Payment to waive property purchase right was qualifying REIT income

Plain-English summary

A real estate investment trust indirectly held a general-partner interest in a partnership that owned a residential rental property with onsite retail tenants. The partnership agreement gave each partner a right of first offer when another partner proposed to sell its interest. One partner agreed to pay the REIT in exchange for a waiver that would facilitate a sale to a third party. The IRS ruled that, to the extent the partnership's assets were real property, the payment was gain from disposing of an interest in real property and therefore qualified under both REIT gross-income tests in Sections 856(c)(2) and (3). The ruling did not decide whether the taxpayer otherwise qualified as a REIT.

Ruling snapshot

• Question: Was the payment for waiving a right of first offer qualifying income under the REIT income tests?
• Outcome: Approved to the extent the partnership's assets constituted real property.
• Key authorities: IRC §§ 856(c)(2), 856(c)(3), and 856(c)(5)(C); Treas. Reg. § 1.856-3(g).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201820012 Third Party Communication: None
Release Date: 5/18/2018 Date of Communication: Not Applicable
Index Number: 856.01-00, 856.02-00
Person To Contact:
-------------------------- --------------, ID No. ------------------
------------------------------------- Telephone Number:
--------------------------------------- ----------------------
---------------------------------------- Refer Reply To:
---------------------------------- CC:FIP:B01
PLR-126476-17
Date: February 14, 2018

LEGEND:

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

State = -------------
Date = ---------------------------
General Partner = ---------------------------------
Partnership = --------------------------------------------
Partner 1 = -----------------------------
Partner 2 = ------------------------------------------------------------------------

Property = ------------------------------------------------------------------------
---------------------------------------------------------------------------------
-------------------------------------
A = ----
B = ------
C = -----
D = ------
E = ----
F = --
G = -----
H = ----------------

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

    This is in reply to a letter dated August 25, 2017, submitted on behalf of

Taxpayer, requesting a ruling that the Payment described below, is qualifying income
for the purposes of § 856(c)(2) and (3) of the Internal Revenue Code (the “Code”).

PLR-126476-17 2

                                       FACTS

    Taxpayer is a State corporation that intends to operate in a manner that qualifies

as a real estate investment trust (“REIT”) under §§ 856-860 and elected to be taxed as
a REIT pursuant to § 856 commencing with its taxable year that ended on Date.
Taxpayer owns (directly and indirectly) 100% of General Partner, which is a disregarded
entity for Federal income tax purposes. General Partner owns a A% interest in
Partnership as the general partner with Partner 1 and Partner 2 owning B% and C%,
respectively (General Partner, Partner 1 and Partner 2 each a “Partner” and together
the “Partners”). Partnership owns Property. Property is a D-unit residential rental
property with some onsite retail tenants.

   The partnership agreement (the “Partnership Agreement”) among the Partners

provides each Partner with a right of first offer (the “Right of First Offer”) in the event of
a proposed sale of all or part of a partnership interest by another Partner. The
Partnership Agreement states that if any Partner wishes to sell all or part of its
partnership interest, such Partner must first give written notice to the other Partners
(“Notice”) of its intent to sell, the purchase price, and such other terms as set forth in the
Partnership Agreement. The non-selling Partners then have a E-day period to purchase
the selling Partner’s partnership interest on the same terms and conditions as are
contained in the Notice or to elect to have the entire Property sold. If the non-selling
Partners do not act on the Right of First Offer, the selling Partner then has F months
from the end of the E-day period to consummate the sale on terms no less favorable to
the selling partner than provided in the Notice.

   In the proposed transaction, Partner 1 plans to sell its interest in Partnership to a

third party. Pursuant to an amendment to the Partnership Agreement (the
“Amendment”), General Partner will waive its Right of First Offer for one year, and
Partner 1 may retain a G% interest in Partnership that it may dispose of at any time
(including at a time beyond the waiver period) without being subject to the Right of First
Offer provisions of the Partnership Agreement. In exchange for agreeing to the
Amendment, Partner 1 will pay $H to Taxpayer out of the closing escrow from the sale
of Partner 1’s partnership interest (the “Payment”).

                                  LAW AND ANALYSIS

   Section 856(c)(2) provides that, in order for a corporation to qualify as a REIT, at

least 95 percent of the corporation's gross income (excluding gross income from
prohibited transactions) must be derived from dividends; interest; rents from real
property; gain from the sale or other disposition of stock, securities, and real property
(including interests in real property and interests in mortgages on real property);
abatements and refunds of taxes on real property; income and gain derived from

PLR-126476-17 3

foreclosure property; certain commitment fees; gain from certain sales or other
dispositions of real estate assets; and certain mineral royalty income.

   Section 856(c)(3) provides that, in order for a corporation to qualify as a REIT, at

least 75 percent of the corporation's gross income (excluding gross income from
prohibited transactions) must be derived from rents from real property; interest on
obligations secured by real property; gain from the sale or other disposition of real
property (including interests in real property and interests in mortgages on real
property); dividends and other distributions on, and gain from the sale of REIT stock;
abatements and refunds of taxes on real property; income and gain derived from
foreclosure property; certain commitment fees; gain from certain sales or other
dispositions of real estate assets; and qualified temporary investment income.

   Section 856(c)(5)(C) provides that the term “interest in real property” includes fee

ownership and co-ownership of land or improvements thereon, leaseholds of land or
improvements thereon; options to acquire land or improvements thereon; and options to
acquire leaseholds of land or improvements thereon. Treas. Reg. § 1.856-3(g) 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 will be deemed to be entitled to the income of
the partnership attributable to such share.

    The Right of First Offer represents Taxpayer’s future right to purchase interests

in a partnership that holds assets that Taxpayer would be treated as owning in
proportion to any partnership interests it purchased. Thus, to the extent that
Partnership’s assets constitute real property, the Right of First Offer is an interest in real
property for purposes of § 856(c)(5)(C) and payment for the waiver of the Right of First
offer is gain from the disposition of an interest in real property within the meaning of §
856(c)(2)(D) and (3)(C).

                                  CONCLUSIONS

    Based on the facts and representations submitted by Taxpayer, we rule that to

the extent that Partnership’s assets constitute real property, the Payment is gain from
the disposition of an interest in real property within the meaning of § 856(c)(2)(D) and
(3)(C).

    Except as specifically ruled upon above, no opinion is expressed concerning any

Federal income tax consequences related to the facts herein under any other provisions
of the Code. Specifically, we do not rule whether Taxpayer qualifies as a REIT under
Part II of subchapter M of Chapter 1 of the Code.

PLR-126476-17 4

  This ruling is directed only to the taxpayer requesting it. Taxpayer should attach

a copy of this ruling to each tax return to which it applies. 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 under a penalties 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 rulings, it is subject to verification on examination.

     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)