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In a private letter ruling (PLR 201930003), the IRS has ruled that (1) floating docks at certain of the taxpayer's marinas constitute real property for purposes of Reg. Section 1.856-10(b) and therefore are considered real estate assets for purposes of IRC Section 856(c)(4) and (5); (2) rental fees received for storing boats in the racking structure of dry dock storage facilities will be considered rents from real property for IRC Section 856(d) purposes; and (3) the presence of cabins available for short-term rental at one of the taxpayer's marinas will not cause the other assets at the property to be treated as lodging facilities within the meaning of IRC Section 856(d)(9)(D)(ii).

Facts

Taxpayer intends to file Form 1120-REIT to be taxed as a real estate investment trust (REIT), and indirectly owns interests in Company, a partnership that owns and leases or leases and subleases five waterfront properties that operate as marinas. The properties all offer floating docks that form boat slips, storage facilities, boat servicing facilities, and support facilities (e.g., laundry, restaurant, etc.). One of the five marinas also has cabins that are available for rent to the general public for up to one week. The cabins are generally leased to parties other than lessees of dock slips or dry dock storage space.

The floating docks provide ingress and egress for slip holders to access their boats. They are generally attached to poured concrete walkways on land, or in the case of the coastal marinas, are attached to timber or steel bulkheads that retain contact with the land. The floating docks are held in place by one of two mechanisms. Three of the marinas use pilings to hold the docks in place, and the other two marinas use winches and cables that are permanently anchored to the seabed. The floating docks rise and fall with the tides, along with the boats, and remain attached to the pilings so the docks remain at the same level in relation to the boats at both high or low tide. The floating docks are designed to remain in place indefinitely and are constructed to withstand the particular wind, current, and wave conditions of the area in which they are built and are not removed unless damaged or have reached the end of their useful lives. Removing the docks would be extremely time-consuming and expensive.

The dry dock facilities contain vertical rows of steel racking structures that are leased to tenants to store their boats. Tenants are not permitted to enter the structures and are not given a designated space. The taxpayer represents that the dry dock storage facilities are inherently permanent structures for purposes of Reg. Section 1.856-10(d)(2). A taxable REIT subsidiary (TRS) or an independent contractor from which Taxpayer derives no income will move boats into and out of the dry dock storage facility. Although no other services are provided in connection with the storage fee for leasing space in the dry dock facility, boat owners may request "dry dock services," including boat maintenance and repairs prior to storage, for which separate fees are charged.

Finally, the short-term rental cabins described above will be owned by a TRS and managed by the taxpayer. Linens and basic toiletries will be provided, and the cabins will be cleaned when guests leave. The taxpayer represents that the income it receives from the cabins will be treated as nonqualifying income for purposes of the 95% and 75% income tests of IRC Sections 856(c)(2) and (3).

Law and analysis

Floating docks

At least 75% of the value of a REIT's total assets at the close of each quarter of its tax year must consist of real estate assets, cash, cash terms and government securities (IRC Section 856(c)(4)(A)). "Real estate assets" are defined in part as real property, including interests in real property, interests in mortgages on real property, and shares in other qualified REITs (Reg. Section 1.856-3(b)(1)).

Reg. Section 1.856-10(b) and (d) provides that "real property" means land and improvements to land in the form of inherently permanent structures. An inherently permanent structure is one that is affixed to the land, including by weight, serves a passive function, such as to contain, support, shelter, cover, protect, or provide a conduit or route, and does not serve an active function, such as to manufacture, create, produce, convert, or transport. Reg. Section 1.856-10(d)(2)(iii)(B) provides a list of assets that may qualify as inherently permanent structures if they are permanently affixed. Stationary docks (but not floating docks) are included in the list. Reg. Section 1.856-10(d)(2)(iv) provides that the following factors must be considered when evaluating whether an asset that serves a passive function and is not otherwise listed in Reg. Section 1.856-10(d)(2)(iii)(B) qualifies as an inherently permanent structure:

• The manner in which the asset is affixed to the real property
• Whether the asset is designed to be removed or to remain in place indefinitely
• Whether removal would damage the asset or the real property to which it is affixed
• Circumstances that indicate the asset will not be affixed indefinitely
• The time and expense required to move the asset

After evaluating the specific facts and circumstances at issue, the IRS concluded that all of the floating docks, whether secured to the seabed by pilings or by winches and cables, constitute real property under Reg. Section .856-10(b) and therefore qualify as real estate assets under IRC Section 856(c)(4) and (5).

Dry dock storage

IRC Section 856(c)(2) requires a REIT to derive at least 95% of its gross income from specific sources, including rents from real property, and IRC Section 856(c)(3) requires a REIT to derive at least 75% of its gross income from specified sources, including rents from real property.

Reg. Section 1.856-4(a) provides, in part, that the term "rents from real property" means, generally, the gross amounts received for the use of, or right to use, real property of the REIT.

The IRS concluded that the dry dock boat storage facilities qualify as inherently permanent structures and although tenants do not have a right of entry and are not given the right to use a specifically enumerated space, amounts received from leasing its racking structure space will not be treated as other than rents from real property for IRC Section 856(d) purposes.

Cabins

A TRS is defined in IRC Section 856(l)(1) as a corporation directly or indirectly owned by a REIT that jointly elects with the REIT to be treated as a TRS. A TRS may not directly or indirectly manage a lodging facility (IRC Section 856(l)(3)).

Although one of Taxpayer's marinas includes cabins (which were determined to constitute a lodging facility), the IRS concluded that the cabins did not change the nature of the rest of the marina. The PLR states that "the characterization of a separately identifiable item of property that is rented and used independently of the greater property on which the item of property is physically located should not dictate the characterization of the greater property — for example, the presence of a restaurant on a marina property should not automatically render the entire marina property a restaurant." Therefore, the IRS ruled that the presence of the cabins does not cause the marina as a whole to be treated as a lodging facility.

Implications

PLR 201930003 is the first private letter ruling to conclude that floating docks will be treated as real property for purposes of the REIT rules. A prior private letter ruling, PLR 201310020, had concluded that boat slips (i.e., the fixed plots of water space in which boats are berthed¹ at a marina were real property and that income received by the REIT from the leasing of the boat slips was qualifying rents from real property for purposes of the 95% and 75% income tests. PLR 201310020 did not conclude on the characterization of the floating docks associated with the boat slips, but rather the taxpayer represented that the portion of the boat slip rental income attributable to the floating docks and any other personal property at the marina would not exceed 15% of the total rental income from the boat slip leases for purposes of 15% ancillary personal property test of IRC Section 856(d)(1)(c). Thus, the taxpayer effectively represented that it would treat the floating docks as personal property.

PLR 201930003 provides great detail concerning the factual basis necessary for the IRS to conclude that the floating docks qualify as "real property" under Reg. Section 1.856-10, which became effective August 8, 2016. PLR 201930003 is also the first private letter ruling to conclude that rental fees received for storing boats in dry dock storage facilities will constitute rents from real property. Moreover, this ruling makes clear that the overall character of a property will not be determined by the existence of a business conducted there, in this case lodging, if that business only comprises a small amount of the revenues derived from the property by the taxpayer. This is a very positive result for many REITs that lease properties that include different rental types at a given property.

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ENDNOTE

¹ Note that Reg. §1.856-10(c), promulgated after PLR 201310020, defines land to include water and air space superjacent to land.