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Overall, testimony established that the services were the crucial
determinant in attorneys’ choosing to lease from AGI, and we
found the testimony on behalf of petitioners credible and
compelling. See Anderson v. City of Bessemer City, 470 U.S. 564,
575 (1985). We therefore find the payments to AGI were
principally for the services provided and not for the space
leased. Consequently, the leasing activity is not a rental
activity.
Material Participation
Finally, to qualify the losses as nonpassive, petitioners
must carry their burden to prove not only that the extraordinary
personal services exception applies, but also that petitioners
materially participated in the activity.
Material participation is defined as involvement in the
operations of an activity that is regular, continuous, and
substantial. Sec. 469(h)(1). A taxpayer may also satisfy the
material participation requirement if the individual satisfies
any one of seven regulatory tests. See sec. 1.469-5T(a),
Temporary Income Tax Regs., supra at 5725; see also Lapid v.
Commissioner, T.C. Memo. 2004-222 (citing Mordkin v.
Commissioner, T.C. Memo. 1996-187, which upheld the regulatory
“safe harbor” tests letting taxpayers prove material
participation by showing they spent a certain number of hours on
an activity). The test most applicable in this case is whether
petitioner wife participated in the nonrental activity for more
than 500 hours during the year. See Harrison v. Commissioner,
T.C. Memo. 1996-509; sec. 1.469-5T(a)(1), Temporary Income Tax
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