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S corporations: new opportunities for rental activities?

In the past, regular or C corporations were prevented from converting to S status if their plimary activity was renting real estate and they had accumulated earnings and profits as C corporations. Earlier proposed IRS regulations held rentals from offices and apartment buildings would be considered passive, triggering the 34% tax of section 1362 at the S level on rentals in excess of 25% of the gross receipts. Further, maintaining this status for three years forced reversion to C or regular status at the beginning of the fourth year.

Now, in a surprising turn, the final regulations say rents are not passive if derived in the active trade or business of renting property. Rental activities will be considered active if the S corporation either provides significant services or incurs substantial costs in the rental business (regulations section 1. 1362-2(c)(5)(ii)(B)(2)).

The regulations provide no clear line for determining whether the S corporation has provided significant services or incurred substantial costs. Rather, the regulations suggest a "facts and circumstances" test that involves looking at factors such as the number of persons employed in providing the services and the types and amounts of costs and expenses that are incurred (other than depreciation).

Also, the rules say that net leasing will not be considered as part of the conduct of an active trade or business.

Observation: This new interpretation will open up S status for many C corporations that in the past could not have considered an S election because of the section 1362-section 1375 excess passive gross receipts tax.

Also, amended returns for open years may be filed by S corporations that paid the section 1375 excess passive receipts tax, although amended returns also will be required by the S corporation shareholder who received a pass-through deduction for this tax.
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Article Details
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Publication:Journal of Accountancy
Article Type:Brief Article
Date:Mar 1, 1993
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