per se bar does not apply to real estate
professionals.
Taxpayers sought to deduct losses from rental properties
they owned, contending that Delores Gragg’s status as a real
estate professional rendered the real estate losses per se
nonpassive and deductible under IRC § 469, regardless of
material participation. The panel explained that the statutory
text, regulations, and relevant case law all point in one
direction: although taxpayers who qualify as real estate
professionals are not subject to § 469(c)(2)’s per se rule that
rental losses are passive, they still must show material
participation in rental activities before deducting rental losses
according to the general rule under § 469(c)(1).
** This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.

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GRAGG V. UNITED STATES 3
COUNSEL
Robert L. Goldstein, Law Offices of Robert L. Goldstein, San
Francisco, California, for Plaintiffs-Appellants.
Julie Ciamporcero Avetta and Teresa E. McLaughlin,
Attorneys; Tamara W. Ashford, Acting Assistant Attorney
General; Tax Division, United States Department of Justice,
Washington, D.C.; for Defendants-Appellees.
David Radmore, Staff Attorney; Jenny Y. Li, Senior Counsel;
June Babiracki Barlow, Vice President and General Counsel;
Los Angeles, California; as and for Amicus Curiae California
Association of Realtors.
OPINION
CHRISTEN, Circuit Judge:
In the 1980s and 1990s, Congress substantially amended
the Internal Revenue Code (I.R.C.) to curb widespread abuses
of tax loopholes. One newly added provision, I.R.C. § 469,
restricted taxpayers’ ability to reduce their taxable income
using passive rental losses—that is, losses from rental
properties they own but in which they do not materially
participate. This case requires us to determine the scope of
§ 469. Specifically, it requires us to determine whether § 469
entitles real estate professionals like petitioner Delores Gragg
to deduct rental losses without showing material participation
in the rental property. We hold that it does not. Section 469
allows real estate professionals to deduct rental losses from
their taxable income, but only if they materially participate in
rental activities.

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GRAGG V. UNITED STATES 4
I.
In 1986, Congress passed the Tax Reform Act of 1986 to
curb taxpayers’ deduction of losses from so-called “passive”
investments. Tax Reform Act of 1986, Pub. L. No. 99-514,
§ 501(a), 100 Stat. 2085, 2233 (codified as amended at I.R.C.
§ 469). It implemented a simple rule: taxpayers could not
reduce the taxable portion of their true income with
investment losses unless they materially participated in the
investment. Id. §§ 501(c), (h) (defining “material
participation” as “regular, continuous, and substantial”
participation). But investments in rental properties were
treated differently. The Tax Reform Act of 1986 rendered
losses from rental activity per se passive, and therefore per se
nondeductible. Id. § 501(c)(2). This per se bar applied to
rental property regardless of the extent of a taxpayer’s
participation. Id.
In 1993, Congress decided the Tax Reform Act of 1986
had gone “too far.” 139 Cong. Rec. H6134-01, H6157 (daily
ed. Aug. 5, 1993). The Committee on the Budget deemed it
“unfair that a person who performs personal services in a real
estate trade or business in which he materially participates
may not offset losses from rental real estate activities against
income from nonrental real estate activities.” H.R. Rep. No.
103-111, at 613 (1993), reprinted in 1993 U.S.C.C.A.N. 378,
844. Congress subsequently enacted § 469(c)(7) to create an
exception to the per se bar on deducting rental losses: for
taxpayers who qualify as real estate professionals,1 the per se
1 The statute does not use the term “real estate professionals,” but rather
refers to “taxpayers in real property business.” I.R.C. § 469(c)(7). We
use the industry shorthand “real estate professionals” for ease of reference.
Both parties agree that Delores qualified as a real estate professional for

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GRAGG V. UNITED STATES 5
rental bar “shall not apply.” Omnibus Budget Reconciliation
Act of 1993, Pub. L. No. 103-66, § 13143(a), 107 Stat. 312,
440 (codified at I.R.C. § 469).
This case is about the scope of that exception. Delores
and Charles Gragg sought to deduct from their taxable
income rental losses they incurred in 2006 and 2007. Delores
is a licensed real estate agent who worked for a real estate
brokerage during both years. On their 2006 joint tax return,
the Graggs deducted $38,153 in losses from rental properties
they owned. On their 2007 return, they deducted $40,390 in
rental losses. The Graggs’ joint returns were audited in 2009,
and they submitted documents establishing that Delores was
a real estate professional under § 469(c)(7). The Internal
Revenue Service (IRS) requested “a written log of all . . .
rental related activities that w[ould] support the deduction
claimed.” In response, the Graggs submitted two undated
one-page notes estimating the hours Delores spent working
on the Graggs’ rental properties in 2006.
The IRS disallowed the rental losses because it concluded
that the Graggs were required to show they materially
participated in the rental properties, and had not done so. The
Graggs paid the deficiencies for both years and timely filed
administrative refund claims with the IRS for both years.
They argued that Delores’s status as a real estate professional
rendered their rental losses per se nonpassive and
“request[ed] that the[] claims be immediately denied so that
[the Graggs could] initiate a District Court action.” The IRS
disallowed the Graggs’ claims, and the Graggs timely filed
suit for a refund in the district court under I.R.C. § 7422. The
Graggs’ complaint renewed their argument that by virtue of
the relevant time period.

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GRAGG V. UNITED STATES 6
Delores’s status as a real estate professional, their rental
losses were automatically nonpassive and they did not need
to prove material participation. The government and the
Graggs filed cross motions for summary judgment. The
district court granted summary judgment in favor of the
government, and the Graggs timely appealed. We have
jurisdiction under 28 U.S.C. § 1291.
II.
The issue on appeal is whether I.R.C. § 469(c)(7)
automatically renders a real estate professional’s rental losses
nonpassive and deductible, or whether it merely removes
§ 469(c)(2)’s per se bar on treating rental losses as passive.
The Graggs advocate for the former interpretation, and the
government argues for the latter.
The text of the statute favors the government’s
interpretation. Section 469(c)(1), which was part of the
statute as originally enacted in 1986, provides the general rule
that any activity in which a taxpayer does not materially
participate is passive:
(c)(1): The term “passive activity” means any
activity (A) which involves the conduct of any
trade or business, and (B) in which the
taxpayer does not materially participate.
The next section, 469(c)(2), is the per se rental bar. This
section was also part of the original 1986 legislation. It
establishes that rental activity is per se passive, regardless of
whether the taxpayer materially participates:

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GRAGG V. UNITED STATES 7
(c)(2): Passive activity includes any rental
activity. Except as provided in paragraph (7),
the term “passive activity” includes any rental
activity.
Section 469(c)(7), added in the 1993 amendments, provides
the exception; if the taxpayer is a real estate professional, the
per se bar does not apply:
(c)(7)(A): If this paragraph applies to any
taxpayer for a taxable year . . . paragraph (2)
shall not apply to any rental real estate
activity of such taxpayer for such taxable year
. . . .
The Graggs contend these provisions, taken together,
establish that after a taxpayer qualifies as a real estate
professional under § 469(c)(7), all rental losses are
automatically rendered nonpassive and deductible, regardless
of material participation. The text of the statute does not
support this interpretation. The effect of the (c)(7) exception
is merely that “paragraph (2)”—the per se bar—“shall not
apply.” If the per se rental bar does not apply, the general
(c)(1) rule does, and the activity is passive unless the taxpayer
materially participates.
The IRS Treasury Regulations implementing § 469
reinforce this interpretation. Treasury Regulation § 1.469-
9(e)(1) states that a taxpayer who qualifies as a real estate
professional can treat rental losses as nonpassive, but only so
long as she materially participates:
Section 469(c)(2) [(the per se rental bar)] does
not apply to any rental real estate activity of a

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GRAGG V. UNITED STATES 8
taxpayer for a taxable year in which the
taxpayer is a qualifying taxpayer under
paragraph (c) of this section [i.e., a real estate
professional]. Instead, a rental real estate
activity of a [real estate professional] is a
passive activity under section 469 for the
taxable year unless the taxpayer materially
participates in the activity.
Treas. Reg. § 1.469-9(e)(1) (emphasis added). A subsequent
provision confirms that even taxpayers who establish real
estate professional status must separately show material
participation in rental activities (as opposed to other real
estate activities) before claiming any rental losses as
nonpassive:
[I]f a qualifying taxpayer develops real
property, constructs buildings, and owns an
interest in rental real estate, the taxpayer’s
interest in rental real estate may not be
grouped with the taxpayer’s development
activity or construction activity. Thus, only
the participation of the taxpayer with respect
to the rental real estate may be used to
determine if the taxpayer materially
participates in the rental real estate activity
under [the material participation safe harbor
provisions in] § 1.469-5T.
Id. § 1.469-9(e)(3)(i) (emphasis added). These regulations
cannot be reconciled with the Graggs’ understanding that the
(c)(7) exception excuses real estate professionals from the
material participation requirement.

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GRAGG V. UNITED STATES 9
Our court has not previously addressed the Graggs’
interpretation of § 469, but their argument has been squarely
rejected by the Tax Court, and we view Tax Court opinions
as persuasive authority. See Dobson v. C.I.R., 320 U.S. 489,
502 (1943) (“The Tax Court is informed by experience and
kept current with tax evolution and needs by the volume and
variety of its work . . . [and] uniform administration would be
promoted by conforming to [its decisions] when possible.”).
In Perez v. C.I.R., the taxpayer argued, as the Graggs do here,
that “because she [was] a qualifying real estate professional
pursuant to section 469(c)(7)(B), all her real estate activities,
including rental activities, [were] not passive and therefore
she [was] not subject to the passive activity loss limitations.”
100 T.C.M. (CCH) 351, at *1 (2010). The Tax Court
disagreed, ruling that “[c]aselaw clearly requires that a
taxpayer claiming deductions for rental real estate losses meet
the ‘material participation’ requirement[].” Id. at *2.
The Graggs do not seriously grapple with Perez. Instead,
they contend that Agarwal v. C.I.R., another Tax Court case,
supports their cause. It does not. The issue in Agarwal was
whether a real estate agent could qualify as a real estate
professional under § 469(c)(7)(C), notwithstanding the text of
the statute, which specified that it applied to brokerages.
T.C. Summ. Op. 2009-29, 2009 WL 513391 at *3 (U.S. Tax
Ct. 2009). The Graggs contend that Agarwal permits material
participation to be calculated as a function of a taxpayer’s
combined real estate activities, effectively removing the
requirement that the taxpayer independently show material
participation with regard to rental activities. The court in
Agarwal did not specify how it determined material
participation, but it recognized that “the determination of
whether the qualifying taxpayer materially participated . . .
must be met with respect to each rental activity,” suggesting

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GRAGG V. UNITED STATES 10
that it would not permit a taxpayer to combine rental and
nonrental activities for purposes of calculating material
participation. Id. at *4 & n.4. Agarwal provides no
compelling reason to depart from the Tax Court’s decision in
Perez, nor have we found one.
The Graggs argue on appeal that even if they must show
material participation before deducting rental losses, they
“could potentially satisfy” this requirement by meeting one or
more of the material participation safe harbor provisions in
the Treasury Regulations. But the Graggs did not make this
argument before the district court. There, they conceded that
“Plaintiff Delores Gragg does not contend that she meets the
material participation requirements . . . for each rental real
estate activity” and focused instead on the argument that
“[t]hese tests are irrelevant” to them by virtue of Delores’s
status as a real estate professional. We decline to address
their new argument that limited evidence in the record—two
undated notes estimating the total hours spent on rental
properties in 2007—satisfies the Graggs’ burden of
demonstrating material participation in rental activities for
2006 and 2007.2 In the district court, the Graggs did not
attempt to demonstrate material participation in their 2006
and 2007 rental activities, and those losses are therefore
nondeductible.
Section 469’s text, regulations, and relevant case law all
point in one direction: though taxpayers who qualify as real
estate professionals are not subject to § 469(c)(2)’s per se rule
2 The Treasury Regulations provide that material participation “may be
established by any reasonable means,” and “[c]ontemporaneous daily time
reports . . . are not required if the extent of such participation may be
established by other reasonable means.” Treas. Reg § 1.469-5T(f)(4).

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GRAGG V. UNITED STATES 11
that rental losses are passive, they still must show material
participation in rental activities before deducting rental
losses. Congress endeavored to narrow the scope of
permissible deductions for passive losses in real estate
investments, in part by requiring material participation before
losses may be deducted. Real estate professionals were not
exempted from this requirement.
AFFIRMED.

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