PLR 200014031: Manufactured home park rents are not passive investment income

Plain-English summary

An S corporation owned and operated a manufactured home park and asked whether the rents it received were passive investment income under § 1362. The corporation described maintenance, security, recreation, and other services provided through employees and contractors. Based on the submitted facts and representations, the IRS ruled that its rents were outside the passive investment income category because it actively operated the rental business. The letter did not decide whether the corporation otherwise qualified as an S corporation. It also cautioned that the separate passive activity rules of § 469 could still apply to the rental activity.

Ruling snapshot

• Question: Do the park's rents count as passive investment income for the S corporation termination rule?
• Outcome: Approved: the rents do not count as passive investment income under § 1362(d)(3)(C)(i).
• Key authorities: IRC § 1362(d)(3)(C)(i); Treas. Reg. § 1.1362-2(c)(5)(ii)(B)(2).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Index Number: 1362.02-03
Washington, DC 20224

Person to Contact:
Number: 200014031
Telephone Number:
Release Date: 4/7/2000
Refer Reply To:
PLR115310-99 / CC:DOM:P&SI:3
Date:
January 10, 2000

LEGEND

Company =

Shareholder =

Property =

d1 =

x
=

y
=

z
=

This letter responds to a letter dated September 10, 1999, written by your authorized representative on behalf of Company, requesting a ruling that the rental income Company receives from the Property, will not be passive investment income within the meaning of § 1362(d)(3)(C)(i) of the Internal Revenue Code.

FACTS

According to the information submitted, Company, a subchapter C corporation with accumulated earnings and profits, made an election on d1 under § 1362(a) to be taxed as an S corporation. Company is wholly owned by Shareholder, and is in the business of owning and operating Property, a manufactured home park that currently has x units. Each manufactured home resident that lives in the Property pays a monthly fee to Company pursuant to a rental agreement.

PLR-115310-99
2

Among the services that Company provides in its active management of the Property through its employees and through independent contractors are as follows: lawn and shrub care on residential lots, security patrols, a swimming pool and a pool house, a laundromat, a recreation hall, snow removal, street repair, garbage collection, maintenance of storm drains, insect control, and parking. For the fiscal year ending d2, Company received or accrued y in rents and paid or incurred z in relevant expenses on the Property.

LAW AND ANALYSIS

Section 1361(a)(1) defines an “S corporation” as a small business corporation for which an election under § 1362(a) is in effect for the taxable year.

Section 1362(d)(2)(A) provides than an election under § 1362(a) shall be terminated whenever (at any time after the first day of the first taxable year for which corporation is an S corporation) such corporation ceases to be a small business corporation.

Section 1362(d)(3)(A) provides that an election under § 1362(a) shall be terminated whenever the corporation has accumulated earnings and profits at the close of each of 3 consecutive taxable years, and has gross receipts for each of such taxable years more than 25 percent of which are passive investment income. Any termination under this paragraph shall be effective on and after the first day of the first taxable year beginning after the third consecutive taxable year referred to above.

Section 1362(d)(3)(C)(i) provides that except as otherwise provided, the term "passive investment income" means gross receipts derived from royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities.

Section 1.1362-2(c)(5)(ii)(B)(2) of the Income Tax Regulations provides that "rents" does not include rents derived in the active trade or business of renting property. Rents received by a corporation are derived in an active trade or business of renting property only if, based on all the facts and circumstances, the corporation provides significant services or incurs substantial costs in the rental business. Generally, significant services are not rendered and substantial costs are not incurred in connection with net leases. Whether significant services are performed or substantial costs are incurred in the rental business is determined based upon all the facts and circumstances including, but not limited to, the number of persons employed to provide the services and the types and amounts of costs and expenses incurred (other than depreciation).

After applying the relevant law to the facts submitted and the representations made, we conclude that the rents Company receives from the Property are not passive investment income under § 1362(d)(3)(C)(i).

Except for the specific ruling above, no opinion is expressed or implied concerning the federal tax consequences of the facts of this case under any other

PLR-115310-99
3

provision of the Code. Specifically, no opinion is expressed regarding Company’s eligibility under § 1361 to be an S corporation. Further, the passive investment income rules of § 1362 are completely independent of the passive activity rules of § 469; unless an exception under § 469 applies, the rental activity remains passive for purposes of
§ 469.

Pursuant to a power of attorney on file with this office, we are sending a copy of this letter to your authorized representative.

This ruling is directed only to the taxpayer who requested it. According to § 6110(k)(3) of the Code, this ruling may not be used or cited as precedent.

Sincerely yours,

William P. O'Shea
Chief, Branch 3
Office of the Assistant Chief
Counsel
(Passthroughs and Special
Industries)

Enclosures (2):

Copy of this letter
Copy for § 6110 purposes