PLR 1314021: IRS approves § 115 exclusion for a state agency's real estate acquisition company

Plain-English summary

A state agency formed a wholly owned company to acquire, hold, and sell real estate investments using a third-party loan facility. The taxpayers asked whether the company's income would be excluded from gross income under IRC § 115(1), which covers income from an essential governmental function that accrues to a state or political subdivision. The IRS concluded that investing public assets and limiting investment risk through the company performed an essential governmental function, and that the company's income accrued to the state agency. The ruling approved the exclusion based on the submitted facts and representations, without addressing other federal tax consequences.

Ruling snapshot

• Question: Is the real estate acquisition company's income excluded from gross income under IRC § 115(1)?
• Outcome: Approved, based solely on the submitted facts and representations.
• Key authorities: IRC §§ 115(1), 6012(a)(2), and 6110(k)(3); Rev. Rul. 77-261 and Rev. Rul. 90-74

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201314021 Third Party Communication: None
Release Date: 4/5/2013 Date of Communication: Not Applicable
Index Number: 115.00-00
Person To Contact:
---------------------------------- ----------------------, ID No. --------------
------------------------------------ Telephone Number:
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------------------------------------------ Refer Reply To:
CC:TEGE:EOEG:EO
PLR-138309-12
Date:
December 11, 2012

     Entity:                     --------------------------------------------------

     Company:                    ----------------------------------
                                 ------------------------

     State:                      ---------------

     Jurisdiction:               --------------

     Agreement:                  -------------------------------------------------------------------
                                 ---------------------------------------------------------------------------------
               -------------------------------------------------------------

     Date:                       ----------------------

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

   This letter responds to a letter from your authorized representative signed August

31, 2012, submitted on behalf of Entity and Company (the Taxpayers), requesting
rulings that Company’s income will be excluded from gross income under § 115 of the
Internal Revenue Code. The Taxpayers represent the facts as follows.

                                                   FACTS

   Entity was created and is operated under State law as an agency of State. Its

purpose is to provide professional investment management of various trusts and
operating funds established under the laws of State. Entity has broad authority to invest
and reinvest, to collect income and rents, to acquire, manage, and sell real estate, and
to employ outside counsel and contractors.
PLR-138309-12 2

   Entity formed Company on Date as a limited liability company under the laws of

Jurisdiction. Entity is the sole member of Company. The Agreement provides that no
person other than a state, a political subdivision of a state, or an entity whose income is
excluded from gross income under § 115 may be admitted as a member of Company.

   Entity is the initial manager of Company, with full and exclusive authority to

handle Company’s business affairs, in accordance with the Agreement. The manager
may delegate any of its authority to another person, as long as the manager retains the
power to direct and control the delegate. Entity may select any legal entity to serve as a
successor manager under an advisory agreement to be reached between the successor
and Company. Entity may remove a successor manager at any time, with or without
cause.

     Company’s purpose, as stated in the Agreement, is to acquire, hold, and sell

investments, and to engage in any lawful activity. Entity intends for Company to serve
as an acquisition vehicle for its real estate investments. Company will enter into a loan
facility with a third-party lender, allowing it to draw on funds to acquire real estate
investments. Company will hold each investment in a separate, wholly-owned
subsidiary, and will pledge its interests in these subsidiaries as security for the loan
facility. The manager or an agent engaged by the manager will negotiate the loan
facility and will identify, negotiate, and purchase real estate investments.

    As the sole member of Company, Entity will be allocated all Company profits and

losses and will receive all distributions from Company. Upon Company dissolution, and
after the satisfaction of its legal obligations, all of Company’s remaining assets will be
distributed to Entity. Entity will bear all risk of loss from Company, limited to the amount
of its capital contributions.

                               LAW AND ANALYSIS

    Section 115(1) provides that gross income does not include income derived from

any public utility or the exercise of any essential government function and accruing to a
state or any political subdivision thereof.

    In Rev. Rul. 77-261, 1977-2 C.B. 45, income from an investment fund,

established under a written declaration of trust by a state, for the temporary investment
of cash balances of the state and its participating political subdivisions, was excludable
from gross income for federal income tax purposes under § 115(1). The ruling indicated
that the statutory exclusion was intended to extend not to the income of a state or
municipality resulting from its own participation in activities, but rather to the income of a
corporation or other entity engaged in the operation of a public utility or the performance
of some governmental function that accrued to either a state or municipality. The ruling
points out that it may be assumed that Congress did not desire in any way to restrict a
PLR-138309-12 3

state’s participation in enterprises that might be useful in carrying out projects that are
desirable from the standpoint of a state government and which are within the ambit of a
sovereign properly to conduct. In addition, pursuant to § 6012(a)(2) and the underlying
regulations, the investment fund, being classified as a corporation that is subject to
taxation under subtitle A of the Code, was required to file a federal income tax return
each year.

    In Rev. Rul. 90-74, 1990-2 C.B. 34, the income of an organization formed,

funded, and operated by political subdivisions to pool various risks arising from their
obligations regarding public liability, workers’ compensation, or employees’ health is
excludable from gross income under § 115. In this ruling, private interests did not
materially participate in the organization, nor did they benefit more than incidentally from
the organization.

    Company enables Entity to invest a portion of the trusts, operating funds, capital

funds, and property of State and to engage in certain investment strategies, while
limiting Entity’s exposure to the risks of such investments. Providing such means for
investing public assets and for limiting investment risk constitutes the performance of
essential governmental functions. See Rev. Rul. 90-74 and Rev. Rul. 77-261.

   All of Company’s income accrues to Entity, an agency of State. Entity is

allocated all Company profits and losses and receives all Company distributions. No
private interests participate in, or benefit from, the operation of Company other than as
providers of goods or services. The benefit to third-party lenders or to buyers and
sellers in the real estate market is incidental to the public benefit. Upon Company’s
dissolution, no assets remaining after winding up will be distributed to any entity other
than a state, a subdivision of a state, or an entity the income of which is excluded from
gross income under § 115. See Rev. Rul. 90-74.

                                     RULING

   Based solely on the facts and representations submitted by the Taxpayers, we

conclude that the income of Company is derived from the exercise of an essential
governmental function and will accrue to a state or a political subdivision thereof for
purposes of § 115(1). Consequently, we rule that Company’s income is excludable
from gross income under § 115(1).

   Except for the specific ruling above, we express or imply no opinion concerning

the federal tax consequences of the facts of this case under any other provision of the
Code.

    Under a power of attorney on file with this office, we are sending copies of this

letter to your authorized representatives.
PLR-138309-12 4

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

§ 6110(k)(3), this ruling may not be used or cited as precedent.

                                     Sincerely,




                                     SYLVIA HUNT
                                     Assistant Chief
                                     Exempt Organizations Branch
                                     Office of Division Counsel /
                                            Associate Chief Counsel
                                     (Tax Exempt & Government Entities)

enclosures: copy for § 6110 purposes