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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