In PLR 201609004, the IRS ruled that a REIT's proposed sales of its real estate properties pursuant to a plan of liquidation will not constitute prohibited transactions under Section 857(b)(6)(B). Accordingly, the REIT will not be subject to the 100% prohibited transaction tax.

Facts and representations

Taxpayer is a REIT that owns and leases residential real estate properties to third parties through a number of subsidiary entities, most of which are disregarded for federal income tax purposes. LP, a partnership, owns in excess of X percent of all classes of stock of Taxpayer, including all of its voting common stock. Taxpayer's preferred stock is owned by Y persons. To facilitate the winding down and dissolution of LP, Taxpayer intends to adopt a liquidation plan under which it will dispose of all of its remaining assets during Years 2 and 3.

Taxpayer acquired its properties with the intent to own them for a long-term holding period and to derive profits from capital appreciation and rental income from the properties. Each individual property has a holding period of Z months or greater, and all of the individual properties will have been operated as rental properties for at least two years at the time of the proposed sale. Taxpayer will also use independent third-party brokers to dispose of the properties.

Law and analysis

Section 857(b)(6) generally subjects a REIT to a 100% tax on the net income derived from a prohibited transaction. A prohibited transaction is defined as a sale or other disposition of property described in Section 1221(a)(1) that is not foreclosure property. Property described in Section 1221(a)(1) includes property held by a taxpayer "primarily for sale to customers in the ordinary course of its trade or business."

Section 857(b)(6)(C), however, grants a safe harbor from treatment as a prohibited transaction for sales that meet five specified conditions. The Taxpayer apparently will not meet the safe harbor requirements for all or some years and, thus, must look to judicially developed factors to determine whether the property will be treated as held primarily for sale to customers, thereby subjecting gains on sales to the prohibited transactions tax.

The courts have identified several factors to consider in making the determination of whether real property is held primarily for sale to customers in the ordinary course of the taxpayer's trade or business (see, e.g., Cottle v. Commissioner, 89 T.C. 467, 487 (1987)), including:

— The nature and purpose of the property acquisition and duration of ownership
— The nature and extent of taxpayer's efforts to sell the property
— The number, extent, continuity and substantiality of sales
— The extent of subdividing, developing and advertising to increase sales
— Taxpayer's time and effort devoted to sales

Based on the facts and representations made, the Service ruled that sales of Taxpayer's assets under a liquidation plan will not constitute prohibited transactions under Section 857(b)(6)(B).

Implications

PLR 201609004 is the sixth private letter ruling published in recent years in which the Service has concluded on a facts-and-circumstances basis whether REIT property was held "primarily for sale to customers in the ordinary course of a REIT's trade or business" and, thus, subject to the 100% prohibited transactions tax. See PLRs 201346005 (Tax Alert 2013-2297), 201340004 (Tax Alert 2013-2055), 201315004 (Tax Alert 2013-817), 200953018 (Tax Alert 2010-20) and 200945025 (Tax Alert 2009-1732). See also PLRs 9816024, 9724013, 9123042, 9041047 and 8938004.

The redaction of certain facts in the ruling and the absence of a stated analysis make it difficult to draw conclusions.

Overall, it is favorable news to see that the IRS continues to rule in this area. As noted in footnote 1 of PLR 201609004, the issue of whether property is "held primarily for sale to customers in the ordinary course of a trade or business" is included in a list of topics in Section 4 of Revenue Procedure 2015-3 on which the Service will "not ordinarily" issue a private letter ruling, unless there are unique and compelling reasons to justify issuance of a ruling. The Service indicated in PLR 201609004 that the taxpayer had demonstrated such reasons.

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