In PLR 202047003, the IRS addressed income received by a real estate investment trust (REIT) from leasing advertising space to tenants on signs attached to the exterior of its rental buildings. The IRS ruled that the income will not fail to be qualifying rents from real property under IRC Section 856(d) solely because (1) the REIT will derive a de minimis amount of rents from the short-term rentals of space on the signs or (2) the REIT will lease sign space to a taxable REIT subsidiary (TRS) (as long as the requirements of the Limited Rental Exception of IRC Section 856(d)(8)(A) are satisfied).

Facts

Taxpayer, an entity that has elected to be taxed as a REIT, owns real property, including Building 1 and Building 2.

A steel billboard superstructure to which Type 1 Signs and Type 2 Signs are attached is affixed to the exterior sides of Building 1. A steel billboard superstructure to which a Type 1 Sign is attached is affixed to the exterior sides of Building 2. Taxpayer has elected under IRC Section 1033(g)(3) to treat each Type 1 Sign as real property for purposes of Chapter 1 of the Internal Revenue Code. Taxpayer leases the space on the Type 1 Signs to user-tenants wishing to display advertisements to the public.

The space on all but one of the Building 1 Type 1 Signs is leased for multiple-year terms to user-tenants that continuously display their advertisements. The remaining Building 1 Type 1 Sign is leased to multiple user-tenants (Multi-Tenant Sign) and each of the user-tenant's advertisements will be displayed only for certain intervals, rotating with those of the other user-tenants.

Certain segments of the space on the Building 2 Type 1 Sign are leased to long-term user-tenants displaying their advertisements on their respective segments continuously; other segments of space on the Building 2 Type 1 Sign are a Multi-Tenant Sign, where space is leased to multiple user-tenants and advertisements will be displayed only for certain intervals, rotating with those of the other user-tenants.

Taxpayer's lease agreements for space on the Multi-Tenant Signs are generally expected to have a term of at least a specified, but undisclosed, number of days, but Taxpayer may engage in leases of shorter periods (presumably, less than 30 days). Taxpayer's income from short-term leases will comprise no more than a de minimis portion of Taxpayer's total revenues from the leased signs at the buildings for the calendar year.

Taxpayer represents that (1) user-tenants will pay fixed, arm's-length rent; (2) any services Taxpayer renders will be the usual or customary services rendered in connection with the rental of Type 1 Signs in the geographic area; and (3) these services will not be rendered primarily for the convenience of user-tenants.

Taxpayer intends to lease the Multi-Tenant Signs to a TRS, which will pay fixed, arm's-length rent. Taxpayer represents that the rents will be comparable to the rents paid by the other Type 1 Sign user-tenants, adjusted to reflect the current market conditions. If the TRS rents all the Type 1 Signs from Taxpayer, Taxpayer represents that the TRS's rental payments will be substantially comparable to rents paid by unrelated tenants for comparable space located in the same geographic area. Taxpayer also represents that, in all cases, at least 90% of the leased space of Building 1 and Building 2 will be leased to persons other than TRSs and related persons.

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. 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 received from the lease of interests in real property to tenants, (2) charges for certain customary services furnished to tenants, and (3) certain insubstantial rent from personal property (IRC Section 856(d)(1)). The term "rents from real property" does not include (1) rents based on the income or profits of a tenant, (2) rents from certain 10%-or-greater related tenants, except as otherwise provided in IRC Section 856(d)(8), and (3) impermissible tenant services income (IRC Section 856(d)(2)).

Under IRC Section 856(d)(8)(A) (Limited Rental Exception), rents paid to a REIT by its TRS for the use of property are not treated as related-party rents if "at least 90[%] of the leased space of the property is rented to persons other than TRSs of such REIT and other than persons described in IRC Section 856(d)(2)(B)." This provision applies, however, only to the extent that the rents are "substantially comparable to [the] rents paid by the other tenants of the REIT's property for comparable space."

The IRS noted that Taxpayer expects the vast majority of revenues from leasing signs to user-tenants to be attributable to long-term leases. In the limited situations in which Taxpayer may lease space directly to user-tenants on a short-term basis, the IRS noted, the short-term revenue will represent at most a de minimis portion of Taxpayer's overall revenue from leasing signs. The IRS also explained that the short-term revenues will be derived from contracts for the use of advertising space and not contracts for the provision of services. The IRS concluded that the generation of a de minimis amount of short-term revenue from short-term leases will not preclude Taxpayer's income from the leased signs at the buildings from qualifying as rents from real property under IRC Section 856(d).

In addition, the IRS concluded that Taxpayer's lease of Type 1 signs to its TRS will satisfy all of the requirements of the Limited Rental Exception of IRC Section 856(d)(8)(A); accordingly, the TRS's lease of some or all of the Type 1 signs will not cause Taxpayer's income from leasing signs at the buildings to fail to qualify as rents from real property under IRC Section 856(d). The IRS based its conclusion on the following facts and representations:

• The TRS will lease less than 10% of the leased space at Building 1 and Building 2, and at least 90% of the leased space of each building will be leased to persons other than TRSs or other related persons;
• The rent paid by the TRS to Taxpayer will be comparable to the rents paid by the other Type 1 Sign user-tenants, adjusted to reflect current market conditions
• If the TRS rents all the Type 1 Signs from Taxpayer, the rental payments paid by the TRS to Taxpayer will be substantially comparable to rents paid by unrelated tenants for comparable space located in the same geographic area.

Implications

PLR 202047003 is the fourth private letter ruling in which the IRS has acknowledged that a small percentage of rents received from short-term leases (presumably, leases with a term of less than 30 days) of advertising space on signs (i.e., signs that qualify as outdoor advertising displays that have been subjected to an IRC Section 1033(g)(3) election) will not fail to be treated as rents from real property. See PLR 201522002 (revenue attributable to short-term rental agreements will not be material); PLR 201431018 (revenue attributable to short-term rental agreements have been less than 1% or 2% of its total revenues from leases of space on outdoor advertising displays); and PLR 201431020 (revenue attributable to short-term leases are approximately 3% of the total revenues from leases of space on outdoor advertising displays).

For purposes of the Limited Rental Exception of IRC Section 856(d)(8)(A), the IRS determined that the "property" to be tested under the "90% leased space rule" is the building(s), as contrasted with the sign(s) on the building(s).

For purposes of the "comparable rents for comparable space" requirement of the Limited Rental Exception, the IRS also concluded that the REIT could look to rents paid for comparable space in the geographic market in which the buildings are located if there will be no comparable space leased to third parties at the Taxpayer's building(s) (which would be the case if all of the Type 1 signs are leased to the TRS).

In PLRs 202012003, 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 rents for 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).