Pipeline-use fees qualified as REIT rents from real property

Plain-English summary

A REIT owned a partnership interest in a subsidiary that operated regulated oil and gas pipelines treated by the taxpayer as real property. Pipeline users reserved monthly capacity and paid tariff-based fees according to the volume moved, not their income or profits, while using the pipelines continuously over extended periods. The taxpayer represented that associated pumps, compressors, meters, and other personal property accounted for no more than 15 percent of the relevant fees. The subsidiary limited its own work to asset-management and customary activities, with other services performed by a taxable REIT subsidiary or independent contractor. Based on those facts and representations, the IRS ruled that the REIT's allocable share of pipeline-use fees qualified as rents from real property for the 75 percent and 95 percent REIT income tests.

Ruling snapshot

• Question: Did the REIT's share of regulated pipeline-use fees qualify as rents from real property?
• Outcome: approved
• Key authorities: IRC § 856(c) and (d); Treas. Reg. §§ 1.856-3(g), 1.856-4, and 1.512(b)-1(c)(5)

Full text (IRS public release)

 Internal Revenue Service                                       Department of the Treasury
                                                                Washington, DC 20224

 Number: 202410005                                              Third Party Communication: None
 Release Date: 3/8/2024                                         Date of Communication: Not Applicable
 Index Number: 856.01-00
                                                                Person To Contact:
 ------------------------                                       -------------------------, ID No. -----------------
 ------------------------------------------------------------   -----------------------------------------------------
 --------------------                                           Telephone Number:
 ------------------------------------------                     --------------------
 --------------------------------                               Refer Reply To:
 --------------------------------                               CC:FIP:B03
                                                                PLR-113145-23
                                                                Date:
                                                                December 13, 2023


Legend:

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

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

Commission =              --------------------------------------------------

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

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

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

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

Pipelines        =        ------------------------------------------------------------------------------------------
                 --------------------

a                =        ------

b                =        -----------

c                =        ------

d                =        ---

PLR-113145-23                                 2

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

        This letter responds to a letter dated June 23, 2023, and subsequent
correspondence, requesting a ruling on behalf of Taxpayer. Taxpayer requests a ruling
that its allocable share of income from unrelated third parties for the use of certain
pipelines, qualify as rents from real property under section 856(d) of the Internal
Revenue Code (the “Code”) for purposes of section 856(c)(2) and (c)(3).

                                          FACTS

        Taxpayer is a State A corporation that elected to be taxed as a real estate
investment trust (“REIT”) beginning with its taxable year ended Date. Taxpayer invests
in energy infrastructure assets, such as pipelines, storage terminals, and gas
distribution assets.

       Subsidiary is a State B limited liability company that is classified as a partnership
for U.S. federal income tax purposes. Taxpayer currently owns an approximately a
percent voting interest in Subsidiary and intends to acquire a controlling interest upon
receiving Commission approval. Subsidiary owns the Pipelines, oil and gas pipelines
located in State C, through two disregarded entities (the “Pipeline Companies”).

       The Pipelines were constructed to connect certain oil fields to certain refineries.
Taxpayer represents that the Pipelines are inherently permanent structures under
section 1.856-10 of the Income Tax Regulations and, thus, are real estate assets for
purposes of section 856 of the Code. The Pipelines are regulated by Commission.

       Subsidiary enters into arrangements with one or more unrelated third-party users
(each, a “Pipeline User”) with respect to each Pipeline pursuant to the nomination
process described below (each, a “Pipeline Use Agreement”). The Pipeline Use
Agreements generally have a term of b, and Pipeline Users generally utilize the
Pipelines on a continuous and consistent basis for extended periods, often years.
Taxpayer represents that Subsidiary does not oversell capacity on a Pipeline and is
obligated at all times to ensure that the capacity confirmed each month for each
Pipeline User is available for use by the relevant Pipeline User.

       Pipeline Users use a monthly nomination process governed by the Commission
rules and regulations to confirm the capacity to be reserved for each Pipeline User
during the following month. Pursuant to the nomination process, the Subsidiary
establishes certain minimum aggregate monthly throughput amounts necessary to
maintain optimal operations of each Pipeline. Each Pipeline User informs Subsidiary as
to the kind and quantity of product the Pipeline User intends to place on a particular
Pipeline in the coming month (a “nominated amount”). Provided that the nominated
amounts for each Pipeline User in the aggregate meet the minimum aggregate monthly
throughput requirement, each nominated amount becomes a confirmed amount. Once
a Pipeline User’s nominated amount becomes a confirmed amount, Subsidiary reserves

PLR-113145-23                                       3

a portion of the monthly capacity on the relevant Pipeline for that Pipeline User’s
confirmed amount. Subsidiary does not confirm nominated amounts in excess of the
total monthly capacity of any Pipeline. Taxpayer represents that to its knowledge, a
Pipeline User has never placed c product on a Pipeline in a month in which they have a
nominated and confirmed amount. Taxpayer represents that each Pipeline User who
reserves capacity on a Pipeline for a given month uses at least d percent of such
reserved capacity during that month.

       Pipeline Users pay a fee for the use of a Pipeline that is based on the volume of
product placed on the Pipeline by the Pipeline User (“Pipeline Use Fee”). Pipeline Use
Fees are calculated as the product of the barrels of oil placed on a Pipeline in a given
month and the tariff rate approved by the Commission for each barrel of oil that is
received at a specified origin point on the Pipeline and that exits the Pipeline at a
specified destination point. Taxpayer represents that each Pipeline User is
contractually obligated to deliver product extracted from a particular field or area to a
point connected to a Pipeline and is economically compelled to exclusively use the
Pipeline to satisfy that legal obligation. Each Pipeline User will exclusively use the
Pipeline for the applicable monthly nomination period to deliver such product extracted
from a particular field or area to a point connected to the Pipeline. Subsidiary will agree
to accept and reserve capacity for that product, but will not oversell capacity on a
Pipeline. Taxpayer represents that the Pipeline Use Fee does not depend, in whole in
or in part, on the income or profits of any person.

       The Pipelines include a de minimis amount of personal property (e.g., pumps,
compressors, and meters). Taxpayer represents that, with respect to each Pipeline, the
Pipeline Use Fees attributable to the pumps, compressors, meters, and other personal
property used in connection with the reserved use of the Pipeline does not exceed 15
percent of the total Pipeline Use Fees attributable to both the real and personal property
reserved for use by Pipeline Users for the taxable year.

       Taxpayer represents that Subsidiary will only undertake activities with respect to
the Pipelines that are consistent with its fiduciary duty to manage its assets or that
would not result in unrelated business taxable income under section 512(b)(3) if
received by an organization described in section 511(a)(2). Subsidiary will inspect and
monitor the physical condition of the Pipelines and will mark the location of underground
Pipelines to minimize the possibility of damage due to digging. Subsidiary may test
product as it enters a Pipeline to verify that the product in that Pipeline is, in fact, the
product specified in the Pipeline Use Agreement. Such testing is performed solely to
ensure the safety and integrity of the Pipeline and the environment. Subsidiary will also
make decisions with respect to, and will supervise, the maintenance, repair, and
construction of, the Pipelines in accordance with the requirements of all applicable
governmental authorities, including Commission. 1 Such maintenance, repair, and

1
 The Pipelines are subject to the regulatory authority of the Commission. Accordingly, Taxpayer,
Subsidiary, and the Pipeline Companies are required to comply with all rules and regulations, and orders
of the Commission in order to continue operating the Pipelines.

PLR-113145-23                                 4

construction will be performed by an independent contractor from whom Taxpayer does
not derive or receive any income (“IK”).

       All other activities and services with respect to the Pipelines will be undertaken
by a TRS or an IK, including scheduling use of the Pipeline by the Pipeline Users.
Additionally, a TRS or IK will operate, monitor, maintain, manage, and repair any
pumps, compressors, meters, and other personal property associated with the
Pipelines. The TRS or IK will receive arm’s length compensation from Subsidiary for
performing these activities and services.

       Taxpayer represents that all services furnished to the Pipeline Users are
customarily provided to tenants of similar properties in the geographic market in which
the relevant Pipeline is located.

                                  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” includes (subject to
exclusions provided in section 856(d)(2)): (A) rents from interests in real property; (B)
charges for services customarily furnished or rendered in connection with the rental of
real property, whether or not such charges are separately stated; and (C) rent
attributable to personal property that is leased under, or in connection with, a lease of
real property, but only if the rent attributable to such personal property for the taxable
year does not exceed 15 percent of the total rent for the taxable year attributable to both
the real and personal property leased under, or in connection with, such lease.

       Section 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.

PLR-113145-23                                 5


       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 such 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 1.856-3(g) provides that, in the case of a REIT which is a partner in a
partnership, as defined in section 7701(a)(2) and the regulations thereunder, the REIT
will be deemed to own its proportionate share of each of the assets of the partnership
and will be deemed to be entitled to the income of the partnership attributable to such
share. For purposes of section 856, the interest of a partner in the partnership’s assets
shall be determined in accordance with his 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 shall retain the same character in the hands of the partners
for all purposes of section 856. Thus, for example, if the REIT owns a 30 percent
capital interest in a partnership which owns a piece of rental property the REIT will be
treated as owning 30 percent of such property and as being entitled to 30 percent of the
rent derived from the property by the partnership. Similarly, if the partnership holds any
property primarily for sale to customers in the ordinary course of its trade or business,
the REIT will be treated as holding its proportionate share of such property primarily for
such purpose. Also, for example, where a partnership sells real property or a REIT sells
its interest in a partnership which owns real property, any gross income realized from
such sale, to the extent that it is attributable to the real property, shall be deemed gross
income from the sale or disposition of real property held for either the period that the
partnership has held the real property or the period that the REIT was a member of the
partnership, whichever is the shorter.

     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 (c)(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

PLR-113145-23                                 6

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.

        Section 1.856-4(b)(2)(ii) provides that the 15 percent test in section 856(d)(1)(C)
is applied separately to each lease of real property. However, where the REIT rents all
(or a portion of all) the units in a multiple unit project under substantially similar leases
(such as the leasing of apartments in an apartment building or complex to individual
tenants), the 15 percent test may be applied with respect to the aggregate rent received
or accrued for the taxable year under the similar leases of the property, by using the
average of the REIT’s aggregate adjusted bases of all of the personal property subject
to such leases, and the average of the REIT’s aggregate adjusted bases of all real and
personal property subject to such leases. A lease of a furnished apartment is not
considered to be substantially similar to a lease of an unfurnished apartment (including
an apartment where the REIT provides only personal property, such as major
appliances, that is commonly provided by a landlord in connection with the rental of
unfurnished living quarters).

        Section 1.856-4(b)(3) provides in relevant part that, except as provided in
§1.856-4(b)(6)(ii), no amount received or accrued, directly or indirectly, with respect to
any real property (or personal property leased under, or in connection with, real
property) qualifies as rents from real property where the determination of the amount
depends in whole or in part on the income or profits derived by any person from the
property. However, any amount so accrued or received 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. An amount will not qualify as rents from real property
if, considering the lease and all the surrounding circumstances, the arrangement does
not conform with normal business practice but is in reality used as a means of basing
the rent on income or profits.

        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 the 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

PLR-113145-23                                7

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.

       If a taxpayer that has elected to be taxed as a REIT for U.S. federal income tax
purposes fails to qualify as a REIT for any reason (including as a result of undertaking
actions or failing to undertake actions required by a public utility commission or other
state governmental authority), the taxpayer will cease to be taxed as a REIT. See
section 856(g).

         Taxpayer represents that the Pipelines are real property for purposes of section

856. The Pipeline Use Agreements have a term of b and Pipeline Users generally
utilize the Pipelines on a continuous and consistent basis for extended periods, often
years. No Pipeline Use Agreement will have a term of less than b. Taxpayer
represents that the Pipeline Use Fee will not depend, in whole or in part, on the income
or profits of any person. The Pipeline Use Fees are a regulated fee multiplied by the
amount of product placed on the Pipeline by a Pipeline User. This amount based upon
the volume of product put through the Pipeline is comparable to amounts received
based upon a percentage of gross receipts. Each Pipeline User will exclusively use the
Pipeline for the applicable monthly nomination period to deliver product extracted from a
particular field or area to a point connected to the Pipeline, and Subsidiary will agree to
accept and reserve capacity for that product. Accordingly, the Pipeline Use Fees are an
amount received for the use of, or the right to use, real property of Taxpayer and qualify
as rents from interests in real property under section 856(d)(1)(A).

       Taxpayer represents that Subsidiary will only undertake activities with respect to
the Pipelines that are consistent with its fiduciary duty to manage the REIT itself or are
services the amounts for 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). Subsidiary will inspect and monitor the physical condition of the Pipelines,
mark the location of underground Pipelines, and make decisions with respect to, and
supervise the IK performing, maintenance, repair, and construction of the Pipelines.
Subsidiary may test product as it enters a Pipeline to ensure the safety and integrity of
the Pipeline and the environment. A TRS or IK will perform all other services in
connection with the Pipelines. Therefore, the activities and services performed by
Subsidiary and by a TRS or IK 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 Pipeline Users in connection with a Pipeline Use Agreement are customarily

PLR-113145-23                               8

provided to tenants of similar properties in the geographic market in which the
respective Pipeline is located.

        Taxpayer represents that, with respect to each Pipeline, the Pipeline Use Fees
attributable to the pumps, compressors, meters, and other personal property used in
connection with the reserved use of space on the Pipeline does not exceed 15 percent
of the total Pipeline Use Fees attributable to both the real and personal property
reserved for use by Pipeline Users for the taxable year.

                                     CONCLUSION

       Based on the facts submitted and representations made by Taxpayer, we rule
that Taxpayer’s allocable share of the Pipeline Use Fees qualify as rents from real
property under section 856(d) for purposes of section 856(c)(2) and (c)(3).

       Except as expressly provided herein, no opinion is expressed or implied
concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. 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.

        Furthermore, we express no opinion regarding whether any assets are real
property for purposes of section 856, any amount received by Taxpayer through
Subsidiary will depend 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 property does not exceed 15 percent
of the total rent under section 856(d)(1)(C).

PLR-113145-23                                      9

       This ruling does not apply to the extent there is a change in the facts set forth
herein, including, but not limited to, a change in facts as a result of the Commission
exercising its authority to require any of the Taxpayer, Subsidiary, or the Pipeline
Companies to change the manner in which they operate.

      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
                                                Senior Technician Reviewer, Branch 3
                                                Office of Associate Chief Counsel
                                                (Financial Institutions & Products)


 cc: ----------------------------------
     -----------------------------
     ------------------------------
     ---------------------------

      --------------------
      --------------------------
      ---------------------------
      ------------------------
      ---------------------------

      -----------------------
      ----------------------------
      ---------------------------------------
      --------------------------------
      --------------------------------