IRS rules that a REIT's fees from oil-storage terminals and pipelines qualify as rents from real property

Plain-English summary

A company that invests in energy infrastructure (petroleum storage terminals and pipelines) planned to elect to be taxed as a real estate investment trust (REIT). To keep REIT status, at least 95 percent and 75 percent of a REIT's gross income must come from qualifying sources such as "rents from real property" under Internal Revenue Code § 856. The company asked the IRS to confirm that three streams of income, storage fees from terminal users, wharfage fees it collects and passes through to a port authority, and pipeline use fees, count as rents from real property. The IRS said yes. The fees are paid for the use of real property (tanks, docks, and pipelines that qualify as land, inherently permanent structures, or their components), the fees do not depend on the users' income or profits, and the rent tied to any personal property stays within the 15 percent limit. The company also structured its operations so that it performs only landlord-type activities (design, maintenance, safety testing, security, and the like), while a taxable REIT subsidiary handles everything else, so the arrangement does not generate "impermissible tenant service income." The IRS cautioned that it was not ruling on whether the company actually qualifies as a REIT or whether the assets are in fact real property, and it warned that the same services could produce taxable income for a tax-exempt organization under the different unrelated-business-income rules of § 512(b)(3). This is a common type of "check the income box" ruling that REITs get before launching.

Ruling snapshot

• Question: Do the storage fees, wharfage fees, and pipeline use fees a REIT receives from energy-infrastructure assets qualify as rents from real property under § 856(d) for the 95 percent and 75 percent income tests?
• Outcome: approved (all three fee streams qualify as rents from real property under § 856(d))
• Key authorities: IRC §§ 856(c)(2) and (3), 856(d), 512(b)(3), 511(a)(2); Treas. Reg. §§ 1.856-4, 1.856-10, 1.512(b)-1(c)(5); Rev. Rul. 73-426; Rev. Rul. 67-353

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202150014 Third Party Communication: None
Release Date: 12/17/2021 Date of Communication: Not Applicable
Index Number: 856.01-00, 856.04-00
Person To Contact:
------------------------------ --------------------------, ID No. ----------------
--------------------------------------------------------- Telephone Number:
--------- -------------------
------------------------------ Refer Reply To:
------------------------ CC:FIP:B02
------------------------------------ PLR-126310-20
-------------------------- Date:
-------------------------- May 14, 2021

Legend

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

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

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

Facility A = --------------------------------------------------------------------------------

Facility B = ----------------------------------

Pipeline A = ------------

Pipeline B = -------

Port = -----------------------------

Port Authority = -----------------------------------------

Product = ------------

a = --

b = ---

c = ----------

d = ---

e = -----

f = --

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

    This letter responds to a letter dated November 12, 2020, and subsequent

submissions, requesting a ruling on behalf of Taxpayer. Taxpayer requests a ruling that
amounts received by Taxpayer from unrelated third parties for the use of certain real
property assets described below qualify as rents from real property under section 856(d)
of the Internal Revenue Code (the Code) for purposes of sections 856(c)(2) and (3).

                                      FACTS

   Taxpayer was formed as a State limited liability company on Date, and is

currently disregarded for U.S. federal income tax purposes. Taxpayer intends to elect
to be taxed as a real estate investment trust (REIT) under sections 856 through 859 of
the Code. Taxpayer principally invests in U.S. energy infrastructure assets, including
storage terminal facilities and pipelines, as described below. Taxpayer currently holds
its assets through entities that are disregarded for U.S. federal income tax purposes.
Taxpayer intends to make a joint election with a subsidiary to treat it as a taxable REIT
subsidiary (TRS).

A. Storage Terminal Facilities

    Taxpayer owns two ------------storage terminal facilities, Facility A and Facility B

(each, a Storage Terminal Facility). The Storage Terminal Facilities include various
interests in or rights to occupy land, driveways, roadways, docks, rail spurs, dikes,
fencing, loading/unloading facilities, and storage tanks. The Storage Terminal Facilities
also include other types of real property, including pipes, pipelines, and other inherently
permanent steel structures (for example, racks or docks) and structural components of
inherently permanent structures (for example, vents or fire suppression systems).
Facility A includes waterfront located in the Port with stationary wharves and docks for --
--- tankers. Taxpayer represents that all of the assets described above are either land,
interests in land, inherently permanent structures, or structural components of an
inherently permanent structure within the meaning of section 1.856-10 of the Income
Tax Regulations.

    Taxpayer enters into agreements with unrelated third-party users of the Storage

Terminal Facility (Storage Terminal Users) permitting Storage Terminal Users to store
their products at, and move their products through, the Storage Terminal Facility for a
term that is generally between a and b years, and in no event less than c (Terminal
Usage Agreements). Taxpayer represents that, with respect to each Terminal Usage
Agreement, rent attributable to pumps, compressors, meters, or other personal property
that is leased under, or in connection with, the lease of the Storage Terminal Facility
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 agreement.

    A Terminal Usage Agreement may or may not specify the tank in which the

Storage Terminal User's product will be stored. In some cases, a specified tank or
tanks is identified and dedicated to a Storage Terminal User. In other cases, the
Storage Terminal User has a right to a fixed portion of the storage capacity at the
Storage Terminal Facility but does not have a particular tank or tanks dedicated to it.
Taxpayer does not oversell storage capacity and is obligated at all times to ensure that
the capacity specified in a Terminal Usage Agreement is reserved for and available to
the Storage Terminal User. A Terminal Usage Agreement may provide for the lease of
a portion of the capacity of a storage tank, as opposed to a lease of the entire storage
tank, when the stored content is fungible and may be stored on a comingled basis. At
all times, the Storage Terminal Users retain title to the product stored at the Storage
Terminal Facility.

    Taxpayer will only undertake activities with respect to the Storage Terminal

Facilities that are consistent with its fiduciary duty to manage itself. Taxpayer will
design, construct, inspect, maintain, and repair storage tanks and other real property
assets located at each Storage Terminal Facility. Taxpayer will also paint and repair the
storage tanks to prevent atmospheric corrosion or excessive wear and tear, and test
product in the storage tanks to verify that it is the product specified in the Terminal
Usage Agreement solely to ensure the safety and integrity of the storage tanks and the
environment.

   Taxpayer will also provide electricity to light the Storage Terminal Facilities and

provide security, including monitoring through security cameras and the provision of
security guards, at the Storage Terminal Facilities. Additionally, Taxpayer may heat,
cool, or pressurize the storage tanks located at a Storage Terminal Facility and may
circulate product stored in a storage tank. Such heating, cooling, pressurization, or
circulation1 is performed only when it is necessary to avoid damage to the storage
tanks, pipes, and stored product (for example, so the stored product does not congeal in
the storage tanks) and to make storing a product more efficient (for example, to keep a
product like Product in a liquid state). Taxpayer represents that it is customary for
storage tanks to be designed with the foregoing systems and that the heating, cooling,

1 Circulation is separate and apart from the blending of two products as requested by a Storage Terminal

User. Circulation is performed to minimize the accumulation of sediment deposits on the storage tank
floor in order to protect the storage tanks from the build-up of sediment.

pressurization, or circulation will be applied, as necessary, at standard industry settings
depending on the product stored therein, will not be customized for an individual
Storage Terminal User, and that the systems are not provided primarily for the
convenience of a particular Storage Terminal User. Further, Taxpayer represents that
these services are necessary for the passive storage of the relevant products.

   A TRS will perform all other activities and services. These services will include

connecting and disconnecting loading lines and moving product, capturing and burning
off vapors that are displaced when product is loaded into vessel storage tanks, adding
agents or additives to product in a storage tank for the benefit of a Storage Terminal
User, taking samples of product in a storage tank for the benefit of a Storage Terminal
User, and measuring or weighing product for the benefit of a Storage Terminal User.
On rare occasions, the TRS may also move different types of products owned by a
Storage Terminal User into a single tank, which effects a blending of the different
products. The TRS will monitor, operate, manage, and repair pumps, compressors,
meters, and other personal property. The TRS will receive arm's length compensation
from Taxpayer for the performance of these services.

   Taxpayer represents that, consistent with section 1.856-4(b)(1), all services

furnished to the Storage Terminal Users are customarily provided to tenants of similar
properties in the geographic market in which the Storage Terminal Facility is located.

   A Terminal Usage Agreement provides that storage tank capacity for a specified

minimum volume of product will be reserved for the Storage Terminal User. Under the
Terminal Usage Agreement, the fee paid by a Storage Terminal User (the Storage Fee)
is paid on a monthly basis, is based on volume, and is generally calculated as a fixed
dollar amount multiplied by the amount of product stored and handled at the Storage
Terminal Facility. The fixed dollar amount per barrel may decrease if and when product
stored for a particular Storage Terminal User exceeds an agreed upon minimum volume
commitment for the month. The Storage Terminal User pays for the minimum volume of
product each month regardless of whether it uses the capacity reserved for it.
Taxpayer represents that the Storage Fee does not depend, in whole or in part, on the
income or profits of any person.

   Taxpayer entered into an easement (the Easement) with respect to submerged

land owned by the Port Authority allowing Taxpayer to construct, maintain, repair, and
operate a wharf, dock, or similar structure on the submerged land. In consideration for
the Easement, Taxpayer is required to pay the Port Authority a wharfage fee (the
Wharfage Fee) based on the amount of product loaded or unloaded at its facility.
Pursuant to the Terminal Usage Agreements, Taxpayer collects the Wharfage Fee from
the Storage Terminal Users and passes it on to the Port Authority without a mark-up.
For tax purposes, Taxpayer includes the amounts it collects as Wharfage Fees in its
gross income and deducts the Wharfage Fees it pays to the Port Authority.

B. Pipelines

   Taxpayer owns a d percent equity interest in a long-haul ----------- pipeline

(Pipeline A) and a e percent equity interest in a short-haul ----------- pipeline (Pipeline B)
(each, a Pipeline). Taxpayer represents that the Pipelines are inherently permanent
structures under section 1.856-10.

    Taxpayer enters into agreements for the use of the Pipelines with unrelated third-

parties (Pipeline Users). Each agreement to use a Pipeline is for a term that is
generally between a and b years, and in no event less than c (Pipeline Use
Agreements). Taxpayer represents that, with respect to each Pipeline Use Agreement,
rent attributable to pumps, compressors, meters, or other personal property that is
leased under, or in connection with, the lease of the Pipeline 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 agreement. Taxpayer does not
oversell capacity on the Pipeline and is obligated at all times to ensure that the capacity
specified in a Pipeline Use Agreement will be available for use by the Pipeline User.

   The capacity of Pipeline B is currently substantially committed to a particular

Pipeline User under a b year Pipeline Use Agreement, and it is possible that the
remaining capacity of Pipeline B may be used by other Pipeline Users from time to time.
To date, the remaining Pipeline B capacity has been reserved by only one other
Pipeline User under a Pipeline Use Agreement with a duration of f months. Upon the
expiration of the current b year Pipeline Use Agreement, Taxpayer intends to enter into
another long-term Pipeline Use Agreement or Agreements with the same and/or other
Pipeline Users. Taxpayer will treat as rents from real property only those Pipeline Use
Fees (defined below) earned under Pipeline Use Agreements with a term of at least c.

   Taxpayer will only undertake activities with respect to the Pipelines that are

consistent with its fiduciary duty to manage itself. Taxpayer will design, construct,
inspect, monitor, maintain, and repair the Pipelines. Taxpayer will mark the location of
the Pipelines to minimize the possibility of damage due to digging by unrelated third
parties. Taxpayer may also test product as it enters a Pipeline to verify that it is the
product specified in the Pipeline Use Agreement solely to ensure the safety and integrity
of the Pipeline and the environment.

   A TRS will perform all other activities and services, including scheduling use of

the Pipeline by the Pipeline Users. The TRS will monitor, operate, manage, maintain,
and repair pumps, compressors, meters, and other personal property. The TRS will
receive arm's length compensation from Taxpayer for the performance of these
services.

   Taxpayer represents that, consistent with section 1.856-4(b)(1), all services

furnished to the Pipeline Users are customarily provided to tenants of similar properties
in the geographic market in which the Pipeline is located.

    The fee paid by a Pipeline User (the Pipeline Use Fee) is paid on a monthly

basis, is based on the volume of product placed on the Pipeline, and is generally
calculated as a fixed dollar amount multiplied by the amount of product placed on the
Pipeline. The fixed dollar amount per volumetric measure (i) may change depending
upon the volume of the Pipeline User's product flowing through the Pipeline and/or the
origin point where the product is placed on the Pipeline and (ii) may increase
periodically under the terms of the Pipeline Use Agreement by an agreed upon amount
and/or based on the consumer price index or some other benchmark that measures
inflation. The Pipeline User pays for the minimum volume of product each month that is
specified in its Pipeline Use Agreement regardless of whether it uses the capacity
reserved for it. Taxpayer represents that the Pipeline Use Fee does not depend, in
whole or in part, on the income or profits of any person.

                              LAW AND ANALYSIS

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)(A) provides that, subject to certain exceptions, rents from real

property does not include any amount received or accrued, directly or indirectly, with
respect to any real or personal property, if the determination of such amount depends in
whole or in part on the income or profits derived by any person from such property
(except that any amount so received or accrued will not be excluded from rents from
real property solely by reason of being based on a fixed percentage or percentages of
receipts or sales).

   Section 856(d)(2)(C) provides that any impermissible tenant service income is

excluded from 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 the tenants of the property, or for managing or operating such
property.

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

service income. 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)(7)(C)(ii) provides that impermissible tenant service income does

not include 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 1.856-4(a) defines "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, for purposes of sections 856(c)(2) and (3),

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 as
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. To qualify as a service customarily furnished, the service
must be furnished or rendered to the tenants of the REIT or, primarily for the
convenience or benefit of the tenants, to the guests, customers, or subtenants of the
tenants.

    Section 1.856-4(b)(5)(ii) provides that the trustees or directors of the 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, including establishing rental terms, choosing tenants, entering into renewal
of leases, and dealing with taxes, interest, and insurance relating to the REIT's property.
The trustees may also make capital expenditures with respect to the REIT's property
(as defined in section 263) and may make decisions as to repairs of the REIT's property
(of the type that would be deductible under section 162), the cost of which may be
borne by the REIT. See also Rev. Rul. 67-353, 1967-2 C.B. 252.

   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
courts or motels, or for the use or occupancy of space in parking lots, warehouses, or
storage garages, do not constitute rents 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.

    Revenue Ruling 73-426, 1973-2 C.B. 223, provides that if a REIT obligates a

lessee under the terms of the lease agreement to pay the amount of state and local real
property taxes imposed on the REIT's property, such amount is for the use of, or right to
use the property, and, therefore, constitutes additional rental income to the REIT and
qualifies as rents from real property within the meaning of section 856(d).

    Taxpayer represents that the Storage Terminal Facilities and the Pipelines are

real property for purposes of section 856. The Terminal Usage Agreements and the
Pipeline Use Agreements will typically have a term of a to b years. No Terminal Usage
Agreement or Pipeline Use Agreement will have a term of less than c. Each of the
Terminal Usage Agreements and the Pipeline Use Agreements will provide the user
with the exclusive right to use a fixed portion of the capacity of the Storage Terminal
Facilities or the Pipelines throughout the term of the lease. Taxpayer represents that
the Storage Fee and the Pipeline Use Fee do not depend, in whole or in part, on the
income or profits of any person. Further, the Wharfage Fee is an amount received by
Taxpayer for the use of Taxpayer's wharves and docks that Taxpayer must pay the Port
Authority and is analogous to the state and local real property taxes in Revenue Ruling
73-426. Accordingly, each of the Storage Fee, Wharfage Fee, and Pipeline Use Fee is
an amount received for the use of, or the right to use, real property of Taxpayer and
qualifies as rents from interests in real property under section 856(d)(1)(A).

    With respect to the Pipelines, Taxpayer represents that it will only undertake

activities that are consistent with its fiduciary duty to manage itself and that a TRS will
perform all other activities and services. With respect to the Storage Terminal Facilities,
Taxpayer will only undertake activities that are consistent with its fiduciary duty to
manage itself or that would produce 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), and a TRS will perform all other activities and services.
In connection with the Storage Terminal Facilities, the heating, cooling, or pressurization
of the storage tanks and the circulation of product stored in a storage tank is performed
only when it is necessary to avoid damage to the storage tanks and pipes, to make
storing a product more efficient; and is necessary for the passive storage of the relevant
products. Such heating, cooling, pressurization, or circulation is applied at standard
industry settings depending on the product stored and is not tailored to the needs of
individual Storage Terminal Users. Such heating, cooling, pressurization, or circulation
is not provided primarily for the convenience of a particular Storage Terminal User.
Therefore, the activities and services performed by Taxpayer and by a TRS detailed in
the Facts section of this letter do not give rise to impermissible tenant service income.
Taxpayer represents that all services furnished to the Storage Terminal Users are
customarily provided to tenants of similar properties in the geographic market in which
the Storage Terminal Facility is located, and that all services furnished to the Pipeline
Users are customarily provided to tenants of similar properties in the geographic market
in which the Pipeline is located.

   Taxpayer represents that, with respect to each Terminal Usage Agreement and

each Pipeline Use Agreement, rent attributable to personal property that is leased
under, or in connection with, the lease of the Storage Terminal Facility or the Pipeline
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 agreement.

                                 CONCLUSION

    Based on the facts submitted and representations made, we conclude that the

Storage Fee, Wharfage Fee, and Pipeline Use Fee received by Taxpayer qualify as
rents from real property under section 856(d) for purposes of sections 856(c)(2) and (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. In particular, we express no opinion regarding whether
Taxpayer otherwise qualifies as a REIT under part II of subchapter M of chapter 1 of the
Code. Additionally, no opinion is expressed regarding whether any assets are real
property for purposes of section 856, any amount received by Taxpayer depends on the
income or profits of any person, any activities are fiduciary duties to manage the REIT
itself, any services are customarily provided to tenants of similar properties in the same
geographic market, or any income attributable to personal property leased in connection
with real and personal property does not exceed 15 percent of the total rent under
section 856(d)(1)(C).

    Furthermore, the ruling herein related to whether income from services

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 service may have unrelated business taxable income because the
income may not be excluded under section 512(b)(3) as rents from real property.

  This letter ruling is directed only to the taxpayer who requested it. Section

6110(k)(3) provides that it may not be used or cited as precedent.

    In accordance with the power of attorney on file with this office, a copy of this

letter ruling is being sent to your authorized representatives.

                                       Sincerely,


                                       ___________________________
                                       Andrea M. Hoffenson
                                       Chief, Branch 2
                                       Office of Associate Chief Counsel
                                       (Financial Institutions & Products)

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