PLR 200206030: Active industrial and retail rentals are not passive investment income

Plain-English summary

A company planning to elect S corporation status owned and operated industrial and retail rental property. Its employees, officers, and contractors provided substantial inspection, repair, maintenance, utility, landscaping, tenant, and leasing services. The IRS ruled that the company's rental income was derived from an active rental business and was therefore not passive investment income under section 1362(d)(3)(C)(i). The letter separately explains that the section 1362 passive investment income rules do not determine whether the rental activity is passive under section 469.

Ruling snapshot

• Question: Is rental income from the company's industrial and retail properties passive investment income when it provides substantial rental services and incurs related costs?
• Outcome: Approved, the rents were not passive investment income under section 1362(d)(3)(C)(i).
• 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: 200206030
Washington, DC 20224
Release Date: 2/8/2002
Index Number: 1362.02-03
Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:3 PLR-139512-01
Date:
November 8, 2001

Company:
Property:
State:
a: b: c: d: e: f: g: h: i:

Dear

This letter responds to a letter dated July 19, 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 in State on a and anticipates electing under § 1362(a) to be an S corporation. It owns, operates, leases, and maintains industrial and retail rental property (the Property).

Through its b employees and c officers, as well as various third-party contractors, Company provides various services to the Property in its real estate leasing business. These services include regular property inspection; common area maintenance; maintenance and repair of all structural portions of buildings, including roofs, facades, and foundations; maintenance and repair of building electrical and plumbing systems; major repair of heating, ventilation, and air conditioning equipment; 2 PLR-139512-01

parking lot and sidewalk repair and maintenance; provision of water and sewer; landscaping; and 7-day-a-week “on call” service. In addition to the services provided to tenants, Company handles the usual leasing and administrative functions involved in operating rental real estate.

Company received or accrued approximately d in rents and paid or incurred approximately e in relevant expenses for f on the Property. The rental income and expense figures for g are h and i, 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 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 3
PLR-139512-01

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,
JEANNE SULLIVAN
Senior Technician Reviewer, Branch 3
Office of Associate Chief Counsel
(Passthroughs and Special Industries)

enclosure: copy for § 6110 purposes