PLR 200518038: Managed commercial property rents were not S corporation passive investment income

Plain-English summary

An S corporation owned and managed commercial real estate. It represented that it performed substantial maintenance, safety, landscaping, utility, and renovation services for one property and bore the related operating costs. The IRS ruled that rents from that property were not passive investment income under IRC § 1362(d)(3), which can affect S status when a corporation has accumulated earnings and profits. The ruling did not decide whether the company otherwise qualified as an S corporation. It also said the rental activity could still be passive under the separate § 469 passive activity rules.

Ruling snapshot

• Question: Were rents from the actively managed commercial property passive investment income under § 1362?
• Outcome: Approved: the property's rents were not passive investment income under that provision.
• Key authorities: IRC § 1362(d)(3)(C)(i); 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: 200518038
Release Date: 5/6/2005
Index Number: 1362.02-03

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Person To Contact:
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Telephone Number:
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Refer Reply To:
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CC:PSI:3 – PLR-148739-04
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Date:
January 13, 2005

Company: ---------------
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Shareholders: --------------------
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Property: ---------------------------------------------------------------------------------
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State: -------------

a: ----------------------

b: -------------------

c: -------------

d: -----------

e: -------
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f: -------

g: ------------

h: -----------

i: -------

k: ------------

m: -----------

Dear ------------------:

This letter responds to a letter dated September 10, 2004, as well as subsequent correspondence, submitted on behalf of Company, requesting a ruling that the rental income received by Company from 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 had subchapter C earnings and profits until b, at which time it made a deemed distribution of the entire amount. Company owns, operates, leases, and manages commercial real estate.

Company performs substantially all services and is responsible for substantially all costs necessary to maintain and operate Property. The services Company provides in leasing and managing Property include safety and maintenance inspections; maintenance and repair of building structural components and systems, including heating and air conditioning facilities and equipment; landscaping and grounds maintenance; the provision of utilities; and, as required, space renovation and remodeling.

Company received or accrued approximately c in rents and paid or incurred approximately d in relevant expenses for e on Property. The comparable figures for f are g and h, respectively, and those for i, k and m.

LAW AND ANALYSIS
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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 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 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 a copy to Company.
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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)

enclosures: copy for ' 6110 purposes

cc: