In PLR 202020007, the IRS ruled that certain independent retirement living facilities (IL Facilities) to be owned by a real estate investment trust (REIT) do not constitute "health care facilities" within the meaning of IRC Section 856(e)(6)(D)(ii). Accordingly, a taxable REIT subsidiary (TRS) that is engaged by the REIT to provide services to the residents of the IL Facilities will not be treated as "operating or managing a health care facility" within the meaning of IRC Section 856(l)(3)(A), an activity that otherwise would result in the loss of TRS status. In addition, the IRS ruled that the REIT's provision of noncustomary services to its residents through the TRS will not cause the REIT to recognize impermissible tenant service income or cause any portion of the rents received by the REIT from the residents to fail to qualify as rents from real property under IRC Section 856(d).

Facts

Taxpayer is a REIT that primarily invests in senior health care facilities (e.g., skilled nursing facilities, independent living communities, assisted living communities, continuing care retirement communities and memory care facilities) that are leased to third-party tenants under triple net lease arrangements.

A wholly-owned TRS (PropCo TRS) of Taxpayer currently owns the IL Facilities and leases the IL Facilities to another wholly-owned TRS of Taxpayer (OpCo TRS). OpCo TRS subleases the individual residences in the IL Facilities to residents under lease agreements. Operator, an entity that qualifies as an eligible independent contractor within the meaning of IRC Section 856(d)(9), operates and manages the IL Facilities for OpCo TRS pursuant to a management agreement.

Operator provides the following services to residents:

• Three meals per day
• Housekeeping and linen service
• Transportation to and from local destinations and group activities
• An emergency call system device that is operated by an unrelated third-party responder
• Utilities
• Plastic containers for disposal of hypodermic needles and other sharp medical instruments

The IL Facilities are marketed as "Independent Retirement Living" and require that at least one resident be at least of a specified age. The living quarters for lease in the IL Facilities include at least one bedroom, a kitchenette, bathroom and living room area. The IL Facilities generally offer amenities such as common dining areas, activity rooms, a barber and beauty salons. Handrails are provided in hallways and common bathroom areas of the Facilities. The leases with residents specifically indicate that the IL Facilities do not provide any health care services and that residents are responsible for their own personal and health care needs. The leases also note that the IL Facilities are not licensed as nursing or health care facilities.

The IL Facilities do not conduct preventative health screening of residents, monitor medical needs of residents, require a resident to obtain consent from an IL Facility before contracting with third-parties for in-home health care services, supervise residents' oxygen equipment, maintain "do not resuscitate forms" or have 24-hour staff on-site to monitor the residents. In an emergency, however, on-site personnel are allowed to call 911.

Upon receiving a favorable ruling from the IRS, PropCo TRS will revoke its election to be treated as a corporation and revoke its TRS election and, thus, it will become a disregarded entity of Taxpayer. OpCo TRS will assign the lease agreements (i.e., the subleases of individual residences in the IL Facilities) to PropCo TRS. Accordingly, Taxpayer will become the landlord under the lease agreements with residents. Taxpayer will engage OpCo TRS under a management contract to provide the aforementioned services to the residents of the IL Facilities. OpCo TRS will subcontract with Operator to provide the services to the residents. Taxpayer will collect monthly rent from the residents and make an arm's length payment to the OpCo TRS for the services it provides.

Law and analysis

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.

The term "rents from real property" includes (i) rents received from the lease of interests in real property to tenants, (ii) charges for services customarily rendered to tenants and (iii) rents from the lease of certain de minimis personal property (IRC Section 856(d)(1)).

The term "rents from real property" does not include: (i) rents based on the income or profits of a tenant, (ii) rents received from certain related-party tenants and (iii) impermissible tenant services income (IRC Section 856(d)(2)).

Under IRC Section 856(d)(7)(A), impermissible tenant services income (ITSI) includes amounts received by a REIT for services furnished by the REIT to tenants of its property, or for managing or operating the property. IRC Section 856(d)(7)(C)(i), however, excludes from ITSI amounts received by the REIT for services furnished, or management or operation provided, through an independent contractor from whom the REIT does not derive or receive any income or through a TRS.

In Revenue Ruling 2002-38, the IRS addressed a REIT that engaged a TRS to provide noncustomary housekeeping services to tenants of the REIT's apartment property where the charge for the housekeeping service was embedded in the tenants' rents. The IRS ruled that the services provided by the TRS do not give rise to ITSI and, thus, do not cause any portion of the rents received by the REIT to fail to qualify as rents from real property.

A TRS is defined in IRC Section 856(l)(1) as a corporation whose stock is directly or indirectly owned, in full or part, by a REIT and that jointly elects with the REIT to be treated as a TRS. A corporation will not qualify as a TRS, however, if it directly or indirectly manages a lodging facility or a health care facility (IRC Section 856(l)(3)).

IRC Section 856(e)(6)(D)(ii) defines a "health care facility" to include a "hospital, nursing facility, assisted living facility, congregate care facility, qualified continuing care facility (as defined in [IRC S]ection 7872(g)(4)), or other licensed facility which extends medical or nursing or ancillary services to patients and which, immediately before the termination, expiration, default, or breach of the lease of or mortgage secured by such facility, was operated by a provider of such services which was eligible for participation in the Medicare program under Title XVII of the Social Security Act with respect to such facility."

In PLR 202020007, the IRS evaluated the surrounding facts and circumstances and determined that the services provided to the residents of the IL Facilities are "not focused on the health and well-being of the residents," concluding that the IL Facilities do not constitute "health care facilities" within the meaning of IRC Section 856(e)(6)(D)(ii). The IRS noted the following in arriving at its conclusion:

• The IL Facilities focus on providing residents with "a convenient and social living environment."
• The IL Facilities offer amenities and services that may be present at congregate care health care facilities; however, "the emphasis of the amenities and services provided at the [IL Facilities] is not the health and wellbeing of the residents."
• Shared meals and transportation to local destinations and group activities are provided "for convenience and to enhance the social lives of the residents as opposed to providing a health benefit."
• While the IL Facilities provide an emergency call device to residents, the device connects to the emergency operator, which is a third party unrelated to Taxpayer.
• The employees at the IL Facilities are not licensed nurses and are "not available 24 hours a day to monitor or assist the residents."
• The residents are screened prior to signing a lease agreement to ensure that they are capable of providing for their own health care needs.

The IRS also ruled (in accordance with IRC Section 856(d)(7)(C)(i) and Revenue Ruling 2002-38) that the provision of services by Operator (through the TRS) will not be considered to be provided by Taxpayer. Therefore, the provision of services will not give rise to ITSI and will not cause any portion of the rents received by Taxpayer from the residents to fail to qualify as rents from real property under IRC Section 856(d).

Implications

PLR 202020007 is the third private letter ruling in which the IRS has ruled, based on the surrounding facts and circumstances, that certain senior independent living facilities do not constitute "health care facilities" for purposes of IRC Section 856(e)(6)(D)(ii). In particular, the IRS considered whether certain "independent retirement living facilities" constituted "congregate care facilities," a term which is not defined in the Internal Revenue Code or its regulations. The IRS determined that the independent retirement living facilities were not congregate care facilities because the services provided to the residents are "not focused on the health and well-being of the residents." See also PLRs 201828008 (independent living facility "does not focus on the health and well-being of its residents")(Tax Alert 2018-1566) and 200813005 (independent living facilities are "not licensed facilities and will not provide any medical, nursing or ADL services to tenants").

The IRS has also ruled in four private letter rulings, based on the surrounding facts and circumstances, that certain senior independent living facilities do constitute "congregate care facilities" and, thus, are "health care facilities" for purposes of IRC Section 856(e)(6)(D)(ii). See PLR 201828008 (independent living facilities are operated with an "emphasis on health and wellness of seniors"), 201509019 (age-restricted independent living communities "actively monitors the residents' health and provides services to help improve the health and wellbeing of its elderly residents"), 201429017 (senior living facilities offer services that have a "significant health care related focus") and 201147015 (senior independent living facilities provide services "specially targeted to monitor and help improve the health and well-being of its residents").

It is important to determine whether a particular senior independent living facility does or does not constitute a "congregate care facility." If the senior independent living facility does constitute a congregate care facility, a REIT may not engage a TRS to provide operation or management services at the senior independent living facility. The REIT, however, can consider leasing the independent living facility to a TRS under the related-party rent exception of IRC Section 856(d)(8)(B) if the TRS engages an eligible independent contractor to operate and manage the senior independent living facility on behalf of the TRS.

While the IRS to date has not provided a bright-line test to make the determination of whether a particular senior independent living facility constitutes a congregate care facility, PLR 202020007 provides some additional insight on the IRS's view of the definition of a congregate care facility.

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