Treats apartment services as qualifying REIT rental activity

Plain-English summary

A real estate investment trust owned three luxury apartment properties and asked whether services provided there would create impermissible tenant service income. The services included leasing, common-area internet, routine maintenance, landscaping, security, doorman functions, common-area upkeep, and occasional social or holiday events intended to attract and retain tenants. The taxpayer represented that these services were customary for comparable luxury apartments in the area, available to all tenants, and not personal services for particular tenants. Lifeguard, extermination, cable, and internet services were supplied by independent contractors from whom the REIT received no income. The IRS ruled that the taxpayer-provided and marketing services did not create impermissible tenant service income and would not prevent the rents from qualifying as rents from real property under section 856(d). The ruling did not decide whether the taxpayer otherwise qualified as a REIT or whether an exempt organization offering the same services would avoid unrelated business taxable income.

Ruling snapshot

• Question: Would the apartment amenities, customary property services, and tenant-wide marketing events create impermissible tenant service income for the REIT?
• Outcome: Approved.
• Key authorities: IRC §§ 511(a)(2), 512(b)(3), and 856(c) and (d); Treas. Reg. §§ 1.512(b)-1(c)(5) and 1.856-4(b).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201812009
Release Date: 3/23/2018
Third Party Communication: None
Date of Communication: Not Applicable
Index Number: 856.04-00

Person To Contact:
[redacted], ID No. [redacted]
Telephone Number:
[redacted]
Refer Reply To:
CC:FIP:B02
PLR-136399-16
Date:
December 14, 2017

Legend:

Taxpayer = [redacted]
State A = [redacted]
Area = [redacted]
Property A = [redacted]
Property B = [redacted]
Property C = [redacted]

Dear [redacted]:

This is in reply to a letter dated November 14, 2016, requesting a ruling on behalf
of Taxpayer. Taxpayer requests a ruling that the provision of services described below
does not give rise to impermissible tenant service income and will not cause rent
received from tenants to be treated as other than rents from real property under section
856(d) of the Internal Revenue Code.

FACTS

Taxpayer is a State A corporation that has elected to be taxed as a real estate
investment trust (REIT) under section 856 of the Code. Through disregarded entities,

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Taxpayer wholly owns three separate residential properties in Area: Property A,
Property B, and Property C (each a “Property” and collectively, the “Properties”).

Description of the Properties

Each Property includes some or all of the following amenities that are available to
all tenants of that Property at no additional cost: a swimming pool; an exercise room
with exercise equipment, televisions, and water; sports courts and related equipment; a
tennis court; a fire pit; a roof deck; a lounge with a television, a movie screen, and
games; a kitchen; a picnic area with grills; a playground; a dog playground; a jogging
path; laundry rooms; and a business center (collectively, the “Facilities”).

Taxpayer represents that rent attributable to personal property that is leased
under, or in connection with, any lease of the Properties does not exceed 15 percent of
the total rent for the taxable year attributable to both the real and personal property
leased under, or in connection with, such lease.

Services provided at the Properties

Taxpayer provides the following services at each Property: leasing functions;
wireless internet in common areas of the Property; ordinary and necessary maintenance
functions such as service to HVAC, plumbing, and electrical systems, and repair of
basic kitchen appliances and light fixtures in tenants’ units; landscaping of the
Property’s grounds; security services; routine doorman services as described below;
and routine maintenance, cleaning, and activities to ensure the safety and security of
tenants and Taxpayer’s property in the common areas, including the Facilities described
above (collectively, the “Taxpayer Provided Services”). The doorman services provided
at each Property include managing the flow of residents and non-residents into and out
of the Property, monitoring security cameras and other security systems, admitting
guests, receiving packages, assisting locked-out tenants, and acting as the first point
of contact for an apartment emergency.

Taxpayer will also engage in occasional marketing activities (hereinafter, the
“Marketing Services”) to enhance its ability to attract new tenants and keep existing
tenants. The Marketing Services are seasonal holiday parties and social events¹ to
help bolster a positive atmosphere and feeling of community at the Properties, which
will attract new tenants and induce current tenants to renew their leases. The Marketing
Services will be available to all tenants, and not specifically to any particular tenant.

Taxpayer represents that the Taxpayer Provided Services and Marketing
Services are customarily furnished or rendered in connection with the rental of real
property in luxury apartment buildings located in the geographic area where the

¹ Social events may include a tasting event (for which a local merchant may donate products), a
breakfast, a happy hour, an ice cream party, an outing, a bingo night, a raffle, or a pool party.

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Properties are located. Taxpayer further represents that the Taxpayer Provided
Services and Marketing Services are provided to all tenants and do not constitute
personal services rendered to any particular tenant.

Services provided by a third party:

In addition to the services provided by Taxpayer, Taxpayer has hired
independent contractors from whom it does not derive or receive any income to provide
lifeguards at the pools, extermination services, and cable and internet.

LAW AND ANALYSIS

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.

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(d)(1) provides that rents from real property include (subject to
exclusions provided in section 856(d)(2)): (A) rents from interests in real property; (B)
charges for services customarily furnished or rendered in connection with the rental of
real property, whether or not such charges are separately stated; and (C) rent
attributable to personal property leased under, or in connection with, a lease of real
property, but only if the rent attributable to the personal property for the taxable year
does not exceed 15 percent of the total rent for the tax year attributable to both the real
and personal property leased under, or in connection with, such lease.

Section 1.856-4(b)(1) provides that, for purposes of §§ 856(c)(2) and (c)(3), the
term “rents from real property” includes charges for services customarily furnished or
rendered in connection with the rental of real property, whether or not the charges are
separately stated. Services furnished to tenants of a particular building will be
considered customary if, in the geographic market in which the building is located,
tenants in buildings of a similar class (such as luxury apartment buildings) are
customarily provided with the service.

Section 1.856-4(b)(5)(ii) provides that trustees or directors of the REIT are not
required to delegate or contract out their fiduciary duty to manage the trust itself, as
distinguished from rendering or furnishing services to the tenants of the property or
managing or operating the property. Thus, the trustees or directors may do all those
things necessary, in their fiduciary capacities, to manage and conduct the affairs of the
trust itself, including establishing rental terms, choosing tenants, entering into renewal of
leases, and dealing with taxes, interest, and insurance relating to the trust’s property.
The trustees may also make capital expenditures with respect to the trust’s property (as
defined in section 263) and may make decisions as to repairs of the trust’s property (of

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the type that would be deductible under section 162), the cost of which may be borne by
the trust. See also Rev. Rul. 67-353, 1967-2 C.B. 252.

Section 856(d)(2)(C) provides that any impermissible tenant service income is
excluded from the definition of rents from real property. Section 856(d)(7)(A) defines
impermissible tenant service income to mean, with respect to any real or personal
property, any amount received or accrued directly or indirectly by the REIT for services
furnished or rendered by the REIT to the tenants of such property, or for managing or
operating such property.

Section 856(d)(7)(B) provides that if the amount of impermissible tenant service
income exceeds one percent of all amounts received or accrued during any taxable
year directly or indirectly by the REIT with respect to such property, the impermissible
tenant service income of the REIT will include all of the amounts received or accrued
with respect to the property. Section 856(d)(7)(D) provides that the amounts treated as
received by a REIT for any impermissible tenant service shall not be less than 150
percent of the direct cost of the REIT in furnishing or rendering the service (or providing
the management or operation).

Section 856(d)(7)(C) provides certain exclusions from impermissible tenant
service income. 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 shall not be treated as furnished,
rendered, or provided by the REIT, and there shall not be taken into account any
amount which would be excluded from unrelated business taxable income under section
512(b)(3) if received by an organization described in section 511(a)(2).

Section 512(b)(3) provides, in part, that there shall be excluded from the
computation of unrelated business taxable income all rents from real property and all
rents from personal property leased with such real property, if the rents attributable to
such personal property are an incidental amount of the total rents received or accrued
under the lease, determined at the time the personal property is placed in service.

Section 1.512(b)-1(c)(5) provides that payments for the use or occupancy of
rooms and other space where services are also rendered to the occupant, such as for
the use or occupancy of rooms or other quarters in hotels, boarding houses, or
apartment houses furnishing hotel services, or in tourist camps or tourist homes, motor
courts or motels, or for the use or occupancy of space in parking lots, warehouses, or
storage garages, do not constitute rent from real property. Generally, services are
considered rendered to the occupant if they are primarily for his convenience and are
other than those usually or customarily rendered in connection with the rental of rooms
or other space for occupancy only. The supplying of maid service, for example,
constitutes such service; whereas the furnishing of heat and light, the cleaning of public

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entrances, exits, stairways, and lobbies, and the collection of trash are not considered
as services rendered to the occupant.

In determining whether a taxpayer has income that is impermissible tenant
service income, only the income that is attributable to a provision of a service is
analyzed. Although services may be provided in the Facilities, the Facilities themselves
are not services. Income that is attributable to making available to all tenants at no
additional cost a space such as one of the Facilities is not income from the provision of
a service and is therefore not impermissible tenant service income. Any services (e.g.,
the Taxpayer Provided Services) that are provided in or with respect to the Facilities are
analyzed as any other service provided to tenants.

Taxpayer has represented that the Taxpayer Provided Services and Marketing
Services are customarily furnished or rendered in connection with the rental of real
property in luxury apartment buildings located in the geographic area where the
Properties are located. Taxpayer further represents that the Taxpayer Provided
Services and Marketing Services are provided to all tenants and do not constitute
personal services rendered to any particular tenant.

The income from the Taxpayer Provided Services and Marketing Services is, for
purposes of determining whether the income is qualifying income for REIT qualification
purposes, income that would be excluded from unrelated business taxable income
under section 512(b)(3) if received by an organization described in section 511(a)(2) or
is an activity that is a fiduciary duty to manage the trust itself. Taxpayer represents that
any additional services are provided through independent contractors from whom
Taxpayer does not derive or receive any income.

Accordingly, income from the Taxpayer Provided Services and Marketing
Services is not impermissible tenant service income and, therefore, will not cause any
portion of the rents received by Taxpayer from the tenants of each Property to fail to
qualify as rents from real property under section 856(d).

CONCLUSION

Based on the facts and representations submitted, we rule that income from the
Taxpayer Provided Services and Marketing Services is not impermissible tenant service
income and, therefore, will not cause any portion of the rents received by Taxpayer from
the tenants of each Property to fail to qualify as rents from real property under section
856(d).

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. Specifically, no opinion is expressed or implied on whether
Taxpayer otherwise qualifies as a REIT under subchapter M of the Code.

PLR-136399-16 6

Furthermore, the ruling herein relates to whether income from services
performed by Taxpayer is impermissible tenant service income and is specifically limited
to whether the income is qualifying income for REIT qualification purposes. The
definition of rents from real property under section 856(d) differs in scope and structure
from the definition of rents from real property under section 512(b)(3), which applies to
exempt organizations described in section 511(a)(2). Therefore, an exempt
organization providing the same services may have unrelated business taxable income
because the income may not be excluded under section 512(b)(3) as rents from real
property.

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,

Andrea M. Hoffenson
Chief, Branch 2
Office of Associate Chief Counsel
(Financial Institutions & Products)