Stephen and Ann Schwalbach - Page 4

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          Falls.  Petitioners also reported on this schedule that they had            
          realized a $10,148 passive loss on an investment in an S                    
          corporation named Golfview Heights, Inc., and that they had                 
          realized a $6,297 passive loss on an investment in a partnership            
          named South Main Dental Partners.  Petitioners took into account            
          all these items of income and loss, the effect of which was that            
          they reported net passthrough and rental income of $33,318                  
          ($50,556 + ($10,148) + ($6,297) + ($1,670) + $877).                         
               Respondent determined that the three losses aggregating                
          $18,115 (($10,148) + ($6,297) + ($1,670)) could offset only the             
          $877 gain, resulting in an adjustment (increase) in income of               
          $17,238.  According to the notice of deficiency:                            
               On Schedule E, Part I of your 1994 return, in regards                  
               to property B [i.e., the River Falls building], you                    
               reported a net profit of $50,556.  This property is                    
               related to your corporation for which you are a                        
               material participant.  You further offset passive                      
               losses of $16,445 from other companies shown on                        
               Schedule E, Part II against the non-passive income from                
               related property B.  Internal Revenue Code section 469                 
               changes the net income from the related rental property                
               B from non-passive to passive income.[1]                               
               Further, on Schedule E, Part V of your 1994 return,                    
               your total net profit that you reported on your return                 
               was $33,318.  However, it has been determined that your                
               total net profit on Schedule E is $50,556.  Your                       
               increase in net profit of $17,238 is based on the                      
               unallowable loss of $17,238 * * * as summarized below.                 

               1 Actually, the regulations under sec. 469 change the net              
          income from the rental property from passive to nonpassive                  
          income.  Based on our reading of the entire notice of deficiency,           
          we conclude that respondent's mischaracterization in the notice             
          of deficiency is merely a typographical error.                              

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