The IRS recently issued a private letter ruling (PLR 201816003
), in which it ruled on the application of the real estate investment trust (REIT) qualification tests to payments from a city to incentivize development.
In general, a corporation does not qualify as a REIT unless it satisfies an asset test under Section 856(c)(4) and a pair of income tests under Sections 856(c)(2) and 856(c)(3). To satisfy the asset test, at least 75% of the value of a REIT’s assets must be represented by real estate assets, cash and cash items (including receivables) and government securities. The regulations under Section 856 provides that receivables must arise in the ordinary course of the REIT’s operation to qualify under the provision. Further regulations provide that for purposes of the asset test, a REIT that is a partner in a partnership is treated as owning its proportional share of the assets of the partnership.
For purposes of both income tests, a portion of the corporation’s gross income must be derived from a list of sources that includes, among many other items, “abatements and refunds of taxes on real property.” Section 856(c)(5)(j)(ii) provides that, to the extent necessary to carry out the purposes of the REIT provisions, the IRS is authorized to determine any item can be treated as qualifying income for purposes of the income tests.
In the PLR, a REIT was a partner in a partnership that was developing a mixed-use shopping center located in a city. To incentivize the shopping center, the city pledged to make annual payments to the partnership based on the amount city tax revenues were increased by the development. Part of each payment constituted a rebate of the partnership’s property taxes paid to the city, but the partnership could also receive payment in excess of its property tax burden. Each year, the partnership recorded its unpaid claims relating to these payments as receivables.
In applying the asset test, the IRS first looked through the REIT’s interest in the partnership to its proportional share of the receivables. Noting that the receivables arose from the development of real property on land in connection with the leasing business of the partnership and the REIT, the IRS ruled that they arose in the ordinary course of the REIT’s business. Accordingly, the IRS ruled that they were qualifying assets under the asset test.
In applying the income tests to the payments, the IRS ruled separately on (1) the payments to the extent of the partnership’s property tax obligations and (2) amounts in excess of the partnership’s property tax obligation. The IRS ruled that the former was qualifying income under the statutory provision for “abatements and refunds of taxes on real property.” Although the latter was not covered by any of the categories in the statute, the IRS ruled that it was qualifying income under 856(c)(5)(j)(ii), because treating it as such was consistent was the purposes of the REIT provisions.
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