In PLR 201640007, the IRS ruled that a REIT's proposed sales of its real estate properties under a plan of liquidation will not constitute prohibited transactions under Section 857(b)(6). Accordingly, the REIT will not be subject to the 100% prohibited transaction tax.

Facts and representations

Taxpayer is a publicly traded REIT that conducts its business and owns all of its properties through an operating partnership.

In the third quarter of an unidentified year after its formation, Taxpayer's board of directors, together with an outside financial advisor, began pursuing a review of alternatives available to enhance shareholder value. After considering several alternatives, Taxpayer now contemplates a complete liquidation of its portfolio through a sale of its assets.

Taxpayer represents that its stated intention has always been to hold its properties over the long term to generate income and value. Taxpayer has engaged in some disposition activity since its inception, although the ruling suggests that most sales met the requirements of the prohibited transaction safe harbor under Section 857(b)(6). Taxpayer anticipates that the time to fully liquidate its portfolio will take between six months and two years.

Before Taxpayer pursues a plan of complete liquidation, Taxpayer's board of directors plans to take several steps following the receipt of this ruling. Thereafter, Taxpayer's board would formally adopt a plan of liquidation, which Taxpayer would publicly disclose, and would likely need a stockholder vote to pursue such a plan and a sale of substantially all of its assets.

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 will not meet the safe harbor requirements 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 determining 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 a 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

In the analysis section of the ruling, the IRS described that Taxpayer made the following representations that address Taxpayer's purposes for the properties at issue:

— Taxpayer's intention has always been to hold the properties over the long term to generate rental income and appreciated value.

— Taxpayer's disposition of the properties is due to a plan of liquidation, and Taxpayer adopted such a plan only after exploring alternatives that would allow Taxpayer to continue holding the properties.

— Since its incorporation in Year [ ], Taxpayer has sold only a small percentage of its properties.

— The properties Taxpayer acquired in Year [ ] were acquired prior to Taxpayer's consideration of a plan of liquidation.

— Substantially all of the marketing expenditures for sales of Taxpayer's properties will be made through an independent contractor from whom the Taxpayer does not derive or receive any income or a taxable REIT subsidiary of Taxpayer.

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

Implications

PLR 201640007 is the seventh private letter ruling published in recent years in which the IRS has ruled, 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 201609004 (Tax Alert 2016-531), 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.

Overall, it is favorable news to see that the IRS continues to rule in this area. As noted in footnote 1 of PLR 201640007, 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 2016-3 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 201640007 that the taxpayer had demonstrated such reasons.

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