July 12, 2022
IRS rules certain independent retirement living facilities are not health care facilities for purposes of REIT rules
The IRS ruled in PLR 202226002 that certain independent retirement living facilities (Facilities) owned by a real estate investment trust (REIT) will not constitute "health care facilities" within the meaning of IRC Section 856(e)(6)(D)(ii). In addition, the IRS ruled that the provision of certain services to residents will not give rise to impermissible tenant service income (ITSI) and will not cause any rents received by Taxpayer to fail to qualify as rents from real property under IRC Section 856(d).
Taxpayer, a REIT, owns interests in the Facilities through entities treated as partnerships for federal income tax purposes. The Facilities are age-restricted and generally offer amenities, such as a common dining area, beauty salon, theatre room, bistro, and workout rooms. Hallways and bathrooms are equipped with handrails.
Taxpayer intends that the Facilities will be operated and managed as follows after receipt of the ruling. A Facility resident (a Resident) will enter into a month-to-month lease agreement, which will entitle the Resident to individual living quarters within a Facility and certain services (Services) in exchange for fixed monthly payments. The following Services will be provided at the Facilities and included in the monthly rent:
Taxpayer represented that the Services are customarily furnished or rendered to tenants of age-restricted, non-healthcare independent living facilities in the geographic markets in which the Facilities are located.
The Facilities generally will have 24-hour staffing, with either a resident manager or concierge, who will perform duties typical of those of an apartment building manager. The emergency call system will include pull cords or call buttons that enable Residents to contact a third-party operator who can contact the resident manager, concierge or emergency services. Facility staff will be allowed to call 911 in the case of an emergency. The Facilities will provide a program for flu shots, which will be administered by a third party and will be for the convenience of the Residents, who will pay for the service.
The Facilities do not provide any health-care related services and are not licensed as health care facilities. Rather, the Facilities are intended to provide amenities and services to Residents for their living convenience and social purposes. The Facilities will not employ licensed nurses or other healthcare professionals as on-site staff, conduct health screenings, monitor the Residents' medical needs, or supervise Residents' oxygen equipment. Further, the Facilities will not keep "do not resuscitate" forms or any Residents' health records on file. Before moving in, Residents will represent that they are capable of providing for all of their personal and health care needs, and each lease will specifically stipulate that the Resident is responsible for his or her own personal and health care needs.
The Taxpayer subsidiaries that own the Facilities will enter into a management contract with another party (Operator) that will provide the Services to Residents in exchange for arm's-length compensation. Operator may be (1) a taxable REIT subsidiary (a TRS) of Taxpayer (Subsidiary), (2) an independent contractor from whom Taxpayer derives or receives no income (an IK), or (3) a partnership between Subsidiary and an IK. If Subsidiary is the Operator, Subsidiary may subcontract with a third party to provide the Services.
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.
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)).
Treas. Reg. Section 1.856-4(b)(1) considers services furnished to tenants of a particular building to be customary if, in the geographic market in which the building is located, tenants in buildings of a similar class are customarily provided with the service.
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 (ITSI) (IRC Section 856(d)(2)).
Under IRC Section 856(d)(7)(A), 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.
In Revenue Ruling 2003-86, the IRS ruled that a partnership between a TRS and an IK could provide noncustomary services to a REIT's tenants without causing rents paid by tenants to fail to qualify as rents from real property under IRC Section 856(d). In Revenue Ruling 2003-86, the partnership charged tenants separately for the noncustomary services.
IRC Section 856(l)(3)(A) provides that any corporation that directly or indirectly operates or manages a health care facility (as defined in IRC Section 856(e)(6)(D)(ii)) is not a TRS.
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."
The IRS ruled that the Facilities will not constitute health care facilities within the meaning of IRC Section 856(e)(6)(D)(ii); as a result, the direct or indirect operation or management of the Facilities by Subsidiary will not prevent Subsidiary from being treated as a TRS of Taxpayer under IRC Section 856(l)(3)(A). While the Facilities will offer amenities and services found in congregate care facilities, the IRS noted that the emphasis of the amenities and services provided at the Facilities is the Residents' convenience and social lives. Therefore, the IRS concluded that, considering all the facts and circumstances, the Services provided at the Facilities are not focused on the health and well-being of the Residents.
In addition, the IRS ruled (in accordance with IRC Section 856(d)(7)(C)(i), Revenue Ruling 2002-38 and Revenue Ruling 2003-86) that Operator's provision of the Services, including Services for which fees are not separately stated, will not be considered rendered by Taxpayer, will not give rise to ITSI and will not cause any portion of the rents received by Taxpayer to fail to qualify as rents from real property under IRC Section 856(d).
PLR 202226002 is the fourth 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 each such ruling, the IRS has considered whether certain senior independent living facilities constituted "congregate care facilities," a term that is not defined in the Internal Revenue Code or the Treasury regulations. In PLR 202226002, the IRS determined that the 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 202020007 (services provided at independent living facilities "are not focused on the health and well-being of the Residents") (Tax Alert 2020-1374), 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").
Based on the surrounding facts and circumstances, the IRS has also ruled in four private letter rulings that certain senior independent living facilities 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") (Tax Alert 2018-1566), 201509019 (age-restricted independent living community "actively monitors the residents' health and provides services to help improve the health and wellbeing of its elderly residents") (Tax Alert 2015-0480), 201429017 (senior living facilities offer services that have a "significant health care related focus") (Tax Alert 2014-1367), and 201147015 (senior independent living facilities provide services "specially targeted to monitor and help improve the health and well-being of its residents") (Tax Alert 2011-2003).
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 its TRS to provide operation or management services at the facility. The REIT, however, can consider leasing such a 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 facility on behalf of the TRS. Where a senior independent living facility does not constitute a congregate care facility, a TRS may be engaged to operate or manage the facility (and, as in PLR 202226002, subcontract its obligations to a third party).
While the IRS to date has not provided a bright-line test for determining whether a particular senior independent living facility constitutes a congregate care facility, PLR 202226002 provides some additional insight on the IRS's view of the definition of a congregate care facility.
In addition, of the four private letter rulings previously cited in which the IRS ruled that certain senior independent living facilities do not constitute "health care facilities," PLR 202226002 is the first where the REIT will directly contract with an independent contractor, rather than a taxable REIT subsidiary, to perform services such as housekeeping and meal services. This could provide other REITs with more flexibility to provide these types of services in other settings, such as luxury apartment buildings, via an independent contractor instead of a TRS.