Arthur Andersen Real Estate and Hospitality Tax Alert, passive Activity Loss Case Favors Taxpayers

Arthur Andersen A recent case allowed an S corporation to carry over suspended passive activity
losses that were incurred when the taxpayer was a C corporation. In that case
[St. Charles Investment Co. v. Commissioner, No. 99-2020 (10th Cir. 11/14/00)], a
closely held C corporation had losses from a real estate rental business that
were suspended under the passive activity loss rules. Normally, under the
passive activity rules, those losses can be carried over and deducted when the
passive activity is sold or disposed of. However, here the corporation first
converted to an S corporation, and then disposed of the passive activity

The IRS and the Tax Court held that the suspended passive activity losses could
not carry over to the S corporation. Thus, those losses could not be deducted
when the property was sold. This position was based on an S corporation
provision which provides that no carryforwards are allowed from a C
corporation year to an S corporation year. On appeal, the 10th Circuit Court of
Appeals held otherwise, and ruled that the carryover provisions in the passive
activity loss rules essentially override the non-carryover provisions in the S
corporation rules. Therefore, the taxpayer was allowed to deduct the suspended
passive activity losses when the property was sold, even though it had converted
to an S corporation.

For further information on this or related issues, please contact Tony Brown at
(877) 962-2100 or via e-mail at

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