A REIT's energy-savings charge to tenants is not disqualifying "income or profits" rent

Plain-English summary

A real estate investment trust (REIT) operates mostly through an operating
partnership that leases buildings to tenants. The partnership is rolling out a
program to replace older fixtures with more energy-efficient systems and to
charge tenants a monthly fee based on the electricity they save. The taxpayer
asked the IRS to confirm that this fee does not run afoul of the "income or
profits" rule in section 856(d)(2)(A), which strips rent of its favorable REIT
treatment when the amount charged depends on a tenant's income or profits. The
IRS ruled that the fee is fine on this point: it is calculated by multiplying a
fixed rate per kilowatt-hour by the kilowatt-hours saved, so it turns on energy
usage, not on any tenant's business income or profits. This matters because
REITs must keep 95% and 75% of their gross income in qualifying sources
(mostly rents from real property), and a charge tied to a tenant's profits
would count against them. The IRS expressly did not rule on whether the
taxpayer qualifies as a REIT overall or whether the charge otherwise counts as
rents from real property.

Ruling snapshot

• Question: Does a per-kilowatt-hour energy-savings charge paid by tenants depend on the income or profits derived from the leased facilities under section 856(d)(2)(A)?
• Outcome: approved (ruling favorable to taxpayer)
• Key authorities: IRC § 856(c)(2), (c)(3), (d)(1), (d)(2)(A)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201848013 Third Party Communication: None
Release Date: 11/30/2018 Date of Communication: Not Applicable
Index Number: 856.01-00
Person To Contact:
------------------ -----------------, ID No. -------------
-------------------------------- Telephone Number:
------------------ ----------------------
----------------------------------------- Refer Reply To:
------------------------------ CC:FIP:B02
PLR-112165-18
Date:
August 30, 2018

Legend

Taxpayer = --------------------------------------------
State A = --------------
Operating Partnership = --------------------------------------------
Facilities = ------------------------------------------
Systems = -----------------------------
Fixtures = --------------------------------
x = --
y = --

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

    This is in reply to a letter dated April 3, 2018, requesting a ruling on behalf of

Taxpayer. Taxpayer requests a ruling that certain amounts paid to Operating
Partnership by tenants, as described below, do not depend in whole or in part on the
income or profits derived by any person from Facilities leased by Operating Partnership
within the meaning of section 856(d)(2)(A) of the Internal Revenue Code.

                                                FACTS

   Taxpayer is a State A corporation that has elected to be taxed as a real estate

investment trust (“REIT”) under sections 856 through 859. Taxpayer’s activities
primarily occur through Operating Partnership. Operating Partnership leases Facilities
to tenants.

  As part of a new program, Operating Partnership is offering to enter into

agreements with its existing tenants of Facilities to install Systems in place of Fixtures in

Facilities (“the Agreements”). For the typical project, the installation of Systems is
expected to take x to y weeks, depending on the size of the tenant’s space. Metering
devices will also be installed to track energy usage. Taxpayer represents that costs
related to the installation of Systems and the metering devices will be borne by
Operating Partnership. Taxpayer expects Operating Partnership to enter into similar
arrangements with any new tenants that lease Facilities. However, the arrangements
are expected to be integrated in the new tenant’s lease, rather than a separate
agreement.

    Currently, Operating Partnership offers two types of leases to its tenants of

Facilities. Tenants pay a monthly base amount plus either: (1) the tenant’s share of
actual operating expenses; or (2) a fixed amount for operating expenses. In addition,
tenants are directly responsible for amounts paid to the utilities provider for electricity.
Under the Agreements, tenants will be required to pay Operating Partnership a monthly
fee (“the Charge”) for tenant’s use of Systems. The Charge is in addition to the
payments tenants must make under the tenant’s existing lease agreements.

   The Charge is calculated based on the tenant’s energy cost savings from using

Systems. Systems use less kilowatt hours (“kWh”) than Fixtures. Therefore, the use of
Systems results in a net reduction in electricity costs at Facilities. The Charge is
calculated by multiplying a fixed rate per kWh by the amount of kWh saved by using
Systems. The amount of kWh saved is the difference between the actual kWh used as
determined by the metering device and either the amount of kWh that was historically
used under the old system or a stipulated amount. Taxpayer represents that costs
related to the monitoring of energy savings will be borne by Operating Partnership.

                                LAW & ANALYSIS

  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, such lease.

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

amounts 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.

    The Charge is a fee for the use of Systems. The Charge is based on the

electricity cost savings provided by Systems, which results from the fact that Systems
use less electricity than Fixtures. The Charge does not depend on the income or profits
derived by any person from Facilities.

                                   CONCLUSION

  Based on the facts and representations submitted, we rule that the Charge paid

by tenants does not depend in whole or in part on the income or profits derived by any
person from Facilities within the meaning of section 856(d)(2)(A).

   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. Specifically, no opinion is expressed or implied on whether
Taxpayer otherwise qualifies as a REIT under subchapter M of the Code. Additionally,
no opinion is provided regarding whether the amounts paid by tenants of Facilities
otherwise qualify as rents from real property for purposes of section 856.

  This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of

the Code provides that it 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)