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to as the self-rental rule or the recharacterization rule),6 and
provides:
(f)(6) Property rented to a nonpassive activity.
An amount of the taxpayer’s gross rental activity
income for the taxable year from an item of property
equal to the net rental activity income for the year
from that item of property is treated as not from a
passive activity if the property–-
(i) Is rented for use in a trade or business
activity * * * in which the taxpayer materially
participates * * *.[7]
Petitioners concede that they “materially participated” in
the conduct of both the steel company and the restaurant during
1999 and 2000, and they do not contend that section 1.469-
2(f)(6), Income Tax Regs., is either invalid or inapplicable.
Petitioners, however, contend that computation of passive
activity loss requires the netting of income and loss from all
items of rental property grouped within the section 469 passive
activity and that only after such a computation does section
6To illustrate the self-rental rule, suppose taxpayer A owns
a property and all outstanding stock of B Corp. A materially
participates in the operations of B Corp., which generates $100
of income and has $50 of operating expenses in year 1. In year
1, A enters a lease agreement with B Corp. requiring B Corp. to
pay $50 of annual rent to A for A’s property. B Corp. uses the
property in year 1 as its headquarters. If B Corp. were to pay
its $50 net income to A in the form of salary, A would have $50
of income not from a passive activity. However, because the $50
of net income is paid to A in the form of rent, it is per se
passive income pursuant to sec. 469(c)(2). Sec. 1.469-2(f)(6),
Income Tax Regs., recharacterizes the $50 of net rental income as
not from a passive activity.
7As discussed below, sec. 1.469-2(f)(6), Income Tax Regs.,
is authorized by sec. 469(l)(2).
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