PLR 1045014: Easement payments qualify as REIT income

Plain-English summary

The IRS ruled that a real estate investment trust's income from granting permanent and temporary easements qualified under the REIT income tests. The permanent easements were treated as sales of interests in real property, while the temporary easements were treated as rents from real property. The ruling addresses the income recognized from the easements and does not express an opinion on whether the taxpayer otherwise qualifies as a REIT or on the tax consequences under sections 1033 and 118. The determination matters because the classification affects whether the income can count toward the REIT gross-income requirements.

Ruling snapshot

• Question: Do payments for permanent and temporary easements qualify as income from real property for the REIT income tests?
• Outcome: Approved
• Key authorities: IRC §§ 856, 1033, and 118; Treas. Reg. §§ 1.856-3 and 1.856-4

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201045014
Release Date: 11/12/2010
Index Number: 856.01-00
Person To Contact:
------------------------- ------------------------, ID No. -------------
--------------------------------------- Telephone Number:
-------------------------------------- ---------------------
------------------------------------------------- Refer Reply To:
---------------------------- CC:FIP:2
------------- PLR-115781-10
---------------------------------------- Date:
July 22, 2010

Legend:

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

     Property                   =         -----------------------------------------------------------------------

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

     Corporation                =        ------------------------------------------------------

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

     Transport                  =        ------------------------------

     Point A                    =        -------------------------

     Point B                    =        ------------------------------------------------------------------------

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

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

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

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

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

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

PLR-115781-10 2

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

    d                   =      ---------------

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

  This is in reply to your letter dated April 8, 2010 requesting a ruling that the

income received by Taxpayer for certain easements constitutes qualifying income for
purposes of sections 856(c)(2) and (3) of the Internal Revenue Code of 1986, as
amended (the Code).

Facts

   Taxpayer is a State A corporation that has elected to be treated as a real estate

investment trust (REIT) under section 856. Taxpayer is a calendar year taxpayer that
uses the overall accrual method of accounting.

  On Date 1, Taxpayer purchased the Property through a qualified REIT subsidiary

(QRS) and has operated the Property as a rental property since the date of acquisition.

   Corporation is a public benefit corporation chartered by State B. Corporation is

undertaking the Project to connect the services of Transport, another public benefit
corporation, from Point A to Point B. Corporation has determined that it needs to
construct a support facility (the Support Facility) on a site adjacent to the Property in
order to provide adequate support to the Project’s new Transport infrastructure. The
Support Facility will house mechanical equipment, including emergency backup
generators, fans, and exhaust systems.

   As part of the Project, Corporation acquired by eminent domain or otherwise

certain properties on which to build the Support Facility, including the sites adjacent to
the Property as well as certain interests in the Property.

   Pursuant to a threat of condemnation, Taxpayer executed an agreement (the

Agreement) with Corporation on Date 2. The Agreement grants both permanent and
temporary easements in the Property to Corporation. In consideration for the
easements, the Agreement provides that Corporation will make cash payments in the
aggregate amount of approximately $a: this amount consists of an upfront cash
payment of $b and two reimbursement payments of $c and $d. The upfront payment is
in consideration for the easements granted by Taxpayer to Corporation and in lieu of
condemnation by Corporation of the easements. The reimbursement payments are for
construction work that must be performed on structural components of the Property in
order to make the part of the Property to which the easements relate usable for the
intended purposes of the easements.

PLR-115781-10 3

   Taxpayer represents that all of the easements run with the land and shall apply

and bind successors and assigns of the Taxpayer and the Corporation. Taxpayer also
represents that any payments received under the Agreement for reimbursements of lost
rents or profits, building administration costs, or any construction advisory and
supervisory fees are not considered as amounts received for granting the easements for
purposes of this ruling.

   Taxpayer intends to defer a significant portion of the gain realized from granting

the permanent easements to Corporation under the involuntary conversion rules of
section 1033 and to exclude a portion of such gain realized from gross income under
section 118. To the extent such gain is recognized for federal income tax purposes,
Taxpayer requests a ruling that such recognized gain will constitute qualifying gain from
the sale of interests in real property for purposes of the REIT income tests of sections
856(c)(2) and (3). Taxpayer also requests a ruling that any income received from
granting the temporary easements to Corporation constitutes qualifying rents from real
property for purposes of section 856(c)(2) and (3).

Law and Analysis

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

(excluding gross income from prohibited transactions) must be derived from dividends,
interest, rents from real property, gain from the sale or other disposition of stock,
securities, and real property (including interests in real property and interests in
mortgages on real property) which is not property described in section 1221(a)(1), and
certain other sources.

   Section 856(c)(3) provides that at least 75 percent of a REIT’s gross income

(excluding gross income from prohibited transactions) must be derived from rents from
real property, interest on obligations secured by mortgages on real property or on
interests in real property, gain from the sale or other disposition of real property
(including interests in real property and interests in mortgages on real property) which is
not property described in section 1221(a)(1), and certain other sources.

   Section 856(c)(5)(B) of the Code and section 1.856-3(b) of the Income Tax

Regulations (the “Regulations”) define the term “real estate assets,” in part, to mean
real property (including interests in real property and interests in mortgages on real
property) and shares (or transferable certificates of beneficial interest) in other REITs.

   Section 856(c)(5)(C) of the Code and section 1.856-3(c) of the Regulations

define the term “interests in real property” to include fee ownership and co-ownership of
land or improvements thereon, leaseholds of land or improvements thereon, options to
acquire land or improvements thereon, and options to acquire leaseholds of land or
improvements thereon, but does not include mineral, oil, or gas royalty interests.
Section 1.856-3(c) also includes in the definition of “interests in real property,” timeshare
interests that represent an undivided fractional fee interest, or undivided leasehold
interest, in real property, and that entitle the holders of the interests to the use and
enjoyment of the property for a specified period of time each year.

   Section 1.856-3(d) defines the term “real property” to mean land or

improvements thereon, such as buildings or other inherently permanent structures
thereon (including items which are structural components of such buildings or
structures). In addition, the term “real property” includes interests in real property.
Local law definitions are not controlling for purposes of section 856 and the regulations
thereunder.

    Section 856(d)(1) provides that for purposes of sections 856(c)(2) and (3), the

term “rents from real property” includes rents from interests in real property, charges for
services customarily furnished or rendered in connection with the rental of real property,
whether or not such charges are separately stated, and certain rents attributable to
personal property. Section 1.856-4 of the regulations provides that the term “rents from
real property” generally means the gross amount received for the use of, or the right to
use, real property of the REIT. Section 856(d)(2) of the Code and section 1.856-4(b)(3)-
(6) of the Regulations provide certain exclusions to the term “rents from real property,”
including in part, amounts 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.

   Rev. Rul. 71-286, 1971-2 C.B. 263, considers whether air rights over real

property are considered “interest in real property” and “real estate assets” within the
meaning of section 856(c). The term air rights is defined as the long-term leasehold or
fee simple ownership of the space above the ground that a landowner can occupy or
use in connection with the land, plus necessary easements on the surface for support of
structures erected in such air space. The revenue ruling holds that such air rights,
including the necessary surface easements, are considered “interests in real property”
and “real estate assets” within the meaning of section 856(c).

   Rev. Rul. 68-291, 1968-1 C.B. 351, clarifying, Rev. Rul. 59-121, 1959-1 C.B.

212, provides generally that the consideration received for the granting of an easement
constitutes the proceeds from the sale of an interest in real property and should be
applied as a reduction of the cost or other basis of the portion of the land subject to the
easement. See also, Rev. Rul. 54-575, 1954-2 C.B. 145.

   An easement is an interest in real property. Granting such an easement deprives

the taxpayer of practically all beneficial interest in the portion of the land covered by the
easement, except that Taxpayer retains only the mere legal title to the property.
Therefore, the permanent easements will be considered a sale of that portion of the
Property and the temporary easements will be akin to a lease of that portion of the
Property.

PLR-115781-10 5

Conclusion

   Based on the information submitted and the representations made, we conclude

that the income recognized by Taxpayer as a result of the granting of permanent
easements to Corporation is income received from the sale of interests in real property
and thus constitutes qualifying income for purposes of sections 856(c)(2) and (3). In
addition, income recognized by Taxpayer as a result of the granting of temporary
easements to Corporation qualifies as rents from real property, and, thus, constitutes
qualifying income 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, no opinion is expressed regarding whether
Taxpayer qualifies as a REIT under Subchapter M of the Code. Additionally, no opinion
is expressed regarding the application or tax consequences of sections 1033 and 118.

  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,


                                                      Thomas M. Preston
                                                      Thomas M. Preston
                                                      Senior Counsel, Branch 2
                                                      Office of Associate Chief Counsel
                                                      (Financial Institutions & Products)