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In PLRs 201949004, 201949005, and 201949007, the IRS ruled under IRC Section 856(c)(5)(J)(ii) that a real estate investment trust's income from carbon offset credits (Credits) earned under a State program will be considered qualifying income for purposes of the 95% and 75% income tests under IRC Section 856(c)(2) and (c)(3). The IRS also ruled that unless IRC Section 451(b)(1)(A) requires earlier inclusion, income from the Credits will accrue upon the earliest of the following events to occur: Credits are earned, Credits are received, or Credits are due.

Facts

In PLR 201949004, Taxpayer is a State A limited liability company that elected under IRC Section 856 to be treated as a real estate investment trust (REIT) for federal income tax purposes. Taxpayer owns a limited partnership interest in Subsidiary, which indirectly owns timberlands. Manager directly or indirectly manages Subsidiary, which realizes income and gain through timber sales and occasional sales of timberlands.

Subsidiary indirectly owns a membership interest in several limited liability companies classified as partnerships for federal income tax purposes (collectively referred to as "Partnerships," and collectively with Subsidiary referred to as "Entities"). Manager owns the remaining membership interests in Partnerships.

To reduce greenhouse gas emissions, State B enacted a cap-and-trade program that limits overall greenhouse gas emissions but allows certain businesses to buy, sell and trade the rights to produce emissions. Under the program, project developers may receive Credits by engaging in activities on US landholdings that affirmatively reduce greenhouse gas emissions.

Under their carbon offset projects, Entities will receive one Credit for each metric ton of carbon dioxide that specified parcels of their timberlands remove from the atmosphere. Entities must agree to certain restrictions on the use of the parcels for a specified number of years (e.g., each parcel has trees of certain species and ages that cover a set percentage of the parcel). Entities could record these land-use restrictions could under local law, but are not presently planning to do so.

In Year 2, the Agency issued Credits to one of the Partnerships. The other Partnerships expect to receive Credits after Year 2.

Taxpayer represents that Entities intend either to sell Credits to unrelated third-party purchasers or to transfer Credits to Taxpayer's taxable REIT subsidiary, which will sell them to unrelated third-party purchasers.

PLRs 201949005 and 201949007 have similar fact patterns.

Law and analysis

Under IRC Section 61(a), gross income includes income realized in any form, whether in money, property, or services. IRC Section 451 and its regulations explain how to determine the tax year of inclusion for items of gross income.

Under an accrual method of accounting, unless IRC Section 451(b)(1)(A) requires earlier inclusion, an item of gross income is generally includible when all the events have occurred that fix the right to receive the income and the amount can be determined with reasonable accuracy. All the events that fix the right to receive income generally occur upon the earliest of the following: (i) the required performance takes place, (ii) payment is due, or (iii) payment is made.

IRC 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; abatements and refunds of taxes on real property; and certain other sources of income.

IRC 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; abatements and refunds of taxes on real property; and certain other sources of income.

IRC Section 856(c)(5)(J) authorizes the IRS to determine, to the extent necessary to carry out the purposes of the REIT provisions, 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. The legislative history of the REIT provisions indicates that a central concern of the REIT income tests is that a REIT's gross income should largely be composed of passive income.

In PLR 201949004, the IRS ruled that, unless IRC Section 451(b)(1)(A) requires earlier inclusion, income from the issuance of Credits will accrue under IRC Section 451 upon the earliest of the following events: (i) Credits are earned, (ii) Credits are received, or (iii) Credits are due. The IRS also noted that Taxpayer's proportionate share of an Entity's basis in a Credit will equal the proportionate share of the fair market value of such Credit accrued as income by Taxpayer.

In addition, the IRS indicated that Taxpayer's share of income from the issuance of Credits by the State B Program constitutes gross income that is not listed as qualifying income under IRC Sections 856(c)(2) or (c)(3). The IRS noted, however, that Entities will earn Credits by agreeing to certain restrictions on the use of their land for a specified term, so the Credits are akin to receiving payment for granting an easement for a term of years.

Accordingly, the IRS concluded that treating Taxpayer's proportionate share of income from the Credits as qualifying income does not interfere with or impede Congress' objectives in enacting the REIT income tests. Thus, the IRS also ruled under IRC Section 856(c)(5)(J)(ii) that Taxpayer's proportionate share of income from the Credits will be considered qualifying income under IRC Section 856(c)(2) and (c)(3).

Implications

PLR 201949004 is the fourth private letter ruling in which the IRS has exercised its discretionary authority under IRS Section 856(c)(5)(J) to rule that income attributable to the receipt of certain credits by a REIT under a carbon offset program (in the connection with the ownership of timberlands) constitutes qualifying income for purposes of the REIT income tests. See PLRs 201720008, 201123005 and 201123003 (as modified by PLR 201751011).

PLR 201949004 also shares similarities with other recent PLRs in which the IRS has exercised its discretionary authority under IRS Section 856(c)(5)(J). In those cases, the IRS ruled that certain incentive-type income (e.g., cash payments, refundable state income tax credits, and transferable state income tax credits) that a REIT received from a governmental entity for developing real property that is expected to produce qualifying rents will be qualifying income under the REIT income tests. See Tax Alert 2019-2160(addressing PLR 201948006).

Like the recently issued PLR 201948006, PLR 201949004 offers no opinion on the tax consequences of disposing of the credits, including whether a sale of the credits constitutes a prohibited transaction that is subject to the 100% tax under IRC Section 857(b)(6).

It is again good news that the IRS continues to take a favorable view under the REIT income tests regarding credits received by a REIT under a carbon offset program involving timberlands. The income test conclusion in PLR 201949004, however, is based on the IRS's exercise of its discretionary authority under IRC Section 856(c)(5)(J). Thus, REITs with similar situations will want to consider whether to seek their own rulings.

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