Assisted-living joint venture rent qualifies as REIT income

Plain-English summary

A company intending to qualify as a real estate investment trust owned assisted-living facilities through a partnership. The facilities were leased to operating partnerships owned by the REIT's taxable REIT subsidiary and one unrelated partner, and an independent contractor managed each facility. Ordinarily, rent from a sufficiently owned related party is excluded from qualifying REIT rent, but Section 856(d)(8)(B) provides an exception for qualified health care property operated by an eligible independent contractor. The IRS analyzed the rent according to each operating partnership owner's interest. It ruled that the taxable subsidiary's share satisfied the health-care-property exception and the unrelated partner's share qualified without an exception, so the rental income was not excluded from rents from real property.

Ruling snapshot

• Question: Would rent from assisted-living facilities leased to partnerships owned by a taxable REIT subsidiary and one unrelated partner qualify as rents from real property?
• Outcome: Approved, as long as an eligible independent contractor operates each facility.
• Key authorities: IRC §§ 856(c), 856(d)(2)(B), 856(d)(8)(B), 856(d)(9)(A), 856(e)(6)(D), 7872(g)(4)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201828009 Third Party Communication: None
Release Date: 7/13/2018 Date of Communication: Not Applicable
Index Number: 856.00-00
Person To Contact:
-------------------- ------------------------, ID No. ------------------
-------------------------------- ----------------------------------------------------
---------------------------------- Telephone Number:
------------------------------------------------ ----------------------
-------------------------------------------- Refer Reply To:
------------------------------ CC:FIP:B02
PLR-131978-17
Date:
April 18, 2018

Legend:

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

Partner = -------------------------------------------

PropCo = ------------------------------------

Domestic TRS = ----------------------------------------

OpCo = ----------------------------------

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

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

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

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

a = --

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

    This is in reply to a letter dated September 28, 2017, and supplemental

correspondence requesting a ruling on behalf of Taxpayer. Taxpayer has requested a
ruling regarding whether the rents received by Taxpayer qualify as rents from real
property for purposes of section 856(d) of the Internal Revenue Code (“Code”).

Facts:

   Taxpayer was incorporated under the laws of State on Date 1. Taxpayer intends

to qualify and elect to be taxed as a real estate investment trust (“REIT”) under sections
856 through 859 of the Code beginning with its taxable year ended Date 2.

    Taxpayer’s primary business is the acquisition, ownership, and leasing of

assisted living (“AL”) facilities. Taxpayer recently acquired fee ownership of a portfolio
of a AL facilities located in the United States. Taxpayer also acquired a leasehold
interest in one AL facility that is currently under construction, subject to Taxpayer’s
option to purchase. All of the AL facilities (“AL Facilities”) are intended to qualify as
qualified health care properties within the meaning of section 856(e)(6)(D).

    Taxpayer holds its AL Facilities through PropCo, a State limited liability company

that is treated as a partnership for U.S. federal income tax purposes. PropCo, in turn,
holds its interests in the AL Facilities through subsidiary entities (“PropCo Subs”) that
are each disregarded as a separate entity from PropCo for U.S. federal income tax
purposes. Taxpayer formed Domestic TRS, a State limited liability company that will
jointly elect with Taxpayer to be treated as a taxable REIT subsidiary (“TRS”) of
Taxpayer. Domestic TRS and Partner, an entity unrelated to Taxpayer or Domestic TRS
within the meaning of section 856(d)(2)(B), formed OpCo, a State limited liability
company taxed as a partnership for U.S. federal income tax purposes. Pursuant to the
structure permitted by the Housing and Economic Recovery Act of 2008, Pub. L. No.
110-289, § 3061, 122 Stat. 2654, 2901-02 (2008) (“RIDEA”),1 each PropCo Sub that
holds an AL Facility leases the facility to a subsidiary of OpCo (each, an “OpCo Sub”)
that is disregarded as a separate entity from OpCo for U.S. federal income tax
purposes. Each OpCo Sub has entered into a management contract with Manager to
manage and operate its AL Facility.

Law & 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
1
Sections 3031-3071 of the Housing and Economic Recovery Act incorporated significant portions of
proposed legislation introduced as the REIT Investment Diversification and Empowerment Act of 2007, or
“RIDEA”. See H.R. 1147 and S. 2002, 100th Cong. (1st Sess. 2007).

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 taxable year attributable to both the
real and personal property leased under, or in connection with, the lease.

  Section 856(d)(2)(B) provides that rents from real property do not include

amounts received directly or indirectly from a corporation if the REIT owns 10 percent or
more of the total combined voting power or 10 percent or more of the total value of the
shares of the corporation.

     Section 856(d)(8)(B) provides that amounts paid to a REIT by a TRS shall not be

excluded from rents from real property by reason of section 856(d)(2)(B) when a REIT
leases a qualified lodging facility or qualified health care property to a TRS, and the
facility or property is operated on behalf of the TRS by a person who is an eligible
independent contractor.

   Section 856(d)(9)(A) provides that the term “eligible independent contractor”

(“EIK”) with respect to any qualified lodging facility or qualified health care property (as
defined in section 856(e)(6)(D)(i)) means any independent contractor if, at the time such
contractor enters into a management agreement or other similar service contract with
the TRS to operate such qualified lodging facility or qualified health care property, such
contractor (or any related person) is actively engaged in the trade or business of
operating qualified lodging facilities or qualified health care properties, respectively, for
any person who is not a related person with respect to the REIT or the TRS.

    Section 856(e)(6)(D)(i) defines qualified health care property as any real property

that is a health care facility.

     A “health care facility” is defined in section 856(e)(6)(D)(ii) as a hospital, nursing

facility, assisted living facility, congregate care facility, qualified continuing care facility
(as defined in section 7872(g)(4)), or other licensed facility which extends medical or
nursing or ancillary services to patients, and which was operated by a provider of such
services that is eligible for participation in the Medicare program under Title XVII of the
Social Security Act (42 U.S.C.A. § 1395 et seq.) with respect to such facility.

Ruling Request: Whether rental income received directly or indirectly by PropCo from
the lease (or sublease) of an AL Facility to a disregarded subsidiary of OpCo or a
partnership subsidiary of OpCo will qualify as “rents from real property” for purposes of
section 856(d).

  The related-party rent exception of section 856(d)(8)(B) is only available for

amounts paid by a TRS to the REIT and only when the qualified health care facility is
operated on behalf of a TRS by an EIK. In this case, although the amounts paid are for
the lease of qualified health care properties, the amounts are not paid by a TRS directly.
Instead, the amounts are paid by OpCo and OpCo Subs, which each constitute a
partnership that is owned by Domestic TRS and one unrelated party, Partner.
Therefore, the question here is whether the related-party rent exception can apply to
amounts paid by a partnership where the partners are a TRS and only one other
unrelated party.

    Under the facts as represented, the amounts paid by OpCo and OpCo Subs may

qualify as rents from real property for purposes of section 856(d) by analyzing the
income attributable to the partnership interest held by a TRS separately from the
income attributable to any remaining partnership interest. If Domestic TRS were the
sole, direct lessee of each AL Facility, the related-party rent exception of section
856(d)(8)(B) would apply to amounts received directly from Domestic TRS. Therefore,
in this case, amounts attributable to the partnership interest held by Domestic TRS
satisfy the requirements of section 856(d)(8)(B) so long as an EIK manages and
operates the AL Facility rented by the partnership. If Partner, which Taxpayer
represents is not related to Taxpayer within the meaning of section 856(d)(2)(B), were
the sole direct lessee of each AL Facility, the amounts would also qualify as rents from
real property (without the need for any exception). Therefore, in this case, amounts
attributable to the partnership interest held by Partner qualify as rents from real
property.

   In conclusion, rental income received directly or indirectly by PropCo from the

lease of an AL Facility to a partnership between Domestic TRS and a single partner
unrelated to Taxpayer within the meaning of section 856(d)(2)(B), shall not be excluded
from rents from real property by reason of section 856(d)(2)(B) so long as the facility is
operated by an EIK.

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

federal income tax consequences relating to the facts herein under any other provision
of the Code. Specifically, we do not rule 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. 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 this ruling 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
                                           Andrea M. Hoffenson
                                           Chief, Branch 2
                                           Office of Associate Chief Counsel
                                           (Financial Institutions & Products)