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Petitioners argue that respondent’s attempt to limit the
scope of the treatment of self-charged items to interest income
and deductions in section 1.469-7, Proposed Income Tax Regs., is
arbitrary, capricious, or manifestly contrary to section 469, the
underlying statute. Petitioners further argue that the proposed
regulations violate the congressional mandate as expressed in
section 469(l) insofar as such proposed regulations omitted
provisions addressing self-charged items other than self-charged
interest. Petitioners also contend that it was arbitrary,
capricious, and/or manifestly contrary to the underlying statute
for respondent, when applying section 469, to disallow the
characterization of petitioner’s pro rata share of the management
fees expense as nonpassive.
Respondent simply counters that there was an exercise of the
Secretary’s discretion not to issue regulations addressing
whether or not self-charged treatment and netting is clearly
appropriate in situations other than lending transactions.
Respondent further contends that in regard to self-charged
transactions, section 469 is not self-executing and therefore, in
the absence of regulations addressing self-charged treatment for
nonlending transactions, netting is unavailable.
A. Historical Background
Enacted by Congress as part of the Tax Reform Act of 1986,
Pub. L. 99-514, 100 Stat. 2085, the passive activity loss rules
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