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deduction for 1994. Respondent also determined that petitioners
were liable for the accuracy-related penalties for both years.
Respondent used the recharacterization rule of section
1.469-2(f)(6), Income Tax Regs., to characterize petitioners'
income from the Lease as nonpassive. Under this rule:
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 * * * for
the taxable year; * * *
The recharacterization rule was issued on May 15, 1992, and it
reads nearly verbatim as it appeared when it was proposed on
February 25, 1988. See Schwalbach v. Commissioner, 111 T.C. 215,
220-221 (1998).
Petitioners argue that the recharacterization rule does not
apply for the subject years to recharacterize their income from
the Lease because, petitioners state, the effective date and
transition rules in section 1.469-11(b)(1), Income Tax Regs.,
operate to prevent characterizing Dr. Connor as a material
participant of the dental activity of his personal service
corporation. Section 1.469-11, Income Tax Regs., provides in
relevant part:
� 1.469-11. Effective date and transition
rules.--(a) Generally applicable effective dates.
Except as otherwise provided in this section--
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