PIGs for your PALs.

• Author: Harrison, James Edward
• Position: Passive income generator, passive activity loss

Passive income opportunities exist for C corporation owners in the passive activity loss (PAL) rules. TD 8417 (released on May 12, 1992) finalized portions of Temp. Regs. Sec. 1.469-2T(f), which recharacterizes the classification of net income from passive to nonpassive in certain situations. One of these situations involves property owned by an individual and rented to an active trade or business activity in which the taxpayer materially participates.

Regs. Sec. 1.469-2(f)(6) provides that net income from property rentals to a nonpassive activity involving S corporations and partnerships will be treated as nonpassive income and will not be allowed to offset other passive losses. If the rental activity produces a net loss, however, it would be classified as a passive loss. This harsh treatment does not extend to C corporation owners who rent property to their C corporation (see Temp. Regs. Sec. 1.469-4T(b)(2)(ii)(B)).

Ownership of C corporation stock is not participation in the C corporation's activity, and therefore there is no material or significant participation in the trade or business using the property. This provides an opportunity for accelerated tax deductions for C stockholders that is not available for S stockholders, as the following example illustrates.

Example: Doctor D operates a medical practice as a C corporation. Under the personal service corporation rules, D pays tax on its income at 34%. D normally receives a salary that approximates the practice's net income, with no tax paid at the corporate level. He holds other investments personally that produce limited PALs of $10,000 annually. In 1991, D purchases a piece of medical equipment costing $50,000 and rents it to his C corporation for its fair market value (FMV) of $16,000 annually. Depreciation of $10,000 is the only related expense, so D recognizes $6,000 net...