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properties is properly recharacterized as nonpassive (or active)
income under section 1.469-2(f)(6), Income Tax Regs., nonetheless,
respondent was without authority to disallow the claimed
rehabilitation credit (hereinafter this argument is referred to as
petitioners' credit argument). According to petitioners, denial of
the rehabilitation credit defeats the express legislative policy
goal underlying the enactment of section 47; namely, to preserve
historic landmarks and to provide an economic stimulus to areas
susceptible to abandonment.
Petitioners maintain a distinction between recharacterizing
income, on the one hand, and recharacterizing the underlying
activity, on the other. In this regard, petitioners contend that
section 1.469-2(f)(6), Income Tax Regs., authorizes respondent only
to recharacterize income, not to disallow the section 47 credit.
Respondent counters by asserting that once petitioners' net rental
income is recharacterized as nonpassive, the limitation on passive
activity credits (rather than section 1.469-2(f)(6), Income Tax
Regs.) mechanically disallows the rehabilitation credit.
Standard of Review of Section 1.469-2(f)(6), Income Tax Regs.
Petitioners invite us to invalidate a portion of a regulation,
section 1.496-2(f)(6), Income Tax Regs. This we do only in the
gravest of circumstances. A regulation must be sustained unless
unreasonable, plainly inconsistent with the Internal Revenue Code,
arbitrary, or capricious. See Commissioner v. South Tex. Lumber
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