December 17, 2021
IRS rules payments to REIT for storage, wharfage and pipeline use are rents from real property
In a ruling obtained by professionals at EY, the IRS ruled in PLR 202150014 that fees paid to a real estate investment trust (REIT) by unrelated third parties for storage, wharfage and pipeline use qualify as rents from real property under IRC Section 856(d) for purposes of IRC Sections 856(c)(2) and 856(c)(3). The IRS also ruled that the performance of certain services and activities do not give rise to impermissible tenant service income.
Storage terminal facilities
Taxpayer, a limited liability company that intends to elect to be taxed as a REIT, owns two storage terminal facilities, one of which includes waterfront with a stationary wharf for tankers. These facilities include various interests in land, loading and unloading facilities, storage tanks, pipelines, other inherently permanent structures (e.g., racks or docks) and structural components of inherently permanent structures (e.g., vents or fire suppression systems). Taxpayer has agreements with unrelated third-party users of the storage terminal facilities allowing them to store and move their products through the facilities. An agreement may or may not specify the tank in which a user's product will be stored. For example, under some agreements, the user has a right to a fixed portion of the storage capacity at the facility but not the right to a particular tank.
Users pay storage fees that are based on volume of product stored. A user must pay for a specified minimum volume commitment per month even if it uses less than its entire reserved capacity. For each agreement, the rent for the leased personal property (e.g., pumps, compressors, meters) is 15% or less of the total rent for the real and personal property leased under that agreement.
At the facility with waterfront, Taxpayer pays the applicable port authority a wharfage fee based on the amount of product loaded and unloaded at the facility and collects this fee from its storage users. Taxpayer includes the wharfage fees it collects in its gross income and deducts the fees it pays to the port authority.
Taxpayer will (1) construct, maintain and repair the storage tanks and facilities, (2) provide electricity and security, and (3) heat, cool, pressurize or circulate the products in the storage tanks as necessary to avoid damage to the storage tanks, pipes, and stored product, and to make storing a product more efficient. A taxable REIT subsidiary (TRS) of the Taxpayer will receive arm's-length compensation for performing all other activities and services, including moving product, taking samples of product for the benefit of a user, and monitoring and operating pumps, compressors, meters, and other personal property at the facilities.
Taxpayer also owns equity interests in domestic long-haul and short-haul pipelines and has agreements with unrelated third parties to use the pipelines. Pipeline users pay fees under the agreements that are based on volume of product placed on the pipeline. A user must pay for a specified minimum volume commitment per month even if it uses less than its entire reserved capacity. For each agreement, the rent for the leased personal property (e.g., pumps, compressors, meters) is 15% or less of the total rent for the real and personal property leased under that agreement.
Taxpayer will construct and maintain the pipelines and undertake other activities that are consistent with its fiduciary duty to manage itself as a REIT. The TRS will receive arm's-length compensation for performing all other activities and services, including scheduling use of the pipelines and monitoring and operating pumps, compressors, meters and other personal property associated with the pipelines.
Law and analysis
IRC Section 856(c)(2) requires a REIT to derive at least 95% of its gross income from specified sources of passive income, 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 of real estate source income, including rents from real property.
Treas. Reg. Section 1.856-4(a) defines the term "rents from real property" generally as the gross amounts received for the use of, or the right to use, the REIT's real property. Under IRC Section 856(d)(1), the term "rents from real property" includes: "(A) rents from interests in real property, (B) charges for services customarily furnished or rendered in connection with the rental of real property, whether or not such charges are separately stated, and (C) rent attributable to personal property leased under, or in connection with, a lease of real property, but only if the rent attributable to the personal property for the [tax] year does not exceed 15[%] of the total rent for the [tax] year attributable to both the real and personal property leased under, or in connection with, such lease." A service furnished to tenants of a particular building will be considered customary if, in the geographic market in which the building is located, the service is customarily provided to tenants in buildings of a similar class (Treas. Reg. Section 1.856-4(b)(1)).
Under IRC Section 856(d)(2)(C), impermissible tenant service income (defined by IRC Section 856(d)(7)(A) as any amount received or accrued by the REIT for services furnished or rendered to tenants or for managing or operating the property) is excluded from the definition of "rents from real property." Impermissible tenant service income does not include (1) payments received for services, management or operation provided through an independent contractor or the REIT's TRS and (2) any payment that would be excluded from unrelated business taxable income (UBTI) under IRC Section 512(b)(3) if received by an organization described in IRC Section 511(a)(2) (IRC Section 856(d)(7)(C)).
The IRS ruled that the storage fees, wharfage fees and pipeline use fees received by Taxpayer qualify as rents from real property under IRC Section 865(d) for purposes of the REIT gross income tests under IRC Sections 856(c)(2) and (3). In ruling on the storage fees and pipeline use fees, the IRS noted the following:
For the wharfage fees, the IRS stated that those fees are analogous to state and local real property taxes described in Revenue Ruling 73-246, in which the IRS ruled that, if a REIT requires a lessee to pay state and local real property taxes on the REIT's property, the payment qualifies as rents from real property under IRC Section 856(d).
The IRS further ruled that the activities and services performed by Taxpayer and the TRS will not give rise to impermissible tenant service income for the following reasons:
PLR 202150014 expands the types of activities that a pipeline REIT may perform directly (rather than through a TRS). Specifically, the IRS approved of the Taxpayer performing product heating, cooling, pressurization and circulation activities, which are similar to the types of temperature and humidity control activities performed by cold storage and data center REITs (e.g., PLR 202012003 and PLR 201537020). Such activities are analogous to utility services, income from which is excluded from UBTI and is therefore not considered impermissible tenant service income.
In addition, PLR 202150014 is the first PLR in the storage terminal facility and pipeline industry in which the IRS has confirmed that a REIT can own the equipment associated with the facilities and pipelines, such as pumps, compressors and meters, as long as a TRS operates, monitors, manages, maintains and repairs such equipment. The IRS recently confirmed this position with respect to REITs in the fiber optic industry (see PLRs 202132002 and PLR 202133003, Tax Alert 2021-1573). This type of equipment serves an active function with respect to the stored product, whereas the utility-type activities described previously are necessary for the passive storage of the products.
Finally, PLR 202150014 confirms that payments for use of space that are calculated on the basis of capacity or volume qualify as rents from real property, at least where the agreement requires a user to pay for a specified minimum volume commitment, even if less than the user's entire reserved capacity is used. The IRS has previously ruled that capacity-based payments for the right to use or occupy space in storage tanks or pipelines (PLR 201907001, Tax Alert 2019-0721), in a cold storage warehouse (e.g., PLR 202012003, Tax Alert 2020-1035), or on real property assets comprising a fiber optic system or DAS installation were qualifying rents from real property (e.g., PLRs 202132002 and PLR 202133003).
For a summary of these and other significant nontraditional REIT PLRs issued since 2008, please see the attached chart.
Nontraditional REITs slipsheet