May 2, 2017 Grant received in connection with developing rental real property is qualifying REIT income In PLR 201716043, the IRS ruled, under its Section 856(c)(5)(J) authority, that income from an economic redevelopment and growth incentive grant to be received by a real estate investment trust (REIT) will constitute qualifying income for purposes of the 95% and 75% income tests under Section 856(c)(2) and (c)(3). Facts Taxpayer is a REIT that wholly owns Subsidiary 1 and Subsidiary 2 (Subsidiaries), which are disregarded entities for federal tax purposes. The Subsidiaries were organized to own a mixed-use real estate development project incorporating retail, office and light industrial uses. The project will be constructed on land that is eligible for an economic redevelopment and growth incentive grant (Grant) through State that was established under State Act. State Act provides state incentive reimbursement grants to developers to address project financing gaps by reimbursing certain construction costs using a portion of new state incremental taxes derived from a project's development (State Grant Program). The State Grant Program was established to help municipalities targeted for growth to improve their business districts through comprehensive redevelopment. State authorities approved the Subsidiaries' application for a Grant in the maximum amount of [ ] percent of the actual eligible project costs, limited to a maximum aggregate amount of [ ], and not to exceed [ ] percent of the eligible tax revenues out of which the Grant is payable, limited to [ ] percent of the eligible tax revenues in each year. The eligible tax revenues for purposes of the Grant include corporate taxes, a tax imposed on marine insurance companies, public utility franchise and excise taxes, taxes derived from distributive shares of partnership and S corporation income, a tax imposed on the purchase of materials used in certain construction, a hotel and motel occupancy fee, and a portion of a certain fee imposed on the sale of real property at the site of the project. The Subsidiaries will receive annual payments under the Grant for [ ] years. Law and Analysis Under Section 856(c), a REIT must: (i) derive at least 95% of its gross income (excluding gross income from prohibited transactions) from sources listed in Section 856(c)(2), which includes dividends, interest, rent from real property, and certain other items; and (ii) derive at least 75% of its gross income (excluding gross income from prohibited transactions) from sources listed in Section 856(c)(3), which include rents from real property and certain other items. Section 856(c)(5)(J) authorizes the Treasury Secretary to determine, solely for purposes of the REIT provisions 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 201716043, the IRS noted that income from the Grant does not constitute a source of gross income that is listed as qualifying income under Section 856(c)(2) or (c)(3). The IRS also noted that Taxpayer represented that the project, once completed, will be real property for purposes of Section 856 and that substantially all of the other income Taxpayer derives from the project will be qualifying income for purposes of Section 856(c)(2) and (c)(3). The IRS explained that Taxpayer will earn the Grant for developing real property in State in accordance with the State Grant Program, and treating income from the Grant as qualifying income does not interfere with or impede the objectives of Congress in enacting the REIT income tests. Accordingly, under Section 856(c)(5)(J)(ii), it is appropriate for the Secretary to determine that income from the Grant is treated as qualifying income for purposes of Section 856(c)(2) and (c)(3). Implications PLR 201716043 is the fourth private letter ruling to address incentive-type payments received by a REIT from a state (or jurisdiction thereof) in connection with developing real property that will be held as rental investment property. See PLRs 201518010 and 201428002, in which the IRS ruled, under its Section 856(c)(5)(J) authority, that income attributable to the receipt of refundable tax credits relating to the development of real property constitutes qualifying income for purposes of the REIT income tests. Also, see PLR 200528004, as supplemented by PLR 200614024, involving a tax year before the enactment of Section 856(c)(5)(J), in which the IRS ruled that income attributable to the receipt of refundable state tax credits for construction of real property on a hazardous waste site will not be considered in determining whether the REIT satisfies the income tests. REITs and their advisors also may want to consider PLR 200926014, in which the IRS ruled that income attributable to a particular refundable tax credit constituted a refund of real property taxes under Section 856(c)(2)(E) and (c)(3)(E) when the credit was "tied to" the payment of real property taxes. In addition, in PLR 200403023, the IRS ruled that amounts received by a REIT from a municipality as reimbursement for certain costs incurred by the REIT in redeveloping a property (and in which the reimbursement was limited to the incremental real property tax assessed against development site) is treated as an abatement and refund of taxes on real property under Section 856(c)(2)(E). It is good news to see that the IRS continues to take a favorable view under the REIT income tests regarding "incentives" received by a REIT in connection with developing real property that will be held for the production of qualifying rental income. The conclusions in PLRs 201716043, 201518010 and 201428002, however, are based on the IRS's exercise of its discretionary authority under Section 856(c)(5)(J). Thus, REITs with similar situations will want to consider whether to seek their own rulings. ———————————————
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