PALs carried forward from C to S Corporation.

• Author: Lerman, Jerry L.
• Position: Passive activity losses

When converting from a C to an S corporation, a taxpayer cannot carry forward or back any net operating losses (NOLs) arising when the taxpayer was a C corporation to a tax year for which such taxpayer is an S corporation (Sec. 1371(b)(1)). Under Sec. 469(b), however, a closely held C corporation treats a suspended passive activity loss (PAL) as a deduction allocable to such activity in the next subsequent year.

In St. Charles Investment Co., 10th Cir, 11/14/00, a C corporation had suspended PALs from real estate during the years 1988-1990. In 1991, the corporation elected S status, selling its real estate activity and recognizing the PALs suspended in the prior years. The IRS disallowed the deduction of the suspended losses, claiming that Sec. 1371(b)(1) prohibits an S corporation from claiming any carryforward from a year in which it was a C corporation to a year in which it elected S status.

St. Charles argued that it was not claiming a carryforward loss, but following Sec. 469(b), which provides that a taxpayer must treat disallowed PALs as a deduction allowable to the activity for the next year. Sec. 469(f)(2) specifically provides that if a corporation ceases to be a closely held C corporation, the passive-loss rules apply in the same manner as if such...