City reimbursements qualify for a REIT's 95 percent income test

Plain-English summary

A real estate investment trust indirectly owned a mixed-use project and acquired rights under an economic development agreement to receive city reimbursements for public improvements. The reimbursements were funded from incremental sales taxes generated by the project. The IRS exercised its authority under section 856(c)(5)(J) to treat income attributable to those payments as qualifying income for the REIT's 95 percent gross-income test under section 856(c)(2). The ruling applied only to that test, and the taxpayer represented that the income would remain nonqualifying for the separate 75 percent test under section 856(c)(3). The IRS did not rule on the taxpayer's overall REIT status or on the amount, character, or timing of the reimbursement income.

Ruling snapshot

• Question: Does income from city reimbursement payments for public improvements qualify for a REIT's 95 percent gross-income test?
• Outcome: approved, the income qualifies under section 856(c)(2) only
• Key authorities: IRC §§ 856(c)(2), 856(c)(3), 856(c)(5)(J), and 856(f)(1)

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202006001                                              Third Party Communication: None
 Release Date: 2/7/2020                                         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:B02
 ------------------------------------------                     PLR-140446-15
                                                                Date:
                                                                November 12, 2019




Legend:

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

State 1                   =        -------------

State 2                   =        --------

State 2 Act               =         -----------------------------------------------

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

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

LP                        =        -----------------------

City                      =        -----------

Year                      =        -------

Amount 1                  =        ------------------

Amount 2                  =        -----------------

Amount 3                  =        -----------------

a                         =        ------
PLR-140446-15                                2

b                       =   ---

c                       =   ------

d                       =   --

e                       =   ---

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

      This is in reply to a letter dated November 24, 2015, and supplemental
correspondence, submitted on behalf of Taxpayer by its authorized representatives.
Taxpayer requests a ruling under § 856(c)(5)(J) of the Internal Revenue Code with
respect to the qualification under § 856(c)(2) of income attributable to certain
Reimbursement Payments (defined below) received by Taxpayer.

                                             FACTS

        Taxpayer, a State 1 corporation, represents that it is a real estate investment
trust (“REIT”) formed for the purpose of owning and operating real estate. Taxpayer
uses an accrual method of accounting and a calendar tax year. Taxpayer owns a
percent of a joint venture, which is treated as a partnership for U.S. federal income tax
purposes ("JV"). On Date 1, JV acquired an interest in a mixed-use residential, retail,
and office development in City, State 2 (the “Project”) for Amount 1. As part of the
acquisition of the Project, JV also acquired rights and obligations under an Economic
Development Agreement (“EDA”) described below. The Project and the EDA were
previously owned by LP, a State 1 limited partnership.

       State 2 Act authorizes State 2 municipalities to provide assistance for economic
development. Specifically, State 2 municipalities are authorized to provide for
administration of one or more programs including programs for making loans or grants
of public money. The programs must serve the purpose of promoting state and local
development by stimulating business and commercial activity within the municipality.
On Date 2, City entered into the EDA under State 2 Act with LP as an incentive for LP to
make certain improvements to the Project: water, stormwater, wastewater and drainage
improvements; road improvements; and a public park (the "Public Improvements").
Under the EDA, the Public Improvements must be (i) actually constructed, (ii) conveyed
to and accepted by City (with the exception of the public park), and (iii) open to the
public and available for public use. The EDA obligated LP to maintain the public park,
and City to maintain the other Public Improvements. LP was also required to grant an
easement to City to allow for public use of the park.

       The costs of the Public Improvements totaled Amount 2. The EDA requires City
to reimburse LP for amounts expended for the Public Improvements (the
"Reimbursement Payments") after certain Public Improvement construction milestones
PLR-140446-15                                3

are met (the "Reimbursement Date"), subject to the requirement that the development
of the Project leads to the creation of a specified number of jobs. From the
Reimbursement Date forward, at the end of each calendar year, City must determine
the amount of sales tax revenue generated by the Project for that year in excess of the
sales tax revenues generated by the Project in Year (the "Incremental Taxes"). City
must then pay to LP the Reimbursement Payments out of the Incremental Taxes within
b days of the end of the calendar year.

        City may only pay Reimbursement Payments out of the Incremental Taxes. The
total Reimbursement Payments may not exceed the Maximum Reimbursement Amount,
which is the lesser of (1) Amount 2 plus a “simple interest” factor thereon, computed
annually at a rate of c percent per annum beginning on the Reimbursement Date and
ending on the date d years from the Reimbursement Date, or (2) Amount 3. City's
obligation to make Reimbursement Payments is unconditional provided the Project
generates Incremental Taxes. However, the Maximum Reimbursement Amount may be
reduced if any Public Improvements are not constructed, conveyed, or maintained for
public use, or if any of the job creation requirements under the EDA are not satisfied.
City's obligation to make Reimbursement Payments will terminate on the earlier of the
date that (1) City pays the Maximum Reimbursement Amount; or (2) is e years from the
Reimbursement Date.

        While the rights under the EDA may be transferred separately from the Project,
LP assigned its rights and obligations under the EDA to JV as part of the acquisition of
the Project. Aside from the maintenance of the park and job creation certifications,
which are ongoing obligations, the construction and conveyance of the Public
Improvements by LP were completed prior to the date that JV acquired the EDA. The
failure to satisfy these ongoing park maintenance and job creation certification
obligations may reduce the Maximum Reimbursement Amount, but Taxpayer
represents that payments under the EDA are otherwise unconditional.

      Taxpayer represents that, excluding any right or obligation under the EDA,
substantially all assets constituting the Project are qualifying real estate assets under
§ 856(c)(4). Taxpayer also represents that, excluding the Reimbursement Payments,
substantially all income yielded by the Project is expected to qualify under § 856(c)(2)
and (3).

       For purposes of § 856(c)(2) and (3), Taxpayer represents that it intends to use a
method of accounting for income attributable to the Reimbursement Payments that
clearly reflects income, and does not intend to use a method that improperly frontloads
or backloads Taxpayer’s recovery of basis in its interest in the EDA.

       Taxpayer requests a ruling under § 856(c)(5)(J)(ii) that amounts included in
income that are attributable to the EDA will be treated as qualifying income for purposes
of § 856(c)(2). Taxpayer represents that it will treat the amount included in income from
the EDA as non-qualifying income for purposes of § 856(c)(3).
PLR-140446-15                                 4




                                   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 sources that include dividends; interest;
rents from real property; gain from the sale or other disposition of stock, securities, and
real property (including interests in real property); and abatements and refunds of taxes
on real property.

        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 sources that include 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 (including interests
in real property), dividends from REIT stock and gain from the sale of REIT stock, and
abatements and refunds of taxes on real property.

        Section 856(f)(1) provides that, subject to certain exceptions, for purposes of
§ 856(c)(2) and (3), the term "interest" does not include any amount received or
accrued, directly or indirectly, if the determination of such amount depends in whole or
in part on the income or profits of any person.

       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 § 856(c)(2) or (3) may be considered as not
constituting gross income for purposes of § 856(c)(2) or (3), or (ii) otherwise constitutes
gross income not qualifying under § 856(c)(2) or (3) may be considered as gross
income which qualifies under § 856(c)(2) or (c)(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.”

      Based on the facts and representations presented, including Taxpayer's
representation that its income from the Project will predominantly be qualifying income
under § 856(c)(2) and (3), treating the income attributable to the Reimbursement
Payments as qualifying income solely for purposes of § 856(c)(2) does not interfere with
PLR-140446-15                                   5

or impede the objectives of Congress in enacting § 856(c)(2). Accordingly, pursuant to
§ 856(c)(5)(J)(ii), it is appropriate for the Secretary to determine that income from the
Reimbursement Payments is treated as qualifying income for purposes of § 856(c)(2)
only.

                                     CONCLUSION

        Based on the facts and representations submitted, we rule that, pursuant to
§ 856(c)(5)(J)(ii), income attributable to the Reimbursement Payments will be treated as
qualifying income for purposes of § 856(c)(2) only.

        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 relating to the facts herein
under any other provision 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. Further, we
do not rule on the amount, character, or timing of income attributable to the
Reimbursement Payments for purposes other than § 856(c)(2).

       This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)
of the Code 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 ruling letter
to your authorized representatives.

       The ruling contained in this letter is based upon information and representations
submitted by Taxpayer and accompanied by penalties of perjury statements executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for a ruling, it is subject to verification on examination.

                                   Sincerely,


                                   Andrea M. Hoffenson_________________
                                   Andrea M. Hoffenson

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