Fees a fiber-network REIT charges wireless carriers to use its systems are "rents from real property"

Plain-English summary

A company that plans to elect REIT status builds and owns telecommunications infrastructure, mainly fiber optic cable systems, and lets wireless carriers use dedicated capacity under long-term agreements. To stay a REIT, at least 75% and 95% of a company's income must come from qualifying sources such as "rents from real property," so the company asked the IRS to confirm its charges qualify. The IRS ruled yes. The fiber systems are treated as real property (inherently permanent structures), the charges are fixed and not tied to a carrier's profits, and the extra activities the company performs (maintenance, monitoring, arranging electricity, physical security) are either customary landlord services or fiduciary management, with noncustomary services pushed to a taxable REIT subsidiary or independent contractor. So the use-agreement fees are rents from real property under § 856(c)(2) and (c)(3). The IRS also ruled, using its § 856(c)(5)(J) authority, that a one-time positive § 481(a) accounting-method adjustment the company will report won't count as gross income for the REIT income tests.

Ruling snapshot

• Question: Do fiber-system use charges qualify as REIT "rents from real property," and does a § 481(a) adjustment count toward the REIT income tests?
• Outcome: Approved (charges are qualifying rents; § 481(a) adjustment excluded from the income tests)
• Key authorities: IRC §§ 856(c)(2), (c)(3), (d), (c)(5)(J), 481(a), 512(b)(3); Treas. Reg. §§ 1.856-4, 1.856-10; Rev. Rul. 2002-38

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202035008 Third Party Communication: None
Release Date: 8/28/2020 Date of Communication: Not Applicable
Index Number: 856.00-00
Person To Contact:
----------------------------------- ----------------, ID No. ------------
------------------------------------------------ Telephone Number:
--------------------------------------------- --------------------
-------------------- Refer Reply To:
CC:FIP:B02
PLR-128447-19
Date:
May 29, 2020

Legend

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

State = -------------

a = --

b = ---

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

   This responds to a letter dated November 18, 2019, and supplemental

correspondence, requesting rulings on behalf of Taxpayer. Taxpayer requests rulings
that (1) amounts paid by unrelated third parties for the use of certain
telecommunications infrastructure assets under leases, licenses, or other similar
agreements constitute “rents from real property” under section 856(c)(2) and (c)(3) of
the Internal Revenue Code; and (2) a section 481(a) adjustment required to be included
in gross income by Taxpayer will not be treated as gross income for purposes of section
856(c)(2) or (c)(3).

     FACTS

  Taxpayer is a State Corporation that intends to elect to be taxed as a real estate

investment trust (“REIT”) under sections 856 through 859. Taxpayer constructs and/or
acquires telecommunication infrastructure assets (the “Systems”) and then leases,
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licenses and/or otherwise grants the use of the Systems to unrelated third party wireless
carriers (the “Users”). Taxpayer owns the Systems through one or more entities that
will be disregarded for federal income tax purposes. Taxpayer also owns or will acquire
interests, such as leasehold or license interests, easements, rights-of-way, rights of use,
attachment rights or other similar rights or interests, with respect to land, buildings
and/or other inherently permanent structures to support each System (the “Real Estate
Rights”). The primary component of each System (other than the Real Estate Rights) is
fiber optic cable. Each System also includes optical converters, amplifiers, antennae
and other personal property associated with the Systems that perform an active function
(the “Equipment”). In some cases the optical converters, amplifiers and antennae are
owned by Taxpayer and in other cases they are owned by the User. Taxpayer
represents that the Systems (excluding the Equipment and the Real Estate Rights)
constitute inherently permanent structures within the meaning of section 1.856-
10(d)(2)(i) of the Income Tax Regulations.

Ruling Request 1- Rents from the Use of the Systems

   The Use Agreements

   Taxpayer enters into an agreement with a User granting the User the use of the

Systems (the “Use Agreements”). The Use Agreements typically have an initial term of
a to b years with multiple a-year renewal options. A Use Agreement requires a User to
pay Taxpayer a recurring monthly or quarterly charge for the use of the Systems that
may escalate annually based upon a fixed amount or an index that tracks inflation, such
as the Consumer Price Index. Taxpayer represents that no amount received under a
Use Agreement will be based, in whole or in part, on a percentage of any person’s
income or profits. In some cases, a Use Agreement may also require a nonrecurring
payment at the inception of the Use Agreement, and Taxpayer represents that this
nonrecurring payment is for the use of the Systems over time.

   Taxpayer reserves capacity for a User under a Use Agreement and does not

oversell capacity. In addition, the User pays for such reserved capacity regardless of
whether it uses that capacity. Each Use Agreement specifies a particular System and
each User will have dedicated fiber optic strands and coaxial cable or dedicated
wavelengths and frequencies on fiber optic strands and coaxial cables in that System,
such that the Users’ signals will not be combined. Where a User has a right to a portion
of the capacity of a fiber optic cable (rather than an entire strand), the User will have an
exclusive right to use a dedicated wavelength within the specified fiber optic pathway,
but may not have a right with respect to a specifically identified strand or specific
wavelength within a specifically identified strand in a fiber optic cable. In other words,
although the User may not be guaranteed a specific wavelength in a specific strand in
the fiber optic cable, it is guaranteed a wavelength in a strand within the fiber optic cable
in the System.
PLR-128447-19 3

   Activities and Services Provided under the Use Agreements

   Taxpayer is obligated to perform certain activities with respect to the Systems.

These activities include designing the Systems, constructing the Systems, installing the
components of the Systems, and providing limited maintenance and ongoing monitoring
of the Systems (other than monitoring and maintaining the Equipment or any assets
owned by a User) (the “Activities”). Taxpayer will also undertake Activities when a
portion of the System needs to be demolished and replaced due to construction in a
building, the relocation of utility poles, or other similar events.

    Maintaining and monitoring the Systems means responding to alarm conditions,

inspecting a System periodically to ensure it is working properly, repairing broken
components of a System (other than the Equipment or any assets owned by a User),
and making adjustments to a System to ensure that a System is operational, safe and
secure (as opposed to maximizing the quality of a System’s performance as to a
particular User). For example, when an unrelated third party intends to dig at a
particular location, that party is required to call 811 to ensure that there are no utilities
(including fiber optic cable) in the area. In such a case, Taxpayer will locate its fiber
optic cable and mark its presence with flags or semi-permanent paint. Taxpayer will
also relocate fiber optic cable when necessary due to construction activity (a road next
to the fiber optic cable is widened, the poles upon which the fiber optic cable hangs are
relocated, etc.). In addition, Taxpayer will repair the fiber optic cable if it is cut or
otherwise damaged. Taxpayer represents that the Activities are in furtherance of the
Taxpayer’s fiduciary capacity to manage the affairs of the REIT itself within the scope of
section 1.856-4(b)(5)(ii).

   Per the Use Agreements, Taxpayer is obligated to make electricity available to

each User to operate its equipment. Thus, Taxpayer may arrange for electrical service
to be provided to the Users by the local utility, an independent contractor as defined in
section 856(d)(3) (“IK”). The local utility company will perform any work necessary to
provide power to a particular location. The installation of separate meters or disconnect
boxes for power connection at specific locations along the Systems will be performed by
a taxable REIT subsidiary (“TRS”) or an IK. Each User typically pays Taxpayer a one-
time charge for the installation of meters or other necessary equipment for the provision
of electricity and then pays recurring charges for the electricity through the term of the
Use Agreement. The recurring charge for the electricity will either be paid by the User
as part of its recurring monthly or quarterly charge under its Use Agreement or directly
to the utility company.

    Also per the Use Agreements, space is given to Users for the Users to place their

communications equipment that connects to the Systems. This space is within a secure
room or other restricted access area where the System is located that holds multiple
Users’ equipment. Taxpayer is obligated to provide physical security for these restricted
access areas. Physical access to these restricted access areas is controlled through a
tightly managed, controlled process via Taxpayer’s network operations center. Any site
PLR-128447-19 4

access by any visitor must be scheduled in advance. Individuals visiting these sites
must check-in and check-out through the network operations center using a keypad.
The restricted access areas are also monitored remotely at the network operations
center through video cameras. While on site, the visitors are monitored by security
cameras to ensure service continuity, asset protection, and the safety of the personnel
working in these facilities. Access to the network operations center offices is controlled
by key card.

    Additionally, because Taxpayer owns the Real Estate Rights, it is responsible for

maintaining and repairing the Equipment. Either a TRS or an IK will monitor, operate,
manage, maintain and repair the Equipment. The Equipment owned by one User is
often located in close proximity to the Equipment owned by another User. In order to
limit those who have access to space containing the Users’ equipment, a TRS or IK will
also be responsible for maintaining and repairing the Equipment owned by a User that
is connected to a System. The Use Agreement may or may not contain a separately
stated charge for the cost of installing, monitoring, operating, managing, maintaining,
moving, repairing, and replacing Equipment or any assets owned by a User. Taxpayer
represents that all of these activities will be undertaken by a TRS or an IK, regardless of
who owns the Equipment.

    Taxpayer represents that all services provided to Users in connection with the

lease of its Systems are customarily provided by lessors of telecommunication
infrastructure assets in the geographic area in which Systems are located. Taxpayer
further represents that the TRS or IK will receive a fair market value, arm’s-length fee
from Taxpayer for any services provided to the Users for purposes of section 857(c)(7).

   In addition, Taxpayer represents that the rent attributable to the Equipment and

other personal property which is leased under, or in connection with the lease of a
System 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.

Ruling Request 2- Section 481(a) adjustment

    Taxpayer will file a Form 3115, Application for Change in Accounting Method,

under the automatic change procedures described in Rev. Proc. 2015-13, 2105-5 I.R.B.
419, to change its method of accounting for the depreciation of certain assets beginning
with the year in which Taxpayer elects to be treated as a REIT. This automatic change
will result in a positive adjustment under section 481(a) that will be includible in
Taxpayer’s taxable income over a period of four years (the “Section 481(a)
Adjustment”). The Section 481(a) Adjustment relates to a change in the depreciable
useful life of real property being changed from a class of real property with a shorter
useful life to a different class of real property with a longer useful life.
PLR-128447-19 5

   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 dividends; interest; rents from real
property; gain from the sale or other disposition of stock, securities, and real property
(other than property described in section 1221(a)); abatements and refunds of taxes on
real property; income and gain derived from foreclosure property; commitment fees to
make loans secured by mortgages on real property or on interests in real property or to
purchase or lease real property; gain from certain sales or other dispositions of real
estate assets; and certain mineral royalty income.

   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 on interests in real property; gain
from the sale or other disposition of real property (other than property described in
section 1221(a)); dividends or other distributions on, and gain from the sale or
disposition of, transferable shares in other REITs; abatements and refunds of taxes on
real property; income and gain derived from foreclosure property; commitment fees to
make loans secured by mortgages on real property or on interests in real property or to
purchase or lease real property; gain from certain sales or other dispositions of real
estate assets; and qualified temporary investment income.

Ruling Request 1

    Section 856(d)(1) provides that “rents from real property” includes (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 such 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 1.856-4(b)(1) provides that, for purposes of sections 856(c)(2) and (c)(3),

the term rents from real property includes charges for services customarily furnished or
rendered in connection with the rental of real property, whether or not the charges are
separately stated. Services furnished to the tenants of a particular building will be
considered customary if, in the geographic market in which the building is located,
tenants in buildings of a similar class (such as luxury apartment buildings) are
customarily provided with the service. In particular geographic areas where it is
customary to furnish electricity or other utilities to tenants in buildings of a particular
class, the submetering of such utilities to tenants in such buildings will be considered a
customary service. To qualify as a service customarily furnished, the service must be
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furnished or rendered to the tenants of the REIT or, primarily for the convenience or
benefit of the tenant, to the guests, customers, or subtenants of the tenant.

   Section 1.856-4(b)(5)(ii) provides that the trustees or directors of a REIT are not

required to delegate or contract out their fiduciary duty to manage the REIT itself, as
distinguished from rendering or furnishing services to the tenants of its property or
managing or operating the property. Thus, the trustees or directors may do all those
things necessary, in their fiduciary capacities, to manage and conduct the affairs of the
REIT itself. For example, the trustees or directors may deal with taxes, interest, and
insurance relating to the REIT’s property. The trustees or directors may also make
capital expenditures with respect to the REIT’s property and may make decisions as to
repairs of the REIT’s property, the cost of which may be borne by the REIT.

    Section 856(d)(2)(C) excludes impermissible tenant service income from the

definition of rents from real property. Section 856(d)(7)(A) defines “impermissible tenant
service income” to mean, with respect to any real or personal property, any amount
received or accrued directly or indirectly by a REIT for (i) services furnished or rendered
by the REIT to tenants of such property, or (ii) for managing or operating such property.

   Section 856(d)(7)(B) provides that if the amount of impermissible tenant service

income with respect to a property for any taxable year exceeds one percent of all
amounts received or accrued during such taxable year directly or indirectly by the REIT
with respect to such property, the impermissible tenant service income of the REIT will
include all of the amounts received or accrued with respect to the property. Section
856(d)(7)(D) provides that the amounts treated as received by a REIT for any
impermissible tenant service shall not be less than 150 percent of the direct cost of the
REIT in furnishing or rendering the service (or providing the management or operation).

   Section 856(d)(7)(C) excludes from the definition of impermissible tenant service

income (i) amounts received for 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, and (ii) amounts which
would be excluded from unrelated business taxable income under section 512(b)(3) if
received by an organization described in section 511(a)(2).

    Section 512(b)(3) provides, in part, that there shall be excluded from the

computation of unrelated business taxable income all rents from real property and all
rents from personal property leased with such real property, if the rents attributable to
such personal property are an incidental amount of the total rents received or accrued
under the lease, determined at the time the personal property is placed in service.

  Section 1.512(b)-1(c)(5) provides that payments for the use or occupancy of

rooms and other space where services are also rendered to the occupant, such as for
the use or occupancy of rooms or other quarters in hotels, boarding houses, or
apartment houses furnishing hotel services, or in tourist camps or tourist homes, motor
PLR-128447-19 7

courts, or motels, or for the use or occupancy of space in parking lots, warehouses, or
storage garages, do not constitute rent from real property. Generally, services are
considered rendered to the occupant if they are primarily for his convenience and are
other than those usually or customarily rendered in connection with the rental of rooms
or other space for occupancy only. The supplying of maid service, for example,
constitutes such service; whereas the furnishing of heat and light, the cleaning of public
entrances, exits, stairways, and lobbies, and the collection of trash are not considered
as services rendered to the occupant.

   In Rev. Rul. 2002-38, 2002-2 C.B. 4, a REIT pays its TRS an arm’s length rate to

provide noncustomary services to tenants. The REIT does not separately state charges
to tenants for the services. Thus, a portion of the amounts received by the REIT from
tenants represents an amount received for services provided by the TRS. The TRS
employees perform all of the services and the TRS pays all of the costs of providing the
services. The revenue ruling concludes that the services provided to the REIT’s tenants
are considered to be rendered by the TRS, rather than the REIT, for purposes of section
856(d)(7)(C)(i).

    Taxpayer represents that the Systems (excluding the Equipment and the Real

Estate Rights) are inherently permanent structures within the meaning of section 1.856-
10(d)(2)(i) and are therefore real property for purposes of section 856. Under the Use
Agreements, each User has a right to use or to occupy space on a System. The Use
Agreements have an initial term of a to b years with multiple a-year renewal options.
Each Use Agreement requires a fixed, recurring amount to be paid by a User during the
term of the Use Agreement that may escalate annually based upon a fixed amount or
an inflation tracking index. In addition, the User generally pays an upfront amount for
the use of the System in addition to a recurring amount. The User is required to pay for
the contracted usage and Taxpayer does not oversell capacity in its Systems so that
Users always have access to their contracted usage, regardless of the User’s actual
usage. Taxpayer represents that no amount received under a Use Agreement will be
based, in whole or in part, on a percentage of any person’s income or profits.
Accordingly, amounts received by Taxpayer for the right to use or to occupy space on a
System qualifies as rents from interests in real property under section 856(d)(1)(A).

   Taxpayer represents that any service that will be furnished or rendered to a User

under a Use Agreement is a service that is customarily furnished to tenants of Systems
of a similar class to that of Taxpayer in the same geographic area and, except for
arranging for the provision of electricity and providing physical security of the restricted
areas, are performed by either a TRS or an IK. Arranging for the provision of electricity
and providing physical security, as described above, are services usually or customarily
rendered in connection with the rental of telecommunication infrastructure assets similar
to the Systems and which are necessary to maintain Taxpayer’s property. Thus, for
purposes of determining whether the income is qualifying income for REIT qualification
purposes, income from arranging for the provisions of electricity and providing physical
security, as described above, would be excluded from unrelated business taxable
PLR-128447-19 8

income under section 512(b)(3) if received by an organization described in section
511(a)(2). In addition, Taxpayer represents that the performance of the Activities
described above are an exercise of the fiduciary duties of the Taxpayer's directors in
accordance with section 1.856-4(b)(5)(ii) and are not services rendered to a User in
connection with the rental of real property. Therefore, the furnishing of services to
Users and the provision of Activities described above by Taxpayer under a Use
Agreement detailed above does not give rise to impermissible tenant service income,
and will not cause any portion of the rents received by Taxpayer from Users for use of
the Systems to fail to qualify as rents from real property under section 856(d).

   Taxpayer further represents that the rent attributable to the Equipment and other

personal property which is leased under, or in connection with the lease of a System
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.

Ruling Request 2:

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

   Section 481(a) provides that a taxpayer that changes its method of accounting

takes into account necessary adjustments in computing its taxable income.

   Section 1.481-1(d) provides that a section 481(a) adjustment must be properly

taken into account for purposes of computing gross income, adjusted gross income, or
taxable income in determining the amount of any item of gain, loss, deduction, or credit
that depends on gross income, adjusted gross income, or taxable income.

    As noted above, Taxpayer submitted a Form 3115 to change its method of

accounting for depreciation of certain real estate assets. The method changes will
result in a positive Section 481(a) Adjustment that will be includible in taxable income
over a four-year period beginning with the taxable year in which Taxpayer makes its
REIT election. Sections 856(c)(2) and (3) list the sources of permissible income for a
REIT. Income from a section 481(a) adjustment is not specifically enumerated in
section 856(c)(2) or (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
PLR-128447-19 9

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.”

   Any income resulting from a section 481(a) adjustment constitutes gross income.

Pursuant to the authority under section 856(c)(5)(J), that income may be considered
either as not constituting gross income under section 856(c)(2) or (3), or as gross
income which qualifies under those provisions.

   Exclusion of the Section 481(a) Adjustment from Taxpayer's gross income for

purposes of sections 856(c)(2) and (3) does not interfere with Congressional policy
objectives in enacting the income tests under those provisions. Accordingly, pursuant
to section 856(c)(5)(J)(i), we conclude that Taxpayer’s Section 481(a) Adjustment will
not constitute gross income for purposes of sections 856(c)(2) and (3).

  CONCLUSION

   Accordingly, based on the facts as represented, we rule that amounts paid by

Users under the Use Agreements for the use of a System constitute rents from real
property under section 856(c)(2) and (c)(3); and (2) the Section 481(a) Adjustment
required to be included in gross income by Taxpayer will not be treated as gross income
for purposes of section 856(c)(2) or (c)(3).

   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.
Furthermore, no opinion is expressed as to whether the Systems constitute inherently
permanent structures within the meaning of section 1.856-10(d)(2)(i). Additionally, no
opinion is expressed regarding the propriety of Taxpayer’s method change or the
amounts of the Section 481(a) Adjustment.

    Furthermore, the ruling herein relates to whether income from services

performed by Taxpayer is impermissible tenant service income and is specifically limited
to whether the income is qualifying income for REIT qualification purposes. The
definition of rents from real property under section 856(d) differs in scope and structure
from the definition of rents from real property under section 512(b)(3), which applies to
exempt organizations described in section 511(a)(2). Therefore, an exempt
organization providing the same services may have unrelated business taxable income
because the income may not be excluded under section 512(b)(3) as rents from real
property.

  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-128447-19 10

     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 Chief Counsel
                                   (Financial Institutions & Products)

cc: