May 20, 2022 IRS again rules that IRC Section 481(a) adjustment relating to REIT's change in method of accounting is not gross income for purposes of income tests In PLR 202220012, the IRS ruled that an IRC Section 481(a) adjustment resulting from a real estate investment trust's change in accounting method for certain interest expense 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. Facts Taxpayer, a corporation that intends to elect to be taxed as a real estate investment trust (REIT) under IRC Section 856, and its subsidiaries design, build and own certain assets. Taxpayer filed a Form 3115, Application for Change in Accounting Method, to change its method of accounting to capitalize (rather than deduct) certain interest expense with respect to its designated property (as defined in Treas. Reg. Section 1.263A-8(b)). This automatic change resulted in a positive adjustment under IRC Section 481(a), which is 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. 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. 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% or75% 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 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). The IRS noted that this result is consistent with the purposes of the REIT provisions. Implications PLR 202220012 is the ninth 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 will not constitute gross income for purposes of the 95% and 75% income tests, confirming that the IRS is willing to take this action to avoid an adverse effect on REITs' compliance with the income tests. In PLR 202213003, the IRS recently ruled that an IRC Section 481(a) adjustment resulting from a REIT's change in method of accounting from deducting to capitalizing certain administrative and mixed service costs related to the REIT's real property will not constitute gross income for purposes of the 95% and 75% income tests. Additionally, in PLRs 202035008, 202024003, 201716002, 201652012, 201537020, 201503010 and 201301007, the IRS ruled that an IRC Section 481(a) adjustment related to a change in a REIT's method of accounting for depreciation of certain real property assets will not constitute gross income for purposes of the 95% and 75% income tests. Previously, in PLR 200115023, the IRS ruled in the same manner on a change in method of accounting for depreciation of certain real property assets based on authorities that predate the enactment of IRC Section 856(c)(5)(J). ———————————————
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