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In PLR 202012003, the IRS ruled on various matters for a real estate investment trust (REIT) involved in leasing space in warehouses.

Facts

Taxpayer, a corporation that will elect to be taxed as a REIT, intends to raise capital through a public offering or other sale of its stock, and contribute the proceeds to an existing operating partnership (OP) for an interest in the OP or to pay certain costs of Taxpayer. In connection with the stock offering, partners of the OP may contribute all or a portion of their interests in the OP to Taxpayer in exchange for Taxpayer stock. Thereafter, Taxpayer will conduct its business and hold its assets through the OP.

Taxpayer's business consists of the ownership and leasing of space in warehouses to manufacturers, distributors, retailers and other persons (tenants). Taxpayer's rental operations consist of either leasing an entire warehouse to a tenant; leasing a fixed amount of reserved space in a warehouse; or leasing non-exclusive space in a warehouse under a long-term Storage Agreement.

Under the Storage Agreements, tenants pay storage rates (i.e., rents) based on the cubic feet occupied by the number of pallets of goods stored in a particular warehouse and the length of storage use. Pallets remain in a warehouse for an average of a specified number of days that is not disclosed in the ruling. Taxpayer does not guarantee space for all tenants under their Storage Agreements; however, Taxpayer plans storage capacity at each warehouse to ensure it will have available space for all of its tenants. Tenants generally do not have unrestricted access to the inside of the storage facilities.

Taxpayer will not provide any services to tenants in connection with the lease of space in its warehouses other than an undisclosed customary service (which appears to be "freezing" goods for tenants) made available "through the provision of power and electricity." A taxable REIT subsidiary (TRS) or an independent contractor (IK) will perform all handling services, which consist of "loading, unloading, and moving tenants' pallets into, out of, and around a warehouse." Taxpayer represents that handling services are customarily provided to tenants of warehouses in the geographic market in which each Taxpayer's warehouse is located.

Certain other services, including transportation services with third-party carriers and supply chain services (Other Services), will be provided by a TRS. OP will assign the portion of Storage Agreements that provide for Other Services to a TRS. The TRS will receive a separate stated charge for the Other Services. Taxpayer may collect and receive amounts payable by tenants for services provided by a TRS (as agent for and on behalf of that TRS); alternatively, a TRS may collect and receive all or any portion of the amounts payable by tenants for storage space, freezing, and handling as agent for and on behalf of Taxpayer or the OP and, if so, will notify tenants of the agency arrangement in writing. A TRS also may separately contract with and bill tenants for providing Other Services.

Taxpayer may lease space at a warehouse to a TRS, which will be used by the TRS in connection with its provision of services to tenants.

Taxpayer, the OP and a TRS plan to enter into a cost-sharing arrangement to share costs of shared employees and general and administrative overhead expenses. Generally, Taxpayer or OP will incur the costs and receive reimbursements from the TRS, although sometimes the TRS may incur the costs and receive reimbursements from the Taxpayer or OP.

Law and analysis

Ruling 1: Payments from tenants under Storage Agreements qualify as rents from real property

The IRS ruled that amounts received by Taxpayer under the Storage Agreements for providing space based on the amount of cubic feet (volumetric) per pallet and an undisclosed service (which appears to be "freezing" goods for tenants), and for providing handling services performed by a TRS or an independent contractor (from whom Taxpayer does not derive or receive any income), will qualify as "rents from real property" within the meaning of IRC Section 856(d).

Implications

PLR 202012003 is the third private letter ruling in which the IRS has addressed a REIT making available the use of nonexclusive space in a warehouse for storing tenants' goods where the tenants do not have direct access to the stored goods and the REIT arranges for the movement of the goods in and out of the warehouse (generally through a TRS). See PLRs 201503010 (storage of documents and records in warehouses) and PLR 200428019 (storage of goods in temperature-controlled warehouses).

Ruling 2: Rents from TRS qualify as rents from real property

The IRS ruled that rents received by Taxpayer from its TRS from the leasing of space at a warehouse (where at least 90% of the leased space at the warehouse is leased to persons other than the TRS or a related person) will be treated as rents from real property under IRC Section 856(d) through the application of the limited rental exception of IRC Section 856(d)(8)(A).

Implications

Rents received by a REIT from leasing space in a property to a TRS qualifies for the related-party rent exception of IRC Section 856(d)(8)(A) when at least 90% of the leased space at the property is leased to persons other than TRS or other related persons, and "only to the extent" the rents paid by the TRS are "substantially comparable to rents paid by the other tenants of the [REIT's] property for comparable space."

PLR 202012003 is important because the IRS concluded that Taxpayer could look to rents paid by unrelated persons for comparable space in similar warehouses in the "same geographic area," if no comparable space exists at a particular warehouse; if no comparable space exists in the same geographic area, Taxpayer could look to rents paid for comparable space in the "surrounding geographic area."

In PLRs 201537020, 201503010, 201143011, 200525013, and 200234054, the IRS also permitted a REIT to look to rents paid for comparable space in the geographic area (for purposes of the "comparable space" requirement) if comparable space did not exist at the REIT's property. Also see PLR 201206001, in which the IRS ruled that, when there was no comparable space in the geographic area (due to the unique nature of the leased space), the standard could be satisfied if the TRS pays an arm's-length, fair-market-value rental rate for the space it leases (i.e., the rent is comparable to the rent paid by third-party tenants in a building, taking into account differences between the leased space and the space leased by third-party tenants, as determined by an appraisal).

Ruling 3: Reimbursements under a cost-sharing arrangement not included in gross income

The IRS ruled that amounts received as reimbursements by either Taxpayer, OP or TRS under the cost-sharing arrangement will not be included in the receiving member's gross income. Accordingly, reimbursements received by the Taxpayer (including OP) will not be taken into account in the 95% and 75% income tests of IRC Section 856(c)(2) and (3).

Implications

It is helpful to see the IRS rule again that amounts received by a REIT from a TRS under a cost-sharing arrangement, under which the REIT shares the cost of certain REIT employees and general and administrative expenses with a TRS, will not constitute gross income for purposes of the REIT income tests (as contrasted with constituting gross income that is nonqualifying income) when (i) the REIT does not profit under the cost-sharing arrangement; (ii) the REIT is not in the business of providing to third parties services of the type subject to the cost-sharing agreement; and (iii) the REIT does not include the reimbursement in gross income, or deduct or capitalize the reimbursed costs. Similar rulings issued during the last decade include PLRs 201537020, 201522002, 201503010, 201431020, 201423011, and 201314002. All of these private letter rulings cite to Revenue Ruling 84-138 (and cases cited therein) as the controlling authority for their conclusions.

Ruling 4: Contribution of OP interests to Taxpayer not treated as transfers to an investment company.

The IRS ruled that the contribution by certain members of the OP of all or a portion of their interests in the OP to Taxpayer in exchange for Taxpayer's stock will not be treated as a "transfer to an investment company" within the meaning of IRC Section 351(e).

Implications

This ruling is important because, if the contributions were treated as "transfers to an investment company," the contributors would not have qualified for nonrecognition treatment under IRC Section 351 with respect to their contributions of OP interests to Taxpayer. Under Treas. Reg. Section 1.351-1(c)(1), a transfer of property to a REIT is treated as a transfer to an investment company if "[t]he transfer results, directly or indirectly, in diversification of the transferors' interests." Generally, under Treas. Reg. Section 1.351-1(c)(5), a transfer ordinarily results in the diversification of the transferors' interests "if two or more persons transfer nonidentical assets to a corporation in the exchange," although insignificant transfers are ignored. In addition, transfers of identical assets to a newly organized corporation generally are not treated as resulting in diversification. In PLR 202012003, the IRS provided no analysis of Ruling 4.

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