Thursday, March 28, 2024
GiftLaw Pro
GiftLaw Note: Company owns, operates and leases commercial real estate (the "Property"). Through its shareholders and independent contractors, Company provides various services to the Property including inspection, maintenance and repair, janitorial and cleaning services, landscape and pest control. Company also handles the leasing and administrative functions involved in managing the Property. Company sought a ruling that the rental income it received from the Property is not passive investment income.

Section 1362(d)(3)(C) defines passive investment income as gross receipts derived from royalties, rents, dividends, interest, annuities and sales or exchanges of stock or securities. "Rents" are further described in Treasury Regulations as amounts received for the use of, or the right to use, property, but NOT amounts derived in the active trade or business of renting property. Rents are derived in the active trade or business of renting property if, based on all facts and circumstances, the recipient provides significant services or incurs substantial costs in the rental business. However, rents from net leases are not derived in the active trade or business of renting property and are therefore passive investment income.

Based upon the specific facts and circumstances of Company's involvement with the Property, including the significant services it provides with respect to the property and related expenses, the IRS granted Company's request and ruled that its rental income is not passive investment income.

Editor's Note: The issue of whether or not rental income qualifies as passive investment income is significant in the charitable context. While Company did not want its rental income characterized as passive investment income, charities, and in particular charitable remainder trusts (CRTs), do want their rental income to meet the definition of passive investment income. This is because the passive investment income of charities is not subject to unrelated business income tax (UBIT) but income from an active trade or business is subject to UBIT. In the case of a CRT, UBIT will cause the CRT to lose its tax exempt status. Charities and trustees of CRTs should be aware of the definition of rents in Sec. 1362(d)(3)(C) and corresponding Treasury Regulations and take steps to ensure that all rents received do qualify as passive investment income.

Dear * * *:

This letter responds to your letter dated May 27, 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, owned equally by the Shareholders, was incorporated on a and intends to elect under ? 1362(a) to be an S corporation effective b. Company has accumulated earnings and profits.

Company owns, operates, and leases commercial real estate (the Property). It has c tenants, none of whom is under a net lease.

All of the Shareholders are officers and employees of Company. Through the Shareholders, as well as independent contractors, Company provides various services to the Property, including regular property inspection; common area maintenance and repair, including carpeting and painting; janitorial and cleaning services; maintenance and repair of building structural components, including roofs and facades; upkeep and repair of building systems (heating, air conditioning, plumbing, water and sewer, electrical, and lighting); parking lot maintenance; landscape maintenance; snow removal; and pest control. 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 d in rents and paid or incurred approximately e in relevant expenses for f on the Property. The rental income and expense figures for g are h and i, respectively.

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 elect to be treated 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.

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)




© Copyright 1999-2024 Crescendo Interactive, Inc.