REIT may disregard duplicated ground-rent income in gross-income tests

Plain-English summary

A company planned to qualify as a real estate investment trust through interests in two partnerships. One partnership would own the land, while another would lease the land and sublease the property to unrelated tenants, causing the same rent stream to appear in the company's allocable income through both partnerships. The IRS ruled that, for the REIT gross-income tests, the company's share of ground-rent income would be disregarded to the extent it did not exceed its share of the corresponding deductions. The ruling was limited to the submitted facts and did not decide whether the company otherwise qualified as a REIT.

Ruling snapshot

• Question: Could the taxpayer disregard duplicated ground-rent income when applying the REIT gross-income tests?
• Outcome: Approved, subject to the stated facts and representations.
• Key authorities: IRC §§ 318 and 856; Treas. Reg. § 1.856-3(g)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201407011
Release Date: 2/14/2014
Index Number: 856.00-00, 856.01-00
Person To Contact:
------------------------- -----------------, ID No. ------------------
--------------------- Telephone Number:
------------------- ----------------------
------------------------------------------ Refer Reply To:
----------------------------- CC:FIP:02
PLR-129016-13
Date:
November 1, 2013

Legend

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

Holding = -----------------------------------

Leasehold = -------------------------------------------------
Partnership

Fee = -----------------------------------------
Partnership

Entity = ------------------------------------

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

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

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

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

Address = --------------------------------------------

x = --------

y = ----
PLR-129016-13 2

z = ------------

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

   This is in response to your letter dated June 24, 2013, regarding whether for

purposes of determining Taxpayer’s gross income under sections 856(c)(2) and
856(c)(3) of the Internal Revenue Code, Taxpayer’s allocable share of certain amounts
paid from Leasehold Partnership to Fee Partnership will be disregarded as an item of
gross income to the extent of Taxpayer’s allocable share of Leasehold Partnership’s
deductions attributable to those amounts paid to Fee Partnership.

                                      FACTS

   Taxpayer is an Entity organized under the laws of State A. Taxpayer will make

an election to be treated as a real estate investment trust (REIT) for its first taxable year
ending on Date 1. Taxpayer will adopt the calendar year for Federal income tax
reporting and will use the accrual method as its overall method of accounting.

   Taxpayer was formed to invest in Property located at Address through one or

more entities treated as partnerships or disregarded entities for Federal income tax
purposes. Taxpayer will acquire an x% interest in Holding. Holding will acquire a y%
interest in Fee Partnership and a y% interest in Leasehold Partnership. Both Fee
Partnership and Leasehold Partnership are entities organized under the laws of State B.
Fee Partnership owns (through wholly owned subsidiaries, each of which is disregarded
as an entity separate from Fee Partnership for Federal income tax purposes) the land
underlying Property. Leasehold Partnership leases (through wholly owned subsidiaries,
each of which is disregarded as an entity separate from Leasehold for Federal income
tax purposes) the land underlying Property.

   As a result of the ownership percentages, Taxpayer will own indirectly a z%

interest in each of Fee Partnership and Leasehold Partnership. Through entities
disregarded for Federal income tax purposes, Fee Partnership leases the land to
Leasehold Partnership pursuant to a ground lease, which requires payments of fixed
rent and real estate taxes (collectively, “Ground Rents”). Through entities disregarded
for Federal income tax purposes, Leasehold Partnership leases Property to tenants that
are unrelated to Taxpayer.

                                        LAW

  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.
PLR-129016-13 3

  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(c)(4)(A) provides that at the close of each quarter of its tax year, at

least 75 percent of the value of a REIT’s total assets must be represented by real estate
assets, cash and cash items (including receivables), and Government securities.

   Section 856(c)(5)(J) provides, in relevant part, that to the extent necessary to

carry out the purposes of Part II of subchapter M of the Code, the Secretary is
authorized to determine, solely for purposes of such part, whether any item of income or
gain which does not otherwise qualify under section 856(c)(2) or (3) may be considered
as not constituting gross income for purposes of section 856(c)(2) or (3).

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

the term “rents from real property” does not include any amount received or accrued
directly or indirectly from any person if the REIT owns, directly or indirectly, in the case
of a person that is not a corporation, an interest of 10 percent or more in the assets or
net profits of such person.

   Section 856(d)(5) provides that, for purposes of section 856(d), the rules

prescribed in section 318(a) apply with certain modifications to determine ownership of
the stock, assets, or net profits of any person.

   Section 1.856-3(g) of the Income Tax Regulations provides that 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 section 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 partnership for
all purposes of section 856.

                                     ANALYSIS

   Taxpayer will acquire an x% partnership interest in Holding, which owns a y%

partnership interest in each of Fee Partnership and Leasehold Partnership. Pursuant to
section 1.856-3(g), Taxpayer through Holding, will be allocated y% of the gross income
derived by Leasehold Partnership from the rents paid by unrelated tenants in the
Property. Taxpayer, through Holding, will be allocated the same percentage of the
gross income derived by Fee Partnership from the rents paid by Leasehold Partnership.
Further, Taxpayer, through Holding, will be allocated the same percentage of the
deduction attributable to Leasehold Partnership’s payment of rents. Because the only
source of income for Fee Partnership is the Ground Rents paid by Leasehold
Partnership, Taxpayer’s allocable share of income from Leasehold Partnership will be
PLR-129016-13 4

double counted because it is already included in Taxpayer’s allocable share of Fee
Partnership’s gross income for purposes of section 856(c). Thus, pursuant to section
1.856-3(g), Taxpayer would be treated as earning the same gross income twice.

                                   CONCLUSION

    Based on the facts and representations submitted by Taxpayer, for purposes of

determining Taxpayer’s gross income under sections 856(c)(2) and (3), Taxpayer’s
allocable share of Ground Rents paid from Leasehold Partnership to Fee Partnership
will be disregarded as an item of gross income to the extent that those amounts do not
exceed Taxpayer’s allocable share of Leasehold Partnership’s deductions attributable to
the Ground Rents paid by Leasehold Partnership to Fee Partnership.

   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 whether Taxpayer
otherwise qualifies as a REIT under part II of subchapter M of Chapter 1 of the Code.

  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,


                                   Jonathan D. Silver
                                   Jonathan D. Silver
                                   Assistant to the Branch Chief, Branch 2
                                   Office of Associate Chief Counsel
                                   (Financial Institutions & Products)