PLR 200339040: Active property management keeps rents outside S corporation passive income rule

Plain-English summary

An S corporation with accumulated earnings and profits owned and managed a commercial rental property. Its employees and contractors provided maintenance, tenant support, and other services, and it incurred rental business expenses. The IRS ruled that its rents were not passive investment income for the S corporation termination rule in IRC § 1362(d)(3). The letter separately notes that this ruling does not decide the corporation's S corporation eligibility and that the rental activity can still be passive under the different rules in § 469.

Ruling snapshot

• Question: Are the corporation's commercial property rent passive investment income under § 1362(d)(3)?
• Outcome: Approved: the rents are not passive investment income under that rule.
• Key authorities: IRC § 1362(d)(3)(C); Treas. Reg. § 1.1362-2(c)(5)(ii)(B).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Number: 200339040 Washington, DC 20224
Release Date: 09/26/2003
Index Number: 1362.02-03 Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:3 PLR-115991-03
Date:
June 25, 2003

Company:

Shareholders:

Property:

State:

City:
a:
b:

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c:
d:
e:
f:
g:
h:

Dear :

This letter responds to a letter from your authorized representative dated March 5, 2003, as well as subsequent correspondence, submitted on behalf of Company, 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, a State corporation, elected under § 1362(a) to be an S corporation effective a. It has accumulated earnings and profits.

Company owns, operates, leases, and manages commercial real estate (the Property) in City.

Through its president and b full-time employees (a property manager / tenant liaison and a maintenance man), as well as independent contractors, Company provides various services to the Property in its real estate leasing and management business. These services include common area cleaning and maintenance; inspection and maintenance of the building exterior and interior, including the foundation, the roof, and the electrical and HVAC systems; maintenance and repair of interior and exterior plumbing and lighting; interior and exterior painting; repair and maintenance of the parking lot; janitorial services; window washing; landscaping and lawn care; snow removal and ice control; trash removal; pest control; utilities; supervision and compensation of outside vendors and service providers; emergency response and property access for public safety purposes; and the handling of tenant problems, suggestions, and complaints. 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 c in rents and paid or incurred approximately d in relevant expenses for e on the Property. The rental income and expense figures for f are g and h, respectively.

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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

Based solely on the facts and representations submitted, 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 be 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.

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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 yours,

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

Enclosure: copy for § 6110 purposes

cc: