PLR 200546001: Shopping center rents are active income under S corporation rule

Plain-English summary

An S corporation with accumulated earnings and profits received rent from three shopping centers. It managed leasing, collected rents, and provided or arranged services such as landscaping, security, lighting, and upkeep. The IRS ruled that the rents were not passive investment income under the S corporation termination rule because they arose from an active rental business with significant services or costs. The ruling did not decide whether the corporation otherwise qualified for S status. It also cautioned that the separate passive activity rules could still treat the rental activity as passive.

Ruling snapshot

• Question: Did rent from the three shopping centers count as passive investment income for the S corporation termination rule?
• Outcome: Approved; the rents were not passive investment income under section 1362(d)(3).
• Key authorities: IRC §§ 1362(d)(3), 469; Treas. Reg. § 1.1362-2(c)(5)(ii)(B)(2).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 200546001
Third Party Communication: None
Release Date: 11/18/2005
Date of Communication: Not Applicable
Index Number: 1362.02-03
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:PSI:B02
PLR-100857-05
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Date:
July 29, 2005

X = -------------------------------
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A= -----------------------------
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State = -------------

LLC = -----------------------------------------
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Shopping Center 1 = ----------------------------------
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Shopping Center 2 = -------------------------------------------------------------
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Shopping Center 3 = ------------------------------------------------
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Date 1 = ----------------------

Date 2 = -----------------

Date 3 = --------------------------

x = -------------

y = -----------

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

This letter responds to a letter dated December 30, 2004, submitted on behalf of X by X’s authorized representative, requesting a ruling that X’s rental income from

PLR-100857-05
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Shopping Centers 1, 2, and 3 is not passive investment income within the meaning of
§ 1362(d)(3)(C)(i).

The information submitted states that X was incorporated in State on Date 1.
Effective Date 2, X elected to be treated as an S corporation. X has subchapter C earnings and profits.

A, the president of X, represents that X owns an interest in LLC which owns Shopping Center 1 and other property. LLC is treated as a partnership for federal income tax purposes. A represents that X is responsible for managing Shopping Center 1 on behalf of LLC. X has a leasehold interest in Shopping Centers 2 and 3.

A represents that X, either directly or through its independent contractors, provides various services to the tenants of Shopping Centers 1, 2, and 3. Services provided by X include but are not limited to, the following: the provision of water and electricity for common areas, gardening and landscaping, maintaining the pavement, parking lots, exterior lighting, garbage removal, janitorial services for the common areas, security, and marketing and promoting the shopping center. In addition to services provided to tenants, X, directly and through independent contractors, handles the leasing and administrative functions involved with managing Shopping Centers 1, 2, and 3, including billing tenants and collecting rents, finding new tenants and negotiating leases.

In the taxable year ending Date 3, X received or accrued approximately $x in rents, which includes reimbursements by tenants for insurance, property taxes, expenses for maintaining common areas and promotional fees paid by X. X paid or incurred approximately $y in relevant expenses other than depreciation.

Section 1361(a)(1) defines an "S corporation" as a small business corporation for which an election under ' 1362(a) is in effect for the taxable year.

Section 1362(d)(2)(A) provides than an election under ' 1362(a) shall be terminated whenever (at any time after the first day of the first taxable year for which the corporation is an S corporation) such corporation ceases to be a small business corporation.

Section 1362(d)(3)(A) provides that an election under ' 1362(a) shall be terminated whenever the corporation has accumulated earnings and profits at the close of each of 3 consecutive taxable years, and has gross receipts for each of such taxable years more than 25 percent of which are passive investment income. Any termination under this paragraph shall be effective on and after the first day of the first taxable year beginning after the third consecutive taxable year referred to above.

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Section 1362(d)(3)(C)(i) provides that except as otherwise provided, 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)(2) of the Income Tax Regulations 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, but not limited to, 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 and the representations submitted we conclude that the rental income that X derives from Shopping Centers 1, 2, and 3 is not passive investment income as described in ' 1362(d)(3)(C)(i).

Except as specifically set forth above, we express no opinion as to the federal tax consequences of the transaction described above under any other provision of the Code. Specifically, we express no opinion on whether X is a small business corporation eligible to make an S election. Further, the passive investment income rules of ' 1362 are completely independent of the passive activity rules of section ' 469; unless an exception under ' 469 applies, the rental activity remains passive for purposes of ' 469.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

Pursuant to the power of attorney on file with this office, a copy of this letter is being sent to X=s authorized representative.

Sincerely,

J. Thomas Hines
Chief, Branch 2
Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures: 2
Copy of this letter
Copy for ' 6110 purposes cc: