Rental income from actively managed homes is not passive investment income

Plain-English summary

The IRS considered an S corporation that owned, leased, and managed single-family residential properties. The corporation performed leasing, tenant, repair, maintenance, and administrative work, and its leases were generally for one year or less and were not net leases. The IRS ruled that the corporation's rental income from these operations was not passive investment income under IRC § 1362(d)(3)(C)(i), because the rents were derived from the active trade or business of renting property. The ruling addressed the passive investment income rules and did not express an opinion on the corporation's general eligibility as an S corporation or on the separate passive activity rules under IRC § 469.

Ruling snapshot

• Question: Is rental income from the corporation's actively managed residential rental operations passive investment income under IRC § 1362(d)(3)(C)(i)?
• Outcome: Approved
• Key authorities: IRC §§ 1362(a)(1), 1362(d)(3)(A)(i), 1362(d)(3)(C)(i), and 469; Treas. Reg. § 1.1362-2(c)(5)(ii)(B)(1)-(2)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201025040 Third Party Communication: None
Release Date: 6/25/2010 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.02-00,
1362.02-03 Person To Contact:
---------------------, ID No. -----------------
------------------------------- Telephone Number:
-------------------------------- -------------------
------------------ Refer Reply To:
---------------------------------------------- CC:PSI:B03
PLR-149137-09
Date:
March 01, 2010

                                               LEGEND

X = -----------------------------------------------------------------------------------------------------
------------------------

Date = --------------------------
1
Date = ----------------------
2
Year = -------

State = -------------

A = ----

B = --

C = -------------

D = -------------

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

   This letter responds to a letter dated October 25, 2009, as well as subsequent

correspondence, submitted on behalf of X by X’s authorized representative, requesting
a ruling that rental income received by X is not passive investment income within the
meaning of § 1362(d)(3)(C)(i) of the Internal Revenue Code.

                                                FACTS

PLR-149137-09 2

   X was incorporated under the laws of State on Date 1, and elected under

§ 1362(a) to be an S corporation effective Date 2. X owns, leases, and manages A
single-family residential properties. X leases its properties to unrelated individual
tenants under rental arrangements involving a term of one year or less that are not net
leases.

    X is actively involved in performing all of the leasing and administrative functions

necessary for managing its properties, including repair and maintenance services.
Specifically, X supervises and ensures that all vacancies are properly prepared for re-
rental, advertizes for new tenants, and processes prospective tenant applications,
including performing credit checks on prospective tenants and negotiating the lease and
rental agreements. Once the property is rented, X collects the rent, communicates with
tenants during their tenancy, and monitors tenant compliance with lease terms. If a
tenant experiences a repair or maintenance problem with the rental property, X
customarily arranges, supervises, and pays for the required repair and maintenance
work as to major building elements, such as the heating and cooling systems, plumbing,
exterior walls, and roof. In addition, X pays all property taxes and maintains the
casualty and liability insurance on these properties. X has B employees and multiple
independent contractors involved in the day-to-day activities associated with its single-
family residential rental operations.

   In Year, X had C in gross rental receipts and incurred D in operating expenses

(other than depreciation). X also represents it has accumulated earnings and profits. X
does not engage in any business other than its residential rental operations.

                              LAW AND ANALYSIS

  Section 1362(a)(1) provides that, except as provided in § 1362(g), 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) shall be

terminated whenever the corporation (1) has accumulated earnings and profits at the
close of each of three consecutive taxable years, and (2) has gross receipts for each of
such taxable years more than 25 percent of which are passive investment income.

   Section 1362(d)(3)(C)(i) provides that, except as otherwise provided in

§ 1362(d)(3)(C), the term “passive investment income” means gross receipts derived
from royalties, rents, dividends, interest, and annuities.

    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.
PLR-149137-09 3

    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 the 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).

                                  CONCLUSION

   Based solely on the facts submitted and representations made, we conclude that

the rental income X receives from its operations described above is not passive
investment income under § 1362(d)(3)(C)(i).

    Except as expressly provided herein, we express or imply no opinion concerning

the tax consequences of any aspect of any transaction or item discussed or referenced
in this letter. Specifically, we express or imply no opinion regarding X'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.

  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.

  In accordance with the power of attorney on file with this office, we are sending a

copy of this letter to your authorized representatives.

   The ruling contained in this letter is based upon information and representations

submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the ruling request, it is subject to verification on examination.
PLR-149137-09 4

                             Sincerely,

                             /s/

                             Leslie H. Finlow
                             Senior Technician Reviewer, Branch 3
                             Office of the Associate Chief Counsel
                             (Passthroughs & Special Industries)

Enclosures (2)
Copy of this letter
Copy for § 6110 purposes