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In PLR 201845001, the IRS ruled, under its discretionary authority in Section 856(c)(5)(J)(ii), that gross income of a real estate investment trust (REIT) attributable to the receipt or accrual of refundable brownfield tax credits from the development of rental real property is qualifying income for purposes of the 95% and 75% income tests under Section 856(c)(2) and (c)(3).

In addition, the IRS ruled that the REIT's right to receive the brownfield tax credits constitutes a qualifying "receivable" arising in the ordinary course of Taxpayer's operations within the meaning of Reg. Section 1.856-2(d)(1), and thus a qualifying asset for purposes of the 75% asset test of Section 856(c)(4)(A).

Facts

Taxpayer is a corporation that will elect to be taxed as a REIT. Taxpayer owns all of the interests in Subsidiary, a limited liability company that is a disregarded entity for Federal income tax purposes.

Charity, a nonprofit corporation, owns a majority of the shares of Taxpayer. Charity is the sole member of Owner, a limited liability company that is a disregarded entity for Federal income tax purposes. Owner owns the Site and has leased the Site to Subsidiary under a long-term lease. Taxpayer and Subsidiary have incurred significant expenditures in connection with the remediation, rehabilitation and development of the Site.

As a result of remediation, rehabilitation, and development expenditures of Taxpayer and Subsidiary, Taxpayer is eligible for brownfield redevelopment tax credits (Brownfield Credits) in State. The amount of the Brownfield Credits is a percentage of the costs of (1) site preparation, (2) certain tangible property (including buildings and structural components placed in service at the Site), and (3) on-site groundwater remediation.

Taxpayer expects the Brownfield Credits to exceed Taxpayer's State income tax liability. Taxpayer represents that, under State law, the excess is treated as an overpayment of tax and that Taxpayer will elect to receive a refund of the overpayment. The right to receive the Brownfield Credits is properly treated as a receivable on Taxpayer's balance sheet under generally accepted accounting principles (GAAP). The Brownfield Credits are allowable and refundable only with respect to Taxpayer's State income tax liability and are not abatements or refunds of taxes on real property under State law.

Taxpayer represents that Taxpayer, acting through Subsidiary, intends to sublease space at the site to unrelated third parties in order to generate income that will qualify as rents from real property for purposes of Section 856(c)(2) and (3).

Law & Analysis

Section 856(c)(4)(A) requires that, at the close of each quarter of its taxable year, at least 75% of the value of the REIT's total assets must consist of real estate assets, cash and cash items (including receivables), and government securities.

For purposes of Section 856(c)(4)(A), Reg. Section 1.856-2(d)(1) defines "receivables" as only those receivables that arise in the ordinary course of a REIT's operation, excluding receivables purchased from another person. Regulation Section 1.856-2(d)(3) provides that "total assets" means the gross assets of the REIT determined in accordance with GAAP.

Section 856(c)(2) requires a REIT to derive at least 95% of its gross income (excluding gross income from prohibited transactions) from dividends, interest, rents from real property, certain gains from the sale of stock, securities and real property, and abatements and refunds of taxes on real property, as well as certain other income sources.

Section 856(c)(3) requires a REIT to derive at least 75% of its gross income (excluding gross income from prohibited transactions) from rents from real property, interest on obligations secured by real property, gain from the sale or other disposition of real property, dividends from REIT stock, gain from the sale of REIT stock, and abatements and refunds of taxes on real property, as well as certain other sources of income.

Section 856(c)(5)(J) indicates that, to the extent necessary to carry out the purposes of the REIT provisions, the IRS may determine whether any item of income or gain that does not constitute qualifying income under the 95% or 75% income tests may nevertheless be (i) disregarded for purposes of the 95% or 75% income tests or (ii) treated as qualifying income for purposes of the 95% or 75% income tests. The legislative history of the REIT provisions show that the primary concern of the REIT income tests is to ensure that a REIT's gross income is largely passive income.

Asset Tests. In PLR 201845001, the IRS noted that Taxpayer will not purchase the Brownfield Credits from another person, and that the right of Taxpayer to receive the Brownfield Credits arises from the development of real property on land in connection with the leasing business of Taxpayer and Subsidiary. Therefore, the IRS reasoned that the right is a receivable arising in the ordinary course of Taxpayer's operations under Reg. Section 1.856-2(d)(1). The IRS formally ruled that Taxpayer's right to receive the Brownfield Credits, to the extent the right is an asset under GAAP, is a receivable for purposes of Section 856(c)(4).

Income Tests. In PLR 201845001, the IRS noted that the income attributable to the receipt or accrual of the Brownfield Credits is not listed as a qualifying source of income under the 95% or 75% income tests of Sections 856(c)(2) or (3), but that pursuant to Section 856(c)(5)(J), the Secretary has the authority to determine that the income attributable to the receipt or accrual of the Brownfield Credits be considered as qualifying gross income under those provisions. Based on the surrounding the facts and circumstances, including Taxpayer's representations that it intends to sublease the Site to generate rents from real property and that it expects substantially all of the income generated by the Site to be qualifying income for purposes of Sections 856(c)(2) and (3), the IRS determined that treating the income attributable to the receipt or accrual of the Brownfield Credits as qualifying income does not interfere with or impede the objectives of Congress in enacting Sections 856(c)(2) and (3). Accordingly, the IRS ruled, pursuant to its discretionary authority under Section 856(c)(5)(J)(ii), that Taxpayer's income attributable to the receipt or accrual of the Brownfield Credits is considered qualifying income for purposes of Sections 856(c)(2) and (3).

Implications

PLR 201845001 is the latest private letter ruling to address incentive-type payments received by a REIT from a state (or jurisdiction thereof) in connection with developing real property.

See PLR 201841002 (Tax Alert 2018-2069) addressing the receipt of a grant relating to the redevelopment of rental property; PLRs 201816001, 201816002 and 201816003, addressing the receipt of payments relating to the development of a retail shopping center (Tax Alert 2018-0960); PLR 201716043, addressing the receipt of grant payments relating to the development of a mixed-use rental property (Tax Alert 2017-0717); PLR 201518010, addressing receipt of refundable state tax credits relating to development of apartment complexes (Tax Alert 2015-0984); and PLR 201428002 addressing the receipt of refundable state tax credits relating to development of retail buildings (Tax Alert 2014-1304). In these rulings, as in PLR 201845001, the IRS ruled, under its Section 856(c)(5)(J) authority, that incentive-type payments (including refundable tax credits) related to the development of real property that is expected to produce qualifying rents will constitute qualifying income for purposes of the REIT income tests.

In addition, in PLR 201742018 (Tax Alert 2017-1803) the IRS ruled, under its Section 856(c)(5)(J) authority, that incentive payments received by a REIT from a utility company in connection with the installation of a solar PV system on the roof of the REIT's retail property will be considered qualifying income for purposes of the REIT income tests.

Also, see PLRs 201816001, 201816002 and 201816003, in which the IRS ruled that income attributable to the receipt of a refundable tax credit constituted a refund of real property taxes under Section 856(c)(2)(E) and (c)(3)(E), and thus qualifying income for purposes of the 95% and 75% income tests, 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).

PLR 201845001 is also the sixth private letter ruling in which the IRS has concluded that a REIT's right to receive an incentive-type payment (including a refundable tax credit) constitutes a "receivable arising in the ordinary course of a REIT's operation" within the meaning of Reg. Section 1.856-2(d)(1)(iii), and thus, a qualifying asset for purposes of the 75% asset test. See PLRs 201816001, 201816002, 201816003, 201518010, and 201428002.

It is good news that the IRS continues to take a favorable view under the REIT income tests and asset 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 income test conclusion in PLR 201845001, however, is 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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