PLR 200147050: Commercial property rents excluded from S corporation passive investment income

Plain-English summary

A real estate company with accumulated earnings and profits planned to elect S corporation status. It asked whether rent from a large retail property counted as passive investment income, which can terminate an S election if it exceeds the statutory threshold for three consecutive years. The company described its employees, contractors, property services, and operating expenses. Based on those facts and representations, the IRS ruled that the property's rents were not passive investment income under § 1362. The letter did not decide whether the company could elect S status, and it said the rental activity could still be passive under the separate § 469 rules.

Ruling snapshot

• Question: Did rent from the managed commercial property count as passive investment income under § 1362?
• Outcome: Approved: the rents were excluded from passive investment income on the submitted facts.
• Key authorities: IRC §§ 1362(a), 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: 200147050
Washington, DC 20224
Release Date: 11/23/2001
Index Number: 1362.02-03
Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:3 PLR-130231-01
Date:
August 24, 2001

Company:
Property:
Shareholders:

State:
a: b: c: d: e: f: g: h: i: k:

Dear

This letter responds to a letter dated May 21, 2001, from your authorized representative, as well as subsequent correspondence, 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.

FACTS

Company was incorporated under the laws of State on a and anticipates electing under § 1362(a) to be an S corporation effective b. Company has accumulated earnings and profits.

Company is engaged in the business of real estate development and property 2
PLR-130231-01

management. It owns, leases, and manages a large commercial rental property (the Property), with a variety of retail tenants.

Company has c full time employees who work for Company, as well as for affiliated entities engaged primarily in real estate construction and development. Based on the number of employee hours dedicated to real estate rental operations, Company has the equivalent of d full time employees. Through both its employees and independent contractors, Company provides various services to the Property in its real estate leasing and management business. These services include the inspection of exterior and vacant areas; common area maintenance; maintenance of building foundations and exteriors, including roofs; parking lot and sidewalk repair and maintenance; grounds maintenance and landscaping; maintenance of outside plumbing and electrical systems; maintenance of storm drains and water and sewer lines; snow and ice removal; structural remodeling; and 24-hour-a-day availability for emergencies. In addition to the services provided to tenants, Company handles the usual leasing and administrative functions involved in managing real estate.

Company received or accrued approximately e in rents and paid or incurred approximately f in relevant expenses for g on the Property. The rental income and expense figures for h are i and k, respectively.

LAW AND ANALYSIS

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) 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 3 PLR-130231-01

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 submitted and 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, we express or imply no opinion concerning the federal tax consequences of the facts of this case under any other provision of the Code. Specifically, we express or imply no opinion regarding Company's eligibility to elect to be treated as 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.

Under 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), this ruling may not be used or cited as precedent.

Sincerely,
MARY BETH COLLINS
Senior Technician Reviewer, Branch 3
Office of Associate Chief Counsel
(Passthroughs and Special Industries) enclosure: copy for § 6110 purposes