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In Letter Ruling 200813005, the Service ruled that services provided by a taxable REIT subsidiary (TRS) in managing and operating independent living facilities owned by the REIT will not be treated as performed at a "health care facility" and will not cause the rental income received by the REIT from the tenants to be considered as other than "rents from real property."

Facts

Taxpayer is a domestic corporation that elected to be treated as a real estate investment trust (REIT), and is engaged in the acquisition, ownership, and management of hospital and senior care properties. Except for certain medical office buildings, Taxpayer's facilities are leased to health care operating companies under triple net leases that require the lessee to pay all property-related expenses.

Taxpayer is negotiating to acquire independent living facilities. Taxpayer has determined that it will be able to acquire and operate these facilities more cost-efficiently if the customary and noncustomary services rendered at these facilities are provided through a TRS, rather than leasing the entire facility to an operator on a long-term basis for a monthly lease amount.

Taxpayer represents that the facilities it intends to acquire will meet the generally accepted definition of an independent living facility. Certain customary and noncustomary services provided at the facilities (including preparation and serving of meals, periodic housekeeping, laundry and linen service, parking, local transportation, social and recreational activities, and maintenance of residents' rooms and common areas) will be provided by TRS. Services that will be provided through an independent contractor include basic utility, phone, cable and/or internet services, basic cleaning and janitorial services, and coin-operated laundry machines. In addition, unrelated third parties may lease space for beauty and barber services, a commercial bank, and a sundry store.

Services provided by TRS will be priced on an arm's-length basis, with fees collected by Taxpayer from the tenants and remitted to TRS.

The services provided at the independent living facilities will not include assistance with activities of daily living (ADLs), such as medications, showering and bathing, dressing, personal hygiene and grooming, toileting, mobility, monitoring, and eating. The facilities will not include medical or nursing services, or skilled nursing licensed beds.

Only tenants physically and mentally capable of providing for their own health care and personal needs, or who individually contract with independent third-party care providers, will be permitted to reside in these facilities. Also, the facilities will not be licensed and will not participate in the Medicare program.

Analysis

To qualify as a REIT, an entity must derive at least 95% of its gross income from sources listed in Section 856(c)(2) and at least 75% from sources listed in Section 856(c)(3). "Rents from real property" are listed in both sections.

Under Section 856(d)(7)(A), "rents from real property" do not include amounts received or accrued directly or indirectly by a REIT for services furnished or rendered by the REIT to tenants of the property. However, services provided or rendered through a TRS or independent contractor, from whom the REIT does not derive or receive any income, are not treated as furnished, rendered, or provided, by the REIT.

Under Section 856(l)(3)(A), a TRS may not directly or indirectly operate or manage a lodging facility or 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, or other licensed facility that extends medical or nursing or ancillary services to patients, and that was operated by a provider of such services that is eligible for participation in the Medicare program under Title XVIII of the Social Security Act with respect to the facility.

The Service noted that the independent living facilities described by Taxpayer are not licensed facilities and will not provide any medical, nursing, or ADL services to tenants. Also, the Service looked at the distinctions drawn between residential property and health care facilities in other areas of the Code and regulations. See Section 42 and Reg. Section 1.42-11(b), and Revenue Ruling 98-47, 1998-2 CB 399.

Accordingly, the Service concluded that the independent living facilities do not qualify as health care facilities and the TRS is not precluded from operating or managing the independent living facilities. All of the services are provided to tenants through either a TRS or an independent contractor from whom Taxpayer does not derive income. Therefore, the services provided will not cause rental income from those tenants to be treated as other than rents from real property.

Implications

In order to satisfy the REIT income tests, as a general matter a REIT that owns a health care property must master lease the facility to an operator. A REIT cannot generally derive qualifying rents if it directly operates a health care property, because either the use of the property by the customer is incidental to the services provided (e.g., a hospital) or there are extensive noncustomary services provided to the customers/tenants at the facility (e.g., nursing home or assisted living facility). Moreover, a REIT cannot use a TRS to provide noncustomary services to tenants of a "health care facility" because a TRS may not operate or manage a health care facility.

In Letter Ruling 200813005, the Service ruled that the independent living facilities to be acquired by the REIT did not constitute "health care facilities," and thus the REIT was not precluded from using its TRS to assist in operating and managing the independent living facilities. REITs that currently hold or are considering acquiring independent living facilities may want to consider whether this structure is more cost effective than using a master lease structure, and consider obtaining their own ruling.