PLR 200047036: Active commercial rentals avoid S corporation passive income rule

Plain-English summary

An S corporation with accumulated earnings and profits owned and managed commercial properties. It used employees, a manager, and contractors to provide maintenance, repairs, parking services, landscaping, and other tenant services. Based on those facts, the IRS concluded that its rents came from an active rental business and were not passive investment income under section 1362(d)(3). The ruling did not decide the company's general eligibility for S status and said the separate section 469 passive activity rules could still apply.

Ruling snapshot

• Question: Are the company's commercial property rents passive investment income for the S corporation termination rule?
• Outcome: Approved; the rents are not passive investment income under section 1362(d)(3).
• Key authorities: IRC §§ 1362(d)(3), 469; Treas. Reg. § 1.1362-2(c)(5)(ii)(B).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200047036
Washington, DC 20224
Release Date: 11/24/2000
Index Number: 1362.02-03
Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:3 PLR-110046-00
Date:
August 25, 2000

Company:

Properties:

Shareholders:

Manager:

State:

City:
a:
b:
c:
d:
e:
f:

Dear

This letter responds to your letter dated March 31, 2000, and received by the Internal Revenue Service on May 12, 2000, as well as subsequent correspondence, requesting a ruling that the rental income received by Company from the Properties is not passive investment income within the meaning of § 1362(d)(3)(C)(i) of the Internal Revenue Code. Company represents the following facts.

Company was incorporated in State on a and has elected under § 1362(a) to be an S corporation effective b. It has C corporation earnings and profits.

Company owns, leases, and operates commercial real estate (the Properties) in City.

Company has c employees, one of whom is part-time. Through these employees, as well as through Manager, a parking facility management company, and third-party contractors, Company provides various services to the Properties in its real estate leasing and management business. These services (not all services are provided to all properties) include regular property inspection; common area maintenance; painting (interior and exterior); maintenance and repair of building systems (plumbing, electrical, and HVAC); parking lot maintenance and repair, including sweeping, repaving, and repainting; maintenance of fencing, walkways, handrails, and exterior lighting and signage; landscaping; trash removal and recycling; pest control; and the conduct of special events. In addition to the services provided to tenants, Company, through Manager, handles the usual leasing and administrative functions involved in managing real estate.

Company received or accrued approximately d in rents and paid or incurred approximately e in relevant expenses for f on the Properties.

Except as provided in § 1362(g), § 1362(a)(1) provides that a small business corporation may elect, in accordance with the provisions of § 1362, to be an S corporation.

Section 1362(d)(3)(A)(i) provides that an election under § 1362(a) terminates whenever the corporation (I) has accumulated earnings and profits at the close of each of three consecutive tax years, and (II) has gross receipts for each of such tax years more than 25 percent of which are passive investment income.

Except as otherwise provided in § 1362(d)(3)(C), § 1362(d)(3)(C)(i) provides that 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)(1) provides that "rents" means amounts received for the use of, or the right to use, property (whether real or personal) of the corporation.

Section 1.1362-2(c)(5)(ii)(B)(2) 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 the number of persons employed to provide the services and the types and amounts of costs and expenses incurred (other than depreciation).

Based solely on the facts as represented by Company in this ruling request, we conclude that the rents Company received from the Properties are not passive investment income under § 1362(d)(3)(C)(i).

The ruling in this letter is based on information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for ruling, it is subject to verification on examination.

Except for the specific ruling above, no opinion is expressed or implied concerning the federal income tax consequences of the facts of this case under any other provision of the Code. Specifically, no opinion is expressed regarding Company's eligibility to elect S corporation status. 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.

In accordance with the 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), this ruling may not be used or cited as precedent.

Sincerely,
ROBERT HONIGMAN
Acting Assistant to the Chief, Branch 3
Office of Associate Chief Counsel
(Passthroughs and Special Industries)

enclosure: copy for § 6110 purposes