TRS investment did not amount to operating a lodging facility

Plain-English summary

A real estate investment trust's taxable REIT subsidiary proposed buying a nonmanaging interest in an LLC that leased a building from the REIT's operating partnership and planned to convert it into a possible lodging facility. A separate company would exclusively manage the facility, employ all service personnel, and receive an arm's-length fee. The subsidiary would have no employees, control, or role in operating the property. Based on ownership representations and the section 318 attribution rules as modified by section 856, the manager qualified as an independent contractor because neither it nor relevant common owners held the prohibited share percentages. The IRS ruled that the subsidiary would not be treated as directly or indirectly operating or managing a lodging facility and would not lose its TRS status because of the investment. The ruling did not decide whether the property actually qualified as a lodging facility or whether the REIT otherwise satisfied its qualification and rent tests.

Ruling snapshot

• Question: Would a nonmanaging TRS investment in the tenant LLC cause the TRS to be treated as operating a lodging facility?
• Outcome: Approved, based on the represented independent-contractor and ownership facts
• Key authorities: IRC §§ 318, 856(d), 856(l)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201533006 Third Party Communication: None
Release Date: 8/14/2015 Date of Communication: Not Applicable
Index Number: 856.07-00
Person To Contact:
---------------- ----------------------, ID No. ------------------
------------------------------------- Telephone Number:
----------------------------- ----------------------
------------------------ Refer Reply To:
----------------------------------------- CC:FIP:B01
PLR-132082-14
Date:
May 15, 2015

Legend:

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

OP = ----------------------------

LP = ----------------------

TRS = -------------------------------------

LLC = --------------------------------------

Company = -----------------------------------

Manager = ------------------------------

State = --------------

a = ----

b = ----

c = -----

d = --

e = ----
PLR-132082-14 2

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

    This responds to a letter dated August 25, 2014, and subsequent

correspondence, submitted on behalf of Taxpayer. Taxpayer requests rulings with
respect to the qualification of its taxable REIT subsidiary (“TRS”) under section 856(l) of
the Internal Revenue Code ("Code") where the TRS will own an interest in an LLC that
is the lessee of real property that will be used as a lodging facility and operated and
managed by an “independent contractor” within the meaning of section 856(d)(3) with
respect to Taxpayer.

                                      FACTS

   Taxpayer is a domestic corporation that has elected under section 856(c) to be

treated as a real estate investment trust (“REIT”) for federal income tax purposes, is the
managing general partner of OP, and owns approximately a percent of the outstanding
common units of OP. OP, through separate limited liability companies, partnerships,
and REITs, owns and operates numerous real properties.

   TRS is a State corporation and a “taxable REIT subsidiary” (“TRS”) of Taxpayer.

OP owns all of the interests in TRS. TRS has made a loan to LLC; the loan is
outstanding and guaranteed by Company. Company is a State corporation and the
parent of an affiliated group of corporations that provide “co-working” collaborative office
rental space to entrepreneurs, startups, and small businesses. TRS proposes to make
an equity investment to obtain a b percent interest in LLC. TRS will not be a managing
member of LLC.

   LLC is a limited liability company that will be classified as a partnership for

federal tax purposes after TRS’s investment. Company currently owns c percent of LLC
and, after TRS’s proposed equity investment, will own a b percent interest and be the
managing member.

   LLC has leased real property from LP, an entity wholly owned by OP that is

disregarded as an entity separate from OP for federal income tax purposes. The real
property is currently being used as an office building, and LLC will convert the property
into an establishment that may fall within the definition of a “lodging facility” under
section 856(d)(9)(D)(ii) (“Facility”).

    Manager, a wholly owned subsidiary of Company, will manage and operate

Facility pursuant to a management agreement between LLC and Manager. Manager
will employ the persons providing services at Facility and will receive an arm’s-length
fee from LLC for managing Facility.

   Taxpayer represents that Manager is an “independent contractor” within the

meaning of section 856(d)(3) with respect to Taxpayer. Taxpayer does not derive or
receive any income from Manager. Taxpayer's common shares are publicly traded on
PLR-132082-14 3

the New York Stock Exchange. Section 16(a) of the Securities Exchange Act of 1934
requires Taxpayer's trustees, executive officers, and persons who own more than ten
percent of a registered class of securities to annually file reports of ownership with the
SEC and furnish copies of such reports to Taxpayer. Based on such reports, Taxpayer
represents that there are only d shareholders of Taxpayer that own ten percent or more
of the Taxpayer's shares directly, indirectly, or constructively, and that such
shareholders own approximately e percent of Taxpayer's shares.

     Manager will have the sole right to operate and manage Facility. TRS will not

have any ability to control, nor will it participate in, the operation or management of
Facility. Moreover, TRS will not have any authority over the persons providing services
at Facility. Under the proposed management agreement, Manager will have exclusive
responsibility for the selection, hiring, employment, retention, training, control,
determination of benefits and compensation, discharge, and other terms of employment
of all the individuals providing services at Facility.

   Taxpayer makes the following additional representations:

          1. Company does not directly or indirectly own shares of Taxpayer.

          2. Manager does not directly or indirectly own shares of Taxpayer.

          3. Persons owning directly, indirectly, or constructively ten percent or more
          of Company do not as a group own 35 percent or more of Taxpayer's
          shares directly, indirectly, or constructively.

          4. In applying the 35 percent limitation in section 856(d)(3)(B), the last
          sentence (the “flush language”) at the end thereof has been taken into
          account, and the stock ownership of all persons owning 5 percent or more
          of the Taxpayer’s shares has been taken into account.

          5. TRS does not have any employees, and will not have any employees,
          who perform any services for, or relating to, the Facility.

                              LAW AND ANALYSIS

   Section 318 generally provides that for the purposes of certain provisions

of the Code, the stock owned by a taxpayer includes stock constructively owned by
such taxpayer (the "attribution rules").

  Section 318(a)(2)(A) provides that stock owned, directly or indirectly, by or for a

partnership is considered as owned proportionately by its partners.

  Section 318(a)(2)(C) provides that if 50 percent or more in value of the stock in a

corporation is owned, directly or indirectly, by or for any person, such person is
PLR-132082-14 4

considered as owning the stock owned, directly or indirectly, by or for such corporation,
in that proportion which the value of the stock which such person so owns bears to the
value of all the stock in such corporation.

    Section 318(a)(3)(A) provides that stock owned, directly or indirectly, by

or for a partner is considered as owned by the partnership.

  Section 318(a)(3)(C) provides that if 50 percent or more in value of the stock in a

corporation is owned, directly or indirectly, by or for any person, such corporation is
considered as owning the stock owned, directly or indirectly, by or for such person.

    Under section 856(d)(5), the section 318 attribution rules are applicable in

determining the ownership of stock, assets, or net profits for purposes of section 856(d).
However, section 856(d)(5) modifies the operation of section 318 for purposes of
section 856(d) in two significant ways. First, the "50 percent" threshold for the
attribution of corporate stock ownership in sections 318(a)(2)(C) and 318(a)(3)(C) is
lowered to ten percent. Second, in the case of a partnership, attribution via section
318(a)(3)(A) applies only to partners who own 25 percent or more of the capital interest
or the profits interest in the partnership.

   Section 856(c)(4)(B)(iii) provides that a corporation shall not be considered a

REIT for any taxable year unless at the close of each quarter of the taxable year, except
with respect to a TRS, (i) not more than 5 percent of the value of its total assets is
represented by securities of any one issuer, (ii) the trust does not hold securities
possessing more than 10 percent of the total voting power of the outstanding securities
of any one issuer, and (iii) the trust does not hold securities having a value of more than
10 percent of the total value of the outstanding securities of any one issuer.

    Section 856(d)(3) defines an “independent contractor” as any person who does

not own, directly or indirectly, more than 35 percent of the REIT’s shares and, if such
person is a corporation, not more than 35 percent of the total combined voting power of
whose stock (or 35 percent of the total shares of all classes of whose stock) is owned
directly or indirectly, by one or more persons owning 35 percent or more of the shares
of the REIT. The flush language of section 856(d)(3) provides further that in the event
that any class of stock of either the real estate investment trust or such person is
regularly traded on an established securities market, only persons who own, directly or
indirectly, more than 5 percent of such class of stock shall be taken into account as
owning any of the stock of such class for purposes of applying the 35 percent limitation
set forth in subparagraph (B) (but all of the outstanding stock of such class shall be
considered outstanding in order to compute the denominator for purpose of determining
the applicable percentage of ownership). Thus, section 856(d)(3) imposes two tests
that Manager must pass in order to qualify as an independent contractor: (A) Manager
does not own directly, indirectly, or constructively, 35 percent or more of Taxpayer's
shares, and (B) a person or group of persons owning directly, indirectly, or
PLR-132082-14 5

constructively 35 percent or more of Manager do not also own 35 percent or more of
Taxpayer's shares.

   Section 856(d)(7)(C) 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 the REIT shall not be treated as furnished, rendered, or provided by the REIT.

    Section 856(l) provides that a REIT and a corporation (other than a REIT) may

jointly elect to treat such corporation as a TRS. To be eligible for treatment as a TRS,
section 856(l)(1) provides that the REIT must directly or indirectly own stock in the
corporation, and the REIT and the corporation must jointly elect such treatment.

   Section 856(l)(2) provides that any corporation in which a TRS owns directly or

indirectly more than 35 percent of the total voting power or value of the outstanding
securities shall be treated as a TRS.

     Section 856(l)(3)(A) provides that a TRS cannot directly or indirectly operate or

manage a lodging facility or a healthcare facility. Section 856(l)(4)(A) gives “lodging
facility” the same meaning given to the term in section 856(d)(9)(D)(ii). A “lodging
facility” is defined in section 856(d)(9)(D)(ii) as a hotel, motel, or other establishment
more than one-half of the dwelling units of which are used on a transient basis. Section
856(d)(9)(D)(iii) provides that a “lodging facility” also includes customary amenities and
facilities operated as part of, or associated with, the lodging facility so long as such
amenities and facilities are customary for other properties of a comparable size and
class owned by other owners unrelated to such REIT.

    Under the proposed structure, Facility will be managed and operated by

Manager, an “independent contractor” within the meaning of section 856(d)(3) with
respect to Taxpayer. Manager will manage and operate Facility, and will have exclusive
authority over the persons providing services at Facility. TRS will not participate in the
operation or management of Facility and will have no control over the employment of
the individuals providing services. TRS has no employees. Accordingly, TRS will not
be considered to be directly or indirectly operating or managing a lodging facility in
violation of section 856(l)(3)(A).

1. Manager Does Not Own 35 Percent or More of Taxpayer's Shares

        a. Manager does not actually own 35 percent or more of Taxpayer's
   

   shares because Manager does not directly or indirectly own any of
   Taxpayer's shares.

         b. Manager does not constructively own any of Taxpayer's shares.
   

   In order for Manager to constructively own Taxpayer's shares, such
   shares would need to be attributed to Manager under section 318(a)(3)(C)
   PLR-132082-14 6

   from a person owning stock in Manager ("downward attribution") or under
   sections 318(a)(2)(A) or 318(a)(2)(C) from an entity in whom Manager
   owns an interest ("upward attribution").

   Manager does not constructively own Taxpayer's shares by downward attribution
   because Company, Manager's parent, does not own any shares of Taxpayer, and, as
   discussed below, no shareholders of Company own 35 percent or more of Taxpayer's
   shares. Additionally, Manager does not constructively own any shares of Taxpayer by
   upward attribution because it does not own any interests in other entities. Thus,
   Manager does not constructively own Taxpayer's shares under section 318(a)(3)(C).
   Accordingly, Manager does not fail to qualify as an independent contractor by reason of
   section 856(d)(3)(A).

2. A Person or Group of Persons Owning 35 Percent or More of Manager Does Not
   Also Own 35 Percent or More of Taxpayer's Shares

   No person or persons owning 35 percent or more of Manager actually own 35
   percent or more of Taxpayer's shares. Therefore, in order for Manager to fail to qualify
   as an independent contractor under section 856(d)(3)(B), either (1) the shareholders of
   Company would have to own 35 percent or more of Taxpayer's shares actually or
   constructively, and those shares would have to be attributed down to Company, or (2)
   35 percent or greater ownership of the Taxpayer's shares would have to be attributed
   down to LLC.

   a. Company Does Not Constructively Own 35 Percent of Taxpayer's Shares

   Section 856(d)(5) requires stock ownership of at least ten percent before a
   shareholder or group of shareholders' stock ownership can be attributed down to a
   corporation. Thus, any ownership of shares of Taxpayer by Company shareholders
   owning individually or collectively less than ten percent of Company cannot be attributed
   down to Company; only ten percent or more shareholders of Company can affect the
   determination under section 856(d)(3)(B).

   Because persons owning ten percent or more of Company do not as a group
   own 35 percent or more of Taxpayer's shares either actually or constructively, an
   amount of shares of Taxpayer that would disqualify Manager as an independent
   contractor under section 856(d)(3)(B) cannot be attributed down to Company.

   b. Thirty-Five Percent of Taxpayer's Shares Cannot Be Attributed Down to
   Company

   Manager would not qualify as an “independent contractor” if any other person or
   

   persons were to constructively own 35 percent or more of both Manager and Taxpayer.
   In this case, the only potential person for such constructive ownership would be LLC.
   PLR-132082-14 7

   Company’s c percent ownership of Manager is attributed down to LLC under
   section 318(a)(3)(A) because Company owns b percent of LLC. Therefore, if 35
   percent or more of Taxpayer's shares can be attributed down to LLC, LLC would
   constructively own more than 35 percent of both Manager and Taxpayer. However,
   only d shareholders of Taxpayer own more than ten percent of Taxpayer's shares, and
   those shareholders own only approximately e percent of Taxpayer's shares; no other
   shares of Taxpayer can be attributed down to LLC. Accordingly, it is not possible for
   LLC to constructively own 35 percent or more of Taxpayer's shares. Therefore, there is
   no person or entity that constructively owns 35 percent or more of both Manager and
   Taxpayer.

                                CONCLUSIONS
   

   Accordingly, based on the facts submitted and representations made, we
   conclude that under the circumstances described above in which Taxpayer represents
   that Manager will qualify as an “independent contractor” within the meaning of section
   856(d)(3) with respect to Taxpayer, TRS will not be considered to be directly or
   indirectly operating or managing a lodging facility in violation of section 856(l)(3)(A),
   even assuming that Facility qualifies as a “lodging facility” within the meaning of section
   856(d)(9). Therefore, TRS will not fail to qualify as a TRS under section 856(l) of
   Taxpayer by reason of TRS’s acquisition of a b percent ownership interest in LLC.

   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 as to whether Taxpayer
   otherwise qualifies as a REIT or whether TRS otherwise qualifies as a TRS of Taxpayer
   under part II of subchapter M of Chapter 1 of the Code. Furthermore, no opinion is
   expressed as to whether the Facility qualifies as a “lodging facility” within the meaning
   of section 856(d)(9), and no opinion is expressed as to whether, under section
   856(d)(2), amounts received by Taxpayer from LLC are excluded from “rents from real
   property” for purposes of sections 856(c)(2) and (3).

   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.

   The ruling contained in this letter is based upon information and representations
   submitted by the 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 a ruling, it is subject to verification on examination.
   PLR-132082-14 8

   In accordance with the Power of Attorney on file with this office, copies of this
   

   letter are being sent to your authorized representatives.

                                  Sincerely,
   
                                  ______________________________
                                  Robert A. Martin
                                  Senior Technician Reviewer, Branch 1
                                  Office of Associate Chief Counsel
                                  (Financial Institutions & Products)
   

Enclosures (2):
A copy of this letter
A copy for section 6110 purposes