Charles, Inc. was a closely held C corporation engaged in the real estate rental business in 2011. The company had $6 million in passive activy losses. In 2012, Charles elected to be taxed as an S corporation, and the company sold a number of rental properties. May these suspended passive activity losses (PAL) be claimed as deductions under section 469(g)(1)(A)?
Recall that an S corporation cannot use carryforwards from a year in which it was a C corporation. If the PAL deductions are disallowed, may Charles readjust its cost basis in the sold property upward? Summarize your findings in a memo to the tax research file of your firm. Be sure to cite your sources.