Environmental remediation tax credits count as qualifying REIT income

Plain-English summary

A real estate investment trust indirectly owned a partnership developing a mixed-use project on a contaminated site in an economically distressed area. A state program awarded transferable tax credits for eligible environmental cleanup costs, and the REIT expected to sell the credits because it had little state tax liability. The REIT represented that the credits would offset remediation costs, the completed project would be a qualified real estate asset, and substantially all project income would otherwise qualify under the REIT income tests. The IRS ruled that income recognized from the credits under section 451 would be qualifying income for both the 95 percent and 75 percent tests. The credits supported permissible real estate development and treating them as qualifying income did not frustrate Congress's goal that REIT income remain largely passive.

Ruling snapshot

• Question: Does income from state environmental remediation tax credits qualify for the REIT gross-income tests?
• Outcome: approved, credit income recognized under section 451 qualifies under both section 856(c)(2) and (c)(3)
• Key authorities: IRC §§ 451 and 856(c)(2), (c)(3), and (c)(5)(J)(ii); Treas. Reg. §§ 1.451-1(a) and 1.856-3(g)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202005018 Third Party Communication: None
Release Date: 1/31/2020 Date of Communication: Not Applicable
Index Number: 856.01-00
Person To Contact:
------------------------------- ----------------, ID No. -------------
--------------------------- Telephone Number:
---------------------------------------- ----------------------
----------------------------------------- Refer Reply To:
-------------------------------------- CC:FIP:B02
PLR-115802-15
Date:
October 16, 2019

Legend

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

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

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

Company = ----------------------------------------

Area = -----------------------------------------

Date = ---------------------

x= ---------------------

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

   This is in in response to your letter dated April 29, 2015, and subsequent

correspondence, requesting a ruling that the Tax Credits (described below) will be
treated as qualifying income for purposes of section 856(c)(2) and (c)(3) of the Internal
Revenue Code (“Code”) pursuant to section 856(c)(5)(J)(ii).

   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. Taxpayer uses
the calendar year and an accrual method as its overall method of accounting. Taxpayer
holds indirect interests, through one or more tiers of partnership subsidiaries, in
Company, which holds property located in Area (the “Property”).

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    State B has a tax credit program that allows taxpayers to claim a credit against

their state tax liability for a percentage of the eligible costs incurred to rehabilitate a
hazardous waste site on property located within an economically distressed area (the
“Tax Credits”). The Tax Credits are available to eligible taxpayers who commence and
diligently pursue an environmental response on or before Date, and who achieve and
maintain a permanent solution or remedy operation status with respect to the property.
The tax credit program allows for the transfer, sale or assignment of the Tax Credits to a
corporation or nonprofit organization.

   To qualify, the property must be owned or leased by the taxpayer for business

purposes and located in an economically distressed area and reported to the
department of environmental protection. In addition, the eligible costs must relate to the
net response and removal costs paid by the taxpayer for the purpose of achieving a
permanent solution or to remedy operation status of the property. The Property is
located in an area designated by State B as an economically distressed area, and the
site has been reported to the State B Department of Environmental Protection.
Taxpayer, through the activities undertaken by Company, will be involved in the
construction, development, ownership, and operation of a mixed-use real estate
development project on the Property (the “Project”). The Project will consist of
substantial remediation and redevelopment activities on the Property.

    Taxpayer expects that the Project will generate an estimated $x worth of Tax

Credits. Taxpayer represents that it will include its proportionate share of the income
from the Tax Credits when required under section 451. As a REIT, Taxpayer does not
expect to incur a material amount of State B tax liability and, thus, Company will sell the
Tax Credits to other eligible persons. Taxpayer further represents that the Tax Credits
will be sold or disposed of by the unextended due date of the federal income tax return
for the taxable year in which the Tax Credits are included in income in accordance with
section 451.

    Taxpayer further represents that the proceeds from the sale of the Tax Credits

will be used to offset the actual costs previously expended to accomplish the
remediation work related to Property and the Project. In addition, Taxpayer represents
that substantially all of the income from the Project will be qualifying income for
purposes of sections 856(c)(2) and (c)(3). Taxpayer further represents that upon
completion, the Project will be a qualified real estate asset under section 856(c)(5)(B).

                                       LAW

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

must be derived from 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), abatement and refunds of taxes on real property, income and

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gain derived from foreclosure property, certain commitment fees, and gain from certain
sales or other dispositions of real estate assets.

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

must be derived from 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), 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, certain commitment fees, gain from certain sales or other
disposition 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 section 856(c)(2) or (c)(3) may be considered as not
constituting gross income for purposes of section 856(c)(2) or (c)(3), or (ii) otherwise
constitutes gross income not qualifying under section 856(c)(2) or (c)(3) may be
considered as gross income which qualifies under section 856(c)(2) or (c)(3).

    Section 1.856-3(g) of the Income Tax Regulations provides that 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 is 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 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 shall retain the same character in the hands of
the partners as in the hands of the partnership for all purposes of section 856.

    Section 61(a) provides that, except as otherwise provided, gross income includes

all income from whatever source derived.

   Section 451(a) provides that the amount of any item of gross income shall be

included in the gross income for the taxable year in which received by the taxpayer,
unless, under the method of accounting used in computing taxable income, such
amount is to be properly accounted for as of a different period.

    Under an accrual method of accounting, unless section 451(b)(1)(A) requires

earlier inclusion, an item of gross income is includible when all the events have
occurred which fix the right to receive such income and the amount thereof can be
determined with reasonable accuracy. See section 451(b) and section 1.451-1(a). All
the events that fix the right to receive income generally occur upon the earliest of the
following: (1) the required performance takes place, (2) payment is due, or (3) payment
is made. See Schlude v. Commissioner, 372 U.S. 128 (1963); Rev. Rul. 2003-10,
2003-1 C.B. 288.

PLR-115802-15 4

   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 822-823 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.”

                                    ANALYSIS

    Income attributable to the receipt of the Tax Credits constitutes gross income that

is not listed as qualifying income under section 856(c)(2) or (c)(3). Taxpayer represents
that the Project will be a qualified real estate asset for purposes of section 856 and that
substantially all of the income from the Project will be qualifying income for purposes of
sections 856(c)(2) and (c)(3). Furthermore, Taxpayer represents that it will include its
proportionate share of the Tax Credits in income when required under section 451. The
State B tax credit program provides the Tax Credits as a government incentive to
redevelop property that may not otherwise be a profitable venture for the REIT and,
therefore, the Tax Credits are received in connection with the development of real
property, an activity that is permissible for REITs. Treating income from the receipt of
the Tax Credits 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), it is appropriate for the Secretary to determine that amounts included in
income with respect to the Tax Credits in accordance with section 451 shall be treated
as qualifying income for purposes of section 856(c)(2) and (c)(3).

                                  CONCLUSION

   Based on the facts and representations submitted by Taxpayer, we conclude that

amounts included in Taxpayer’s income with respect to the Tax Credits in accordance
with section 451 will be qualifying income for purposes of section 856(c)(2) and (c)(3)
pursuant to section 856(c)(5)(J)(ii).

   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 whether taxpayer
otherwise qualifies as a REIT under part II of subchapter M of Chapter 1 of the Code.
Nor is any opinion expressed with respect to the tax consequences of any dispositions
of the Tax Credits, including whether a sale of the Tax Credits constitutes a prohibited
transaction as described in section 857(b)(6)(B)(iii).

  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.

PLR-115802-15 5

     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
                                   Branch Chief, Branch 2
                                   Office of Associate Chief Counsel
                                   (Financial Institutions & Products)