PLR 200049014: Actively managed property rents excluded from S corporation passive investment income

Plain-English summary

A corporation planning an S election owned commercial and residential rental properties. Its full-time employees leased and maintained the properties, collected rent, handled tenant matters, and arranged repairs. The IRS ruled that the rents were earned in an active rental business and were not passive investment income under section 1362(d)(3). That classification matters because excessive passive investment income can terminate an S election for a corporation with accumulated earnings and profits. The IRS did not decide whether the corporation otherwise qualified for S status and said the separate section 469 passive activity rules could still treat the rentals as passive.

Ruling snapshot

• Question: Are rents from the corporation's managed properties passive investment income under section 1362?
• Outcome: No; the rents are excluded from that category on the stated facts.
• Key authorities: IRC §§ 1362(d)(3), 1361, 469; Treas. Reg. § 1.1362-2(c)(5)(ii)(B).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Number: 200049014 Washington, DC 20224
Release Date: 12/8/2000
Index Number: 1362.02-03 Person to Contact:

Telephone Number:

Refer Reply To:
CC:DOM:P&SI:1-PLR-115041-00
Date:
August 29, 2000

Legend:

X
=

State =

D1
=

D2
=

D3
=

D4
=

Properties =
 2
PLR-115041-00

a
=

b
=

c
=

d
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e
=

f
=

This responds to your letter dated July 17, 2000, submitted on behalf of X, requesting a ruling that the rental income received by X from renting certain properties is not passive investment income within the meaning of section 1362(d)(3)(C)(i) of the Internal Revenue Code.

FACTS

X was incorporated in State on D1. X anticipates making an election to be treated as an S corporation for its taxable year beginning D2.

X owns Properties in State, consisting of a commercial rental properties, b rental houses or duplexes, and c rental apartment units. X maintains a full-time staff of d employees involved in its day-to-day operations. The employees’ duties include the following: negotiate and sign leases; settle tenant disputes; oversee rental collections; serve notices to pay or quit and notices to vacate; prepare rent increases, review rental applications and credit reports; show properties to prospective tenants; answer tenant complaints; inspect properties for repair; perform plumbing, electrical and carpentry 3 PLR-115041-00

maintenance; maintain common areas; and arrange for hiring of repair subcontractors as needed.

From D3 through D4, X received or accrued $e in rents and paid or incurred $f in relevant expenses with respect to Properties.

LAW AND ANALYSIS

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

Section 1362(d)(3)(A)(i) provides that an election under section 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 subparagraph (C), section 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) of the Income Tax Regulations 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, 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).

CONCLUSION

Based solely on the facts as presented in this ruling request, and viewed in light of the applicable law and regulations, we conclude that the rents X receives from the rental of Properties are not passive investment income under section 1362(d)(3)(C)(i). 4 PLR-115041-00

Except as specifically set forth above, no opinion is expressed concerning the federal tax consequences of the facts of this case under any other provision of the Code. Specifically, no opinion is expressed concerning whether X otherwise satisfies the S corporation eligibility requirements under section 1361. Further, the passive investment income rules of section 1362 are completely independent of the passive activity rules of section 469; unless an exception under section 469 applies, the rental activity remains passive for purposes of section 469.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to the taxpayer.

Sincerely,

/s/ David R. Haglund

David R. Haglund
Senior Technician Reviewer, Branch 1
Office of Associate Chief Counsel
(Passthroughs and Special Industries)

Enclosures (2):
Copy of this letter
Copy for section 6110 purposes