REIT liquidation sales are not prohibited transactions

Plain-English summary

A real estate investment trust considered selling its portfolio under a complete liquidation plan after reviewing alternatives for increasing shareholder value. It represented that it had acquired and held the properties for long-term rental income and appreciation, had historically sold only a small percentage of its holdings, and had acquired its newest properties before considering liquidation. It also planned to use an independent contractor or taxable REIT subsidiary for substantially all marketing expenditures. The IRS ruled that the asset sales under the proposed liquidation plan would not be prohibited transactions subject to the 100 percent tax under section 857(b)(6).

Ruling snapshot

• Question: Would a REIT's portfolio sales under a complete liquidation plan be prohibited transactions?
• Outcome: Approved, the represented sales would not constitute prohibited transactions.
• Key authorities: IRC §§ 856(d)(3), 857(b)(6), 1221(a)(1).

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201640007                                              Third Party Communication: None
Release Date: 9/30/2016                                        Date of Communication: Not Applicable
Index Number: 857.02-03
                                                               Person To Contact:
---------------------                                          --------------------, ID No. ----------------
------------------------------------------                     Telephone Number:
--------------------------------------                         --------------------
----------------------------------------------                 Refer Reply To:
 ----------------------------------------                      CC:FIP:B01
                                                               PLR-106103-16
                                                               Date:
                                                               June 29, 2016




Legend:

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

Company A                           =        ----------------------------------------

Company B                           =        -----------------------------------------------

Operating Partnership               =        --------------------------------------------------

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

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

City                                =        ---------------------

Month 1                             =        ------

Month 2                             =        -------------

Month 3                             =        --------

Month 4                             =        -----

Month 5                             =        -----

Year 1                              =        ------

Year 2                              =        ------
PLR-106103-16                                             2

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

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

A                                   =        -------

B                                   =        -------

C                                   =        ------

D                                   =        -----

E                                   =        -----

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

       This letter responds to your letter dated February 23, 2016, in which Taxpayer
requests a ruling that the sale of Taxpayer’s assets pursuant to a proposed plan of
liquidation will not be considered prohibited transactions for purposes of section
857(b)(6) of the Internal Revenue Code.

                                                       Facts:

         Taxpayer was incorporated in State A in Month 1 of Year 1. Taxpayer completed
its initial public offering (“IPO”) in Month 2 of Year 1, and elected to be treated as a “real
estate investment trust” (“REIT”) for its first tax year ending Date 1.

         Taxpayer was formed to focus on the ---------------------------------------------------------
---------------------------------------------------- in select markets throughout the United States.
In connection with its IPO, Taxpayer --------------------------------------------------------------------
--------------------------------------------------------------------------of more than A ---------------------
properties from Company A and the owners of the membership interests of entities
managed by Company B. Prior to the IPO, Taxpayer owned --- properties and held -----
--------------------- Taxpayer has acquired additional properties each year subsequent to
the IPO and, as of Date 2, Taxpayer owned approximately B -----------------properties.

      Taxpayer conducts its business and owns all of its properties through Operating
Partnership, a State B limited partnership. As of Date 2, Taxpayer owned, through a
combination of direct and indirect interests, C percent of the partnership interests in
Operating Partnership.

         ------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
PLR-106103-16                                             3

--------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------, in the third quarter of Year
2, Taxpayer’s board of directors, together with an outside financial advisor, began
pursuing a review of alternatives available to enhance shareholder value. After
considering several alternatives, Taxpayer now contemplates a complete liquidation of
its portfolio through a sale of its assets.

         Taxpayer represents that its stated intention has always been to hold its
properties over the long-term to generate income and value. Taxpayer has engaged in
some disposition activity since its inception. Through Date 2, Taxpayer has sold D of its
properties. Of these sales, E were sold in a single transaction ---------------------------------
---------- Taxpayer represents the remainder of its sales met the requirements of the
prohibited transaction safe harbor under section 857(b)(6). Taxpayer also represents
that all of its properties acquired in Year 2 were acquired prior to Taxpayer’s
consideration of a liquidation.

         Taxpayer anticipates that the time to fully liquidate its portfolio will take between
6 months and 2 years, depending upon whether Taxpayer’s properties are -----------------
---------------------------------------------------------------------------------- The sale of Taxpayer’s
properties could extend beyond 2 years in the event Taxpayer needs to wait ---------------
------------------------------------------------------------------ Taxpayer represents that
substantially all of the marketing expenditures with respect to sales of its properties will
be made through an independent contractor (as defined in section 856(d)(3)) from
whom the Taxpayer does not derive or receive any income or a taxable REIT subsidiary
of Taxpayer.

         Before Taxpayer pursues a plan of complete liquidation, Taxpayer’s board of
directors plans to take several steps following the receipt of this ruling. First, the board
will perform an updated assessment of the state of Taxpayer’s business. The
assessment will involve a review of the current state of Taxpayer’s strategic plan and
projections and an updated review of strategic alternatives. Taxpayer’s board will then
initiate a portfolio liquidation following this updated review ---------------------------------------
------------------------------ Subsequently, Taxpayer’s board would formally adopt a plan of
liquidation, which Taxpayer would publicly disclose and would likely need to pursue a
stockholder vote to pursue such a plan and a sale of substantially all of its assets.

                                             Law and Analysis:

        Section 857(b)(6)(A) imposes a 100 percent tax on a REIT's net income from
prohibited transactions. Section 857(b)(6)(B)(iii) defines the term “prohibited
transaction” as the sale or other disposition of property described in section 1221(a)(1)
that is not foreclosure property. Section 1221(a)(1) property, in turn, consists of
property held by the taxpayer primarily for sale to customers in the ordinary course of
his trade or business. Section 857(b)(6)(B)(ii) provides that losses attributable to
PLR-106103-16                                4

prohibited transactions are not taken into account in determining the amount of net
income derived from prohibited transactions.

       Section 857(b)(6)(C) excludes certain sales from the definition of a prohibited
transaction. Under section 857(b)(6)(C), the term “prohibited transaction” does not
include a sale of property which is a real estate asset (as defined in section
856(c)(5)(B)) if—

      (i) the REIT has held the property for not less than 2 years;

      (ii) aggregate expenditures made by the REIT, or any partner of the REIT, during
      the 2-year period preceding the date of sale which are includible in the basis of
      the property do not exceed 30 percent of the net selling price of the property;

      (iii) (I) during the taxable year the REIT does not make more than 7 sales of
      property (other than sales of foreclosure property or sales to which section 1033
      applies), or (II) the aggregate adjusted bases (as determined for purposes of
      computing earnings and profits) of property (other than sales of foreclosure
      property or sales to which section 1033 applies) sold during the taxable year
      does not exceed 10 percent of the aggregate bases (as so determined) of all of
      the assets of the REIT as of the beginning of the taxable year, or (III) the fair
      market value of property (other than sales of foreclosure property or sales to
      which section 1033 applies) sold during the taxable year does not exceed 10
      percent of the fair market value of all of the assets of the REIT as of the
      beginning of the taxable year, or (IV) the REIT satisfies the requirements of
      subclause (II) applied by substituting “20 percent” for “10 percent” and the 3-year
      average adjusted bases percentage for the taxable year (as defined in
      subparagraph (G)) does not exceed 10 percent, or (V) the REIT satisfies the
      requirements of subclause (III) applied by substituting “20 percent” for “10
      percent” and the 3-year average fair market value percentage for the taxable
      year (as defined in subparagraph (H)) does not exceed 10 percent;

      (iv) in the case of property, which consists of land or improvements, not acquired
      through foreclosure (or deed in lieu of foreclosure), or lease termination, the
      REIT has held the property for not less than 2 years for production of rental
      income; and

      (v) if the requirement of clause (iii)(I) is not satisfied, substantially all of the
      marketing and development expenditures with respect to the property were made
      through an independent contractor (as defined in section 856(d)(3)) from whom
      the REIT itself does not derive or receive any income or a taxable REIT
      subsidiary.
PLR-106103-16                                        5

       The legislative history underlying section 857(b)(6), which was added to the
Code by the Tax Reform Act of 1976, indicates that the purpose of that section was to
“prevent a REIT from retaining any profit from ordinary retailing activities such as sales
to customers of condominium units or subdivided lots in a development project.” S.
Rep. No. 84-938, at 470 (1976), 1976-3 (Vol. 4) C.B. 508).

        To determine whether a taxpayer holds property “primarily for sale to customers
in the ordinary course of its trade or business,” the Tax Court has held that several
factors must be considered, none of which is dispositive. Among those factors are: (1)
the nature and purpose of the acquisition of the property and the duration of the
ownership; (2) the extent and nature of the taxpayer's efforts to sell the property; (3) the
number, extent, continuity, and substantiality of the sales; (4) the extent of subdividing,
developing, and advertising to increase sales; and (5) the time and effort the taxpayer
habitually devoted to the sales. Generally, it is the purpose for which property is held at
the time of the sale that is determinative, although earlier events may be considered to
decide the taxpayer's purpose at the time of the sale. See Cottle v. Commissioner, 89
T.C. 467, 487 (1987).

       Taxpayer has made the following representations that address its purposes with
respect to the properties at issue. Taxpayer represents that its intention has always
been to hold the properties over the long-term to generate rental income and
appreciated value. Taxpayer’s disposition of the properties in issue is due to a plan of
liquidation, and Taxpayer adopted such a plan only after exploring alternatives that
would allow Taxpayer to continue holding the properties. Since its incorporation in Year
1, Taxpayer has sold only a small percentage of its properties. The properties Taxpayer
acquired in Year 2 were acquired prior to Taxpayer’s consideration of a plan of
liquidation. Substantially all of the marketing expenditures with respect to sales of
Taxpayer’s properties will be made through an independent contractor (as defined in
section 856(d)(3)) from whom the Taxpayer does not derive or receive any income or a
taxable REIT subsidiary of Taxpayer.

                                             Conclusion:

        Based on the facts presented and representations made, we conclude that sales
of Taxpayer's assets pursuant to a plan of liquidation under the above circumstances
will not constitute prohibited transactions within the meaning of section 857(b)(6).1


1
  Section 4 of Rev. Proc. 2016-3 sets forth those areas in which rulings or determination letters will not
ordinarily be issued by the Service. “Not ordinarily” means that unique and compelling reasons must be
demonstrated to justify the issuance of a ruling or determination letter. See Rev. Proc. 2016-3, sec. 2.01.
Section 4.02(5) of Rev. Proc. 2016-3 provides that one of the areas in which rulings or determination
letters will not ordinarily be issued is any matter dealing with the question of whether property is held
primarily for sale to customers in the ordinary course of a trade or business. In this case, Taxpayer has
demonstrated unique and compelling reasons to justify issuance of the ruling.
PLR-106103-16                                  6

       This ruling's application is limited to the facts, representations, Code sections,
and regulations cited herein. 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 with
regard to whether Taxpayer otherwise qualifies as a REIT under subchapter M 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,



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



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