Senior facilities and foreign income receive mixed REIT rulings

Plain-English summary

A company planning to elect REIT status acquired independent-living and assisted-living facilities in the United States and another country. The IRS ruled that the integrated senior facilities with meals, housekeeping, safety systems, resident managers, and health-oriented services were congregate care facilities and therefore qualified health care property. One apartment-style facility lacked those features and did not qualify as a health care facility, although the REIT could have a taxable REIT subsidiary manage it. Rent from domestic operating partnerships qualified when an eligible independent contractor continued to operate the facilities. The IRS also treated specified Subpart F and Section 956 inclusions tied to qualifying passive or real-estate activity as qualifying income for the 95 percent REIT income test. Related Section 986(c) currency gains were treated as passive foreign exchange gain and excluded from gross income for that test.

Ruling snapshot

• Question: How would senior facilities, partnership rent, foreign subsidiary inclusions, and related currency gains be treated under the REIT rules?
• Outcome: Mixed. Most facilities and income items received favorable treatment, but the apartment-style Facility A was not qualified health care property.
• Key authorities: IRC §§ 856(c), 856(d), 856(e)(6)(D), 856(n), 951, 954, 956, 957, 986(c), 988; Treas. Reg. §§ 1.856-4(b)(1), 1.956-2(c)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201828008 Third Party Communication: None
Release Date: 7/13/2018 Date of Communication: Not Applicable
Index Number: 856.00-00
Person To Contact:
-------------------- ------------------------, ID No. ------------------
-------------------------------- ----------------------------------------------------
--------------------------------- Telephone Number:
------------------------------------------------ ----------------------
-------------------------------------------- Refer Reply To:
------------------------------ CC:FIP:B02
PLR-131977-17
Date:
April 18, 2018

Legend:

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

PropCo = ---------------------------------

Domestic TRS = ---------------------------------------

Partner = ------------------------------------------

OpCo = ---------------------------------

Country = ------------

Foreign TRS = ------------------------------

Manager A = ----------------------------------------

Manager B = ---------------------------------------

State = --------------

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

Date 2 = ---------------------------

Date 3 = ---------------------------

Facility A = ----------------------------------

a = ----

b = ----

c = --

d = ----

e = ----

f = --

g = --

h = ---

i = -----

j = ----

k = --------

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

   This is in reply to a letter dated September 28, 2017, and supplemental

correspondence requesting rulings on behalf of Taxpayer. Taxpayer has requested
rulings regarding i) the definition of “qualified health care property” under section
856(e)(6)(D) of the Internal Revenue Code (“Code”), for purposes of the related-party
rent exception of section 856(d)(8)(B); ii) whether the rents received by Taxpayer qualify
as rents from real property for purposes of section 856(d); iii) whether, pursuant to
section 856(c)(5)(J), certain income inclusions under Subpart F of the Code are
qualifying income under section 856(c)(2); and iv) whether certain foreign currency gain
is excluded from income for purposes of section 856(c)(2).

Facts:

   Taxpayer was incorporated under the laws of State on Date 1. Taxpayer intends

to qualify and elect to be taxed as a real estate investment trust (“REIT”) under sections
856 through 859 of the Code beginning with its taxable year ended Date 2.

The Facilities

   Taxpayer’s primary business is the acquisition, ownership, and leasing of

independent living (“IL”) and assisted living (“AL”) facilities. Taxpayer recently acquired
fee ownership of a portfolio of a IL facilities (b in the U.S. and c in Country) and a
leasehold interest in d IL facilities (e in the U.S. and f in Country) that are currently
under construction or in the leasing stage, subject to Taxpayer’s option to purchase
these facilities. Taxpayer also acquired an AL facility (“AL Facility”) located in Country.
The IL facilities, with the exception of Facility A, (“IL Facilities”) and the AL Facility are
intended to qualify as qualified health care properties within the meaning of section
856(e)(6)(D).

   Domestic Holding Structure

    Taxpayer holds its U.S. facilities though PropCo, a State limited partnership that

is treated as a partnership for U.S. federal income tax purposes. PropCo, in turn, holds
its interests in the U.S. facilities through subsidiary entities (“PropCo Subs”) that are
disregarded for U.S. federal income tax purposes. Taxpayer formed Domestic TRS, a
State limited liability company that will jointly elect with Taxpayer to be treated as a
taxable REIT subsidiary (“TRS”) effective Date 3. Domestic TRS and Partner, an entity
unrelated to Taxpayer or Domestic TRS within the meaning of section 856(d)(2)(B)
formed OpCo, a State limited liability company that is taxed as a partnership for U.S.
federal income tax purposes. Pursuant to the structure permitted by the Housing and
Economic Recovery Act of 2008, Pub. L. No. 110-289, § 3061, 122 Stat. 2654, 2901-02
(2008) (“RIDEA”),1 each PropCo Sub that holds a U.S. IL Facility leases the IL Facility to
a subsidiary of OpCo (each, an “OpCo Sub”) that is disregarded as a separate entity
from OpCo for U.S. federal income tax purposes. Each OpCo Sub has entered into a
management contract with Manager A to operate its IL Facility. Taxpayer represents
that Manager A satisfies the requirements for an independent contractor within the
meaning of section 856(d)(3). Taxpayer also represents that Manager A currently
operates g third-party owned facilities similar to the IL Facilities and a third-party owned
AL facility and that Manager A currently seeks to manage additional facilities owned by
unrelated parties.

   Foreign Holding Structure

    Taxpayer holds each of its foreign IL Facilities and its AL Facility in Country

(each a “Foreign IL Facility” or “Foreign AL Facility,” and together the “Foreign
Facilities”) through a separate limited partnership in Country that is treated as a
partnership for U.S. federal income tax purposes (each, a “Foreign PropCo”). Each
Foreign PropCo is h percent owned by a different Country GP TRS of Taxpayer (each,
a “Foreign GP TRS”) whose only asset is the h percent ownership in a Foreign PropCo.
1
Sections 3031-3071 of the Housing and Economic Recovery Act incorporated significant portions of
proposed legislation introduced as the REIT Investment Diversification and Empowerment Act of 2007, or
“RIDEA”. See H.R. 1147 and S. 2002, 100th Cong. (1st Sess. 2007).

Taxpayer holds the balance of each Foreign PropCo through a qualified REIT
subsidiary (“QRS”) in Country.

    Consistent with the structure permitted by RIDEA, each Foreign PropCo holding

a Foreign IL Facility leases its facility to Foreign TRS, a TRS of Taxpayer located in
Country. Foreign TRS has entered into a management contract with Manager B, a
subsidiary of Manager A, to manage and operate the Foreign IL Facilities. Manager B
is a disregarded entity with respect to Manager A for U.S. federal income tax purposes.

    Due to Country licensing requirements, the Foreign PropCo holding the Foreign

AL Facility has leased the facility to a nominee corporation (“Nominee Corp TRS”),
which is wholly owned by Foreign TRS and is also a TRS of Taxpayer. Nominee Corp
TRS holds the lease as bare trustee for the benefit of Foreign TRS. Nominee Corp TRS
has also entered into a management contract with Manager B to operate the Foreign AL
Facility.

   IL Facilities

    The IL Facilities are unlicensed, senior residential facilities located in various

geographic markets throughout the U.S. and Country. There are an average of i units
per IL Facility. At the U.S. IL Facilities, the minimum age for entry is j. The Foreign IL
Facilities do not have an express age limitation due to Country age-discrimination laws,
but are marketed to seniors. The average age of residents at all IL Facilities is
approximately k years old. The units are leased on a month-to-month basis for a fixed
monthly fee. The monthly fee includes the rental of a unit, cable television, all utilities
other than phone service, and access to all services and amenities described below.

   The IL Facilities provide congregate dining for three meals per day. Most

individual units have a sink and refrigerator but not a full kitchen; however, a few of the
units do have a full kitchen. Dining meals are prepared by Manager A employees.
Menus are planned with a focus on nutrition, reviewed and approved by a nutritionist,
and provide options tailored to meet common dietary restrictions. Fruit and snacks are
provided 24 hours a day.

   The IL Facilities provide weekly housekeeping and linen service, laundry

machines for resident use at no additional cost, and general maintenance service for all
units. The IL Facilities have architectural modifications designed for an aging
population, including bathroom grips, wide hallways with handrails, and places to stop
and rest. Doors to the facilities are locked at night for security.

  The IL Facilities provide social and recreational services designed to improve

residents’ well-being, social gatherings and outings, and transportation services for
shopping and medical appointments. Planned activities may include speakers
regarding wellness and health issues common to seniors. The IL Facilities have
common areas, activity rooms, lounges, exercise equipment, and a hairdressing salon.

    All IL Facilities are equipped with an emergency call system with pull-cords or

call buttons that immediately alert on-call staff. Personal emergency pendants are
available at most facilities for an additional charge. In the event of an emergency, on-
site staff will call 911, facilitate the entry of the emergency medical team to the
resident’s location, and contact the resident’s family. IL Facilities provide each resident
with a “file of life” for important medical records and, if residents want them, Do Not
Resuscitate (“DNR”) forms to be kept in the unit for emergencies.

   Resident managers live at the IL Facilities. At least one staff member is on-call

24 hours a day. Resident managers interact with residents on a daily basis and
informally observe resident behavior and well-being, alerting emergency contacts or
adult protective services when necessary. Resident managers will work with the
resident and the resident’s family or adult protective services in the event they believe
the resident requires a higher level of care than is available at the IL Facilities.
Vaccinations are available at the facilities from a third party provider for an additional
fee. Information about third party care providers are provided to residents upon
request. Residents unable to come to the dining hall may have meals delivered for up
to three days without incurring an additional fee.

    A small number of IL Facilities have a small percentage of units that are

cottages, which are separate buildings having two to four units, typically occupied by
married couples. The cottages are adjacent to the main IL Facilities and have full
kitchens. Cottage residents have one meal per day included in their monthly fee and
may add other meals for an additional fee. Cottage residents receive the same
housekeeping and linen services as other residents and may participate in all facility
activities and health and wellness services.

   Facility A

   Facility A consists of multiple buildings each with townhome-type apartment

units. The lease term is typically 12 months. Facility A does not provide housekeeping
or linen service. Each apartment unit has a full kitchen and an open layout. Facility A
has a club house with a dining room but only provides daily continental breakfast and
lunch available for an additional fee, which only a minority of residents choose to
purchase. The dining room cannot accommodate all residents at the same time. There
is no emergency pull-cord call system within Facility A. Each unit has its own separate
exterior entrance and residents are responsible for locking their own units. Facility A
provides many of the same amenities and activities that the IL Facilities provide, such
as a game room and transportation options. Taxpayer has formed a separate TRS for
the management and operation of Facility A.

Foreign Activities

     Foreign TRS and Nominee Corp TRS lease the Foreign Facilities from each

Foreign PropCo and, in turn, lease the individual units at the Foreign Facilities to
residents for a flat fee on a long-term basis—typically month-to-month leases for use of
the units and facilities and access to the care and services provided at those Foreign
Facilities. Taxpayer represents that the rental income received from residents that is
attributable to personal property does not exceed 15 percent of the total rent for the
taxable year attributable to both the real and personal property under the leases.
Taxpayer further represents that the rental income does not depend upon the income or
profits of any person or subtenant. Additionally, Taxpayer represents that all services
provided to tenants at the Foreign Facilities are customarily provided to residents at AL
facilities or IL facilities, as applicable, in the geographic market in which the Foreign
Facilities are respectively located. Taxpayer also represents that Manager B is an
independent contractor within the meaning of section 856(d)(3), and that all services at
the Foreign Facilities will be provided by Manager B.

    Foreign TRS, the Foreign GP TRSs, and Nominee Corp TRS will be controlled

foreign corporations (“CFCs”) within the meaning of section 957(a) with respect to which
Taxpayer will be a U.S. shareholder within the meaning of section 951(b). Taxpayer
expects to report section 951(a)(1)(A) inclusions attributable to one or more CFC's
foreign personal holding company income ("FPHCI") as defined in section 954(c).
These inclusions are attributable to rental income, interest, dividends, and gain from the
sale of property that gives rise to dividend, interest, or rental income. The section
951(a)(1)(A) inclusions attributable to rental income result from Foreign TRS and
Nominee Corp TRS earning rental income from the aforementioned leasing of units to
residents at the Foreign Facilities. By virtue of its partnership with each Foreign
PropCo, each Foreign GP TRS will also earn a share of section 951(a)(1)(A) inclusions
attributable to rent paid by Foreign TRS.

    In addition, with regard to foreign TRSs that are CFCs, Taxpayer may be

required by section 951(a)(1)(B) to include in its gross income amounts that arise in
connection with the pledge of a foreign TRS’s assets to secure a debt incurred by
Taxpayer (or by PropCo or a PropCo Sub) to finance the acquisition of real estate
assets that produce qualifying income under section 856(c)(2) (“Section 956
Inclusions”). Taxpayer also expects to recognize foreign currency gains with respect to
distributions of previously taxed earnings and profits as described in section 986(c)(1)
attributable to the section 951(a)(1)(A) inclusions.

Law & Analysis:

The Facilities

  Section 856(c)(2) provides that at least 95 percent of a REIT's gross income

must be derived from, among other sources, rents from real property.

  Section 856(c)(3) provides that at least 75 percent of a REIT's gross income

must be derived from, among other sources, rents from real property.

    Section 856(d)(1) provides that rents from real property include (subject to

exclusions provided in section 856(d)(2)): (A) rents from interests in real property; (B)
charges for services customarily furnished or rendered in connection with the rental of
real property, whether or not such charges are separately stated; and (C) rent
attributable to personal property leased under, or in connection with, a lease of real
property, but only if the rent attributable to the personal property for the taxable year
does not exceed 15 percent of the total rent for the taxable year attributable to both the
real and personal property leased under, or in connection with, the lease.

    Section 1.856-4(b)(1) provides that services furnished to tenants of a particular

building will be considered customary if, in the geographic market in which the building
is located, tenants in buildings that are of a similar class are customarily provided with
the service.

   Section 856(d)(2)(A) provides that rents from real property do not include any

amount received or accrued, directly or indirectly, with respect to any real or personal
property, if the determination of such amount depends in whole or in part on the income
or profits derived by any person from such property.

    Section 856(d)(2)(C) excludes impermissible tenant service income from the

definition of rents from real property. Section 856(d)(7)(A) defines impermissible tenant
service income to include, with respect to any real or personal property, any amount
received or accrued directly or indirectly by a REIT for services furnished or rendered by
the REIT to tenants of the property, or for managing or operating such property.

   Section 856(d)(7)(C)(i) excludes from the definition of impermissible tenant

service income amounts received for services furnished or rendered, or management or
operating provided, through an independent contractor from whom the REIT does not
derive or receive any income or through a TRS of the REIT.

    Section 856(d)(3) defines an independent contractor as any person who does not

own directly or indirectly, more than 35 percent of the shares or certificates of beneficial
interest in the REIT, and if such person is a corporation, not more than 35 percent of the
total combined voting power of whose stock, or if such person is not a corporation, not
more than 35 percent of the interest in whose assets or net profits is owned, directly or
indirectly, by one or more persons owning 35 percent or more of the shares or
certificates of beneficial interest in the trust.

  Section 856(d)(2)(B) provides that rents from real property do not include

amounts received directly or indirectly from a corporation if the REIT owns 10 percent or
more of the total combined voting power or 10 percent or more of the total value of the
shares of the corporation. Section 856(d)(8)(B) provides that amounts paid to a REIT
by a TRS shall not be excluded from rents from real property by reason of section
856(d)(2)(B) when a REIT leases a qualified lodging facility or qualified health care
property to a TRS, and the facility or property is operated on behalf of the TRS by a
person who is an eligible independent contractor.

   Section 856(d)(9)(A) provides that the term “eligible independent contractor”

(“EIK”) with respect to any qualified lodging facility or qualified health care property (as
defined in section 856(e)(6)(D)(i)) means any independent contractor if, at the time such
contractor enters into a management agreement or other similar service contract with
the TRS to operate such qualified lodging facility or qualified health care property, such
contractor (or any related person) is actively engaged in the trade or business of
operating qualified lodging facilities or qualified health care properties, respectively, for
any person who is not a related person with respect to the REIT or the TRS.

    Section 856(e)(6)(D)(i) defines qualified health care property as any real property

that is a health care facility.

     A “health care facility” is defined in section 856(e)(6)(D)(ii) as a hospital, nursing

facility, assisted living facility, congregate care facility, qualified continuing care facility
(as defined in section 7872(g)(4)), or other licensed facility which extends medical or
nursing or ancillary services to patients, and which was operated by a provider of such
services that is eligible for participation in the Medicare program under Title XVII of the
Social Security Act (42 U.S.C.A. § 1395 et seq.) with respect to such facility.

Ruling Request #1: Whether each of the IL Facilities is a congregate care facility within
the meaning of section 856(e)(6)(D) and therefore constitutes a “qualified health care
property” within the meaning of section 856(e)(6)(D).

   In the present case, each IL Facility is located in one building or on the same

campus and is operated as an integrated facility with an emphasis on health and
wellness of seniors. The average age of residents at all IL Facilities is k years old, and
each IL Facility either has a minimum age or is marketed to seniors. Residents receive
regular linen and housekeeping services, eat meals in a community dining hall that are
planned for the dietary needs of seniors, and are offered a variety of activities and
events regarding health and wellness issues common to seniors. The IL Facilities are
equipped with wide hallways, handrails, bathroom grips, and other architectural features
useful to an aging resident population. Every unit is equipped with an emergency call
system and emergency pendants are available for residents. Residents are provided a
“file of life” containing important medical documents, including DNR forms if applicable,
to post within their unit for use during emergencies. Twenty-four hour on-call staffing
includes a resident manager that eats with, interacts with, and informally observes
resident behavior. The exterior doors to the building are locked at night for resident
security.

   Based on the facts as represented, we rule that each of the IL Facilities are

congregate care facilities within the meaning of section 856(e)(6)(D)(ii) and, therefore,
each IL Facility constitutes a “qualified health care property” within the meaning of
section 856(e)(6)(D).

Ruling Request #2: Whether Facility A is a congregate care facility within the meaning
of section 856(e)(6)(D) and therefore constitutes a “qualified health care property” within
the meaning of section 856(e)(6)(D).

   Facility A is made up of multiple buildings with townhome apartment units. The

units have full kitchens and individual exterior doors that must be locked by the resident.
Although Facility A provides some of the same amenities as the IL Facilities, it does not
focus on the health and well-being of its residents and does not offer the emergency call
systems, a resident manager that interacts with and observes the residents, or a meal
plan with a congregate dining room that accommodates all residents.

    Although Facility A is comprised of age-restricted multifamily residential housing

buildings, it does not provide for congregate living with a focus on the health and well-
being of the residents. Accordingly, based on the facts as represented, we rule that
Facility A does not constitute a health care facility within the meaning of section
856(e)(6)(D)(ii), and, as a result, Facility A may be operated or managed by a TRS of
Taxpayer.

Ruling Request #3: Whether rental income received directly or indirectly by PropCo
from the lease (or sublease) of an IL Facility to a disregarded subsidiary of OpCo or a
partnership subsidiary of OpCo will qualify as “rents from real property” for purposes of
section 856(d).

   Taxpayer represents that Manager A is an independent contractor within the

meaning of section 856(d)(3). Taxpayer further represents that Manager A manages a
third-party owned AL facility and g third-party owned facilities that are similar in all
respects to the IL Facilities and is currently seeking to manage additional facilities
owned by unrelated parties. Therefore, Manager A is actively engaged in the trade or
business of operating qualified health care properties for persons unrelated to Taxpayer
or any TRS of Taxpayer, and Manager A qualifies as an EIK within the meaning of
section 856(d)(9) with respect to the IL Facilities it manages and operates for the OpCo
Subs.

   The related-party rent exception of section 856(d)(8)(B) is only available for

amounts paid by a TRS to the REIT and only when the facility is operated on behalf of a
TRS by an EIK. In this case, the amounts are not paid by a TRS directly. Instead, the
amounts are paid by OpCo and OpCo Subs, which each constitute a partnership that is
owned by Domestic TRS and one unrelated party, Partner. Therefore, the question
here is whether the related-party rent exception can apply to amounts paid by a
partnership where the partners are a TRS and only one other unrelated party.

    Under the facts as represented, the amounts paid by OpCo and OpCo Subs may

qualify as rents from real property for purposes of section 856(d) by analyzing the
income attributable to the partnership interest held by a TRS separately from the
income attributable to any remaining partnership interest. If Domestic TRS were the
sole, direct lessee of each IL Facility, the related-party rent exception of section
856(d)(8)(B) would apply to amounts received directly from Domestic TRS. Therefore,
in this case, amounts attributable to the partnership interest held by Domestic TRS
satisfy the requirements of section 856(d)(8)(B) so long as an EIK continues to manage
and operate the IL Facility rented by the partnership. If Partner, which Taxpayer
represents is not related to Taxpayer within the meaning of section 856(d)(2)(B), were
the sole direct lessee of each IL Facility, the amounts would also qualify as rents from
real property (without the need for any exception). Therefore, in this case, amounts
attributable to the partnership interest held by Partner qualify as rents from real
property.

   In conclusion, rental income received directly or indirectly by PropCo from the

lease of an IL Facility to a partnership between Domestic TRS and a single partner
unrelated to Taxpayer within the meaning of section 856(d)(2)(B), shall not be excluded
from rents from real property by reason of section 856(d)(2)(B) so long as the facility
continues to be operated by an EIK.

Foreign Activities

   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 (3) may be considered as not
constituting gross income for purposes of sections 856(c)(2) or (3), or (ii) otherwise
constitutes gross income not qualifying under sections 856(c)(2) or (3) may be
considered as gross income which qualifies under sections 856(c)(2) or (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. 86-2020,
2d Sess. 4, at 6 (1960), 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.”

   Subpart F Inclusions

    Section 957 defines a CFC as a foreign corporation in which more than 50

percent of the total combined voting power of all classes of stock entitled to vote, or the
total value of the stock, is owned by United States Shareholders on any day during the
corporation’s taxable year. A United States Shareholder is defined in section 951(b) as
a United States person who owns 10 percent or more of the total voting power of the
foreign corporation. Taxpayer represents that it is a United States Shareholder within
the meaning of section 951(b) with respect to certain subsidiaries that are CFCs.

   Section 951(a)(1)(A)(i) generally provides that if a foreign corporation is a CFC

for an uninterrupted period of 30 days or more during a taxable year, every person who
is a United States Shareholder of the corporation and who owns stock in the corporation
on the last day of the taxable year in which the corporation is a CFC shall include in
income the shareholder’s pro rata share of the CFC’s subpart F income for the taxable
year.

   Section 952 defines subpart F income to include foreign base company income,

as determined under section 954. Under section 954(a)(1), foreign base company
income includes FPHCI. Section 954(c)(1)(A) generally defines FPHCI to include
(among other things) dividends, interest, royalties, rents, and annuities. Section
954(c)(1)(B) also includes gain from the sale or exchange of property which (among
other things) gives rise to income described in section 954(c)(1)(A) (after application of
paragraph (2)(A)) other than property which gives rise to income not treated as FPHCI
by reason of section 954(h) or (i) for the taxable year.

   Section 956 Inclusions

   Section 951(a)(1)(B) provides that if a foreign corporation is a CFC for an

uninterrupted period of 30 days or more during a taxable year, every person who is a
United States shareholder of the corporation and who owns stock in the corporation on
the last day of the taxable year in which the corporation is a CFC shall include in gross
income the amount determined under section 956 with respect to the shareholder for
such year (but only to the extent not excluded from gross income under section
959(a)(2)).

   Section 956(a) provides that in the case of a CFC, the amount determined under

section 956 with respect to any United States shareholder for any taxable year is the
lesser of – (1) the excess (if any) of – (A) such shareholder’s pro rata share of the
average of the amounts of United States property held (directly or indirectly) by the CFC
as of the close of each quarter of such taxable year, over (B) the amount of earnings
and profits described in section 959(c)(1)(A) with respect to such shareholder, or (2)
such shareholder’s pro rata share of the applicable earnings of such CFC. In general,
the amount taken into account in the preceding sentence under (1) with respect to any
property shall be its adjusted basis as determined for purposes of computing earnings &
profits, reduced by any liability to which the property is subject.

   Section 956(c) provides that United States property includes an obligation of a

United States person. Section 956(d) states that a CFC shall, under regulations
prescribed by the Secretary, be considered as holding an obligation of a United States
person if such CFC is a pledgor or guarantor of such obligation. Section 1.956-2(c)(1)
provides that except as provided in section 1.956-2(c)(4), any obligation (as defined in
section 1.956-2(d)(2)) of a United States person (as defined in section 957(d)) with
respect to which a CFC is a pledgor or guarantor shall be considered for purposes of
section 956(a) and section 1.956-2(a) to be United States property held by such CFC.
Section 1.956-2(c)(2) provides that if the assets of a CFC serve at any time, even
though indirectly, as security for the performance of an obligation of a United States
person, then the CFC will be considered a pledgor or guarantor of that obligation.

   Foreign Currency Gain

   In general, section 959(d) provides that when a United States shareholder of a

CFC includes in income a Subpart F Inclusion, the subsequent distribution to the
shareholder of the previously taxed income attributable to the inclusion is not treated as
a dividend for purposes of chapter 1 of the Code.

    Section 986(c)(1) provides that foreign currency gain or loss with respect to

distributions of previously taxed earnings and profits (as described in section 959)
attributable to movements in exchange rates between the times of the deemed and
actual distribution shall be recognized and treated as ordinary income or loss from the
same source as the associated income inclusion.

   Section 856(n)(1)(A) provides that “passive foreign exchange gain” for any

taxable year shall not constitute gross income for purposes of section 856(c)(2).

    Section 856(n)(3) defines passive foreign exchange gain as: (A) real estate

foreign exchange gain (as defined in section 856(n)(2)); (B) foreign currency gains (as
defined in section 988(b)(1)) which is not real estate foreign exchange gain and is
attributable to (i) any item of income or gain described in section 856(c)(2), (ii) the
acquisition or ownership of obligations (other than foreign currency gains attributable to
any item of income or gain described in clause (i)), or (iii) becoming or being the obligor
under obligations (other than foreign currency gain attributable to any item of income or
gain described in clause (i)); and (C) any other foreign currency gains determined by the
Secretary.

Ruling Request # 4: Whether Subpart F Inclusions and Section 956 Inclusions of
Taxpayer with respect to the Foreign TRS, Nominee Corp TRS, or a Foreign GP TRS
may be treated as qualifying income under section 856(c)(2).

    Taxpayer represents that it is a United States shareholder within the meaning of

section 951(b) with respect to Foreign TRS, the Foreign GP TRSs, and Nominee Corp
TRS all of which Taxpayer represents are CFCs. Taxpayer’s CFCs earn subpart F
income attributable to foreign base company income that is FPHCI that consists of
rental income, interest, dividends and gain from the sale of property that gives rise to
dividend, interest or rental income.

     Taxpayer represents that the rental income received by the CFCs from the

residents at the Foreign Facilities is for the month-to-month use of space at the Foreign
Facilities, is for a flat fee, and is not based on the income or profits of any person.
Taxpayer also represents that all services provided to residents of the Foreign Facilities
are provided by Manager B and are customarily provided to tenants of similar IL or AL
facilities, as applicable, in the geographic regions in which the Foreign Facilities are
respectively located. Taxpayer further represents that the rental income received from
residents which is attributable to personal property does not exceed 15 percent of the
total rent for the taxable year attributable to both the real and personal property under
the leases. Taxpayer also represents that Manager B is an independent contractor as
defined in section 856(d)(3) and is providing all services at the Foreign Facilities.
Manager B, a disregarded entity with respect to Manager A for federal income tax
purposes, is also an EIK by virtue of its subsidiary relationship to Manager A, an EIK.

    Therefore, if the Taxpayer were in the TRS’s place and receiving the rental

income from the Foreign Facility residents directly, the rental income would not be
impermissible tenant services income. Based upon the representations made by
Taxpayer, the items of rental income underlying the subpart F income would be
qualifying rents from real property if Taxpayer were earning the income directly rather
than leasing the Foreign Facilities to its TRSs. Therefore, the subpart F income
attributable to qualifying rents from real property, dividends, interest, and gain from the
sale or property that gives rise to dividend, interest, or qualifying rents from real property
(“Subpart F Inclusions”), is passive income and treating such income as qualifying
income for purposes of section 856(c)(2) does not interfere with or impede the policy
objectives of Congress in enacting the income test under section 856(c)(2).
Accordingly, we rule that under section 856(c)(5)(J)(ii), Subpart F Inclusions of
Taxpayer with respect to Foreign TRS, Nominee Corp TRS, or a Foreign GP TRS are
considered as gross income that qualifies for purposes of section 856(c)(2).

   Taxpayer has represented that assets of one of its CFCs may be pledged as

collateral for certain debt of Taxpayer that was incurred to finance Taxpayer’s
acquisition of real estate assets. This pledge may cause Taxpayer to recognize Section
956 Inclusions. Taxpayer represents that any Section 956 Inclusions will occur as a
result of debt of Taxpayer that arises in connection with the acquisition, improvement, or
development of interests in real estate assets that produce qualifying income under
section 856(c)(2). To the extent Taxpayer recognizes Section 956 Inclusions as a result
of a CFC’s pledge of assets that secures debt of the Taxpayer that is used to finance
the acquisition, improvement, or development of real property from which income is
derived that qualifies under section 856(c)(2), treating such income as qualifying income
for purposes of section 856(c)(2) would not interfere with or impede the policy objectives
of Congress in enacting the income test under section 856(c)(2). Accordingly, we rule
that under section 856(c)(5)(J)(ii), Taxpayer’s Section 956 Inclusions are considered as
gross income that qualifies for purposes of section 856(c)(2).

Ruling Request # 5: Whether foreign currency gains under section 986(c)(1) with
respect to the Foreign TRS, Nominee Corp TRS, or a Foreign GP TRS are excluded
from income for purposes of section 856(c)(2).

   While the section 986(c) gains are not foreign currency gains defined in section

988(b)(1), such section 986(c) gains are attributable to the Subpart F Inclusions, items
of income that we determine are qualifying income for purposes of section 856(c)(2).
This section 986(c) gain is substantially similar to passive foreign exchange gain
described in section 856(n)(3)(B)(i) that is excluded from gross income for purposes of
section 856(c)(2). Therefore, pursuant to section 856(n)(3)(C), the section 986(c) gains
with respect to Foreign TRS, Nominee Corp TRS, or a Foreign GP TRS are excluded
from gross income for purposes of section 856(c)(2) because these foreign currency
gains are considered passive foreign exchange gain that is excluded from gross income
for purposes of section 856(c)(2).

   Except as specifically ruled upon above, no opinion is expressed concerning any

federal income tax consequences relating to the facts herein under any other provision
of the Code. Specifically, we do not rule whether Taxpayer otherwise qualifies as a
REIT under part II of subchapter M of Chapter 1 of the Code.

  This ruling is directed only to the taxpayer requesting it. Taxpayer should attach

a copy of this ruling to each tax return to which it applies. Section 6110(k)(3) of the
Code provides that this ruling may not be used or cited as precedent.

     In accordance with the Power of Attorney on file with this office, a copy of this

letter is being sent to your authorized representatives.

                                          Sincerely,


                                           Andrea M. Hoffenson
                                           Andrea M. Hoffenson
                                           Chief, Branch 2
                                           Office of Associate Chief Counsel
                                           (Financial Institutions & Products)-