The Beechers thereafter filed a petition in the United States Tax Court challenging this determination. The court rendered judgment for the Commissioner, basing its decision on its own precedent, as well as that of the Seventh, First, and Fifth Circuits, citing Krukowski v. Commissioner, 279 F.3d 547 (7th Cir.2002), Sidell v. Commissioner, 225 F.3d 103 (1st Cir.2000), and Fransen v. United States, 191 F.3d 599 (5th Cir.1999). II. STANDARD OF REVIEW
Unless otherwise noted, all references to sections of the Internal Revenue Code or Treasury Regulations are to the versions in effect during tax years 2009 and 2010. Fransen v. United States, 191 F.3d 599, 600 (5th Cir. 1999). Relevant to this appeal, section 469 never specifically defines the term "taxpayer" to either include or exclude an S corporation.
The Courts of Appeals for the First, Fifth, and Seventh Circuits have also upheld the validity of section 1.469–2(f)(6), Income Tax Regs. See Krukowski v. Commissioner, 279 F.3d 547 (7th Cir.2002); Sidell v. Commissioner, 225 F.3d 103 (1st Cir.2000); Fransen v. United States, 191 F.3d 599 (5th Cir.1999). Section 1.469–2(f)(6), Income Tax Regs., explicitly recharacterizes net rental activity income from an “item of property” rather than net income from the entire rental “activity”. Both section 469 and the regulations thereunder clearly distinguish between net income from an “item of property” and net income from the entire “activity”,
We find this argument to be unpersuasive, as have the First and Fifth Circuits. See Sidell v. Commissioner, 225 F.3d 103, 107 (1st Cir. 2000); Fransen v. United States, 191 F.3d 599, 601 (5th Cir. 1999). Section 496( l) authorizes the Secretary to "prescribe such regulations as may be necessary or appropriate to carry out provisions of [Section 469], including regulations which specify what constitutes an activity, material participation, or active participation" and regulations "requiring net income or gain from a limited partnership or other passive activity to be treated as not from a passive activity."
Although the statute mentions limited partnerships as one possible subject of regulation, the category is open-ended, not closed, as witness Congress's use of the inclusive phrase "or other." Accord Fransen v. United States, 191 F.3d 599, 600-01 (5th Cir. 1999). Given the apparent breadth of authority ceded to the Secretary, and the congruence between the final regulations and the statute's evident goal (eliminating tax shelters), it is exceedingly difficult to imagine how the application of the self-rental rule to shareholders of closely-held C corporations (which the Tax Court accurately called the "epitome" of self-renting transactions, see Sidell, T.C. Memo. 1999-301, at 20) can be considered arbitrary, capricious, or contrary to Congress's will.
We disagree with petitioner that the recharacterization rule is invalid. The recharacterization rule is a legislative regulation, see Schwalbach v. Commissioner, 111 T.C. 215, 220, 1998 WL 567814 (1998) (the Secretary had to comply with the Administrative Procedure Act (APA), 5 U.S.C. sec. 553(b) and (c) (1994), when he prescribed sec. 1.469–2(f)(6), Income Tax Regs., because the rules contained therein are legislative rather than interpretative); see also Fransen v. United States, 191 F.3d 599, 600 (5th Cir.1999); thus, it is invalid only if it is arbitrary, capricious, or manifestly contrary to the statute, see Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 844, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984); see also McKnight v. Commissioner, 99 T.C. 180, 183, 1992 WL 184971 (1992). The rechacterization rule is not arbitrary, capricious, or manifestly contrary to the statute.
Passive activity rules apply to personal services corporations, see I.R.C. § 469(a)(2)(C), and for purposes of determining whether a taxpayer materially participates in an activity, participation of his spouse will be included as participation of the taxpayer. See I.R.C. § 469(h)(5); Treas. Reg. § 1.469-5T (f)(3); see also Fransen v. United States, 191 F.3d 599, 601 (5th Cir. 1999). On this basis, the parties agree that if the regulations setting out the passive activity rules deem Michael Connor to have participated materially in the activities of his personal services corporation, the income from the rental of his dental office would be characterized as non-passive.
The deference accorded to a legislative regulation is so high that such regulations have controlling weight unless they are arbitrary, capricious, or manifest contrary to the underlying statute. Chevron, U.S.A., Inc. v. Natural Resource Defense Council, Inc., 467 U.S. 837, 843-44 (1984); Fransen v. United States, 191 F.3d 599, 600 (5th Cir. 1999). This standard of deference is sometimes referred to as the " Chevron deference."
The Court noted in Dirico that section 1.469-2(f)(6), Income Tax Regs., has been "upheld repeatedly" by this Court and others. Dirico v. Commissioner, 139 T.C. at 404 n.5 (citing Krukowski v. Commissioner, 279 F.3d 547, 552 (7th Cir. 2002), aff'g 114 T.C. 366 (2000), Sidell v. Commissioner, 225 F.3d 103, 107-108 (1st Cir. 2000), aff'g T.C. Memo. 1999-301, Fransen v. United States, 191 F.3d 599, 601 (5th Cir. 1999), and Shaw v. Commissioner, T.C. Memo. 2002-35). III.
Although sec. 1.469-2(f)(6), Income Tax Regs., has been challenged as invalid, its validity has been upheld repeatedly. See, e.g., Krukowski v. Commissioner, 279 F.3d 547, 552 (7th Cir. 2002), aff'g 114 T.C. 366 (2000); Sidell v. Commissioner, 225 F.3d 103, 107-108 (1st Cir. 2000), aff'g T.C. Memo. 1999-301; Fransen v. United States, 191 F.3d 599, 601 (5th Cir. 1999); Shaw v. Commissioner, T.C. Memo. 2002-35. The fact that section 1.469-2(f)(6), Income Tax Regs., recharacterizes the net rental activity income from "an item of property" rather than the net income from the taxpayer's entire rental activity means that the passive losses generated by unprofitable rental properties remain passive activity losses.