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The Service recently released PLR 201125013, in which it ruled that certain senior living communities, containing both assisted living units and independent living units, to be acquired by a real estate investment trust (REIT) constitute "qualified health care properties" within the meaning of Section 856(e)(6)(D)(i). Accordingly, the REIT may lease the communities to its taxable REIT subsidiary (TRS) pursuant to the special rule of Section 856(d)(8).

Additionally, the Service ruled the entity that will contract with the TRS to manage the communities will be considered to be "actively engaged in the trade or business of operating health care properties for any person [who is not related to the REIT or TRS]" within the meaning of section 856(d)(9)(A) and, thus, will qualify as an eligible independent contractor (EIK).

Facts

Taxpayer is a corporation that elected to be treated as REIT. Taxpayer owns hospitals, skilled nursing, medical office buildings, and senior housing projects.

Taxpayer intends to acquire senior housing communities that are currently owned and operated by Targets. Taxpayer will lease the senior housing communities that constitute "qualified health care properties" to a wholly-owned TRS which, in turn will hire an EIK to operate and manage the properties. Taxpayer will directly engage an independent contractor (the same entity that will serve as EIK) to operate and manage the senior housing communities that are considered to be independent living facilities.

The majority of the senior housing communities are comprised of both independent living (IL) and assisted living (AL) residents (Mixed-Use Communities). Each Mixed-Use Community is and will continue to be operated and marketed as one integrated community with different service options and units available for AL (including Alzheimer residents who reside in separate secure wings of the communities) and IL residents. There are a significant number of AL residents in each Mixed-Use Community, and a significant portion of the gross income is from the AL residents. Taxpayer represents that transitioning a resident from IL to AL within a Mixed-Use Community is generally a simple process. For certain Mixed-Use Communities, the IL and AL residents are in different buildings, units, or sections of units, but they are located on the same real estate parcel. In these communities, AL residents typically eat in dining areas separate from IL residents; however, consistent with all the other Mixed-Use Communities, these IL and AL communities are operated and marketed as one integrated community. IL and AL residents share common area facilities for front desk reception, social activities, and fitness activities. Mixed-Use Communities are generally licensed under the laws of the state in which the community is located, although two states do not require licenses.

TRS will enter into a contract with the former manager/owner (Manager) of the Mixed-Use Communities to operate and manage the communities. At such time, Manager will also operate and manage at least [y] unrelated Mixed-Use Communities (in which Manager has an ownership interest) through a management contract with a third party. Furthermore, Manager will be operating qualified health care properties either (1) pursuant to [x] management contracts for [x] separate qualified health properties or (2) pursuant to [y] management contracts for an unrelated third party and a self-managed property that Manager may lease from an unrelated third party or that Manager may own prior to closing and retain. Manager is in negotiations to finalize the terms of a management contract with another unrelated party owner to manage a fully-licensed Mixed-Use Community. Manager intends to successfully close this management contract before the merger date. Furthermore, Manager is pursuing consent to continue to lease certain Mixed-Use Communities for its own benefit and is pursuing other unrelated third party contracts and the retention of self-managed properties (owned or leased).

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.

Section 856(d)(2)(B) states that, with the exception of the special rule of Section 856(d)(8), rents from real property does not include amounts received, directly or indirectly, from a corporation if the REIT owns 10% or more of the total combined voting power or 10% 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(e)(6)(D)(i) defines qualified health care property as any real property which 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 with respect to the facility.

Section 856(d)(9)(A) provides that the term "eligible independent contractor" with respect to any qualified lodging facility or qualified health care property 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 real estate investment trust or the TRS.

The Service noted that the AL and IL residents are located in the same building or on the same real estate parcel; all of the AL units are licensed by the State in which they are located (to the extent licensing is required); when a resident requires assistance with activities of daily living, the resident may transition from an IL unit to an AL unit (depending upon availability); and a significant number of units in each of the Mixed-Use Communities will be occupied as AL units. Accordingly, the Service ruled that the Mixed-use Communities are qualified health care properties under Section 856(e)(6)(D)(ii).

The Service also explained that Manager will be engaged in the operation of at least [y] health care properties for a third party pursuant to a management contract and will pursue other management contracts, and has a history of operating AL and other senior living facilities. Accordingly, the Service ruled that Manager will be considered to be actively engaged in the trade or business of operating health care properties within the meaning of Section 856(d)(9)(A) and will qualify as an "eligible independent contractor" under Section 856(d)(9)(A) with respect to the health care facilities it manages or operates for the TRS.

Implications

PLR 201125013 is the third private letter ruling in which the Service has ruled that certain mixed-use senior living properties constitute "qualified health care facilities" based on an analysis of the surrounding facts and circumstances. As in the prior rulings, the Service does not appear to have established "bright line" tests for making such determinations. See prior PLRs 201104023 and 201104033 (Tax Alert 2011-0227).

PLR 201125013 is the second private letter ruling to address whether a particular manager was "actively engaged in the trade or business of operating qualified lodging facilities or qualified health care properties for any person [who is not related to the REIT or TRS]" and, thus, could qualify as an EIK. Because of redactions in the ruling, it is not entirely clear how many qualified health care properties that the Manager will be operating for persons unrelated to the REIT or TRS. However, it appears that the Service counted properties that will either be owned by the Manager (and, thus, self-managed by the Manager) or leased from a third-party (and, thus, Self-managed by Manager). See PLR 200825034 (Tax Alert 2008-0933) for the first ruling.