April 5, 2018 Services provided by REIT to tenants of its apartment properties do not give rise to impermissible tenant service income In PLR 201812009, the IRS ruled that specified services provided by a REIT to the tenants of its apartment properties will not give rise to impermissible tenant service income and will not cause any portion of the rents received by the REIT from the tenants to fail to constitute qualifying rents from real property. Facts Taxpayer is a REIT that owns three apartment properties (Properties). Each Property includes some or all of the following amenities available to all tenants at no additional cost: a swimming pool; an exercise room with exercise equipment, televisions, and water; sports courts and related equipment; a fire pit; a roof deck; a lounge with a television, a movie screen, and games; a kitchen; a picnic area with grills; a playground; a dog playground; a jogging path; laundry rooms; and a business center (collectively, the Facilities). Taxpayer provides the following services at each Property: leasing functions, wireless internet in common areas, ordinary and necessary maintenance functions such as service to HVAC, plumbing, and electrical systems, repair of basic kitchen appliances and light fixtures in tenants' units, landscaping of the Property's grounds, security services, routine doorman services, and routine maintenance, cleaning, and activities to ensure the safety and security of tenants and Taxpayer's property in the common areas, including the Facilities (collectively, the Taxpayer-Provided Services). The doorman services include managing the flow of residents and nonresidents into and out of the Property, monitoring security cameras and other security systems, admitting guests, receiving packages, assisting locked-out tenants, and acting as the first point of contact for an apartment emergency. Taxpayer engages in occasional marketing activities to enhance its ability to attract new tenants and keep existing tenants, including hosting seasonal holiday parties and social events (Marketing Services). Social events may include a tasting event (for which a local merchant may donate products), a breakfast, a happy hour, an ice cream party, an outing, a bingo night, a raffle, or a pool party. In addition to services provided directly by Taxpayer, Taxpayer has hired independent contractors (from whom Taxpayer does not derive income) to provide lifeguards at the pools, extermination services, and cable and internet. Law and analysis Section 856 imposes certain limitations on REITs. Under Section 856(c)(2), a REIT must derive at least 95% of its gross income from certain categories of income, including rents from real property. Under Section 856(c)(3), a REIT must derive at least 75% of its gross income from certain sources, including rents from real property. Section 856(d)(1) defines rents from real property to include: (A) rents from interests in real property, (B) charges for services customarily rendered in connection with the rental of real property, and (C) rent attributable to certain leased personal property. Reg. Section 1.856-4(b)(1) provides that services rendered to tenants of a particular building will be considered customary if, in the geographic market in which the building is located, tenants in buildings of a similar class are customarily provided with the service. Section 856(d)(2)(C) excludes any impermissible tenant service income from the definition of "rents from real property." Section 856(d)(7)(A) defines "impermissible tenant service income" to mean, with regard to any real or personal property, any amount received or accrued directly or indirectly by the REIT for services furnished or rendered by the REIT to tenants at the property, or for managing or operating the property. Section 856(d)(7)(C), however, provides certain exclusions from impermissible tenant service income. Section 856(d)(7)(C) does not treat, for purposes of Section 856(d)(7)(A), services furnished or rendered, or management or operation provided, through an independent contractor from whom the REIT does not derive or receive any income, or through a TRS of the REIT, as furnished, rendered, or provided by the REIT, and does not take into account any amount that would be excluded from unrelated business taxable income under Section 512(b)(3) if received by an organization described in Section 511(a)(2). In its analysis, the IRS first noted that, when determining if impermissible tenant service income exists, only the income that is attributable to a provision of a service is analyzed. Although services may be provided in the Facilities, the IRS explained that the Facilities themselves are not services. Thus, income that is attributable to making the Facilities available to all tenants at no additional cost is not income from the provision of a service and is therefore not impermissible tenant service income. Any services that are provided in or with respect to the Facilities, however, are analyzed as any other service provided to tenants. The IRS recited that Taxpayer had represented that the Taxpayer-Provided Services and Marketing Services are customarily furnished in luxury apartment buildings in Taxpayer's geographic area and that services are provided to all tenants and do not constitute personal services rendered to any particular tenant (i.e., representations in regards to the customary services test of Section 856(d)(2)(B) and Treas. Reg. Section 1.856-4(b)(1) and the additional customary services test of Treas. Reg. Section 1.512(b)-1(c)(5)). The IRS concluded that the income from the Taxpayer-Provided Services and Marketing Services is: (i) income that would be excluded from unrelated business taxable income under Section 512(b)(3) if received by a tax-exempt organization described in Section 511(a)(2), and thus is excluded from impermissible tenant service income under Section 856(d)(7)(C)(ii); or (ii) income attributable to a fiduciary function of the REIT under Reg. Section 1.856-4(b)(5)(ii), and thus not treated as income derived from services rendered to tenants. Accordingly, the IRS ruled that income from the Taxpayer-Provided Services and Marketing Services is not impermissible tenant service income and, therefore, will not cause any portion of the rents received by Taxpayer from the tenants of each Property to fail to qualify as rents from real property under Section 856(d). Implications PLR 201812009 is the first private letter ruling in over 17 years to address a comprehensive list of services provided by a REIT to the tenants of its apartment properties, and thus serves as a "refresher" ruling. Of interest, this ruling presents a detailed description of the scope of doorman services provided at the apartment properties. In addition, it is helpful to find that the IRS reasoned that the provision of the physical facilities/amenities are not generally considered services themselves, but rather the services provided in connection with the facilities must be analyzed under the REIT rules as services provided to tenants. ———————————————
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