Academic journal article Journal of Accountancy

Self-Rent and Passive Losses

Academic journal article Journal of Accountancy

Self-Rent and Passive Losses

Article excerpt

Since the enactment of the passive loss rules in 1986, taxpayers have sought ways to produce passive income so they could claim otherwise denied passive losses. The Treasury Department issued regulations to deter some obvious schemes. One regulation deals with self-rent activities. Recently the courts evaluated its validity.

Chester Sidell was the sole shareholder of KGR Industries, a C corporation. To meet KGR's expansion needs, Sidell purchased and rehabilitated a historic property. He rented it to KGR and claimed the rehabilitation tax credit against the rental income. The IRS reclassified the rental income as nonpassive and denied the credit. The Tax Court upheld the denial and the taxpayer appealed.

Result. For the IRS. The taxpayer's main argument was that the self-rent rule in Treasury regulations section 1.469-2(f)(6) was invalid to the extent it covered C corporations. He argued that congressional intent was to limit the regulations to reclassifying income of pass-through entities only.

Regulations section 1.469-2 (f)(6) reclassifies as ordinary any net rental income from a lease of property to an activity in which the taxpayer materially participates. Regulations section 1.469-4(a) defines taxpayer activities as including those conducted by C corporations as well as pass-through entities. Both regulations were issued under IRC section 469(1), which authorizes the Treasury to issue regulations to carry out the passive loss rules.

The First Circuit Court of Appeals noted that because the regulations are legislative--written under a specific delegation of authority to write guidance--they can only be invalidated if the court determines they are "arbitrary, capricious or manifestly contrary to the statute." Since section 469(1) authorizes the Treasury to issue regulations that reclassify income as nonpassive for both limited partnerships and other activities, it is clear that Congress intended C corporations to be included in the reclassification. …

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