PLR 200237005: Shopping center rents excluded from S corporation passive income

Plain-English summary

A company planning to elect S corporation status owned and managed a retail shopping center. It had no employees, but its president and a paid consultant supervised contractors who inspected, maintained, repaired, and improved the property; the company also handled leasing and administration. The IRS ruled that the center's rents were not passive investment income under section 1362(d)(3), based on those services and costs. It did not decide whether the company could make an S election. The letter also made clear that the separate passive activity rules of section 469 could still treat the rental activity as passive.

Ruling snapshot

• Question: Do rents from the managed shopping center count as passive investment income for the S corporation termination rule?
• Outcome: Approved: the rents are excluded on the stated facts
• Key authorities: IRC § 1362(d)(3); Treas. Reg. § 1.1362-2(c)(5)(ii)(B)(2)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200237005
Washington, DC 20224
Release Date: 9/13/2002
Index Number: 1362.02-03
Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:3 PLR-106573-02
Date:
May 31 , 2002

Company:

Property:

Shareholders:

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

Dear
:

This letter responds to a letter dated January 22, 2002, 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

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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 intends to elect under § 1362(a) to be an S corporation effective b. Company owns, operates, leases, and maintains a retail shopping center (the Property), with approximately c tenants.

Company has no employees. Mostly it uses independent contractors, closely supervised by Company’s president and a paid consultant, to provide various services in its business of leasing and managing Property. These services include regular property inspection; maintenance and repair of building structure and systems, including roofs, heating, air conditioning, and plumbing; parking lot maintenance and repair, including lighting; storm drain and gutter maintenance; sign maintenance; landscaping; snow removal; garbage collection; pest control; and buildouts for new tenants. 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 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

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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 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 election 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

cc: