PLR 200252036: Shopping center rents are excluded from S corporation passive investment income

Plain-English summary

A corporation planning to elect S status asked whether rents from shopping centers it owned and managed would count as passive investment income. Its employees and contractors inspected and maintained the properties and performed leasing and management work. Based on those facts, the IRS ruled that the rents were excluded from passive investment income under IRC § 1362(d)(3)(C)(i). The ruling did not decide whether the corporation was eligible to elect S status. It also explained that the separate passive activity rules of IRC § 469 could still treat the rental activity as passive.

Ruling snapshot

• Question: Do rents from the corporation's managed shopping centers count as passive investment income under the S corporation rules?
• Outcome: approved
• Key authorities: IRC §§ 1362 and 469; Treas. Reg. § 1.1362-2(c)(5)(ii)(B)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Number: 200252036 Washington, DC 20224 Release Date: 12/27/2002 UIL: 1362.02-03 Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:3 PLR-127217-02
Date:
September 3, 2002

Company:

Properties:

Shareholders:

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

Dear :

This letter responds to your letter dated May 9, 2002, as well as subsequent correspondence, submitted on behalf of Company, requesting a ruling that the rental income received by Company from the Properties 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 and manages c shopping centers (the Properties), with approximately d tenants. The Properties were developed and constructed by Company.

Company has e officer-employees. Through its employees, as well as independent contractors, Company provides various services to the Properties in its real estate leasing and management business. These services include regular property inspection; maintenance and repair of building structural components and systems, such as roofs, roof drains, and ventilation and air conditioning systems; building painting; parking lot maintenance and repair, including sweeping and striping; maintenance of lighting in parking areas and canopies, such as bulb replacement and stanchion repair; landscaping and grounds maintenance; snow and ice removal; and assistance to 3

tenants with holiday lighting and decorations. 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 f in rents and paid or incurred approximately g in relevant expenses for h on the Properties. The rental income and expense figures for i are k and m, 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).

CONCLUSION
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Based solely on the facts and representations submitted, 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 the original of this letter to you and copies to Company and Company’s other 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,

/s/
MARY BETH COLLINS
Senior Technician Reviewer, Branch
3
Office of Associate Chief Counsel
(Passthroughs and Special
Industries)

enclosure: copy for § 6110 purposes