Property Leasing Website Is a Brokerage Service for Purposes of Sec. 1202

(Parker Tax Publishing February 2022)

The Office of Chief Counsel advised that a corporation which operates a website that facilitates the leasing of property between lessors and lessees constitutes a business involving the performance of services in the field of brokerage services within the meaning of Code Sec. 1202(e)(3)(A). Therefore, the corporation's stock was not considered qualified small business stock and a taxpayer who sold shares of stock in the corporation was not entitled to exclude any of the gain from the sale under Code Sec. 1202. CCM 202204007.

Background

The Office of Chief Counsel was asked for assistance in determining whether a corporation that facilitates the leasing of property between lessors and lessees constitutes a business involving the performance of services in the field of brokerage services within the meaning of Code Sec. 1202(e)(3)(A).

The facts involved a taxpayer who sold stock in a corporation which operates a website on which potential lessees may make nonbinding reservations for the use of certain facilities at specified rental rates from facility lessors that are included in the website database. The corporation has no authority to enter into or sign leases on behalf of the potential lessors or lessees. A legally binding rental agreement for the use of a facility does not arise until the potential lessor and lessee enter into a lease agreement. The corporation's website will show a user that is considering leasing one or more facilities in a particular location the facilities in that area that are included in the website database.

Potential lessees do not pay any fee to the corporation for the use of the corporation's website. In its Terms of Service for lessees, the corporation states that it has no control over the facilities to be leased and does not guarantee the accuracy of any listings. Nor does the corporation guarantee that a lessee will actually be able to lease a facility listed in its database. The lessors are responsible for all payments to the corporation. As a condition of being listed in the corporation's public, searchable database, the corporation charges lessors a recurring periodic fee. The corporation also charges a contingent fee based on a percentage of rent paid by a lessee actually leasing a facility from a lessor through a search of the corporation's database. The corporation requires lessees to pay the rent for the leased facility through the corporation's website.

The facilities listed for lease on the corporation's website include real property. The corporation's Terms of Service state that it is not responsible for, and does not engage in, brokering, selling, purchasing, exchanging, or leasing posted properties. Although it may hold a real estate broker license in one or more states, the corporation asserts that it is not a broker with respect to the leasing of the facilities. Further, a lessee's use of the website constitutes an acknowledgement that the corporation has pre-negotiated rental rates with the lessors included on its website, part of which will be retained by the corporation as compensation for its services.

The corporation may also provide other services to lessors. For example, the corporation may charge a lessor a monthly fee to build and host a website for the lessor to be used in conjunction with the leasing of the lessor's facility. Liability for this monthly fee is not contingent on the lessor successfully leasing its facility to potential lessees.

Code Sec. 1202

For taxpayers other than corporations, under Code Sec. 1202(a), gross income does not include a certain percentage of any gain from the sale or exchange of qualified small business stock (QSB stock) held for more than five years. The gain exclusion is 100 percent for QSB stock acquired after September 27, 2010, 75 percent for QSB stock acquired after February 17, 2009, and before September 28, 2010, and 50 percent for QSB stock acquired on or before February 17, 2009.

Under Code Sec. 1202(c), QSB stock generally is any stock in a C corporation which is originally issued after August 10, 1993, if: (1) on the date of the stock's issuance the corporation is a qualified small business; and (2) the stock is acquired by the taxpayer at its original issue in exchange for money or other property or as compensation for services. Code Sec. 1202(c)(2)(A) requires that in order to be treated as QSB stock, during substantially all of the taxpayer's holding period for the stock, the corporation issuing the stock must satisfy the active trade or business requirement of Code Sec. 1202(e). This requires the corporation to use at least 80 percent of its assets (by value) in the active conduct of one or more qualified trades or businesses. An active trade or business is any trade or business other than trades or businesses expressly listed in Code Sec. 1202(e)(3).

Code Sec. 1202(e)(3)(A) specifically provides that a trade or business involving the performance of services in various fields, including "brokerage services," is not an active trade or business under Code Sec. 1202(e). The term "brokerage services" is not defined in Code Sec. 1202 nor is it explained in the legislative history to Code Sec. 1202.

Chief Counsel's Analysis

The Chief Counsel's Office advised that the corporation provides brokerage services within the meaning of Code Sec. 1202(e)(3)(A) and therefore, the taxpayer was not entitled to exclude any of the gain from the sale of stock in the corporation under Code Sec. 1202.

The Chief Counsel's Office considered several definitions of "broker" including those provided in Code Secs. 6045 and 199A, as well as the dictionary definition of the term. For purposes of the broker information reporting requirement under Code Sec. 6045(a), Code Sec. 6045(c) defines a broker broadly as a dealer or any other person who (for a consideration) regularly acts as a middleman with respect to property or services. The narrower definition of brokerage services in Reg. Sec. 1.199A-5(b)(2)(x), which applies for purposes of the deduction for qualified business income under Code Sec. 199A, is limited to services in which a person arranges transactions between a buyer and seller with respect to securities (as defined in Code Sec. 475(c)(2)) for a commission or fee, including stock brokers and other similar professionals but not including services by real estate or insurance agents or brokers. However, Reg. Sec. 1.199A-5(b)(2)(i) provides this definition applies only for purposes of Code Sec. 199A and may not be taken into account for purposes of applying any other Code provision. One dictionary definition of "broker" provides that a broker is one who acts as an intermediary, such as an agent who arranges marriages or who negotiates contracts for a purchase and sale (e.g., for real estate, commodities, or securities). Another definition of broker provided in a treatise states that the most important factor is whether the party is dealing for itself or for another and that a broker must be acting for compensation and on behalf of someone else.

The Chief Counsel's Office determined that the corporation should be classified as a broker under the common meaning of the term and the definition under Code Sec. 6045, rather than the narrower definition that applies for purposes of Code Sec. 199A. The Chief Counsel's Office reasoned that gross income is broadly defined under Code Sec. 61, and Code Sec. 1202 excludes from gross income all or a portion of the gain from the sale of QSB stock. The list of activities in Code Sec. 1202(e)(3), the Office of Chief Counsel noted, limits the scope of the Code Sec. 1202 exclusion. Therefore, precedent supported the IRS in interpreting the term "brokerage services" broadly, so as to provide a narrow construction of the exclusion.

The Office of Chief Counsel's found that the actions and services provided by the corporation supported the position that the corporation is a broker for purposes of Code Sec. 1202(e)(3)(A). The Chief Counsel's Office found that the corporation served as an intermediary between a buyer and a seller and did not just passively publish advertisements on its website that were provided to it from potential lessors desiring to lease property. In the view of the Chief Counsel's Office, the corporation's website was solely devoted to effectuating agreements between potential lessors and potential lessees of certain property.

The Chief Counsel's Office observed that the corporation did not have the authority to enter into leasing agreements on behalf of lessors that use its services. However, the Chief Counsel's Office concluded that brokerage activity can include simply bringing a potential buyer and seller together to work out the transaction. In addition, in the view of the Chief Counsel's Office, the fact that the corporation's services are provided by software created by people rather than directly by people does not change the functional nature of the services.

For a discussion of the exclusion of gain from the sale of small business stock, see Parker Tax ¶116,165.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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