In PLR 201649013, the IRS ruled, pursuant to its authority under Section 856(c)(5)(J)(ii), that a real estate investment trust's (REIT's) Subpart F Inclusions and PFIC Inclusions attributable to the REIT's investments in foreign taxable REIT subsidiaries (TRSs) constitute qualifying income for purposes of the 95% income test under 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, a domestic corporation that will elect to be taxed as a REIT, makes direct and indirect investments in commercial timber businesses. Taxpayer operates in foreign countries through one or more foreign corporate subsidiaries and associated intermediate holding companies (each, a Foreign Sub). Taxpayer has elected with certain Foreign Subs that are qualified REIT subsidiaries under Section 856(i) to treat each of the Foreign Subs as a TRS under Section 856(l) (each, a Foreign TRS).

Taxpayer anticipates that its Foreign TRSs will be either: (1) controlled foreign corporations (CFCs) under Section 957(a); (2) passive foreign investment companies (PFICs) under Section 1297(a) that Taxpayer will elect to treat as qualified electing funds (QEFs) for all tax years in which the corporation was a PFIC included in Taxpayer's holding period of the PFIC stock (pedigreed QEF); or (3) PFICs for which Taxpayer has not made a mark-to-market election and that is not a pedigreed QEF with respect to Taxpayer.

Taxpayer expects to include in its gross income:

— Section 951(a)(1)(A) inclusions 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 (iv) items that would constitute "rents from real property" under Section 856(d) if received by a REIT (collectively, Subpart F Inclusions); and

— 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 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

Section 856(c) requires a REIT to 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, and rent from real property.

Section 856(c)(5)(J) authorizes the Treasury Secretary to determine, solely for purposes of subpart M of the Code, whether any item of income or gain that does not qualify for the 95% income test under Section 856(c)(2) and/or the 75% income test under Section 856(c)(3) may nevertheless be considered as (i) not constituting gross income for purposes of the 95% or 75% income tests, or (ii) qualifying income for purposes of the 95% or 75% income tests.

In PLR 201649013, the IRS cited the legislative history underlying the tax treatment of REITs that indicates that "a central concern behind the gross income restrictions is that a REIT's gross income should largely be composed of passive income." The IRS noted that 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 this 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, pursuant to its authority under Section 856(c)(5)(J)(ii), that Taxpayer's Subpart F 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, are qualifying income for purposes of Section 856(c)(2). These Section 986(c) gains are substantially similar to passive foreign exchange gains 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 201649013 is the thirteenth 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 foreign TRSs in making its determination. See PLRs 201605005, 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 201649013 is also the sixth private letter ruling to conclude that that Section 986(c) gains recognized with respect to distributions of PTI from the foreign TRSs are excluded from gross income for purposes of the 95% income test. See PLRs 201605005, 201537020, 201503010, 201301007 and 201251005.

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