Utility's base solar payment qualifies as REIT income

Plain-English summary

A REIT's partnership owned a mixed-use shopping center and the underlying land and planned to install a solar system on the roof. The system would serve only the center and would be treated as a structural component of real property. A utility incentive provided a base amount plus an increment for transferring renewable energy credits. The taxpayer would treat the credit increment as nonqualifying income. The IRS ruled that the base solar incentive amount qualified for the section 856 gross-income tests because that treatment was consistent with the REIT regime's passive-income objectives.

Ruling snapshot

• Question: Does the base portion of the utility's solar incentive qualify for the REIT income tests?
• Outcome: approved
• Key authorities: IRC § 856(c)(2), (3), and (5)(J)(ii); Treas. Reg. §§ 1.856-3(g), 1.856-10

Full text (IRS public release)

Internal Revenue Service                                          Department of the Treasury
                                                                  Washington, DC 20224

Number: 201742009                                                 Third Party Communication: None
Release Date: 10/20/2017                                          Date of Communication: Not Applicable
Index Number: 856.01-00
                                                                  Person To Contact:
-----------------                                                 ----------------, ID No. ------------------
------------------------------------------------------------      Telephone Number:
--------------                                                    ----------------------
-----------------------------                                     Refer Reply To:
-------------------------------------                             CC:FIP:B03
------------------------------------------------                  PLR-106601-17
-------------------------------------                             Date:
                                                                  July 20, 2017



LEGEND:

REIT 1                              =        -----------------------------
                                             ---------------------------

REIT 2                              =        -----------------------------
                                             ---------------------------

REIT 3                              =        -----------------------------
                                             ---------------------------

Partnership                         =        ------------------------------------------

Retail Center                       =        -------------------------------

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

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

City                                =        ------------------

City Utility                        =        --------------------------------------------------------------

State Initiative                    =        ----------------------------------

A                                   =        ------------

B                                   =        ------

C                                   =        ------
PLR-106601-17                                2


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

       This letter responds to your letter dated February 23, 2017 and a subsequent
submission, requesting a ruling on behalf of REIT 1 (“Taxpayer”), that, pursuant to
section 856(c)(5)(J)(ii) of the Internal Revenue Code (“Code”), Taxpayer’s income from
the Base Solar Incentive Amount (as defined below) will be considered qualifying
income for purposes of sections 856(c)(2) and (c)(3).

                                         FACTS

       Taxpayer is a State A limited liability company that has elected to be taxed as a
real estate investment trust (“REIT”) under sections 856 through 859 of the Code.

        Collectively, Taxpayer, REIT 2, and REIT 3 wholly own Partnership, a State A
limited liability company treated as a partnership for U.S. federal income tax purposes.
Partnership owns an A square foot, mixed-use shopping center (“Retail Center”) and the
land on which such shopping center is located. Partnership leases space at Retail
Center to tenants for use as retail outlets. Retail Center features anchor stores,
boutique specialty shops, personal services, restaurants, and other retail outlets
typically found in a mixed-use regional shopping center, along with associated common
spaces, parking, and landscaping. Taxpayer represents that Retail Center is a building
within the meaning of § 1.856-10(d)(2)(ii) of the Income Tax Regulations and is
therefore real property within the meaning of § 1.856-10(b). Taxpayer also represents
that the rental income that is generated from leasing space at Retail Center is qualifying
income for purposes of sections 856(c)(2) and (c)(3).

       The State Initiative mandates that all State B electric utilities implement a solar
incentive program. In accordance with the State Initiative, the City Utility has
established a solar incentive program (“Solar Incentive Program”) that offers an
estimated performance-based incentive (“Solar Incentive”) to City Utility customers who
purchase or lease and install solar PV systems and who meet certain other eligibility
requirements, including a requirement that the solar PV system must be owned or
leased by the building owner who is also the owner of the roof space or a City Utility
customer who demonstrates their rights to the roof space for the duration of the
incentivized period. The Solar Incentive consists of a one-time, lump sum, upfront
payment that is the lesser of (1) the amount calculated by a formula that estimates the
expected performance of the customer’s solar PV system (“Incentive Formula”) or (2)
the net installed cost of the system, after any tax benefits or other outside funding
sources are subtracted from the gross cost of the system. Thus, in no case will the
amount of the Solar Incentive exceed the net installed cost of the solar PV system.

       The Incentive Formula is based on the capacity of the solar PV system, adjusted
to consider inverter and module losses, and a design factor that compares the
PLR-106601-17                                 3

estimated output of the solar PV system to the simulated output of an optimal reference
system. These factors are multiplied by one of two incentive rates, depending on
whether or not a participant in the Solar Incentive Program retains ownership of
renewable energy credits (“RECs”) or transfers the RECs to City Utility. The incentive
rate for a City Utility customer that transfers its RECs to City Utility is $B per watt (“REC
Incentive Rate”). The incentive rate for a customer that retains ownership of its RECs is
$C per watt (“Base Incentive Rate”).

        Taxpayer represents that Partnership intends to purchase or lease and
permanently install a solar PV system on the roof of Retail Center. Taxpayer represents
that the solar PV system will be designed and intended to produce electricity only to
serve Retail Center and that Partnership will not sell any electricity generated by the
solar PV system to third parties. Taxpayer also represents that the solar PV system will
be a structural component within the meaning of § 1.856-10(d)(3). Taxpayer intends for
the solar PV system to comply with the terms of the Solar Incentive Program and allow
Partnership to apply for and receive a Solar Incentive from City Utility. Taxpayer
represents that Partnership intends to transfer any RECs that it receives in connection
with the solar PV system and would therefore qualify for the REC Incentive Rate.
Taxpayer is not seeking a ruling with respect to its receipt of any portion of the Solar
Incentive that is attributable to the transfer of RECs to City Utility (“Solar Incentive REC
Component”), and Taxpayer intends to treat such an amount as non-qualifying income
for purposes of sections 856(c)(2) and (c)(3). The portion of the Solar Incentive that is
not attributable to the transfer of RECs to City Utility is the “Base Solar Incentive
Amount.” Thus, Taxpayer intends to treat the difference between the Solar Incentive
calculated using the REC Incentive Rate and the Solar Incentive calculated using the
Base Incentive Rate as non-qualifying income for purposes of sections 856(c)(2) and
(c)(3). Taxpayer is seeking a ruling under section 856(c)(5)(J)(ii) that the Base Solar
Incentive Amount will be considered qualifying income for purposes of sections
856(c)(2) and (c)(3).

                                   LAW AND ANALYSIS

        Section 856(c)(2) provides that in order for a corporation to qualify as a REIT, at
least 95 percent of the corporation's gross income (excluding gross income from
prohibited transactions) must be derived from sources that include dividends; interest;
rents from real property; gain from the sale or other disposition of stock, securities, and
real property (other than section 1221(a)(1) property); abatements and refunds of taxes
on real property; income and gain derived from foreclosure property; commitment fees;
and gain from certain sales or other dispositions of real estate assets.

       Section 856(c)(3) provides that in order for a corporation to qualify as a REIT, at
least 75 percent of the corporation's gross income (excluding gross income from
prohibited transactions) must be derived from rents from real property, interest on
obligations secured by mortgages on real property or interests in real property, gain
PLR-106601-17                                4

from the sale or other disposition of real property (other than section 1221(a)(1)
property), dividends from REIT stock and gain from the sale of REIT stock, abatements
and refunds of taxes on real property, income and gain derived from foreclosure
property, commitment fees to make loans secured by mortgages on real property or to
purchase or lease real property, gain from certain sales or other dispositions of real
estate assets, and qualified temporary investment income.

        Section 856(c)(5)(J) provides that to the extent necessary to carry out the
purposes of Part II of subchapter M of the Code, the Secretary is authorized to
determine, solely for purposes of such part, whether any item of income or gain which
(i) does not otherwise qualify under sections 856(c)(2) or (c)(3) may be considered as
not constituting gross income for purposes of sections 856(c)(2) or (c)(3), or
(ii) otherwise constitutes gross income not qualifying under sections 856(c)(2) or (c)(3)
may be considered as gross income which qualifies under sections 856(c)(2) or (c)(3).

       The legislative history underlying the tax treatment of REITs indicates that a
central concern behind the gross income restrictions is that a REIT's gross income
should largely be composed of passive income. For example, H.R. Rep. No. 2020, 86th
Cong., 2d Sess. 4 (1960) at 6, 1960-2 C.B. 819, at 822-23 states, “[o]ne of the principal
purposes of your committee in imposing restrictions on types of income of a qualifying
real estate investment trust is to be sure the bulk of its income is from passive income
sources and not from the active conduct of a trade or business.”

       Under § 1.856-3(g), a REIT that is a partner in a partnership is deemed to own its
proportionate share of each of the assets of the partnership and to be entitled to the
income of the partnership attributable to that share. For purposes of section 856, the
interest of a partner in the partnership's assets is determined in accordance with the
partner's capital interest in the partnership. The character of the various assets in the
hands of the partnership and items of gross income of the partnership retain the same
character in the hands of the partners for all purposes of section 856.

        Income attributable to the receipt of the Base Solar Incentive Amount constitutes
gross income not listed as qualifying income under sections 856(c)(2) or (c)(3).
Taxpayer will earn the Base Solar Incentive Amount for purchasing or leasing and
installing a solar PV system on the roof of Retail Center in accordance with the State
Solar Initiative. In order to be eligible for the Solar Incentive Program, a solar PV
system must be owned or leased by the building owner who is also the owner of the
roof space or a party who demonstrates its rights to the roof space for the duration of
the incentivized period. Taxpayer represents that Partnership intends to permanently
install a solar PV system on the roof of Retail Center. Taxpayer also represents that the
solar PV system, once completed, will be a structural component within the meaning of
§ 1.856-10(d)(3), that it will therefore be real property within the meaning of
§ 1.856-10(b), and that substantially all of the other income Taxpayer derives from
Retail Center will be qualifying income for purposes of sections 856(c)(2) and (c)(3).
PLR-106601-17                                5

Under these circumstances, treating income from the Base Solar Incentive Amount as
qualifying income does not interfere with or impede the objectives of Congress in
enacting sections 856(c)(2) and (c)(3). Accordingly, pursuant to section 856(c)(5)(J)(ii),
the Base Solar Incentive Amount is treated as qualifying income for purposes of
sections 856(c)(2) and (c)(3).

                                     CONCLUSION

       Based on the fact submitted and representations made by Taxpayer, we hereby
rule that pursuant to section 856(c)(5)(J)(ii), Taxpayer’s income from the Base Solar
Incentive Amount is considered qualifying income for purposes of sections 856(c)(2)
and (c)(3).

       This ruling’s application is limited to the facts, representations, Code sections,
and regulations cited herein. 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 otherwise qualifies as a REIT under subchapter M of the
Code. Additionally, no opinion is expressed regarding whether any credits or offsets
earned in connection with the Solar Incentive Program constitute gross income, whether
such income is qualifying income for purposes of section 856(c)(2) and (c)(3), and
whether any credit or offset qualifies as real property for purposes of section 856.

       This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent. In accordance with the
provisions of a power of attorney on file, we are sending a copy of this ruling letter to
your authorized representatives.

      The rulings contained in this letter are based upon information and
representations submitted by the taxpayers and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of the
material submitted in support of the request for rulings, it is subject to verification on
examination.

                                      Sincerely,

                                      _________________________________
                                      Julanne Allen
                                      Assistant Branch Chief, Branch 3
                                      Office of the Associate Chief Counsel
                                      (Financial Institutions & Products)

Enclosure:
      Copy for section 6110 purposes