In PLR 201740017, the IRS ruled that a pipeline dehydrator is a structural component of an inherently permanent structure and, thus, a real estate asset. The IRS also ruled that amounts received for the use of a pipeline system constitute qualifying rents from real property and that certain activities will not cause otherwise qualifying rent to be excluded from "rents from real property", for purposes of the REIT income and asset tests under Section 856(c).

Facts

Taxpayer is a publicly traded REIT that owns and invests in pipeline transmission systems, each comprised of fee ownership, leases or rights-of-way with respect to land, pipelines and certain other assets. The pipelines are designed and intended to remain permanently in place.

Pipeline Transmission System A consists of two pipelines constructed of steel and high-density polyethylene. Buried underground, the pipelines begin at certain production plants owned by third parties and provide conduit for the delivery of Product A to wells also owned by third parties that are unrelated to Taxpayer. Pipeline Transmission System A also contains a dehydrator that was installed (either bolted or fused) during the construction of the pipelines to remove moisture from Product A to protect the integrity of the pipelines. Taxpayer represents that the pipeline would corrode and become unable to provide a conduit for the delivery of Product A within a matter of days or weeks if the dehydrator were removed. Additionally, Taxpayer represents that the utility of Product A is not improved by the removal of moisture as the third parties inject it with water at the junction point between Pipeline Transmission System A and the wells.

Taxpayer represents that removing the dehydrator would cause damage to the pipeline and the dehydrator, although not so extensive that the dehydrator could not be reused at a different location. Due to the expense and complication of installing and removing the dehydrator, it is designed to remain in place indefinitely, including after the tenant vacates the property.

Pipeline Transmission System B, consisting of a pipeline and certain other related assets, is owned by one of Taxpayer's taxable REIT subsidiaries (TRS), which intends to distribute it to Taxpayer. Pipeline Transmission System B is constructed of steel and high-density polyethylene buried underground on the user's property, subject to a license granted by user, and provides a conduit for the transportation of Product B and another product. Devices to regulate pressure and avoid explosion (regulators) are built into the pipeline. User, for its exclusive use of the pipeline, pays TRS a fixed monthly fee (Base Fee) based on the length of the pipeline with an annual increase for inflation. After the assets are distributed to Taxpayer, Taxpayer's employees will make decisions and supervise independent contractors regarding maintenance and repair of the pipeline and the construction of additions. Taxpayer's employees will also inspect the regulators and pipeline, including checking for leaks by using a sniffer, and mark the pipeline's location to avoid damage by unrelated parties (collectively, the Activities). Taxpayer will not render any services to any retail customer of user.

Law and analysis

Treatment of the dehydrator as real property. Applying the factors in Treas. Reg. Section 1.856-10(d)(3)(iii) to the dehydrator as a structural component of Pipeline Transmission System A's pipeline, the IRS found that the dehydrator is designed to be part of the pipeline indefinitely and will remain in place when the user vacates. It was installed during construction of the pipeline and was either bolted or fused to the pipeline, and is difficult, costly and time-consuming to install and remove from the pipeline. In addition, if removed, the dehydrator would sustain damage and would also damage the pipeline. It is not required by or useful to the user and, accordingly, does not produce or contribute to the production of income other than from consideration for the use or occupancy of space within the pipeline. In addition, the dehydrator's sole purpose is to keep the pipeline from corroding and to protect the integrity of the pipeline in its passive function as a conduit for Product A. Accordingly, the IRS ruled that the dehydrator is a structural component of the pipeline and, thus, qualifies as real property for purposes of Section 856.

Treatment of amounts for the use of Pipeline Transmission System B as qualifying rents. Treas. Reg. Section 1.856-4(a) defines "rents from real property" as the gross amounts received for the use of, or the right to use, real property. As the Taxpayer's pipeline is real property by reason of it being an inherently permanent structure under Treas. Reg. Section 1.856-10(d)(2)(iii)(B), the IRS considered whether Taxpayer's agreement with the user is for the use of space in or upon real property. The IRS found that the arrangement similar to a lease because it: (1) provided a fixed amount based on the length of the pipeline; and (2) gave the user sole use of the pipeline for a term of years. Accordingly, the amounts under the agreement with the user constitute "rents from interests in real property" within the meaning of Section 856(d)(1)(A).

Activities undertaken with respect to Pipeline Transmission System B. The IRS also concluded that the Activities undertaken by Taxpayer with respect to the Pipeline Transmission System B are among those activities permitted to be provided by trustees or directors as part of their fiduciary duty to manage Taxpayer in accordance with Treas. Reg. Section 1.856-4(b)(5)(ii) and are not services rendered to the tenant. Accordingly, the IRS ruled that the Activities will not cause any rents received by Taxpayer to fail to qualify as rents from real property under Section 856(d).

Implications

PLR 201740017 is the first ruling to apply the factors set forth in the real property regulations of Treas. Reg. Section 1.856-10 to a distinct asset (a dehydrator) and conclude that it is a structural component of an inherently permanent structure and, thus, real property for REIT testing purposes. The ruling is also instructive by approving as qualifying rents amounts paid for use of the pipeline under an arrangement similar to a lease. The IRS further ruled that the Activities may be performed with respect to the pipeline without tainting otherwise qualifying rents because the Activities were part of the trustees' and directors' fiduciary duty to manage the REIT, rather than services provided to the users of the real property.

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