In PLR 201707010, the IRS ruled that a proposed sales of real estate properties by a real estate investment trust (REIT) under a plan of liquidation will not constitute prohibited transactions under Section 857(b)(6). Accordingly, the REIT's gains on the sales will not be subject to the 100% prohibited transaction tax.

Facts and representations

Taxpayer is a non-listed public REIT that owns interests in multifamily properties (Properties), many of which appear to have been developed by the REIT.

The amount of capital initially raised by Taxpayer through an initial stock offering and a follow-on offering was significantly less than the capital Taxpayer anticipated raising when Taxpayer was initially launched. Taxpayer believed this lack of capital would make Taxpayer likely too small to effectively list on a public exchange. Accordingly, Taxpayer's advisor began to explore strategic alternatives for providing liquidity to Taxpayer's investors. A special committee of Taxpayer's independent board of directors (Special Committee) was appointed to oversee the process and engaged Company to assist in the matter.

The advisor and Company recommended, and the board of directors and Special Committee agreed, that a plan of dissolution of Taxpayer and sale of the Properties through multiple transactions would be in the best interest of the Taxpayer's shareholders for the following reasons:

— Most of the outstanding loans on the Properties are maturing and Taxpayer does not have sufficient capital to repay the loans.
— Certain Properties are owned through partnerships containing buy-sell options and Taxpayer will not have sufficient capital to buy out partners and will likely be forced to sell the Properties at prices that may not maximize value to its shareholders.
— The costs of maintaining a non-listed public REIT are significant in relation to the relatively small capital base of the Taxpayer.

Taxpayer began the process of moving forward with a formal plan of complete liquidation and dissolution under Section 331. Taxpayer intends to strategically sell each of the Properties to maximize shareholder value. The proceeds of the sales will be distributed to shareholders through one or more distributions.

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 Properties 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

Taxpayer made the following representations addressing its purposes for the Properties:

— Taxpayer acquired the Properties with the intent to hold them for a long-term period and to derive its profits from rental income and capital appreciation, consistent with its operation as a REIT.
— Taxpayer does not intend to reinvest the proceeds from the sale of the Properties in other real estate interests.
— Taxpayer will take the actions and perform the activities required for winding up its affairs, preserving the value of its assets and distributing its assets to its shareholders in accordance with the Plan after all of the Properties have been sold.

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

The IRS noted that Taxpayer represented that it acquired the Properties with the intent to hold the Properties for the long term and to derive its profits from rental income and capital appreciation; Taxpayer is only selling the Properties because it is undergoing a complete liquidation of all of its assets and a corporate dissolution; before liquidating, Taxpayer did not make numerous, extensive, continuous, or substantial sales of properties; and Taxpayer has sold and will continue to sell all of the Properties through third-party brokers and will not use the proceeds of the Property sales to invest in additional real estate assets.

Implications

PLR 201707010 is the eighth 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 201640007 (Tax Alert 2016-1724), 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. However, PLR 201707010, as well as the seven previously listed private letter rulings listed, all address sales of property in connection with a REIT's plan of liquidation. Moreover, these rulings are based on all the facts and circumstances, which in PLR 201707010 are somewhat unusual. Finally, as noted in footnote 1 of PLR 201707010, 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 IRS will "not ordinarily" issue a private letter ruling, unless there are unique and compelling reasons to justify issuance of a ruling. The IRS indicated in PLR 201707010 that Taxpayer had demonstrated such reasons.

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