PLR 9950025: Active property management keeps rent outside S corporation passive income

Plain-English summary

An S corporation with accumulated earnings and profits owned and managed industrial rental properties. Its employees and contractors provided maintenance, inspections, tenant assistance, emergency service, and other management work. Based on those services and the stated expenses, the IRS ruled that its rental receipts were outside the passive investment income category used in § 1362's S election termination rule. The ruling did not decide whether the company otherwise qualified as an S corporation. It also explained that the separate passive activity rules of § 469 could still treat the rental activity as passive.

Ruling snapshot

• Question: Were the company's industrial property rents passive investment income under § 1362(d)(3)?
• Outcome: Approved: the rents were not passive investment income for that rule.
• Key authorities: IRC §§ 1362(d)(3), 469; Treas. Reg. § 1.1362-2(c)(5)(ii)(B).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Index Number: 1362.02-03 Washington, DC 20224

Number: 199950025
Person to Contact:
Release Date: 12/17/1999 Telephone Number:

Refer Reply To:
CC:DOM:P&SI:3 PLR-111459-99
Date:
September 20, 1999

Company:

Properties:

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a:

b:

c:

d:

e:

f:

g:

h:

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j:

Dear

This letter responds to Company’s letter signed June 14, 1999, plus subsequent correspondence, requesting a ruling that Company's rental income from the Properties is not passive investment income within the meaning of § 1362(d)(3)(C)(i) of the Internal Revenue Code. Company represents the following facts.

Company was incorporated in State in a and elected under § 1362(a) to be an S corporation effective b. It has accumulated subchapter C earnings and profits.

Company owns, leases, and manages c industrial properties (the Properties). It has d full-time employees, including its president and sole shareholder.

Through its employees, as well as through independent contractors, Company provides various services to the Properties in its real estate leasing and management

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business. These services include regular property inspections; common area maintenance; maintenance and repair of building structural components and systems (e.g., roofs, exterior walls, foundations, heating, air conditioning, plumbing, and electrical); maintenance and repair of parking lots and pavement; landscaping and grounds maintenance; fire alarm and sprinkler maintenance; assistance to tenants in remodeling, financing, and vendor selection; trash collection and recycling; 24-hour emergency service; and resolution of tenant complaints. In addition to the services provided to tenants, Company handles the usual leasing and administrative functions involved in managing real estate.

The Company received or accrued approximately e in rents and paid or incurred approximately f in relevant expenses on the Properties for g. The comparable figures for h are i and j.

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 subparagraph (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, 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 as presented in this ruling request, and viewed in light

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of the applicable law and regulations, 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, no opinion is expressed or implied concerning the federal income tax consequences of the facts of this case under any other provision of the Code. Specifically, no opinion is expressed regarding Company's status 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.

In accordance with the power of attorney on file with this office, we are sending the original of this letter to your authorized representative and a copy to you.

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,

WILLIAM P. O’SHEA
Chief, Branch 3
Office of Assistant Chief Counsel
(Passthroughs and Special Industries)

Enclosure: copy for § 6110 purposes

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