In PLR 201620001, the IRS ruled that, for purposes of the 95% and 75% income tests of Sections 856(c)(2) and (3), a real estate investment trust (REIT) may exclude from its gross income its allocable share of management fee income from its operating partnership (OP) representing the OP's allocable share of management fee income from a lower-tier partnership (Manager) that received the management fees from the OP for providing management services to the OP. Accordingly, the REIT was not required to include such portion of nonqualifying management fee income in its income tests.

Facts

Taxpayer, a corporation which recently completed an initial public offering of its stock, intends to elect to be treated as a REIT. Taxpayer owns a general and limited partnership interest in the OP, a limited partnership, whose primary business involves investments in mortgage loans.

After a restructuring transaction, OP will own a [b%] interest in Manager, an entity that is treated as a partnership for federal income tax purposes. Manager has a management agreement with Taxpayer and OP under which Manager manages OP's business and investment activities and day-to-day operations for a base and incentive management fee. Accordingly, Taxpayer, through its partnership interest in OP, will have gross income that includes distributive shares of both: (i) OP's investment income from its mortgage loans; and (ii) OP's [b%] allocable share of the management fees received by Manager.

Ruling and analysis

Regulation Section 1.856-3(g) provides, in part, that a REIT that is a partner in a partnership is deemed to own its proportionate share of each of the assets of the partnership and to be entitled to the income of the partnership attributable to that share.

Section 856(c)(5)(J) states that, to the extent necessary to carry out the purposes of the REIT provisions, the Service is authorized to determine whether any item of income or gain that does not constitute qualifying income under the 95% and 75% REIT income tests may nevertheless be: (i) ignored for purposes of the 95% or 75% REIT income tests, or (ii) treated as qualifying income for purposes of the 95% or 75% REIT income tests.

The IRS explained that the management fees are derived from the same investments that generate the investment income, and that including the management fees in Taxpayer's gross income would cause the amounts to be "counted twice" for purposes of the REIT income tests under Section 856(c). Accordingly, under the authority of Section 856(c)(5)(J)(i), the IRS ruled that Taxpayer may exclude from its gross income (for purposes of the 95% and 75% REIT income tests of Section 856(c)(2) and (c)(3)) Taxpayer's allocable pro rata share of OP's allocable pro rata share of management fees that Manager receives from OP. The IRS noted that, under the facts of the instant case, excluding the management fees from Taxpayer's gross income for purposes of the REIT income tests does not interfere with Congressional policy objectives in enacting the income tests under those provisions.

Implications

PLR 201620001 is the first private letter ruling issued in over 15 years in which the IRS ruled that a REIT may exclude "self-charged" management fees from the 95% and 75% income tests. Unlike the earlier rulings, PLR 201620001 addresses a situation in which a lower-tier partnership of the REIT is providing management services to an upper-tier partnership of the REIT. In addition, in the earlier rulings (which predate the enactment of Section 856(c)(5)(J)), the IRS's conclusion appeared to be based on an application of the "partnership look-through" rule of Treas. Reg. Section 1.856-3(g), while in PLR 201620001, the IRS cites its discretion under Section 856(c)(5)(J), although the rationale for the conclusions was similar - i.e., avoiding the "double counting" of gross income for purposes of the income tests. Overall it is a favorable development to have this new "refresher" private letter ruling addressing self-charged management fees. Although the support the IRS chose to use for this PLR ruling is the recently enacted Section 856(c)(5)(J), which is discretionary, the PLR ruling is similar to the 20 plus self-charged rulings the IRS has issued over the past two decades.

As noted, the IRS previously issued several "self-charged fee" private letter rulings concluding that, if a REIT owns a significant interest in a partnership and the REIT is providing management, development or other types of services to the partnership in consideration for fees, the REIT may, under Treas. Reg. Section 1.856-3(g), disregard the portion of the fee income received from the partnership that is attributable to the REIT's capital interest in the partnership for purposes of the income tests, while the portion of the fee income that is attributable to the other partners' interests in the partnership will be treated as nonqualifying income. See, e.g., PLRs 199952084, 199930043, 9808011, 9719018, 9701028, 9646027, 9552038, 9535014, 9521010, 9515005, 9502037, 9452032, 9431005, 9428018 and 9343027. Many of these rulings involve REITs that own interests in an operating partnership that is, in turn, providing services to lower-tier partnerships (in which the operating partnership was a partner).

The IRS has also issued "self-charged loan" private letter rulings concluding that a REIT may ignore the "self-charged" portion of a loan (and related interest) to a partnership (in which the REIT is a significant partner) for purposes of applying the asset and income tests under the partnership look-through rule in Reg. Section 1.856-3(g) and/or the IRS's discretion under Section 856(c)(5)(J). See PLRs 201118015 (Tax Alert 2011-821), 200740004 (Tax Alert 2007-818), 200234054 (Tax Alert 2002-732), and 9514006. Finally, the IRS has issued "self-charged" rent private letter rulings concluding that a REIT may ignore the REIT's allocable share of rental income from a "lessor partnership" to the extent of the REIT's allocable share of related rental deductions of the "lessee partnership" for purposes of the income tests, based on the partnership look-through rule of Reg. Section 1.856-3(g) and/or the IRS's discretion under Section 856(c)(5)(J). See PLRs 201407011(Tax Alert 2014-512), 201204006 (Tax Alert 2012-219), 200705019 (Tax Alert 2007-129) and 200405007 (Tax Alert 2004-140).

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