Forest carbon-offset issuance produced qualifying REIT income

Plain-English summary

A company planning to elect real estate investment trust status owned commercial forestland and proposed a project that would generate carbon offsets through improved forest management. The project required long-term restrictions on harvesting and other uses of the land, and the taxpayer would include the fair market value of offsets in income when issued. The IRS viewed the offset issuance as similar to payment for granting a term easement over real property. It ruled that, unless section 451(b)(1)(A) required earlier inclusion, the income would accrue when the offsets were first earned, received, or due. It also used its section 856(c)(5)(J)(ii) authority to treat income from issuance of the offsets as qualifying income for both REIT gross-income tests, but it did not rule that income from later sales of the offsets would qualify.

Ruling snapshot

• Question: When would forest carbon-offset issuance income accrue, and would that issuance income qualify for the REIT gross-income tests?
• Outcome: approved, accrual occurs at the earliest specified event and issuance income qualifies under both REIT income tests
• Key authorities: IRC §§ 451, 856(c)(2), 856(c)(3), 856(c)(5)(J)(ii); Treas. Reg. §§ 1.856-3, 1.856-4, and 1.856-10

Full text (IRS public release)

 Internal Revenue Service                                 Department of the Treasury
                                                          Washington, DC 20224

 Number: 202401011                                        Third Party Communication: None
 Release Date: 1/5/2024                                   Date of Communication: Not Applicable
 Index Number: 856.00-00
                                                          Person To Contact:
 ------------                                             --------------, ID No. -----------------
 ------------------------                                 Telephone Number:
 -------------------------------                          --------------------
 -------------------------                                Refer Reply To:
 --------------------                                     CC:FIP:B03
                                                          PLR-107822-23
                                                          Date:
                                                          October 6, 2023




Legend

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

Registry                           =   -----------------------------------

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

Intermediary                       =   ---------------------------------------------------------

Agreement                          =   ----------------------------------------------------------------

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

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

State C                            =   --------------

a                                  =   -----------

b                                  =   ---

c                                  =   ---


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

      This responds to a letter dated April 4, 2023, and subsequent correspondence,
submitted on behalf of Taxpayer. Taxpayer intends to elect to qualify to be taxed as a

PLR-107822-23                                 2

real estate investment trust (“REIT”) under § 856 of the Internal Revenue Code
(“Code”). For purposes of its status as a REIT under § 856, Taxpayer requests certain
rulings regarding the treatment of income from Registry’s anticipated issuance of the
Offsets (defined below) to Taxpayer in exchange for Taxpayer agreeing to the
restrictions in the Agreement:

       (1) Unless § 451(b)(1)(A) requires earlier inclusion, income with respect to
       the issuance of the Offsets accrues under § 451 upon the earliest of the
       following events to occur: the Offsets are earned, the Offsets are received,
       or the Offsets are due; and

       (2) Pursuant to § 856(c)(5)(J)(ii), income from the issuance of the Offsets
       will be considered qualifying income under § 856(c)(2) and (c)(3).

                                          FACTS

       Taxpayer is a State A limited liability company that intends to elect to be taxed as
a REIT for federal income tax purposes. Taxpayer will adopt the calendar year as its
annual accounting period and an accrual method of accounting as its overall method for
federal income tax purposes.

       Taxpayer wholly owns Subsidiary, a State A limited liability company that is
disregarded as separate from Taxpayer for federal income tax purposes. Taxpayer
owns approximately a acres of commercial forestland in State B and State C.
Subsidiary is expected to hold title to some of this property (the “Site”). The Site will
qualify as real property within the meaning of § 856, and substantially all of the Site will
be land, including unsevered natural products of the land (e.g., trees), within the
meaning of § 1.856-10(c) of the Income Tax Regulations.

       Registry is a greenhouse gas registry and emissions tracking system used by
members to transparently register project-based verified emissions reductions and
removals as serialized offsets and to record the issuance, retirement, and cancellation
of these offsets. Taxpayer (through Subsidiary) intends to participate in a carbon
sequestration project involving the development and implementation of forestland
management parameters on the Site designed to enhance the Site’s long-term capacity
to sequester atmospheric carbon (the “Project”). After Subsidiary receives the Site from
Taxpayer, Subsidiary intends to enter into the Agreement with Intermediary, pursuant to
which Intermediary will develop the Project for Subsidiary in compliance with the
requirements of Registry. The Project is expected to end no earlier than c years after
the date the Agreement is executed.

        The Agreement will establish the framework under which Intermediary, as
Taxpayer’s technical consultant, will develop projects on the Site for Taxpayer and sets
forth the respective rights and obligations of the owner of the Site and Intermediary with
respect to the Project. Development of the Project involves calculating the estimated

PLR-107822-23                                  3

quantity of additional carbon that can be sequestered at the Site through improved
forest management (e.g., harvesting at levels below those otherwise allowable under
existing law, regulations, and other restrictions) and submitting those calculations and
estimates for independent verification in accordance with the standards of Registry.
Once the quantity of additional carbon estimated to be sequestered at the Site under
the Project is verified, the Project will be eligible for carbon emission offsets (the
“Offsets”). The quantity of Offsets for which the Project will be eligible is directly linked
to the sequestration of additional carbon resulting from the improved forest
management identified in the Project.

        The Site will be all of the land owned by Subsidiary. The Site will be described in
detail in the Project documents. The owner of the Site will agree to comply with the
Project’s improved forest management requirements associated with the Offsets. The
Restrictions will be restrictions that could be recorded as easements under local law.
Restrictions from the Project will include the following land use restrictions (the
“Restrictions”):

       1. Not to conduct any activities that will result in a reversal of sequestered
          carbon or the ability of the Site to generate specified Offsets;

       2. Not to harvest above a specified volume of timber each year or a
          volume in excess of a specified amount of growth in a single year;

       3. Not to conduct activities on the Site that will result in material
          reductions of Offsets arising from Taxpayer’s voluntary activities that
          result in the aggregate harvest levels exceeding the aggregate
          projected harvest on the project by more than b percent; and

       4. To manage the Site in a manner to ensure compliance with the
          requirements of the program in which the Site is enrolled.

        Taxpayer will commit to the Restrictions for at least c years, unless Taxpayer
sells the Site and the new owner properly assumes Taxpayer’s obligations. The
Restrictions will apply only to property that is subject to the Project under the Agreement
and, upon registration of the Offsets, will be binding on the Site for the duration of the
Project. Taxpayer may add additional parcels of land under the Agreement that may
also generate Offsets if included in future carbon sequestration projects or an expansion
of the Project. The Registry will require Taxpayer to assess the risk of reversal of
Offsets and select a risk mitigation mechanism for the Project. Taxpayer intends to
participate in the Registry’s buffer pool. In order to participate in the Registry’s buffer
pool, Taxpayer must contribute a risk-adjusted number of Offsets to the Pool. In the
event of an unintentional reversal of Offsets (e.g., a forest fire) that exceeds the number
of Offsets that Taxpayer has contributed to the Buffer Pool, Taxpayer will be required to
contribute Offsets equal to a percentage of the excess of reversed Offsets over the
contributed Offsets. In the event of an unintentional reversal of Offsets, Taxpayer will

PLR-107822-23                                 4

not otherwise be required to replenish its buffer pool contribution. On the other hand, in
the event of an intentional reversal of Offsets, Taxpayer will be required to replace all
reversed Offsets.

        Pursuant to the Agreement, Intermediary will analyze the Site and develop
forestland development parameters complying with the Registry’s standards to ensure
that the Site complies with the Project’s requirements to be eligible to generate the
Offsets. The Project will be filed with the Registry, and the Offsets will be issued based
on the quantity of additional carbon that can be sequestered at the Site due to the
Restrictions. After verification of the quantity and type of Offsets attributable to the Site
each reporting period, the Offsets attributable to that reporting period will be registered
by the Registry. Upon registration of the Offsets by the Registry, the Registry will award
Offsets to Taxpayer, Taxpayer will transfer the Offsets to Intermediary, and Intermediary
will market the Offsets for sale to third parties that are unrelated to Taxpayer (each a
“Buyer”). Under the Agreement, Intermediary will agree to aggregate, market, and
ultimately sell the Offsets to Buyers under one or more independently operated carbon
service credit trading regimes. Taxpayer will bear the benefits and burdens of
ownership of the Offsets from the issuance of the Offsets to Taxpayer until the sale of
the Offsets by Intermediary to Buyers. Neither Taxpayer nor its subsidiaries intend to
hold the Offsets for the purposes of speculating on future appreciation.

        Taxpayer represents that Taxpayer will include the fair market value of the
Offsets upon issuance in gross income. Income from the Offsets is intended to
compensate Taxpayer for the loss of revenue from otherwise permissible timber sales
and the decrease in value and income resulting from Taxpayer’s adherence to the
Restrictions. Upon the eventual sale of the Offsets, proceeds are remitted to Taxpayer
with Intermediary retaining a portion of the proceeds as commission. Taxpayer will treat
any gain from the sale of the Offsets as income not qualifying under § 856(c)(2) and
(c)(3).

                                   LAW AND ANALYSIS

       Section 61(a) defines gross income as “income from whatever source derived,”
except as otherwise provided by law. See § 1.61-1(a). Gross income includes income
realized in any form, whether in money, property, or services. Id. This definition
encompasses all “accessions to wealth, clearly realized, and over which the taxpayers
have complete dominion.” Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431
(1955).

       Section 451 and the regulations thereunder provide rules for determining the
taxable year of inclusion for items of gross income.

PLR-107822-23                                5

       Under an accrual method of accounting, unless § 451(b)(1)(A) requires earlier
inclusion, an item of gross income is generally includible when all the events have
occurred which fix the right to receive such income and the amount thereof can be
determined with reasonable accuracy. All the events that fix the right to receive income
generally occur upon the earliest of the following: (1) the required performance takes
place, (2) payment is due, or (3) payment is made. See Schlude v. Commissioner, 372
U.S. 128 (1963); Rev. Rul. 2003-10, 2003-1 C.B. 288. However, § 451(b)(1)(A) sets
forth special rules requiring earlier inclusion in the case of certain accrual-method
taxpayers.

        Section 856(c)(2) provides that for a corporation to qualify as a REIT for any
taxable year, at least 95 percent of its gross income (excluding gross income from
prohibited transactions) must be derived from sources that 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,
certain commitment fees, and gain from certain sales or other dispositions of real estate
assets.

        Section 856(c)(3) provides that for a corporation to qualify as a REIT for any
taxable year, 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 real property, gain from the sale or other disposition
of real property (other than property in which the corporation is a dealer), dividends from
REIT stock 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, gain from certain sales or other dispositions of real estate assets, and qualified
temporary investment income.

        Section 856(d)(1) provides that rents from real property include (subject to
exclusions provided in § 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, the lease.

       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 (c)(3) may be considered as
not constituting gross income for purposes of § 856(c)(2) or (c)(3), or (ii) whether any
item of income or gain that otherwise constitutes gross income not qualifying under §

PLR-107822-23                                6

856(c)(2) or (c)(3) may be considered as gross income that qualifies under § 856(c)(2)
or (c)(3).

       Section 1.856-4(a)(1) provides that, subject to the exceptions of § 856(d) and
§ 1.856-4(b), the term “rents from real property” means, generally, the gross amounts
received for the use of, or the right to use, real property of the REIT.

        Under § 1.856-3(g), a REIT that is a partner in a partnership is deemed to own its
proportionate share of each of the assets of the partnership and to be entitled to the
income of the partnership attributable to that share. For purposes of § 856, the interest
of a partner in the partnership's assets is determined in accordance with the partner's
capital interest in the partnership. The character of the various assets in the hands of
the partnership and items of gross income of the partnership retain the same character
in the hands of the partners for all purposes of § 856.

       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, 86 th
Cong., 2d Sess. 4 (1960) at 6, 1960-2 C.B. 819, at 822-23 states, “[o]ne of the principal
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.”

        Taxpayer will earn the Offsets as a result of agreeing to and complying with
Restrictions that satisfy Registry’s standards for carbon sequestration at the Site. The
Agreement will impose land-use restrictions by requiring Taxpayer to abstain from
certain uses of its land and perform certain actions on its land. Taxpayer has
represented that such land-use restrictions are restrictions that could be recorded as
easements under local law. Under the Agreement, Taxpayer will incur penalties if it
does not abide by the Restrictions to which it has agreed. For these reasons, the
Offsets are akin to receiving payment for granting an easement for a term of years with
respect to the real property. Cf. Wineberg v. Commissioner, 326 F.2d 157, 169-70 (9th
Cir. 1963) (holding amount received for granting 10-year right to use a road was rent
rather than sale of an interest in land), aff’g T.C. Memo. 1961-336; Nay v.
Commissioner, 19 T.C. 114, 119 (1952) (concluding amount received for granting a
“right of way” for a term not to exceed three years is ordinary income because such a
“limited easement” does not constitute sale of real property). Under these
circumstances, treating Taxpayer’s income with respect to the issuance of the Offsets
as qualifying income does not interfere with or impede the objectives of Congress in
enacting § 856(c)(2) and (c)(3).

                                    CONCLUSIONS

       Based on the information submitted and representations made, we rule as
follows:

PLR-107822-23                                  7

       (1) Unless § 451(b)(1)(A) requires earlier inclusion, income with respect to the
issuance of the Offsets will accrue under § 451 upon the earliest of the following events
to take place: the Offsets are earned, the Offsets are received, or the Offsets are due;
and

      (2) Pursuant to § 856(c)(5)(J)(ii), income from the issuance of the Offsets will be
considered qualifying income under § 856(c)(2) and (c)(3).

        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 with
regard to whether Taxpayer will otherwise qualify as a REIT under subchapter M of the
Code. Furthermore, no opinion is expressed with respect to the tax consequences of
any dispositions of the Offsets, including whether a sale of the Offsets gives rise to
qualifying income under § 856(c)(2) or (c)(3) and whether such a sale constitutes a
prohibited transaction as described in § 857(b)(6)(B)(iii).

      The rulings contained in this letter are based upon information and
representations submitted by Taxpayer and accompanied by a penalty of perjury
statement executed by an appropriate party. 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 requesting it. Section 6110(k)(3) of
the Code provides that it may not be used or cited as precedent.


         In accordance with the Power of Attorney on file with this office, a copy of this
letter is being sent to your authorized representatives.

                                        Sincerely,



                                        Jason D. Kristall
                                        Chief, Branch 3
                                        Office of Associate Chief Counsel
                                        (Financial Institutions & Products)


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