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from assets used in or held for use in the conduct of the U.S.
trade or business (asset use test), and (2) whether the
activities of the trade or business were a material factor in the
realization of the income (business activities test). Sec.
864(c)(2)(A) and (B). All other U.S.-source income, besides
fixed or determinable annual or periodic income and capital
gains, is treated as effectively connected with the conduct of
the taxpayer's U.S. trade or business (regardless of whether an
actual connection exists). Sec. 864(c)(3).
Petitioner contends that the Ginter and Gomes properties are
capital assets that produce passive income rather than ECI from a
U.S. trade or business. Petitioner's argument assumes that the
sale of the Ginter and Gomes properties would not produce ECI
under either the asset use or business activities test of section
864(c)(2). Respondent contends that the Ginter and Gomes
properties are step 1 assets as petitioner had reported them on
its original Forms 1120F. Respondent maintains that the Ginter
and Gomes properties are ordinary income assets and would
nevertheless produce ECI under section 864(c)(3). Respondent
also contends that even if the Ginter and Gomes properties are
capital assets, their sale would produce ECI under section
864(c)(2). As discussed below, we find that the Ginter and Gomes
properties are ordinary income assets and produce ECI under
section 864(c)(3).
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