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The IRS has ruled (PLR 2012-29-007) that an S corporation's
rental income is not passive income under Section
1362(d)(3)(C)(i).
The private letter ruling addresses an S corporation that,
through its employees and other agents, provided certain services
regarding rental real estate property it owned. These services
include maintenance and repair such as cleaning, painting,
electrical, plumbing, roof and structural maintenance, garbage and
recycling, landscaping services, and pest control. Also provided
were operational and management services such as paying all water,
gas, heat, light, power, sewer, and janitorial charges and other
utilities or services needed for the property; maintaining the
structural and exterior portions of the property in good condition;
providing trash removal and window-cleaning services; furnishing
property-related inspections; maintaining common areas; and
furnishing landscaping and snow removal service.
Section 1362(d)(3)(A)(i) provides that an S corporation election
will be terminated whenever the corporation:
has accumulated earnings and profits at the close of each of
three consecutive taxable years; and
has gross receipts for each of such taxable years, more than 25
percent of which are passive investment income.
In general, "passive investment income" means gross
receipts derived from rent, and "rent" is defined as
amounts received for the use of, or for the right to use, property
(whether real or personal) of the corporation. The regulations
provide that the term "rents" does not include rents
derived from the active trade or business of renting property.
Rents are derived from 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.
The IRS ruled in PLR 2012-29-007 that the rental income received
by the S corporation from its rental property was not passive
income as described in Section 1362(d)(3)(C)(i) based on all facts
and circumstances presented.
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The Internal Revenue Service has recently published an IRS Large Business & International Directive, which updates an earlier directive to field agents addressing the examination of capitalization and repair costs issues.
A state cannot include income in the apportionable base and then exclude the receipts and related factors that generated that very same income from the apportionment formula.
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