August 3, 2018 IRS addresses REIT's leasing of assisted living communities to a TRS joint venture In PLR 201828009, the IRS has ruled that rents received by a real estate investment trust (REIT) from the leasing of assisted living facilities to a partnership formed between a taxable REIT subsidiary (TRS) and an unrelated partner constitute qualifying rents from real property, so long as the assisted living facilities are operated by an eligible independent contractor (EIK). Facts Taxpayer is a corporation that intends to elect to be taxed as a REIT. Taxpayer is in the business of acquiring, owning and leasing assisted living facilities (AL Facilities). The AL Facilities owned by Taxpayer are intended to qualify as qualified health care properties within the meaning of Section 856(e)(6)(D). Taxpayer holds its AL Facilities through PropCo, a partnership, which in turn, holds its interests in the AL Facilities through disregarded subsidiary entities (the PropCo Subs). Taxpayer formed Domestic TRS, an entity that will qualify as a TRS of Taxpayer. Domestic TRS and an unrelated entity (Partner), formed OpCo, a partnership. Each PropCo Sub that holds an AL Facility leases the facility to a subsidiary of OpCo (each, an OpCo Sub) that is disregarded as a separate entity from OpCo. Each OpCo Sub has entered into a management contract with Manager to manage and operate its AL Facility. Law and analysis To qualify as a REIT, an entity must derive at least 95% of its gross income from sources listed in Section 856(c)(2) and at least 75% from sources listed in Section 856(c)(3). Both sections include "rents from real property." Section 856(d)(2)(B) provides that, with the exception of the special rule of Section 856(d)(8), rents from real property do not include amounts received by a REIT directly or indirectly from a tenant if the REIT owns 10% or more of voting power or value of the ownership interests of the tenant. Section 856(d)(8)(B) provides that amounts paid to a REIT by a TRS shall not be excluded from rents from real property by reason of Section 856(d)(2)(B) when a REIT leases a qualified lodging facility or qualified health care property to a TRS, and the facility or property is operated on behalf of the TRS by an eligible independent contractor. Section 856(e)(6)(D)(i) defines qualified health care property as any real property that is a "health care facility," defined in Section 856(e)(6)(D)(ii) as "a hospital, nursing facility, assisted living facility, congregate care facility, qualified continuing care facility (as defined in Section 7872(g)(4)), or other licensed facility which extends medical or nursing or ancillary services to patients, and which is operated by a provider of such services that is eligible for participation in the Medicare program under Title XVII of the Social Security Act with respect to the facility." In PLR 201828009, the IRS noted that the question raised is whether the related-party rent exception of Section 856(d)(8)(B) can apply in a situation where the lessee is not a TRS, but rather the lessee is a partnership in which the TRS is a partner. The IRS reasoned that rents paid by OpCo and OpCo Subs to the REIT (indirectly through PropCo) may qualify as rents from real property by analyzing the income attributable to the partnership interest held by Domestic TRS separately from the income attributable to any remaining partnership interest. The IRS explained that if Domestic TRS were the sole, direct lessee of each AL Facility, the related-party rent exception of Section 856(d)(8)(B) would apply to amounts received directly from TRS. Therefore, amounts attributable to the partnership interest held by Domestic TRS satisfy the requirements of Section 856(d)(8)(B) so long as an EIK manages and operates the AL Facility rented by the partnership. If Partner, which Taxpayer represents is not related to Taxpayer within the meaning of Section 856(d)(2)(B), were the sole direct lessee of each AL Facility, the rents received by the REIT would also qualify as rents from real property (without the need for any exception). Therefore, in this case, amounts attributable to the partnership interest held by Partner qualify as rents from real property. Accordingly, the IRS concluded that rental income received directly or indirectly by PropCo (and, thus, by Taxpayer under the "look-through rule" of Reg. Section 1.856-3(g)) from the lease of an AL Facility to a partnership between Domestic TRS and a single partner (that is unrelated to Taxpayer), shall not be excluded from rents from real property by reason of Section 856(d)(2)(B) so long as the facility is operated by an EIK. Implications PLR 201828009 (along with contemporaneously released PLR 2018008) confirms that a REIT will not be precluded from qualifying for the related party rent exception of Section 856(d)(8)(B) solely as a result of the lessee being a partnership between a TRS and persons unrelated to the REIT (as contrasted with a TRS being the lessee), so long as the other partners are unrelated to the REIT. The IRS also appears to have approved of TRS joint venture lessees for purposes of Section 856(d)(8)(B) in PLRs 201429017 and 201104023 (and related companion PLRs 201225008 and 201225009); however, these rulings did not contain an analysis of the matter. It is also noted that the IRS concluded in Revenue Procedure 2003-66 that a REIT can satisfy the related-party rent exception of Section 856(d)(8)(A) (relating to the leasing up to 10% of the space in a non-hotel/health care property to a TRS) when the space is leased to a partnership in which the TRS is a partner and the other partners consist of persons unrelated to the REIT and the TRS. It is unclear why the IRS did not discuss Revenue Procedure 2003-66 in PLR 201828009.
| |||||||||
| |||||||||
