REIT subsidiary does not operate health care facilities managed by an independent operator

Plain-English summary

A real estate investment trust's taxable REIT subsidiary planned to acquire indirect majority interests in foreign partnerships that owned senior housing and health care communities. The local partnerships would remain the legal employers of community workers, but an independent operator would exclusively manage daily operations and supervise every employee. The subsidiary had no employees, no operational role, and no legal or contractual right to participate in daily management. The IRS ruled that the subsidiary's indirect ownership and its share of employee expenses would not cause it to be treated as operating or managing a health care facility under section 856(l)(3)(A). The ruling did not decide whether the parent otherwise qualified as a REIT, whether the subsidiary otherwise qualified as a taxable REIT subsidiary, or whether the communities were health care facilities.

Ruling snapshot

• Question: Would indirect ownership of the property-owning partnerships cause the taxable REIT subsidiary to operate or manage their health care facilities?
• Outcome: approved (the subsidiary would not be treated as operating or managing the facilities)
• Key authorities: IRC §§ 856(d), 856(e)(6)(D), 856(l)

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 202029002                                            Third Party Communication: None
Release Date: 7/17/2020                                      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:B01
                                                             PLR-117873-19
                                                             Date:
                                                             January 28, 2020


Legend:

Taxpayer                      = ---------------------------------------------------------------------------------
                                ---------------------------------------------------------
Subsidiary                    = --------------------------------------------
Fund                          = ------------------------------------------------------------------
General Partner               = --------------------------------
Operator                      = --------------------------------------------------
Country                       = ----------
State A                       = -------------
Region A                      = ----------
Region B                      = ----------------
Communities                   = ---------------------------------------------------------------------------------
                                ---------------------------------------------------------------------------------
                                ---
Community                     = -------------------------------------------------------------
Employees
a                             = ---
b                             = ---
c                             = ---

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

         This ruling responds to a letter dated July 31, 2019, submitted on behalf of
Taxpayer. Taxpayer requests a ruling that Subsidiary, a taxable REIT subsidiary (a
“TRS”) of Taxpayer, will not be considered to be operating or managing a health care
facility within the meaning of section 856(l)(3)(A).

                                                     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, directly and
PLR-117873-19                                2

indirectly through subsidiaries, owns a portfolio of senior housing and health care
properties.

       Fund is a Region A limited partnership that owns a Communities, each through a
separate limited partnership organized under the laws of Country (each, a “Sub LP”).
Fund is the limited partner of each Sub LP. General Partner, a corporation incorporated
under the laws of Country, is the general partner of Fund. A corporate subsidiary of
General Partner (“Sub GP”) owns a nominal economic interest in each Sub LP and is
the general partner of each Sub LP. General Partner has all management rights with
respect to Fund, and Sub GP has all management rights with respect to the Sub LPs.
Taxpayer represents that the Communities are or will be “qualified health care
properties” within the meaning of section 856(e)(6)(D).

       Operator is a corporation incorporated under the laws of Country and an affiliate
of a minority partner in Fund. Operator currently operates each completed Community
pursuant to an arm’s-length management contract with the Sub LP that owns the
Community.

       Subsidiary is a Region B corporation and a TRS of Taxpayer. Subsidiary entered
into an agreement to purchase a b-percent limited partnership interest in Fund and c
percent of the stock of General Partner (the “Acquisition”).

        At the time of the Acquisition, the existing management contracts between the
Sub LPs and Operator will be terminated and new arm’s-length management contracts
will be entered into between the Sub LPs and Operator. Upon completion of a
Community, the Sub LP that owns the Community will enter into an arm’s-length
management contract with Operator under the same terms as the existing management
contracts for the completed Communities. Under the management contracts, Operator
will have the exclusive right to manage the day-to-day operation of the Communities
and to provide daily supervision and direction of the employees at the Communities.
Operator will be responsible for collecting revenues from, and paying the expenses of,
the operation of the Communities. Operator will be responsible for setting the policies of
each Community; maintaining and insuring the Communities; procurement for the
Communities; recruiting, hiring, supervision, training, and discharge of employees;
setting and collecting all fees; obtaining permits or licenses for operating the
Communities; and managing and directing day-to-day activities at the Communities.
Operator provides and approves all forms of, and manages the execution, maintenance,
compliance, and cancellation of, all resident agreements, leases, and occupancy
agreements. Operator will be responsible for all accounting and financial matters
relating to each of the Communities.

       Under the terms of the management agreements, Subsidiary will not be involved
in any component of the day-to-day operations of, or services provided at, the
Communities. Subsidiary has no employees. Subsidiary will not have any employees
who perform any services relating to the Communities.
PLR-117873-19                                 3

       Community Employees at each Community are employed directly by the Sub LP
that owns that Community. This employment structure has been in place prior to the
Acquisition. Maintaining this arrangement is more efficient for Sub LPs in Region A.

       After the Acquisition, each Sub LP will continue to employ directly the Community
Employees of the Sub LP's Community. All employees with supervisory roles over
Community Employees will be employed by Operator. Operator will have the exclusive
authority to supervise and control the Community Employees of each Community.
Operator has and will continue to have and exercise the exclusive right and
responsibility to recruit, train, supervise, hire, and terminate all employees at all levels,
irrespective of the identity of the legal employer.

        Taxpayer represents that Operator is, and after the Acquisition will be, an
independent contractor with respect to Taxpayer under section 856(d)(3) from whom
Taxpayer receives no income. After the Acquisition, the Communities will be the only
qualified health care properties managed by Operator, and the Sub LPs will be
Operator’s only customers.

                                   LAW AND ANALYSIS

        Section 856(c)(4)(B)(iv) provides that a corporation shall not be considered a
REIT for any taxable year unless, at the close of each quarter of the taxable year,
except with respect to a TRS, (I) not more than 5 percent of the value of its total assets
is represented by securities of any one issuer, (II) the corporation does not hold
securities possessing more than 10 percent of the total voting power of the outstanding
securities of any one issuer, and (III) the corporation does not hold securities having a
value of more than 10 percent of the total value of the outstanding securities of any one
issuer.

        Section 856(d)(2)(B) provides that the term “rents from real property” does not
include, except as provided in section 856(d)(8), any amount received or accrued
directly or indirectly from any person if the REIT owns, directly or indirectly: (i) in the
case of a corporation, stock possessing 10 percent or more of the total combined voting
power of all classes of stock entitled to vote, or 10 percent or more of the total value of
shares of all classes of stock of such corporation; or (ii) in the case of any person that is
not a corporation, an interest of 10 percent or more in the assets or net profits of such
person.

       Section 856(d)(2)(C) provides that the term “rents from real property” does not
include any impermissible tenant service income.

        Section 856(d)(7)(A) provides that, for purposes of section 856(d)(2)(C), the term
“impermissible tenant service income” means, with respect to any real or personal
property, any amount received or accrued directly or indirectly by the REIT for
(i) services furnished or rendered by the REIT to the tenants of such property, or
(ii) managing or operating such property.
PLR-117873-19                                    4


       Section 856(d)(7)(C)(i) provides that, for purposes of section 856(d)(7)(A),
services furnished or rendered, or management or operation provided, through an
independent contractor from whom the REIT does not derive or receive any income or
through a TRS of the REIT shall not be treated as furnished, rendered, or provided by
the REIT.

        Section 856(d)(3) defines an independent contractor as any person (A) who does
not own, directly or indirectly, more than 35 percent of the shares, or certificates of
beneficial interest, in the REIT; and (B) if such person is a corporation, not more than 35
percent of the total combined voting power of whose stock (or 35 percent of the total
shares of all classes of whose stock), or, if such person is not a corporation, not more
than 35 percent of the interest in whose assets or net profits is owned, directly or
indirectly, by one or more persons owning 35 percent or more of the shares or
certificates of beneficial interest in the REIT.

        Section 856(d)(8)(B) provides that amounts paid to a REIT by a TRS of the REIT
for an interest in real property that is a qualified lodging facility or qualified health care
property leased by the REIT to the TRS and operated on behalf of the TRS by an EIK
shall not be excluded from rents from real property by reason of section 856(d)(2)(B).

       Section 856(d)(8)(B)(ii) provides that a TRS is not considered to be operating or
managing a qualified health care property or qualified lodging facility solely because it
employs individuals working at such facility or property located outside the United
States, but only if an EIK is responsible for the daily supervision and direction of such
individuals on behalf of the TRS pursuant to a management agreement or similar
service contract.

       Section 856(d)(9)(A) provides that the term EIK with respect to any qualified
lodging facility or qualified health care property means any independent contractor if, at
the time such contractor enters into a management agreement or other similar service
contract with the TRS to operate such qualified lodging facility or qualified health care
property, such contractor (or any related person) is actively engaged in the trade or
business of operating qualified lodging facilities or qualified health care properties,
respectively, for any person who is not a related person with respect to the REIT or the
TRS.

       Section 856(e)(6)(D)(i) defines “qualified health care property” as any real
property (including interests therein), and any personal property incident to such real
property, which is a health care facility or is necessary or incidental to the use of a
health care facility.

         Section 856(e)(6)(D)(ii) defines a “health care facility” as a hospital, nursing
facility, assisted living facility, congregate care facility, qualified continuing care facility
(as defined in section 7872(g)(4)), or other licensed facility which extends medical or
nursing or ancillary services to patients and which, immediately before the termination,
PLR-117873-19                                 5

expiration, default, or breach of the lease of or mortgage secured by such facility, was
operated by a provider of such services which was eligible for participation in the
Medicare program under Title XVIII of the Social Security Act with respect to the facility.

       Section 856(l)(1) provides that a TRS of a REIT is a corporation (other than a
REIT) in which the REIT directly or indirectly owns stock and for which the REIT and the
corporation jointly elect treatment as a TRS.

       Section 856(l)(2) provides that any corporation (other than a REIT or a qualified
REIT subsidiary) in which a TRS owns directly or indirectly securities having more than
35 percent of the total voting power or total value of the corporation’s outstanding
securities shall be treated as a TRS.

      Section 856(l)(3)(A) provides that any corporation that directly or indirectly
operates or manages a lodging facility or a health care facility is not a TRS.

         After the Acquisition, Subsidiary will own, indirectly through Fund and the Sub
LPs, a majority interest in the Communities, each of which is or will be a health care
facility. No provision of section 856 prohibits a TRS from owning a health care facility. If
Subsidiary operates or manages a Community, however, Subsidiary will not qualify as a
TRS under section 856(l)(3).

        Based on Taxpayer’s representations, Subsidiary has no direct involvement in
the management of the Communities. Subsidiary has no legal or contractual rights to
participate in the daily operation of the Communities. Operator, an independent
contractor with respect to Taxpayer, has the exclusive authority to supervise and direct
the employees of each Sub LP.

       Community Employees will be employees of the Sub LP that owns the
Community, and Subsidiary will have an indirect majority interest in each Sub LP
through Fund. Therefore, Subsidiary bears a share of the expenses of employing
Community Employees. The prohibition on a TRS operating a health care facility is not
meant to prevent the TRS from bearing the expenses of operating a health care facility.
Section 856(d)(9), for example, acknowledges that a TRS may bear the expenses of
operating a qualified health care property in the context of the structure described in
section 856(d)(8)(B).

        Section 856(d)(8)(B)(ii) establishes that mere legal employment of an individual
working in a qualified health care property is not, per se, operation of the qualified
health care property. The Community Employees will be part of an arrangement similar
to that described in section 856(d)(8)(B)(ii), in which employees of a TRS are
supervised by an EIK. The Community Employees supervised by Operator, however,
will not be employees of Subsidiary, the TRS, but of the Sub LPs, which are limited
partnerships with respect to which Sub GP has all management rights.
PLR-117873-19                                 6

                                      CONCLUSION

       Based on the facts submitted and representations made, we conclude that,
following the Acquisition, Subsidiary will not be considered to be directly or indirectly
operating or managing a health care facility within the meaning of section 856(l)(3)(A)
as a result of Subsidiary’s indirect majority ownership interests in the Sub LPs, each of
which will own a Community and employ Community Employees that work in such
property under the control of Operator pursuant to the management agreements as
described in this letter.

        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. In particular, no opinion is expressed as to whether Taxpayer
otherwise qualifies as a REIT or whether Subsidiary otherwise qualifies as a TRS of
Taxpayer under part II of subchapter M of chapter 1 of the Code. Furthermore, no
opinion is expressed as to whether the Communities qualify as health care facilities
within the meaning of section 856(e)(6)(D)(ii).

       This ruling is directed only to the taxpayers 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 Power of Attorney on file with this office, copies of this
letter are being sent to your authorized representatives.

                                       Sincerely,



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




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