PLR 200123036: Actively managed property rents excluded from S corporation passive income

Plain-English summary

A corporation planning to elect S corporation status asked whether rent from its property would count as passive investment income. It made major management decisions and, through a related manager, provided maintenance, repair, leasing, and tenant services. Based on those represented facts, the IRS ruled that the rents were not passive investment income under IRC § 1362(d)(3). The IRS did not decide whether the corporation qualified to elect S status. It also explained that this ruling did not change how the separate passive activity rules of § 469 might treat the rental activity.

Ruling snapshot

• Question: Do the property's rental receipts count as passive investment income under the S corporation termination rule?
• Outcome: Approved, the rents were excluded from passive investment income on the stated facts
• Key authorities: IRC §§ 1362(d)(3), 469; Treas. Reg. § 1.1362-2(c)(5)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200123036
Washington, DC 20224
Release Date: 6/8/2001
Index Number: 1362.02-03
Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:3 PLR-124966-00
Date:
March 8, 2001

Company:

Manager:

Property:

Shareholders:

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

Dear

This letter responds to a letter from your authorized representative dated October 31, 2000, as well as subsequent correspondence, submitted on behalf of Company, requesting a ruling that the rental income received by Company from the Property 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 is a C corporation with accumulated earnings and profits. It intends to elect under § 1362(a) to be an S corporation.

Company’s assets include the Property. Manager, a related corporation, manages the Property on a day-to-day basis. Company makes all the major property

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management decisions, including those on building repairs and improvements, lease negotiations, and expenses.

Company, through Manager, provides various services in its real estate leasing business. These services include the usual leasing and administrative functions; maintenance and repair of building exterior structure, including the roof; maintenance of exterior lighting; parking lot and sidewalk repair; loading dock maintenance; grounds maintenance; and 24-hour-a-day staff availability for tenant requests and inquiries.

Company received or accrued approximately a in rents and paid or incurred approximately b in relevant expenses for c on the Property. The comparable figures for d are e and f.

In general, § 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.

Section 1362(d)(3)(C)(i) provides that the term "passive investment income" generally 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 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 receives from the Property are not passive investment

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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 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,
DONNA M. YOUNG
Senior Technician Reviewer, Branch 3
Office of Associate Chief Counsel
(Passthroughs and Special Industries)

enclosure: copy for § 6110 purposes