In PLR 201844003, the IRS has ruled that 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), and therefore the REIT's gains on the sales will not be subject to the 100% prohibited transaction tax.

Facts and representations

JV, a partnership for federal income tax purposes, holds [a] percent of the issued common stock of Taxpayer, a State A limited liability company that has elected to be taxed as a REIT. JV formed Taxpayer for the purpose of purchasing and managing multifamily real estate complexes located in the United States.

Pursuant to a joint venture agreement, direct or indirect partners in JV transferred interests in certain multifamily residential real property (Portfolio A) to Taxpayer. Under the agreement, Taxpayer targeted an initial public offering (IPO) within [b] years. In the absence of an IPO, the agreement provides that Taxpayer shall be liquidated after [c] years.

Taxpayer also purchased an indirect interest in other multifamily residential real property (Portfolio B; Portfolio A and Portfolio B are collectively referred to as the "Properties"). The majority of the income Taxpayer received from the Properties was passthrough rental income that Taxpayer represents is qualifying gross income for purposes of the 95% and 75% income tests of Sections 856(c)(2) and (3).

Taxpayer represents that, at all times, it has intended to hold the Properties for a period of at least [c] years, and to realize rental income and capital appreciation from the Properties. However, Taxpayer believes that current market conditions represent the beginning of a long decline in the value of real property in City. Accordingly, Taxpayer now believes its investors will be best served through a disposition of its assets and Taxpayer's full liquidation. Taxpayer has not previously disposed of any real estate assets.

Taxpayer anticipates that the time to fully liquidate the Properties will take between [d] and [e] months. Before Taxpayer pursues a plan of complete liquidation, Taxpayer intends to take several steps following receipt of this ruling, including formally adopting a plan of liquidation. The adoption of the plan will be publicly disclosed, and the sale of Taxpayer's assets will be performed subject to any shareholder or other necessary approvals of the liquidation plan.

Law and analysis

Section 857(b)(6) 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 in the ordinary course of its trade or business.

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 acquisition of the property 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 that address its purposes with respect to the Properties:

• Taxpayer represents that its intention has always been to hold the Properties over the long-term to generate rental income and appreciated value.
• Taxpayer's disposition of the Properties will be due to a plan of liquidation, and Taxpayer will adopt the plan only after exploring alternatives that would allow Taxpayer to continue holding the Properties.
• Since its formation, Taxpayer has not sold any real property.
• Taxpayer acquired the Properties prior to any consideration of a plan of liquidation.
• Substantially all marketing expenditures with respect to sales of the Properties will be made through a taxable REIT subsidiary of Taxpayer or an independent contractor from whom Taxpayer does not derive or receive any income.

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).

Implications

PLR 201844003 is the ninth 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 201707010 (Tax Alert 2017-376), 201640007 (Tax Alert 2016-1724), 201609004 (Tax Alert 2016-531), 201346005 (Tax Alert 2013-2297), 201340004 (Tax Alert 2013-2055), 201315004 (Tax Alert 2013-0817), 200953018 (Tax Alert 2010-0020), 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, it should be noted that PLR 201844003, as well as the eight previously listed private letter rulings listed, all address sales of property in connection with a REIT's plan of liquidations and the conclusions are based on all the surrounding facts and circumstances. Finally, as noted in footnote 1 of PLR 201844003, 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 2018-3 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 201844003 that Taxpayer had demonstrated such reasons.

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