Read the opinion: Dirico [PDF 54 KB]
The taxpayer leased land and telecommunication towers to his wholly owned S corporation. In exchange, the taxpayer received a percentage of the S corporation’s revenues from its leasing of the tower access to third parties.
The taxpayer also leased three parcels of land to the S corporation, but these parcels did not have towers.
The S corporation sold and serviced radios and provided specialized mobile radio services (a pre-cellular telephone technology) to customers for a subscriber fee. Four of the towers leased to the S corporation housed antennas in “free space” (unused) for the rent-free use of the S corporation’s subscribers / customers.
The taxpayer reported the net income from his leases to the S corporation as passive activity rental income, subject to the provisions of section 469 (c)(2). The IRS, however, asserted that:
- The taxpayer’s income from the tower and land rentals to the S corporation was income from property used in a trade or business in which the taxpayer materially participated and thus was non-passive activity income.
- Reg. section 1.469-2(f)(6) applies only to the taxpayer’s profitable tower and land leases to the S corporation, with the effect that the taxpayer’s losses from unprofitable tower and land leases to the S corporation remained as passive activity losses and could not be netted against the rental income.
- The taxpayer’s income from the three land-only leases constituted non-passive activity income because less than 30% of the leased property’s unadjusted basis was subject to depreciation.
Thus, the IRS recharacterized the taxpayer’s income from the profitable rentals of towers and land of approximately $428,000 (for 2004) and approximately, $590,000 (for 2005) as non-passive activity income, but did not recharacterize the losses of $144,000 (for 2004) and $158,000 (for 2005) that were attributable to unprofitable rental properties.
The Tax Court today held:
- The S corporation used the towers and land in a rental, not a trade or business activity, so that the taxpayer’s income from these leases constituted passive activity income (or loss) regardless of the taxpayer’s material participation in that activity.
- Losses from the unprofitable tower and land leases were passive activity losses.
- The land in the land-only leases was not provided in connection with any of the leased towers, so that the land-only leases may not be grouped with the leases of towers and land; thus, because less than 30% of the property covered by those land-only leases was depreciable, the taxpayer’s income constituted non-passive activity income.