September 11, 2020
REIT's income from providing use of telecommunication infrastructure systems to wireless carriers constitutes rents from real property
In PLR 202035008, the IRS ruled that amounts received by a real estate investment trust (REIT) for providing the use of telecommunication infrastructure systems to wireless carriers constitute qualifying rents from real property for purposes of the 95% and 75% income tests of IRC Section 856(c)(2) and (3).
In addition, the IRS ruled that an IRC Section 481(a) adjustment, resulting from the REIT's change in the method of accounting for depreciation of certain real property assets, will not be treated as gross income for purposes of the 95% and 75% income tests. Accordingly, the IRC Section 481(a) adjustment will not adversely affect the REIT's compliance with the income tests.
Taxpayer, a corporation that intends to elect to be taxed as a REIT under IRC Section 856, owns telecommunication infrastructure assets (Systems) that are leased, licensed or otherwise granted use to wireless carriers (Users) under Use Agreements.
Taxpayer also owns leaseholds, licenses, easements, rights-of-way, rights of use, attachment rights or other similar rights or interests, with respect to land, buildings and/or other inherently permanent structures to support each System (Real Estate Rights).
"The primary component of each System (other than the Real Estate Rights) is fiber optic cable. Each System also includes optical converters, amplifiers, antennae and other personal property associated with the Systems that perform an active function (Equipment)," according to PLR. In some situations, the optical converters, amplifiers and antennae are owned by Taxpayer and in other situations they are owned by the User.
Taxpayer performs certain activities (Activities) with respect to the Systems, including designing and constructing the Systems, installing the components of the Systems, and providing limited maintenance and ongoing monitoring (e.g., responding to alarms and repairing broken components).
Taxpayer also provides certain services (Services) under the Use Agreements, including make electricity available to each User to operate its equipment, providing physical security for restricted access area where User communication equipment is located, and maintaining and repairing the Equipment. Either a taxable REIT subsidiary (TRS) or an independent contractor (IK) will monitor, operate, manage, maintain and repair the Equipment, including equipment owned by a User that is connected to a System.
Taxpayer intends to file a Form 3115, Application for Change in Accounting Method, to change its method of accounting for the depreciation of certain real property assets, which will result in a positive adjustment under IRC Section 481(a) that will be includible in Taxpayer's taxable income over four years (IRC Section 481(a) Adjustment).
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: (1) rents from interests in real property, (2) charges for services customarily furnished in connection with the rental of real property and (3) rent attributable to personal property that is leased under or in connection with a lease of real property if the rent attributable to the personal property does not exceed 15% of the total rent attributable to the real and personal property (IRC Section 856(d)(1)).
The term "rents from real property" excludes: (1) rents based on the income or profits of a tenant, (2) rents received from certain related-party tenants and (3) impermissible tenant services income (ITSI) (IRC Section 856(d)(2)).
Under IRC Section 856(d)(7)(A), ITSI includes amounts that a REIT receives for furnishing services to tenants of its property, or for managing or operating the property. IRC Section 856(d)(7)(C)(i), however, excludes from ITSI (1) amounts received by the REIT for services, management or operation provided through an IK from which the REIT does not derive or receive any income or a TRS and (2) amounts that would be excluded from unrelated business taxable income under IRC Section 512(b)(3) if received by an exempt organization.
IRC Section 856(c)(5)(J) authorizes the IRS to determine, to the extent necessary to carry out the REIT provisions' purposes, whether items of income or gain that are not qualifying income under the 95% or 75% income tests may nevertheless be (1) disregarded for purposes of the 95% or 75% income tests or (2) treated as qualifying income for purposes of the 95% or 75% income tests. The legislative history of the REIT provisions shows that the primary concern of the REIT income tests is to ensure that a REIT's gross income is largely passive income.
Ruling 1: Amounts received under Use Agreements constitute rents from real property
The IRS first concluded that amounts received by Taxpayer for providing Users with the right to use or to occupy space on a System qualifies as rents from interests in real property under IRC Section 856(d)(1)(A) based on the following facts and representations:
The IRS then determined that the Taxpayer's provision of Activities and Services does not give rise to ITSI and will not cause any portion of the rents received by Taxpayer from Users for use of the Systems to fail to qualify as rents from real property.
In particular, the IRS noted that Taxpayer represented that the Services are of the type that are customarily furnished to tenants of Systems of a similar class in the same geographic area and, except for arranging for the provision of electricity and providing physical security of the restricted areas, are performed by either a TRS or an IK. The IRS explained that arranging for the provision of electricity and providing physical security are services usually or customarily rendered in connection with the rental of telecommunication infrastructure assets and are necessary to maintain Taxpayer's property. The resulting income is thus excluded from unrelated business taxable income under IRC Section 512(b)(3). In addition, Taxpayer represented that the performance of the Activities are an exercise of its fiduciary duties under Treas. Reg. Section 1.856-4(b)(5)(ii).
Accordingly, the IRS ruled that that amounts paid by Users for the use of a System constitute rents from real property under the 95% and 75% income tests of IRC Section 856(c)(2) and (c)(3).
Ruling 2: IRC Section 481 adjustment excluded from 95% and 75% income tests
The IRS exercised its discretionary authority under IRC Section 856(c)(5)(J) and ruled that the
IRC Section 481(a) Adjustment will not constitute gross income for purposes of the 95% and 75% income tests of IRC Sections 856(c)(2) and (3). Accordingly, the IRC Section 481(a) adjustment will not adversely affect Taxpayer's compliance with the income tests. The IRS noted that this result does not interfere with congressional policy objectives in enacting the REIT income tests, one of which is to ensure that the bulk of a REIT's income is from passive income sources and not from the active conduct of a trade or business.
PLR 202035008 is the fourth private letter ruling in which the IRS ruled that income received by a REIT for providing the use of fiber optic systems and/or distributed antenna systems to wireless telecommunications carriers constitute rents from real property. See PLRs 201901001, 201741002 and 201450017. It should be noted that these rulings are highly fact specific. Technology-driven innovation over the last 20 years has resulted in certain newer forms of arrangements for the use of real property, so it is helpful to see the IRS confirm that those uses of real property may result in "rents from real property" to REITs. It is also a positive development that the TRS in this ruling uses the personal property to perform its services for the Users but does not appear to have to own such personal property.
PLR 202035008 also includes a caveat at the close of the ruling reminding taxpayers that the definition of rents from real property under the REIT rules differs in scope and structure from the definition of rents from real property under IRC Section 512(b)(3), which applies to exempt organizations. As such, an exempt organization providing the same services as Taxpayer may have unrelated business taxable income.
Finally, PLR 202035008 is the seventh private letter ruling in which the IRS exercised its discretionary authority under IRC Section 856(c)(5)(J) to rule that an IRC Section 481(a) adjustment relating to a change in the method of accounting for depreciation will not constitute gross income for purposes of the 95% and 75% income tests. See PLRs 202024003, 201716002, 201652012, 201537020, 201503010, 201301007. In addition, in PLR 200115023, the IRS ruled in the same manner based on certain pre-enactment IRC Section 856(c)(5)(J) authorities.