Fiber-optic capacity payments qualify as REIT rents from real property

Plain-English summary

A corporation intending to elect REIT status leased capacity in permanently affixed fiber-optic and coaxial cables, conduit, and distributed antenna systems under six types of long-term agreements. Tenants received exclusive capacity or pathways for fixed payments that did not depend on their income, profits, or actual usage. The taxpayer represented that associated personal property stayed below the 15 percent limit and that a taxable REIT subsidiary or independent contractor would operate and maintain signal equipment and perform tenant services other than electricity. The IRS ruled that the payments qualified as rents from real property and that the described services and property-maintenance activities did not create impermissible tenant service income. For the limited exception allowing rents from a taxable REIT subsidiary, the relevant property was the continuously connected fiber within the applicable geographic operating area.

Ruling snapshot

• Question: Do payments for fiber-optic capacity and related services qualify as rents from real property for the REIT income tests?
• Outcome: Approved on the stated representations.
• Key authorities: IRC §§ 512(b)(3), 856(c), 856(d); Treas. Reg. §§ 1.512(b)-1, 1.856-4

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202133003 Third Party Communication: None
Release Date: 8/20/2021 Date of Communication: Not Applicable
Index Number: 856.01-00, 856.04-00
Person To Contact:
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------------------------------------- Refer Reply To:
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PLR-117352-20
Date:
February 5, 2021

LEGEND:

Taxpayer = ---------------------------------
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Parent = ---------------------

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

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

a = --

b = ---

c = --

Dear ---------------

   This ruling responds to a letter dated July 30, 2020, and subsequent

correspondence, submitted on behalf of Taxpayer. Taxpayer requested rulings under
section 856 of the Internal Revenue Code (“Code”) with respect to amounts received by
Taxpayer for the use of Taxpayer’s fiber optic cable.

                                             FACTS

   Taxpayer is a corporation organized in State. Taxpayer is an indirect subsidiary

of Parent, which is treated as a real estate investment trust (“REIT”) for federal income
tax purposes. Taxpayer represents that it intends to make an election to be taxed as a
REIT under sections 856 through 859 of the Code. Taxpayer leases systems

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composed of permanently affixed coaxial and fiber optic cable, and the associated
conduit piping (together, the “Real Property Assets”), among other assets. Taxpayer
also leases indoor and outdoor distributed antenna systems or small cell systems
(“DAS”), which are composed of Real Property Assets, among other assets. Taxpayer
represents that the Real Property Assets are real property for purposes of section 856
of the Code. Taxpayer’s customers are wireless carriers, other telecommunication
providers, and private and public entities and organizations (“Tenants”).

   A.     DAS Installations and Fiber Optic Cables

   Some of Taxpayer’s fiber optic cables are connected to and are associated with

DAS installations, while other fiber optic cables form independent networks that are
connected to cell towers or utility poles or are buried under the ground. A fiber optic
cable is composed of ultra-thin strands of glass surrounded by layers of insulating
materials, including cladding (together, “strands”). Many strands are aggregated into a
single fiber optic cable. Multiple fiber optic cables are combined and contained in rigid
conduit piping and are typically buried between two and four feet underground, or are
permanently attached to above ground structures (e.g., utility poles).

   A single strand of fiber has two glass components – the core and the cladding,

which together are about as thin as a typical human hair. An optical converter projects
a beam of light down the glass core; the light reflects off the glass cladding as it travels
down the fiber strand. Since each strand can transport signals of different wavelengths
simultaneously, multiple customers can use the same strand by having separately
designated wavelengths.

   A DAS installation is a system for the transmission of telecommunication signals

through fiber optic and coaxial cables. Wireless carriers supplement their antennas
mounted on cell towers with DAS installations to improve capacity and signal strength in
certain densely populated areas (e.g., a college campus, a sports stadium, or a
convention center) and hard-to-reach areas (e.g., an underground transportation
system). A DAS installation may be located outdoors (“Outdoor DAS”) or inside a
structure (“Indoor DAS”). In an Outdoor DAS, cables are buried in the ground in conduit
piping, or are strung between utility poles. In an Indoor DAS, Real Property Assets are
embedded in, or are affixed to walls or ceilings of a building or other structure.

   With respect to DAS installations, Taxpayer represents that either a taxable REIT

subsidiary (“TRS”) or an independent contractor as defined in section 856(d)(3) from
whom Taxpayer does not derive or receive any income (an “IK”) will operate, monitor,
manage, maintain, and repair all of the equipment that receives, amplifies, converts,
and returns a signal originated by a Tenant, including antennas, optical converters,
lasers, transponders, amplifiers, and regeneration equipment (the “DAS Equipment”).
Taxpayer will typically own the DAS Equipment. Tenants will own the equipment
located at the base stations, which will be stored in metal equipment cabinets owned by

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Taxpayer. Taxpayer represents that the TRS or IK will receive arm’s length
compensation from Taxpayer for operating, monitoring, managing, maintaining, and
repairing the DAS Equipment. Taxpayer represents that it will treat the DAS Equipment
as personal property for purposes of section 856(d)(1)(C), and that the fair market value
of personal property leased under or in connection with the lease of Real Property
Assets of a DAS installation is less than 15% of the fair market value of the real and
personal property subject to such lease.

    With respect to systems that are not associated with a DAS installation,

Taxpayer represents that a TRS or an IK will operate, monitor, manage, maintain, and
repair the equipment that receives, amplifies, regenerates, converts, and returns a
signal originated by a Tenant, including optical converters, filters, lasers, transponders,
amplifiers, and regeneration equipment (the “Signal Equipment”). Taxpayer will typically
own the Signal Equipment. Taxpayer represents that the TRS or IK will receive arm’s
length compensation from Taxpayer for operating, monitoring, managing, maintaining,
and repairing the Signal Equipment. Taxpayer represents that it will treat the Signal
Equipment as personal property for purposes of section 856(d)(1)(C), and that the fair
market value of the personal property leased under or in connection with the lease of
Real Property Assets of a system that is not associated with a DAS installation is less
than 15% of the fair market value of the real and personal property subject to such
lease.

   B.     Agreements for the Use of Real Property Assets

   Taxpayer enters into six different types of contractual agreements with Tenants.

These six types of agreements are DAS Agreements, Indefeasible Rights of Use
Agreements (“IRUs”), Capacity Leases, Wave Leases, Backhaul Leases, and Bifurcated
Leases, each described below (together, “Agreements”). Only DAS Agreements relate
to Real Property Assets associated with DAS installations. Taxpayer may own or lease
their Real Property Assets from third parties.

    Each Tenant will have use of its contracted capacity on its identified pathway at

all times during the term of an Agreement. Each type of Agreement typically involves a
term ranging from a years to b years, and no Agreement is for less than c years. In all
six types of the Agreements, the Tenant is required to pay for the contracted usage,
regardless of the Tenant’s actual usage. Under each type of Agreement, the Tenant is
required to pay a fixed, recurring amount that may be subject to periodic escalation.
Under DAS Agreements, as well as under certain IRUs and Capacity Leases, the
Tenant generally pays an upfront amount in addition to a recurring amount. Taxpayer
represents that it will not receive any amounts under any Agreement that is based on a
percentage of the income or profits of the Tenant, or any other person.

   1. DAS Agreement

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  Under a DAS Agreement, the Tenant has the exclusive right to use either a

designated number of individual strands within the fiber optic pathway, or a dedicated
wavelength within the fiber optic pathway of a DAS installation.

   2. IRU

   Under an IRU, the Tenant has the exclusive right to use all of the wavelengths

(or capacity) in one or more specified strands within a fiber optic cable over a
specifically identified route for the term of the lease.

   3. Capacity Lease

  Under a Capacity Lease, the Tenant has an exclusive right to use a specified

subset of all the wavelengths (or capacity) within a strand located in a fiber optic cable
over a specifically identified route for the term of the lease.

   4. Wave Lease

   Under a Wave Lease, the Tenant has an exclusive right to use a dedicated

wavelength in a strand within the fiber optic cable over a specifically identified route for
the term of the lease. The Tenant under a Wave Lease, however, does not have a right
to a specifically identified strand, or wavelength within a strand, in a fiber optic cable,
unlike a Tenant of an IRU or a Capacity Lease.

   5. Backhaul Lease

    Under a Backhaul Lease, the Tenant has an exclusive right to use all or a

dedicated portion of the capacity of an identifiable fiber optic cable over a specifically
identified route from a cell tower to a collection point for the term of the lease. Under
certain Backhaul Leases, the Tenant does not have an exclusive right to a specifically
identified wavelength on a strand within the fiber optic cable; however, the Tenant has
the exclusive right to either all of the capacity of a particular number of unidentified
strands or to a dedicated portion of the capacity within a strand of a fiber optic pathway.
Signals of different Tenants are not intermingled. The Tenant will own and operate a
mobile switching center and base station equipment for the generation of the initial
digital signal, as well as the ultimate receipt of the signal.

   6. Bifurcated Lease

    Under a Bifurcated Lease, the Tenant has an exclusive right to use a dedicated

portion of the capacity of fiber optic cable owned by Taxpayer over a set of specifically
identified routes, with Taxpayer transferring the Tenant’s signals to a third party at the
termination of Taxpayer’s owned or leased interests. The Tenant’s signal will start at
the Tenant’s premises and follow a dedicated fiber optic pathway owned by Taxpayer to

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equipment (which will be monitored, operated, managed, maintained and repaired by
either a TRS or an IK for an arm’s length fee) that will direct the Tenant’s signal along
one of up to seven dedicated fiber optic pathways owned by Taxpayer. Where the fiber
optic pathway owned by Taxpayer terminates, for example at a data center owned by a
third party, a TRS or an IK will transfer the Tenant’s signal to a server owned by an
unrelated party. Taxpayer will compensate either the TRS or IK with an arm’s length
fee for performing this service. Signals of different Tenants are not intermingled at any
time.

   C.     Services and Activities

   Taxpayer represents that it is obligated to undertake certain activities and to

render certain services that Taxpayer represents are usually and customarily provided
in connection with the lease of Real Property Assets. Taxpayer will provide electricity to
its Tenants. Taxpayer represents that any other service rendered to a Tenant under an
Agreement will be performed either by a TRS of Taxpayer or by an IK. Furthermore,
Taxpayer represents that any service that will be provided or rendered to a Tenant
under each of the six types of Agreements is a service that is customarily furnished to
tenants of Real Property Assets of a similar class in the same geographic area.

    Taxpayer will perform certain activities including designing the DAS installation or

system, constructing the DAS installation or system, installing the components of the
DAS (including antennas, fiber optic and coaxial cables, amplifiers, optical converters,
and other equipment), and providing ongoing monitoring and maintenance of the Real
Property Assets. In addition, if any scheduled excavation work is to take place near its
fiber optic cable, Taxpayer will mark the cable’s location with flags or paint. Taxpayer
will also move and relocate its cable when necessary due to construction activity (e.g. a
road being widened, utility poles being relocated, etc.). Furthermore, Taxpayer will
repair the fiber optic cable if it is cut or otherwise damaged, which can occur from
storms, earthquakes, water incursions, fire, unauthorized digging, animal activity, etc.
Taxpayer will not monitor, repair, or maintain any equipment owned by a Tenant or any
equipment owned or operated by a TRS or an IK.

   D.     Leasing to a TRS

   Taxpayer intends in certain circumstances to lease capacity on its fiber optic

cable to a TRS that is owned by Taxpayer. Taxpayer represents that the capacity
leased to its TRS will be the same type of capacity that is leased to unrelated third
parties (i.e. the TRS will enter into one of the six types of Agreements, as described
above, with Taxpayer). Taxpayer represents that the TRS will lease less than 10% of
the leased capacity as measured within an Area, as described below. Taxpayer
represents that it will not lease capacity to any related person other than to a TRS of
Taxpayer. Taxpayer represents that the amounts Taxpayer will charge the TRS for the
capacity that TRS will contract for is comparable to that paid by unrelated third parties

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for comparable space (i.e. capacity on fiber optic cable). Furthermore, Taxpayer
represents that the rents paid by the TRS to Taxpayer for capacity will not otherwise fail
to satisfy any requirements under section 856 for the rents to qualify as “rents from real
property” for purposes of section 856.

   An Area is a specifically identified geographic region of Taxpayer’s fiber network.

Areas are designated by Taxpayer to facilitate the operation of its continuously
connected fiber across the country. An Area is comprised of a geographic footprint that
allows an assigned team of field employees to focus on local customer and service
needs. An Area is generally designed so that every part of the Area is within a
reasonable driving distance, but is also limited by total fiber miles within the region so
that the assigned team of field employees can effectively service the entire region.
Thus, a more fiber-dense region will have an Area covering fewer total square miles
than one with more dispersed fiber strands.

                                 LAW AND ANALYSIS

   Ruling 1

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

must be derived from, among other sources, rents from real property. Section 856(c)(3)
provides that at least 75 percent of a REIT's gross income must be derived from, among
other sources, rents from real property.

    Section 856(d)(1) provides that "rents from real property" include (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 the 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 856(d)(2)(C) provides that any impermissible tenant service income is

excluded 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 the REIT for services
furnished or rendered by the REIT to tenants at the property, or for managing or
operating the property.

  Section 856(d)(7)(C) provides as exceptions from impermissible tenant service

income (i) 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 taxable REIT subsidiary of the REIT shall not be treated as

PLR-117352-20 7

furnished, rendered, or provided by the REIT, and (ii) there shall not be taken into
account any amount 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) of the Income Tax Regulations 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 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 the
occupant's 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, and there shall not be
taken into account any amount 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 1.856-4(a) defines the term “rents from real property” generally as the

gross amounts received for the use of, or the right to use, real property of the REIT.
Section 1.856-4(b)(1) provides that 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
tenants of a particular building will be considered as customary if, in the geographic
market in which the building is located, tenants in buildings of similar class are
customarily provided with the service. Where it is customary, in a particular geographic
marketing area, to furnish electricity or other utilities to tenants in buildings of a
particular class, the submetering of utilities to tenants in such buildings will be
considered a customary service.

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

required to delegate or contract out their fiduciary duty to manage the trust 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
trust itself. For example, the trustees or directors may establish rental terms, choose

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tenants, enter into and renew leases, and deal with taxes, interest, and insurance
relating to the trust’s property. The trustees may also make capital expenditures with
respect to the trust’s property (as defined in section 263) and may make decisions as to
repairs of the trust’s property (of the type that would be deductible under section 162),
the cost of which may be borne by the trust. See also Rev. Rul. 67-353, 1967-2 C.B.
252.

   Taxpayer represents that the Real Property Assets are real property for purposes

of section 856. Under each of the six types of Agreements, the Tenant has the right to
use or to occupy space on the Real Property Assets. Each of the six types of
Agreements typically involves a term of a years to b years, and no Agreement is for less
than c years. Each Agreement requires a fixed, recurring amount to be paid by the
Tenant during the term of the Agreement. In addition, under DAS Agreements, as well
as under certain IRUs and Capacity Leases, the Tenant generally pays an upfront
amount in addition to a recurring amount. The Tenant is required to pay for the
contracted usage, regardless of the Tenant’s actual usage, and Taxpayer ensures that
the Tenant has access to its contracted usage during the terms of an Agreement.
Taxpayer represents that it will not receive any amounts under any Agreement that is
based on a percentage of the income or profits of a Tenant, or any other person.
Accordingly, amounts received by Taxpayer for the right to use or to occupy space on
the Real Property Assets qualify as "rents from interests in real property" under section
856(d)(1)(A).

  Taxpayer represents that the DAS Equipment and the Signal Equipment are

personal property. Taxpayer further represents that the value of any personal property
leased under the terms of an Agreement will not exceed 15% of the value of the real
and personal property leased under the Agreement.

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

Tenant under each of the six types of Agreements is a service that is customarily
furnished to tenants of Real Property Assets of a similar class to that of Taxpayer in the
same geographic area, and except for the provision of electricity, are performed by
either a TRS or an IK. Additionally, Taxpayer represents that Taxpayer’s performance
of the activities described above represents an exercise of the fiduciary duties of
Taxpayer’s directors in accordance with section 1.856-4(b)(5)(ii), and are not services
rendered to a Tenant in connection with the rental of real property. Therefore, the
furnishing of services listed above that are performed by either a TRS or an IK to
Tenants and the performance of the activities described above by Taxpayer under each
of the six types of Agreements detailed above does not give rise to impermissible tenant
service income, and will not cause any portion of the rents received by Taxpayer from
Tenants for use of Taxpayer’s Real Property Assets to fail to qualify as “rents from real
property” under section 856(d).

   Ruling 2

PLR-117352-20 9

   Section 856(d)(2)(B) provides that the term “rents from real property” does not

include any amount received or accrued directly or indirectly from any person if the
REIT owns, directly or indirectly, in the case of any person which is a corporation, stock
of such person 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 person.

     Section 856(d)(8) provides that amounts paid to a REIT by a TRS of such REIT

shall not be excluded from “rents from real property” by reason of section 856(d)(2)(B)
if, with respect to any property, at least 90 percent of the leased space of the property is
rented to persons other than TRSs of such trust and other than persons described in
section 856(d)(2)(B). The rents shall not be excluded only to the extent that the
amounts paid to the REIT as “rents from real property” are substantially comparable to
such rents paid by the other tenants of the REIT’s property for comparable space.

    Taxpayer represents that in certain circumstances Taxpayer will lease capacity

to its TRS. Taxpayer represents that the capacity leased to its TRS under an
Agreement will be the same type of capacity that is leased to unrelated third parties
under the Agreements. Taxpayer represents that the capacity leased to the TRS and to
unrelated persons under the Agreements is measured within the applicable Area, based
on the methodology as described above. Accordingly, for purposes of the limited rental
exception under section 856(d)(8)(A), the property with regard to Taxpayer’s fiber optic
cable is the continuously connected fiber optic cable within the geographic boundaries
of the applicable Area.

                                  CONCLUSION

  Based on the information submitted and representations made by Taxpayer and

subject to section 856(d)(1)(C), we rule as follows:

   (1) Amounts received by Taxpayer from Tenants for the use of Taxpayer’s Real
       Property Assets and personal property leased pursuant to section
       856(d)(1)(C) qualify as “rents from real property” for purposes of sections
       856(c)(2) and 856(c)(3) of the Code. Furthermore, the furnishing of the
       services listed above that are performed by either a TRS or an IK and the
       performance of the activities described above do not give rise to
       impermissible tenant service income, and will not cause any portion of the
       rents received by Taxpayer under each of the six types of Agreements to fail
       to qualify as “rents from real property” under section 856(d).

   (2) For purposes of the limited rental exception under section 856(d)(8)(A), the
       property with regard to Taxpayer’s fiber optic cable is the continuously
       connected fiber optic cable within the geographic boundaries of the applicable
       Area.

PLR-117352-20 10

    This ruling's application is limited to the facts, representations, Code sections,

and regulations cited herein. 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
concerning whether Taxpayer’s Real Property Assets are real property for purposes of
section 856, whether services are of the type that are customarily furnished to tenants
of real property of a similar class to that of Taxpayer in the same geographic area, or
whether the income attributable to the personal property leased in connection with such
real property does not exceed 15 percent of the total rent under that lease. Additionally,
no opinion is expressed concerning whether Taxpayer otherwise qualifies as a REIT
under subchapter M, part II of Chapter 1 of the Code.

    Furthermore, the ruling herein related to whether income from services and

activities performed by Taxpayer is impermissible tenant service income 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.”

   The ruling contained in this letter is based upon information submitted and

representations made by Taxpayer and accompanied by statements executed under the
penalties of perjury by appropriate parties. While this office has not verified any of the
material submitted in support of the request for rulings, it is subject to verification on
examination.

   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 terms of a power of attorney on file in this office, copies of

this letter are being sent to your authorized representatives.

                                               Sincerely,

                                               ______________________
                                               K. Scott Brown
                                               Branch Chief, Branch 3
                                               Office of the Associate Chief Counsel
                                               (Financial Institutions & Products)

PLR-117352-20 11

Enclosure:
Copy for section 6110 purposes

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