Sec. 469(c)(1). In addition, with an exception that is inapplicable herein, see sec. 469(c)(7), the term "passive activity" includes any rental activity (defined in section 469(j)(8) as "any activity where payments are principally for the use of tangible property"), regardless of the taxpayer's material participation therein, sec. 469(c)(2), (4); see Carlos v. Commissioner, 123 T.C. 275, 278 (2004). A taxpayer's "activities" include those conducted through an S corporation. Sec. 1.469-4(a), Income Tax Regs.
With certain exceptions, the term "passive activity" includes any rental activity, regardless of the level of a taxpayer's material participation in such activity. Sec. 469(c)(2), (4); Carlos v. Commissioner, 123 T.C. 275, 278 (2004). Section 469(l) grants the Commissioner the authority to prescribe regulations that "specify what constitutes an activity, material participation, or active participation" for purposes of section 469.
Rental income that is reclassified as nonpassive cannot be offset by passive losses. See Carlos v. Commissioner, 123 T.C. 275 (2004). Petitioner owned the Connecticut property and the Maine property.
Even when items of property are grouped together in one activity, section 1.469-2(f)(6), Income Tax Regs., still applies to recharacterize rental income from an item of property as nonpassive income. Carlos v. Commissioner, 123 T.C. 275, 282 (2004). The parties disagree about the definition of the phrase "item of property".
We also note that the regulations in question are legislative rather than interpretive, having been promulgated pursuant to congressional direction. See Square D Co. v. Commissioner, 438 F.3d 739 (7th Cir. 2006), aff'g 118 T.C. 299, 307 (2002); Carlos v. Commissioner, 123 T.C. 275, 280 (2004). We hold that the regulation is valid.
The rule of section 1.469-2(f)(6), Income Tax Regs., which is sometimes referred to as the self-rental rule or the recharacterization rule, creates an exception to the normal rule set forth in section 469(c)(2) and (4) that income from a rental activity is passive income for purposes of section 469 regardless of whether a taxpayer materially participates in the activity. See Carlos v. Commissioner, 123 T.C. 275, 279-280 (2004). The parties stipulated that petitioners rented the Westwood property to petitioner's medical corporation for use in the corporation's business.