PLR 200217012: Commercial property rents excluded from passive investment income

Plain-English summary

A commercial real estate company planned to elect S corporation status and asked whether its rental income would count as passive investment income. The company described repairs, maintenance, landscaping, and management services for its properties. The IRS ruled that its rents were excluded from passive investment income under IRC § 1362(d)(3)(C)(i). It did not decide whether the company qualified to elect S corporation status. The letter also said that the separate passive activity rules of IRC § 469 could still apply to the rental activity.

Ruling snapshot

• Question: Are the company's commercial property rents passive investment income for the S corporation termination rule?
• Outcome: Approved
• Key authorities: IRC § 1362(d)(3); Treas. Reg. § 1.1362-2(c)(5)(ii)(B)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Washington, DC 20224
Number: 200217012
Release Date: 4/26/2002
Person to Contact:
Index Number: 1362.02-03
Telephone Number:

Refer Reply To:
CC:PSI:3 PLR-150639-01
Date:
January 15, 2002

Company:

Properties:

Shareholders:

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

Dear

This letter responds to a letter dated September 11, 2001, from your authorized representative, as well as subsequent correspondence, requesting a ruling that the 2 PLR-150639-01

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 owns, leases, and manages commercial real estate (the Properties).
Through the Shareholders, as well as third-party contractors on occasion, Company provides various services to the Properties. These services include building structural repairs, plumbing and electrical repairs, repair and maintenance of the parking lot, landscaping, lawn maintenance, and exterior painting. Interior maintenance, plus additional interior repairs, are handled on a case-by-case basis. In addition, Company handles the usual leasing and administrative functions involved in managing real estate.

Company received or accrued approximately c in rents and paid or incurred approximately d in relevant expenses for e on the Properties. The rental income and expense figures for f are g and h, 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-150639-01

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

enclosure: copy for § 6110 purposes