A REIT's accounting-method-change income adjustment is not counted against its 95%/75% income tests

Plain-English summary

To qualify as a real estate investment trust (REIT), a company must earn most of its income from real-estate sources: at least 95% and 75% of gross income must come from the qualifying categories listed in § 856(c)(2) and (3). Here a company planning to elect REIT status had changed its accounting method (to start capitalizing interest on certain property), which produced a positive § 481(a) adjustment, extra income spread over four years to prevent items from being omitted. That adjustment is not one of the qualifying real-estate income types, so on its face it could jeopardize the income tests. The company asked the IRS to treat the adjustment as not being gross income for those tests. Using its authority under § 856(c)(5)(J)(i), the IRS agreed: the § 481(a) adjustment will not be treated as gross income for purposes of the 95% and 75% tests, which is consistent with the purpose of the REIT rules. The IRS did not rule on whether the company otherwise qualifies as a REIT or on the propriety or amount of the method change.

Ruling snapshot

• Question: Is a § 481(a) accounting-method-change adjustment treated as gross income for the REIT 95% and 75% income tests?
• Outcome: approved (adjustment excluded from gross income for §§ 856(c)(2)-(3) under § 856(c)(5)(J)(i))
• Key authorities: IRC § 856(c)(2), (3), (5)(J); IRC § 481(a); Treas. Reg. § 1.481-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202220012 Third Party Communication: None
Release Date: 5/20/2022 Date of Communication: Not Applicable
Index Number: 856.00-00
Person To Contact:

------------------------------------------ -----------------, ID No. -----------------
------------------------------------------------ Telephone Number:
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-------------------- Refer Reply To:
CC:FIP:B01
PLR-123585-21
Date:
February 22, 2022

Legend

Taxpayer = ---------------------------------------------------------------------------
State = ----------------------------------------------------------------------------------------------
Assets = ---------------------------------------------------------
Date 1 = --------------------------
Date 2 = --------------------------

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

   This ruling responds to a letter dated November 11, 2021, submitted on behalf of

Taxpayer. Taxpayer requests a ruling that a section 481(a) adjustment required to be
included in gross income by Taxpayer will not be treated as gross income for purposes
of section 856(c)(2) or (3) of the Internal Revenue Code (the “Code”).

                                                  FACTS

   Taxpayer is a State corporation that intends to elect to be taxed as a real estate

investment trust (“REIT”) under sections 856 through 860 beginning with its taxable year
ending on Date 1. Taxpayer and its subsidiaries design, build, and own Assets.

   Taxpayer filed a Form 3115, Application for Change in Accounting Method, under

the automatic change procedures described in Rev. Proc. 2015-13, 2015-5 I.R.B. 419,
to change its method of accounting for certain interest expense with respect to its
designated property (as defined in section 1.263A-8(b) of the Income Tax Regulations)
beginning with its taxable year ended Date 2. See section 12.14 of Rev. Proc. 2019-43,
2019-48 I.R.B. 1107, 1160. Taxpayer thereby secured consent to change its method of
accounting from not capitalizing to capitalizing interest with respect to its designated
property. This method change resulted in a positive adjustment under section 481(a)
PLR-123585-21 2

(the “Section 481(a) Adjustment”) that is includible in Taxpayer’s taxable income over a
four-year period that includes Taxpayer’s taxable year ending Date 1.

                              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
(other than property described in section 1221(a)); abatements and refunds of taxes on
real property; income and gain derived from foreclosure property; commitment fees to
make loans secured by mortgages on real property or on interests in real property or to
purchase or lease real property; 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 mortgages on real property or on interests in real property; gain
from the sale or other disposition of real property (other than property described in
section 1221(a)); dividends or other distributions on, and gain from the sale or
disposition of, transferable shares in other REITs; abatements and refunds of taxes on
real property; income and gain derived from foreclosure property; commitment fees to
make loans secured by mortgages on real property or on interests in real property or to
purchase or lease real property; gain from certain sales or other dispositions of real
estate assets; and qualified temporary investment income.

    Section 856(c)(5)(J) provides that, to the extent necessary to carry out the

purposes of part II of subchapter M of chapter 1 of the Code, the Secretary is authorized
to determine, solely for purposes of that part, whether any item of income or gain that
(i) does not otherwise qualify under section 856(c)(2) or (3) may be considered as not
constituting gross income for purposes of section 856(c)(2) or (3), or (ii) otherwise
constitutes gross income not qualifying under section 856(c)(2) or (3) may be
considered as gross income which qualifies under section 856(c)(2) or (3).

   Section 481(a) provides that a taxpayer that changes its method of accounting

takes into account necessary adjustments in computing its taxable income to prevent
amounts from being duplicated or omitted.

   Section 1.481-1(d) provides that a section 481(a) adjustment must be properly

taken into account for purposes of computing gross income, adjusted gross income, or
taxable income in determining the amount of any item of gain, loss, deduction, or credit
that depends on gross income, adjusted gross income, or taxable income.
PLR-123585-21 3

   The Section 481(a) Adjustment constitutes gross income of a type not listed in

section 856(c)(2) or (3). Based on all of the facts and circumstances, however,
exclusion of the Section 481(a) Adjustment from Taxpayer's gross income for purposes
of sections 856(c)(2) and (3) is consistent with the purposes of part II of subchapter M of
chapter 1 of the Code.

                                   CONCLUSION

  Based on the information submitted and the representations made, we rule that,

under section 856(c)(5)(J)(i), the Section 481(a) Adjustment will not be treated as gross
income for purposes of section 856(c)(2) or (3).

   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 regarding whether
Taxpayer otherwise qualifies (or will qualify) as a REIT under part II of subchapter M of
chapter 1 of the Code. Additionally, no opinion is expressed regarding the propriety of
Taxpayer’s method change or the amount of the Section 481(a) Adjustment.

  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,


                                    ____________________________
                                    Steven Harrison
                                    Branch Chief, Branch 1
                                    Office of Associate Chief Counsel
                                    (Financial Institutions & Products)

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