In PLR 201605005, the IRS ruled, under Section 856(c)(5)(J), that a REIT's Subpart F Inclusions and PFIC Inclusions attributable to the REIT's investments in foreign TRSs constitute qualifying income for purposes of the 95% income test of Section 856(c)(2). In addition, the IRS ruled, under Section 856(n)(3)(C), that Section 986(c) foreign currency gains recognized with respect to distributions of previously taxed earnings and profits from the foreign TRSs are excluded from gross income for purposes of the 95% income test.

Facts

Taxpayer is a REIT organized to invest directly and indirectly in the commercial timberland businesses. Taxpayer realizes profits from the harvest and sale of timber and the long-term appreciation of the underlying timber properties. Taxpayer operates in foreign countries through one or more foreign subsidiaries (each, a Foreign Sub). The Foreign Subs are either qualified REIT subsidiaries under Section 856(i), partnerships, disregarded entities or corporations that have made the joint election with Taxpayer under Section 856(l) to be treated as taxable REIT subsidiaries (each, a Foreign TRS).

Taxpayer expects that its Foreign TRSs will be either: (i) controlled foreign corporations (CFCs) within the meaning of Section 957(a), (ii) passive foreign investment companies (PFICs) within the meaning of Section 1297(a), for which Taxpayer has made or intends to make elections under Section 1295(a) to treat as qualified electing funds (QEFs) or (iii) PFICs for which Taxpayer has not made a QEF or mark-to-market election.

Taxpayer expects to include in its gross income:

— Section 951(a)(1)(A) inclusions that are attributable to the CFCs' deriving foreign personal holding company income, including:(i) interest; (ii) dividends; (iii) gains from the sale or other disposition of stock, securities, or real property that is not property described in Section 1221(a)(1), and items that would constitute rents from real property under Section 856(d) if received by a REIT (Subpart F Inclusions)

— Section 1293(a) inclusions and Section 1291(a)(1)(B) inclusions from PFICs that are attributable to the PFIC's deriving: (i) interest; (ii) dividends; (iii) gains from the sale or other disposition of stock, securities, or real property that is not property described in Section 1221(a)(1); and (iv) items that also would constitute "rents from real property" under Section 856(d) if received by a REIT (collectively, PFIC Inclusions).

Taxpayer also expects to recognize foreign currency gains with respect to distributions of previously taxed earnings and profits (PTI) as described in Section 986(c)(1) attributable to the Subpart F Inclusions and PFIC Inclusions.

Law and analysis

Under Section 856(c), a REIT must derive at least 95% of its gross income (excluding gross income from prohibited transactions) from sources listed in Section 856(c)(2), which include dividends, interest, rent from real property and certain other items.

Section 856(c)(5)(J) provides that, to the extent necessary to carry out the purposes of Part II of subchapter M of the Code, the Secretary is authorized to determine, solely for purposes of such 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 qualifying under Section 856(c)(2) or (3).

In PLR 201605005, the IRS noted that the legislative history underlying the tax treatment of REITs indicates that a central concern behind the gross income restrictions is that a REIT's gross income should largely be composed of passive income. Taxpayer's Subpart F and PFIC Inclusions will be attributable to income of CFCs or PFICs that consists of: (i) interest; (ii) dividends; (iii) gains from the sale or other disposition of stock, securities or real property that is not property described in Section 1221(a)(1); and (iv) items that also would constitute rents from real property under Section 856(d) if received by a REIT. Therefore, the IRS explained, the treatment of the Subpart F and PFIC Inclusions attributable to such income as qualifying income for purposes of the 95% income test of Section 856(c)(2) does not interfere with or impede the policy objectives of Congress in enacting the income test under Section 856(c)(2). Accordingly, the IRS ruled, under Section 856(c)(5)(J), that Taxpayer's Subpart F Inclusions and PFIC Inclusions constitute qualifying income for purposes of the 95% income test.

While the Section 986(c) gains are not foreign currency gains as defined in Section 988(b)(1), the IRS noted that these Section 986(c) gains are attributable to the Subpart F Inclusions and QEF Inclusions, and thus items of income that are qualifying income for purposes of Section 856(c)(2). This Section 986(c) gain is substantially similar to passive foreign exchange gain described in Section 856(n)(3)(B)(i). Therefore, under Section 856(n)(3)(C), the IRS ruled that the Section 986(c) gains are excluded from gross income for purposes of the 95% income test because these foreign currency gains are considered passive foreign exchange gain that is excluded from gross income for purposes of Section 856(c)(2).

Implications

PLR 201605005 is the twelfth private letter ruling to conclude that certain Subpart F and PFIC inclusions constitute qualifying income for purposes of the 95% income test. As in prior rulings, the IRS appears to have looked through to the underlying nature of the income and activity of the TRSs in making its determination. See PLRs 201537020, 201503010, 201431018, 201431020, 201423011, 201314002, 201251005, 201246013, 201226004, 201129007 and 201119001. As in the prior rulings, the IRS looked to the definition of foreign personal holding company income under Section 954(c), which is similar in some ways, but not identical, to the definition of qualifying REIT gross income for purposes of the 95% income test under Section 856(c)(2).

PLR 201605005 is also the fifth private letter ruling to conclude that that Section 986(C) gains recognized with respect to distributions of previously taxed earnings and profits from the foreign TRSs are excluded from gross income for purposes of the 95% income test. See PLRs 201537020, 201503010, 201301007 and 201251005.

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