State brownfield-cleanup tax credits count as a good REIT asset and good REIT income

Plain-English summary

Real estate investment trusts (REITs) get their special tax treatment only if they stay heavily invested in real estate and earn mostly passive, real-estate-type income: at least 75% of assets must be real estate (or cash and receivables), and 75% to 95% of income must come from rents and similar sources. Here a REIT cleaned up and redeveloped a contaminated "brownfield" site and, as a result, earned refundable state brownfield redevelopment tax credits that exceed its state income tax, so it will collect the excess as a cash refund. The REIT worried these credits might be a "bad" asset or "bad" income that could blow its asset and income tests. The IRS ruled favorably on both points: the right to receive the credits is a "receivable" arising in the ordinary course of the REIT's business, so it counts as a good asset under § 856(c)(4); and, using the Secretary's authority under § 856(c)(5)(J), the credit income is treated as qualifying income for the 95% and 75% income tests. Both rulings are conditioned on the REIT actually subleasing the site to produce mostly qualifying rental income. The IRS did not decide whether the company otherwise qualifies as a REIT. The takeaway: incidental state cleanup credits will not, by themselves, disqualify an otherwise real-estate-focused REIT.

Ruling snapshot

• Question: Are a REIT's refundable state brownfield redevelopment credits a qualifying "receivable" asset under § 856(c)(4), and is the income from them qualifying income for the REIT income tests under § 856(c)(2) and (3)?
• Outcome: Approved (both rulings favorable, conditioned on the site being subleased to generate mostly qualifying income)
• Key authorities: IRC § 856(c)(4), (c)(2), (c)(3), (c)(5)(J); Treas. Reg. §§ 1.856-2(d), 1.856-10

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201845001                                              Third Party Communication: None
Release Date: 11/9/2018                                        Date of Communication: Not Applicable
Index Number: 856.01-00
                                                               Person To Contact:
------------------------------------------                     --------------, ID No. ------------------
-----------------------------------                            Telephone Number:
--------------------------                                     ----------------------
--------------------------------------------                   Refer Reply To:
                                                               CC:FIP:B01
                                                               PLR-101557-17
                                                               Date:
                                                               August 10, 2018




Legend:

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

Charity                    =        ------------------------------------------------------------

Subsidiary                 =        --------------------------------------

Owner                      =        -------------------------------

Site                       =        ---------------------------------------------------------------

Uses                       =        ------------------------

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

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

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


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

      This letter is in reply to a letter dated December 30, 2016, in which Taxpayer
requests certain rulings in connection with its status as a real estate investment trust
("REIT") under § 856 of the Internal Revenue Code (the "Code"). Specifically, Taxpayer
has asked for the following rulings:
PLR-101557-17                                 2

         (1) The right to receive the Brownfield Credits (defined below) will be considered
         a "receivable" or other asset of taxpayer described in § 856(c)(4)(A); and

         (2) Pursuant to § 856(c)(5)(J)(ii), any gross income of Taxpayer arising from the
         receipt or accrual of the Brownfield Credits will be considered qualifying income
         for purposes of § 856(c)(2) and (3).

Facts:

      Taxpayer is a corporation formed under the laws of State A that will elect to be
taxed as a REIT under §§ 856 through 860 effective Date 1. Taxpayer is the sole
member of Subsidiary, a limited liability company that is a disregarded entity for Federal
income tax purposes.

         Charity, a non-profit corporation formed under the laws of State B, owns a
majority of the shares of Taxpayer. Charity n is the sole member of Owner, a limited
liability company that is a disregarded entity for Federal income tax purposes. Owner
owns the Site, which is located in State A. Owner has leased the Site to Subsidiary
under a long-term lease (the "Lease"). Prior to and subsequent to the execution of the
Lease, Taxpayer and Subsidiary have incurred significant expenditures in connection
with the remediation of adverse environmental conditions at the Site and with the
rehabilitation and development of the Site. Taxpayer represents that the expenditures
have been for the remediation, rehabilitation, or development of real property within the
meaning of § 1.856-10.

       As a result of remediation, rehabilitation, and development expenditures of
Taxpayer and Subsidiary, Taxpayer is eligible for brownfield redevelopment tax credits
(the "Brownfield Credits"). The amount of the Brownfield Credits is a percentage of the
costs of (1) site preparation, (2) certain tangible property (including buildings and
structural components placed in service at the Site), and (3) on-site groundwater
remediation. Taxpayer expects the Brownfield Credits to exceed Taxpayer's State A
income tax liability. Taxpayer represents that, under State A law, the excess is treated
as an overpayment of tax and that Taxpayer will elect to receive a refund of the
overpayment. Taxpayer represents that the right to receive the Brownfield Credits is
properly treated as a receivable on Taxpayer's balance sheet under generally accepted
accounting principles ("GAAP"). The Brownfield Credits are allowable and refundable
only with respect to Taxpayer's State A income tax liability and are not abatements or
refunds of taxes on real property under State A law.

        Taxpayer represents that Taxpayer, acting through Subsidiary, intends to
sublease space at the site to third parties not related to taxpayer as described in
§ 856(d)(2)(B) in order to generate income that will qualify as rents from real property
for purposes of § 856(c)(2) and (3). Taxpayer represents that it expects substantially all
of the income derived from the Site (other than income arising from the receipt or
PLR-101557-17                                 3

accrual of the Brownfield Credits) to be qualifying income for purposes of § 856(c)(2)
and (3).

Law and Analysis:

Asset Test

        Section 856(c)(4)(A) provides that, in order for a corporation to qualify as a REIT
for a taxable year, at the close of each quarter of the taxable year, at least 75 percent of
the value of the corporation's total assets must be represented by real estate assets,
cash and cash items (including receivables), and Government securities.

       Section 1.856-2(d)(1) of the Income Tax Regulations defines the term
"receivables" for purposes of § 856(c)(4)(A) to mean only those receivables that arise in
the ordinary course of a REIT's operation, excluding receivables purchased from
another person.

       Section 1.856-2(d)(3) provides that in determining the investment status of a
REIT, the term "total assets" means the gross assets of the REIT determined in
accordance with GAAP.

        Taxpayer will not purchase the Brownfield Credits from another person. The
right of Taxpayer to receive the Brownfield Credits arises from the development of real
property on land in connection with the leasing business of Taxpayer and Subsidiary.
Therefore, the right is a receivable that arises in the ordinary course of Taxpayer's
operations within the meaning of § 1.856-2(d)(1).

Income Tests

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

       Section 856(c)(3) provides that in order for a corporation to qualify as a REIT for
a taxable year, at least 75 percent of the corporation's gross income (excluding gross
income from prohibited transactions) must be derived from certain enumerated sources,
which include rents from real property, interest on obligations secured by real property,
gain from the sale or other disposition of real property (other than property in which the
corporation is a dealer), distributions on and gain from the sale of REIT stock,
abatements and refunds of taxes on real property, income and gain derived from
PLR-101557-17                                4

foreclosure property, certain commitment fees, 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, (i) whether any item of income or gain that
does not otherwise qualify under § 856(c)(2) or (3) may be considered as not
constituting gross income for purposes of § 856(c)(2) or (3), or (ii) whether any item of
income or gain that otherwise constitutes gross income not qualifying under § 856(c)(2)
or (3) may be considered as gross income that qualifies under § 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. 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."

       Income attributable to the receipt or accrual of the Brownfield Credits is not
derived from any source listed in § 856(c)(2) or (3). Pursuant to § 856(c)(5)(J), the
Secretary has the authority to determine that the income attributable to the receipt or
accrual of the Brownfield Credits be considered as qualifying gross income under those
provisions. On the basis of all of the facts and circumstances, including Taxpayer's
representations that it intends to sublease the Site to generate rents from real property
and that it expects substantially all of the income generated by the Site to be qualifying
income for purposes of § 856(c)(2) and (3), treating the income attributable to the
receipt or accrual of the Brownfield Credits as qualifying income does not interfere with
or impede the objectives of Congress in enacting § 856(c)(2) and (3).

Conclusion

      We hereby rule as follows:

      (1) Taxpayer's right to receive the Brownfield Credits, to the extent the right is an
      asset under GAAP, is a receivable for purposes of § 856(c)(4); and

      (2) Pursuant to § 856(c)(5)(J)(ii), Taxpayer's income attributable to the receipt or
      accrual of the Brownfield Credits is considered qualifying income for purposes of
      § 856(c)(2) and (3).

       The rulings in this letter are conditioned upon the sublease of the Site by
Taxpayer to derive income substantially all of which is qualifying income to Taxpayer,
consistent with Taxpayer's represented expectation.
PLR-101557-17                                  5


        This ruling's application is limited to the facts, representations, Code sections,
and regulations cited herein. Except as specifically ruled upon above, no opinion is
expressed concerning any Federal income tax consequences related to the facts herein
under any other provisions of the Code. Specifically, we do not rule whether Taxpayer
qualifies as a REIT under Part II of Subchapter M of Chapter 1 of the Code.

       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 letter ruling to
your authorized representatives.

      The rulings contained in this letter are based upon information and
representations submitted by the taxpayer and accompanied by a penalty of perjury
statement executed by an appropriate party. Although 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,



                                        Steven Harrison
                                        Chief, Branch 1
                                        Office of Associate Chief Counsel
                                        (Financial Institutions & Products)




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