The IRS rules a REIT's state brownfield redevelopment credits count as a good asset and as qualifying income

Plain-English summary

A company that will elect to be a real estate investment trust (REIT) is cleaning up and redeveloping a contaminated "brownfield" site to lease to unrelated tenants. Under a state cleanup program, its remediation and construction spending earns state "brownfield redevelopment" tax credits, and because the credits are expected to exceed the company's state income tax, the excess is refundable in cash. REITs must pass strict asset and income tests: at least 75 percent of assets must be real estate, cash, and receivables, and most gross income must come from real-estate sources like rents. The company worried the credits might not fit either test, so it asked the IRS two questions. The IRS ruled that the right to receive the credits is a "receivable" arising in the ordinary course of the REIT's leasing business (not purchased from someone else), so it is a good asset for the 75 percent asset test. And using its authority under section 856(c)(5)(J)(ii), the IRS ruled that income from receiving or accruing the credits will be treated as qualifying income for the 95 percent and 75 percent income tests, because the company intends to lease the site for rents and expects substantially all of the site's income to qualify. The rulings are conditioned on the company actually leasing the site to generate qualifying income. This lets a REIT pursue environmental redevelopment incentives without those credits tripping the REIT qualification tests.

Ruling snapshot

• Question: Are a REIT's state brownfield redevelopment credits a "receivable" asset under § 856(c)(4), and is income from the credits "qualifying income" under § 856(c)(2)-(3) via § 856(c)(5)(J)(ii)?
• Outcome: approved (both rulings granted, conditioned on leasing the site for substantially all qualifying income)
• Key authorities: IRC § 856(c)(2), (3), (4)(A), (5)(J); Treas. Reg. §§ 1.856-2(d)(1), (3), 1.856-10; H.R. Rep. No. 2020, 86th Cong., 2d Sess. (1960)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202305009 [Third Party Communication:
Release Date: 2/3/2023 Date of Communication: Month DD, YYYY]
Index Number: 856.01-00
Person To Contact:
----------------------------------------------- -------------------, ID No. -----------------
------------------------------------- Telephone Number:
---------------------------------------- ---------------------
---------------------------------- Refer Reply To:
CC:FIP:B01
PLR-110040-22
Date:
November 09, 2022

Legend:

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

Subsidiary = ---------------------------------------

Site = --------------------------------------------------------------
-------------------------------

Project = ---------------------------------------------------------------------------- ----
----------------------------------

State A = -------------

State B = -------------

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

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

Year 1 = -------

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

   This is in reply to a letter dated May 19, 2022. Taxpayer has requested rulings

with respect to its status as a real estate investment trust ("REIT") under § 856 of the
Internal Revenue Code (the "Code"). Specifically, Taxpayer has asked for the following
rulings:

     (1) The right to receive the Brownfield Credits (defined below) will be considered
     a "receivable" or other asset of taxpayer described in § 856(c)(4)(A); and

     (2) Pursuant to § 856(c)(5)(J)(ii), any gross income of Taxpayer arising from the
     receipt or accrual of the Brownfield Credits will be considered qualifying income
     for purposes of § 856(c)(2) and (3).

Facts:

    Taxpayer is a limited liability company formed under the laws of State A that will

elect to be a REIT for the taxable year ending Date 1. Taxpayer wholly owns
Subsidiary, a State A limited liability company that is a disregarded entity for Federal
income tax purposes.

   Taxpayer, through Subsidiary, owns Site, which is in State B. Taxpayer will

redevelop Site for Project. Taxpayer and Subsidiary will incur significant expenditures in
connection with the remediation of adverse environmental conditions at Site and with
the rehabilitation and development of Site. Taxpayer represents that these
expenditures are for the remediation, rehabilitation, or development of property that is
real property within the meaning of § 1.856-10 of the Income Tax Regulations.

   Taxpayer submitted an application under a State B brownfield cleanup program,

which was approved on Date 2. As a result of Taxpayer's remediation, rehabilitation,
and development of Site, Taxpayer is eligible for certain brownfield redevelopment tax
credits (the "Brownfield Credits"). The amount of the Brownfield Credits is a percentage
of the costs of (1) site preparation, (2) certain tangible property (including buildings and
structural components placed in service at Site), and (3) on-site groundwater
remediation. Taxpayer expects the Brownfield Credits to exceed Taxpayer's State B
income tax liability. Taxpayer represents that, under State B law, the excess is treated
as an overpayment of tax and that Taxpayer will elect to receive a refund of the
overpayment.

   Taxpayer represents that the right to receive the Brownfield Credits is properly

treated as a receivable on Taxpayer's balance sheet under generally accepted
accounting principles ("GAAP"). The Brownfield Credits are allowable and refundable
only with respect to Taxpayer's State B income tax liability and are not abatements or
refunds of taxes on real property under State B law.

   Project is expected to be completed in Year 1 or later. Upon completion,

Taxpayer represents that Taxpayer, acting through Subsidiary, intends to lease space
at the Site to third parties not related to taxpayer as described in § 856(d)(2)(B) in order
to generate income that will qualify as rents from real property for purposes of
§ 856(c)(2) and (3). Taxpayer represents that it expects substantially all of the income
derived from the Site (other than income arising from the receipt or accrual of the
Brownfield Credits) to be qualifying income for purposes of § 856(c)(2) and (3).

Law and Analysis:

Asset Test

    Section 856(c)(4)(A) provides that, in order for a corporation to qualify as a REIT

for a taxable year, at the close of each quarter of the taxable year, at least 75 percent of
the value of the corporation's total assets must be represented by real estate assets,
cash and cash items (including receivables), and Government securities.

   Section 1.856-2(d)(1) of the Income Tax Regulations defines the term

"receivables" for purposes of § 856(c)(4)(A) to mean only those receivables that arise in
the ordinary course of a REIT's operation, excluding receivables purchased from
another person.

   Section 1.856-2(d)(3) provides that in determining the investment status of a

REIT, the term "total assets" means the gross assets of the REIT determined in
accordance with GAAP.

    Taxpayer will not purchase the Brownfield Credits from another person. The

right of Taxpayer to receive the Brownfield Credits arises from the development of real
property on land in connection with the leasing business of Taxpayer and Subsidiary.
Therefore, the right is a receivable that arises in the ordinary course of Taxpayer's
operations within the meaning of § 1.856-2(d)(1).

Income Tests

   Section 856(c)(2) provides that in order for a corporation to qualify as a REIT for

a taxable year, at least 95 percent of the corporation's gross income (excluding gross
income from prohibited transactions) must be derived from certain enumerated sources,
which include dividends, interest, rents from real property, gain from the sale or other
disposition of stock, securities, and real property (other than property in which the
corporation is a dealer), abatements and refunds of taxes on real property, income and
gain derived from foreclosure property, and certain commitment fees.

   Section 856(c)(3) provides that in order for a corporation to qualify as a REIT for

a taxable year, at least 75 percent of the corporation's gross income (excluding gross
income from prohibited transactions) must be derived from certain enumerated sources,
which include rents from real property, interest on obligations secured by real property,
gain from the sale or other disposition of real property (other than property in which the
corporation is a dealer), distributions on and gain from the sale of REIT stock,
abatements and refunds of taxes on real property, income and gain derived from
foreclosure property, certain commitment fees, and qualified temporary investment
income.

   Section 856(c)(5)(J) provides that to the extent necessary to carry out the

purposes of part II of subchapter M of chapter 1 of the Code, the Secretary is authorized
to determine, solely for purposes of such part, (i) whether any item of income or gain
that does not otherwise qualify under § 856(c)(2) or (3) may be considered as not
constituting gross income for purposes of § 856(c)(2) or (3), or (ii) whether any item of
income or gain that otherwise constitutes gross income not qualifying under § 856(c)(2)
or (3) may be considered as gross income that qualifies under § 856(c)(2) or (3).

   Legislative history indicates that Congress intended part II of subchapter M to

apply to certain "organizations specializing in investments in real estate and real estate
mortgages." H.R. Rep. No. 2020, 86th Cong., 2d Sess. 4 (1960), 1960-2 C.B. 819, 820.
Congress intended to restrict the beneficial tax treatment of part II of subchapter M to
"what is clearly passive income from real estate investments, as contrasted to income
from the active operation of businesses involving real estate." Id.

   Income attributable to the receipt or accrual of the Brownfield Credits is not

derived from any source listed in § 856(c)(2) or (3). Pursuant to § 856(c)(5)(J), the
Secretary has the authority to determine that the income attributable to the receipt or
accrual of the Brownfield Credits be considered as qualifying gross income under those
provisions. On the basis of all of the facts and circumstances, including Taxpayer's
representations that it intends to lease Site to generate rents from real property and that
it expects substantially all of the income generated by Site to be qualifying income for
purposes of § 856(c)(2) and (3), treating the income attributable to the receipt or accrual
of the Brownfield Credits as qualifying income is consistent with the purposes of part II
of subchapter M.

Conclusion:

   We hereby rule as follows:

   (1) Taxpayer's right to receive the Brownfield Credits, to the extent the right is an
   asset under GAAP, is a receivable for purposes of § 856(c)(4); and

   (2) Pursuant to § 856(c)(5)(J)(ii), Taxpayer's income attributable to the receipt or
   accrual of the Brownfield Credits is considered qualifying income for purposes of
   § 856(c)(2) and (3).

   The rulings in this letter are conditioned upon the lease of Site by Taxpayer to

derive income substantially all of which is qualifying income to Taxpayer, consistent with
Taxpayer's represented expectation.

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

and regulations cited herein. Except as specifically ruled upon above, no opinion is
expressed concerning any Federal income tax consequences related to the facts herein
under any other provisions of the Code. Specifically, we express no opinion whether
Taxpayer's right to receive the Brownfield Credits is an asset under GAAP or whether
Taxpayer qualifies as a REIT under part II of subchapter M of chapter 1 of the Code.

   This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)

provides that it may not be used or cited as precedent. In accordance with the
provisions of a Power of Attorney on file, we are sending a copy of this letter ruling to
your authorized representatives.

  The rulings contained in this letter are based upon information and

representations submitted by the taxpayer and accompanied by a penalty of perjury
statement executed by an appropriate party. Although this office has not verified any of
the material submitted in support of the request for rulings, it is subject to verification on
examination.

                                    Sincerely,



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



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