REIT may measure partnership interests by hypothetical liquidation shares

Plain-English summary

A company planning to elect REIT status intended to acquire economic interests in ten partnerships that leased and operated U.S. rental properties. Some partnerships did not maintain regulatory capital accounts, and the others had accounts that did not fairly reflect what the REIT would receive on liquidation. The IRS allowed the REIT to measure each capital interest by its percentage share of a hypothetical distribution of partnership asset value net of liabilities. For the REIT income and asset tests, the same percentage could be applied to each partnership item of gross income and each partnership asset.

Ruling snapshot

• Question: How should the prospective REIT determine its capital, income, and asset shares in partnerships whose capital accounts do not reflect its economic interest?
• Outcome: approved, solely for the section 856(c) REIT tests
• Key authorities: IRC § 856(c); Treas. Reg. §§ 1.856-2(c)(1) and 1.856-3(g)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201939001                                              Third Party Communication: None
Release Date: 9/27/2019                                        Date of Communication: Not Applicable
Index Number: 856.00-00, 856.01-00
                                                               Person To Contact:
-------------------                                            -----------------------, ID No. -------------------
---------------------                                          ---------------------------------------------------
--------------------------------------------                   Telephone Number:
----------------------------------------------------           ----------------------
----------------------------                                   Refer Reply To:
                                                               CC:FIP:B01
                                                               PLR-107856-18
                                                               Date:
                                                               June 27, 2019


LEGEND:

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

Date A                              =        ---------------------------

Government Entity                   =        ------------------------------------------------------------------------
                                             -----------------------------------

Partnership A                       =        -------------------------------------------------------

Partnership B                       =        ---------------------------------

Partnership C                       =        ------------------------------------------------------------

Partnership D                       =        -----------------------------------------

Partnership E                       =        ------------------------------------------

Partnership F                       =        ---------------------

Partnership G                       =        -----------------------------------------

Partnership H                       =        ------------------------------------

Partnership I                       =        ------------------------

Partnership J                       =        -----------------------------------------------

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

PLR-107856-18                                 2




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

        This letter responds to your letter, dated March 7, 2018, and supplemental
correspondence, requesting certain rulings on behalf of Taxpayer under section 856(c)
of the Internal Revenue Code (“Code”). Specifically, Taxpayer requests the following
rulings:

    1. For purposes of section 1.856-3(g) of the Income Tax Regulations
       (“Regulations”), Taxpayer’s capital interest in each Partnership (defined below)
       will be determined by (A) deeming the Partnership to have made a liquidating
       distribution in an amount equal to the fair market value of the partnership assets,
       net of the partnership liabilities, and (B) computing the percentage of the deemed
       distribution to which Taxpayer would be entitled under the terms of the
       partnership agreement.

    2. For purposes of section 856(c)(2) and (3) of the Code, Taxpayer’s share of each
       item of gross income of a Partnership will equal the product of (A) the amount of
       such item of gross income and (B) the percentage determined for the Partnership
       under the first requested ruling.

    3. For purposes of section 856(c)(4) of the Code, Taxpayer’s share of each asset of
       a Partnership will equal the product of (A) the value of the asset and (B) the
       percentage determined for the Partnership under the first requested ruling.

                                          FACTS

       Taxpayer, a State A limited liability company, intends to elect to be a real estate
investment trust (“REIT”) under section 856 for its taxable year ending Date A.
Government Entity and one or more non-governmental partners formed, and made
capital contributions to, Partnerships A, B, C, D, E, F, G, H, I, and J (the “Partnerships”),
each of which is classified as a partnership for federal income tax purposes. The
Partnerships lease and operate certain rental properties in the United States.

       Taxpayer intends to acquire, or to be assigned the economic rights to, certain
partnership interests in each Partnership from a non-governmental partner in exchange
for cash equal to the fair market value of the particular interest.

       Taxpayer represents that Partnerships H, I, and J do not maintain capital
accounts in accordance with section 1.704-1(b). Partnerships A, B, C, D, E, F, and G
maintain separate capital accounts for partners in accordance with section 1.704-
1(b)(2)(iv). Taxpayer represents, however, that Taxpayer’s capital accounts in

PLR-107856-18                                  3

Partnerships A, B, C, D, E, F, and G do not fairly reflect what Taxpayer would receive
upon a liquidation of the Partnership or Taxpayer’s interest in the assets of the
Partnership.

        For purposes of section 856(c), Taxpayer intends to determine its capital interest
for a Partnership on a given date by: (1) deeming the Partnership to have made a
distribution in complete liquidation of all of the partners’ interests in an amount equal to
the fair market value of the partnership assets on that date less the partnership liabilities
as of that date, and (2) computing the percentage of that deemed distribution to which
Taxpayer would be entitled (“Percentage Share”).
        .
                                   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 specified sources, including 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 from certain foreclosure property;
fees described in section 856(c)(2)(G); 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
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 certain foreclosure
property; fees described in section 856(c)(3)(G); gain from certain sales or other
dispositions of real estate assets; and qualified temporary investment income.

         Section 856(c)(4) provides that, in order for a corporation to qualify as a REIT,
(A) at the close of each quarter of its taxable year, at least 75 percent of the value of its
total assets must be represented by real estate assets, cash and cash items (including
receivables), and Government securities; and (B) at the close of each quarter of its
taxable year (i) not more than 25 percent of the value of its total assets may be
represented by securities (other than those includible under section 856(c)(4)(A));
(ii) not more than 20 percent of the value of its total assets may be represented by
securities of one or more taxable REIT subsidiaries (TRSs); (iii) not more than 25
percent of the value of its total assets may be represented by nonqualified publicly
offered REIT debt instruments; and (iv) except with respect to TRSs and securities
includible under section 856(c)(4)(A): (I) not more than 5 percent of the value of its total
assets may be represented by securities of any one issuer; (II) the REIT may not hold

PLR-107856-18                                4

securities possessing more than 10 percent of the total voting power of the outstanding
securities of any one issuer; and (III) the REIT may not hold securities having a value of
more than 10 percent of the total value of the outstanding securities of any one issuer.

       Section 1.856-2(c)(1) provides that, for purposes of computing the percentage
requirements of section 856(c)(2) and (3), the term “gross income” has the same
meaning as the term has under section 61 and the Regulations thereunder.

       Section 1.856-3(g) provides that, in the case of a REIT that is a partner in a
partnership, the REIT will be deemed to own its proportionate share of each of the
assets of the partnership and will be deemed to be entitled to the income of the
partnership attributable to such share. For purposes of section 856, the interest of a
partner in a partnership’s assets shall be 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 shall retain the same
character in the hands of the partners for all purposes of section 856.

        Under section 1.856-3(g), Taxpayer will be deemed to own its proportionate
share of each of the assets of each of the Partnerships and will be deemed to be
entitled to the income of each Partnership attributable to such share. Taxpayer’s
proportionate share in each Partnership is determined according to its capital interest in
the Partnership. Section 1.856-3(g) does not define the term capital interest. Because
Taxpayer has determined that none of the Partnerships maintains a capital account that
accurately reflects Taxpayer’s interest in the assets of the Partnership, Taxpayer will
determine the Percentage Share for each Partnership, which is described above.

                                    CONCLUSIONS

    1. Solely for purposes of section 856(c), Taxpayer’s capital interest in each
      Partnership, within the meaning of section 1.856-3(g), will equal its Percentage
      Share for that Partnership.

    2. Solely for purposes of section 856(c)(2) and (3), Taxpayer’s share of each item of
      gross income of each Partnership will equal the product of the amount of that
      item and the Percentage Share determined for that Partnership.

    3. Solely for purposes of section 856(c)(4), Taxpayer’s share of each asset of a
      Partnership will equal the product of the value of that asset and the Percentage
      Share determined for that Partnership.

       Except as specifically ruled upon above, no opinion is expressed or implied
concerning any federal income tax consequences related to the facts herein under any
other provisions of the Code. Specifically, no opinion is expressed or implied regarding
the federal income tax consequences, under section 704 and the Regulations

PLR-107856-18                                  5

thereunder, attributable to maintaining, or distributing based on, the net positive capital
account balances of the particular partnership. Nor is any opinion expressed or implied
with respect to whether Taxpayer otherwise qualifies as a REIT under subchapter M of
chapter 1 of the Code, or whether any of the Partnerships are properly classified as
partnerships for federal income tax purposes.

         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 it may not be used or cited as precedent. The ruling contained in this
letter is based upon information and representations submitted by the Taxpayer under a
penalties of perjury statement executed by an appropriate party. While this office has
not verified any of the material submitted in support of this ruling request, it is subject to
verification on examination.

         In accordance with the Power of Attorney on file with this office, a copy of this
letter is being sent to your authorized representative.


                                       Sincerely,



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




cc: