REIT liquidation sales avoided prohibited-transaction tax

Plain-English summary

A real estate investment trust planned to sell all of its residential rental properties under a plan of liquidation. It asked whether the sales would be prohibited transactions subject to the 100 percent tax imposed by section 857(b)(6). The REIT represented that it acquired the properties for long-term rental income and appreciation, held and operated them as rentals for at least two years, and would use independent brokers to conduct the sales. The IRS concluded that the liquidation sales would not constitute prohibited transactions. The ruling did not address whether the taxpayer otherwise qualified as a REIT.

Ruling snapshot

• Question: Would the REIT's asset sales under a plan of liquidation be prohibited transactions under section 857(b)(6)?
• Outcome: No, based on the stated facts and representations.
• Key authorities: IRC §§ 856(c), 857(b)(6), and 1221(a)(1)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201609004                                              Third Party Communication: None
Release Date: 2/26/2016                                        Date of Communication: Not Applicable
Index Number: 857.00-00
                                                               Person To Contact:
----------------------------------------------------           ------------------------, ID No. ------------------
--------------------------------                               ----------------------------------------------------
--------------------------------------------                   Telephone Number:
----------------------------------------------------           ----------------------
                                                               Refer Reply To:
                                                               CC:FIP:B02
                                                               PLR-122848-15
                                                               Date:
                                                               November 12, 2015


Legend:


Taxpayer                   =         ----------------------------------
-------------------------------------------------------------

LP                         =         -----------------------------------------
-------------------------------------------------------------

State A                    =        --------------

Year 1                     =        --------------------------------------------

a                          =        ----

State B                    =        --------------

Year 2                     =        -------

Year 3                     =        -------

Date 1                     =        ----------------------

b                          =        -----

c                          =        ----

d                          =        ----

PLR-122848-15                                 2


Dear -----------:

This is in reply to a letter requesting a ruling that the sale of Taxpayer’s assets pursuant
to a plan of liquidation will not constitute prohibited transactions within the meaning of
section 857(b)(6) of the Internal Revenue Code (“the Code”).

FACTS:

Taxpayer is a State A statutory trust that has elected to be taxed as a real estate
investment trust (“REIT”) under section 856(c)(1) beginning in Year 1 and for each
taxable year thereafter. Through subsidiary entities that are generally taxed as
disregarded entities for federal income tax purposes, Taxpayer primarily owns and
leases residential real estate to third parties.

LP, a State B limited partnership, owns in excess of a percent of all classes of the stock
of Taxpayer and all of its voting common stock. The remaining non-controlling interest
of Taxpayer is made up of preferred stock owned by b persons. In order to facilitate the
winding down and dissolution of LP, Taxpayer intends to adopt a plan of liquidation
pursuant to which it will dispose of all the real property assets it currently owns between
Year 2 and Year 3.

LAW AND ANALYSIS:

Section 857(b)(6)(A) imposes a 100 percent tax on a REIT’s net income from prohibited
transactions. Section 857(b)(6)(B)(iii) defines the term “prohibited transaction” as the
sale or other disposition of property described in section 1221(a)(1) that is not
foreclosure property. Section 1221(a)(1) property, in turn, consists of “property held by
the taxpayer primarily for sale to customers in the ordinary course of his trade or
business.” Section 857(b)(6)(B)(ii) provides that losses attributable to prohibited
transactions are not taken into account in determining the amount of net income derived
from prohibited transactions.

Section 857(b)(6)(C) excludes certain sales from the definition of a prohibited
transaction. Under section 857(b)(6)(C), the term "prohibited transaction" does not
include the sale of property which is a real estate asset (as defined in section
856(c)(5)(B) and which is described in section 1221(a)(1)) if --

(i) the REIT has held the property for not less than 2 years;

(ii) the aggregate expenditures made by the REIT, or any partner of the REIT, during
the 2-year period preceding the date of sale that are includible in the basis of the
property do not exceed 30 percent of the net selling price of the property;

PLR-122848-15                                  3

(iii) (I) during the taxable year the REIT does not make more than 7 sales of property
(other than sales of foreclosure property or sales to which section 1033 applies), or (II)
the aggregate bases (as determined for computing earnings and profits) of property
(other than sales of foreclosure property or sales to which section 1033 applies) sold
during the taxable year does not exceed 10 percent of the aggregate bases of all the
assets of the REIT as of the beginning of the taxable year, or (III) the fair market value
of property (other than sales of foreclosure property or sales to which section 1033
applies) sold during the taxable year does not exceed 10 percent of the fair market
value of all the assets of the REIT as of the beginning of the taxable year;

(iv) In the case of property, which consists of land or improvements, not acquired
through foreclosure (or deed in lieu of foreclosure), or lease termination, the REIT has
held the property for not less than 2 years for production of rental income; and

(v) If the requirement of clause (iii)(I) is not satisfied, substantially all of the marketing
and development expenditures with respect to the property were made through an
independent contractor (as defined in section 856(d)(3)) from whom the REIT itself does
not derive or receive any income.

The legislative history underlying section 857(b)(6), which was added to the Code by
the Tax Reform Act of 1976, indicates that the purpose of that section was to "prevent a
REIT from retaining any profit from ordinary retailing activities such as sales to
customers of condominium units or subdivided lots in a development project." S. Rep.
No. 938, 84th Cong., 2d Sess. 470 (1976, 1976-3 (Vol. 4) C.B. 508).

To determine whether a taxpayer holds property “primarily for sale to customers in the
ordinary course of its trade or business”, the Tax Court has held that several factors
must be considered, none of which is dispositive. Among those factors are: (1) the
nature and purpose of the acquisition of the property and the duration of the ownership;
(2) the extent and nature of the taxpayer’s efforts to sell the property; (3) the number,
extent, continuity, and substantiality of the sales; (4) the extent of subdividing,
developing, and advertising to increase sales; and (5) the time and effort the taxpayer
habitually devoted to the sales. Generally, it is the purpose for which property is held at
the time of the sale that is determinative, although earlier events may be considered to
decide the taxpayer’s purpose at the time of the sale. See Cottle v. Commissioner, 89
T.C. 467, 487 (1987).

Taxpayer has made the following representations that address its purposes with respect
to the properties at issue. Taxpayer represents that it acquired the properties with the
intent to own the properties for a long-term holding period, and to derive its profits from
capital appreciation and rental income from the properties. The disposition of the
properties is pursuant to a plan of liquidation. As of Date 1, each individual property has
a holding period of c months or greater. As of Date 1, the weighted average holding
period of the properties (based on estimated fair market value as of Date 1) was d

PLR-122848-15                                        4

months. All the individual properties will have been operated as rental properties for at
least two years at the time of its proposed sale. Taxpayer will use one or more
independent third party brokers from which Taxpayer derives no income to dispose of
the properties.

CONCLUSION:

Based on the facts presented and representations made, we conclude that Taxpayer’s
proposed sale of its assets pursuant to the plan of liquidation will not constitute
prohibited transactions under section 857(b)(6)(B).1

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. In particular, no opinion is expressed with regard to whether Taxpayer
qualifies as a REIT under subchapter M of the Code.

This ruling is directed only at the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

In accordance with the terms of a power of attorney on file with this office, a copy of this
letter is being sent to your authorized representatives.


                                                 Sincerely,


                                                 Susan Thompson Baker
                                                 Senior Technician Reviewer, Branch 2
                                                 Office of Associate Chief Counsel
                                                 (Financial Institutions & Products)




1
  Section 4 of Rev. Proc. 2015-3 sets forth those areas in which rulings or determination letters will not
ordinarily be issued by the Service. "Not ordinarily" means that unique and compelling reasons must be
demonstrated to justify the issuance of a ruling or determination letter. See Rev. Proc. 2015-3, sec. 2.01.
Section 4.02(5) of Rev. Proc. 2015-3 provides that one of the areas in which rulings or determination
letters will not ordinarily be issued is any matter dealing with the question of whether property is held
primarily for sale to customers in the ordinary course of a trade or business. In this case, Taxpayer has
demonstrated unique and compelling reasons to justify issuance of the ruling.