S corporations with C year E&P can often avoid termination even with rental income

Real estate S corporations often face termination of S status due to accumulated earnings and profits (E&P) and excessive passive income. S corporations with prior C corporation status that have accumulated E&P at the end of the taxable year will lose S status in cases where passive income exceeds 25% of gross receipts for three consecutive years. Rental income is often considered passive by the IRS. Owners performing additional services of a substantial nature not incidental to the realization of return on real estate investments greater than those necessary to maintain occupancy will be determined to have self-employment income and avoid having the rental income classified as passive. There is a fine line in the determination of how much additional service turns rental income from passive income into self-employment, so real estate S corporations should obtain a ruling from the IRS.