September 21, 2022
IRS issues REIT ruling regarding marina floating docks, cabins, dry dock storage income, insurance proceeds and income from amenities and related services
In PLR 202237004, the IRS ruled on several issues concerning assets of and income from Taxpayer's marinas. First, the floating docks at Taxpayer's marinas constitute real property under Treas. Reg. Section 1.856-10(b) and thus are considered real estate assets for purposes of IRC Section 856(c)(4) and (5). Second, income received for the use of space in indoor and outdoor dry dock storage facilities will be considered rents from real property under IRC Section 856(d). Third, cabins available for short-term rental at one marina will not cause the other assets at the property to be treated as lodging facilities under IRC Section 856(d)(9)(D)(ii). Fourth, BII proceeds related to Taxpayer's lost revenue resulting from natural disasters will be treated as qualifying income for purposes of IRC Sections 856(c)(2) and (3). Fifth, income attributable to certain amenities (or services provided in connection with those amenities) at the marinas is not impermissible tenant service income 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).
Taxpayer, a limited liability company that intends to elect to be taxed as a real estate investment trust (REIT), operates through a partnership (OP), which owns and leases (or leases and subleases) five marinas located on lakes or coasts. The marinas have floating docks that form boat slips, indoor and outdoor storage facilities, boat servicing facilities and support facilities (e.g., laundry facilities, pools, gyms and restaurants). One of the five marinas also has cabins that are available to guests for stays of up to one week.
The floating docks provide ingress and egress for tenants to access their boat slips. The docks are generally attached to poured concrete walkways on land, and coastal docks are also attached to concrete, timber or steel bulkheads that retain contact with the land. The docks have a limited range of vertical movement as necessary for tidal and weather conditions and are affixed to the seabed or lake bottom using either pilings or winches and cables. The floating docks are designed to remain in place indefinitely and are constructed to withstand the wind, current and wave conditions of the area in which they are built. The floating docks are not removed unless they are damaged or have reached the end of their useful lives. Removing the docks would be extremely time-consuming and expensive. Taxpayer represented that in addition to providing a conduit or route for tenants to access their boat slips, the floating docks delineate the area of the slips, protect the boats from damage from the elements and serve no active function within the meaning of Treas. Reg. Section 1.856-10(d)(2)(iii)(A).
The marinas have both indoor and outdoor dry dock storage facilities. The indoor dry dock storage facilities contain vertical rows of steel racking structures that are leased to tenants to store their boats. The outdoor dry dock storage facilities consist of land on which tenants can store their boats on affixed racking structures, movable racking structures, blocks or tenant-owned boat trailers. The dry dock storage leases do not allow tenants to enter the indoor facilities or access the outdoor facilities (except where boats are stored on tenant-owned trailers). The dry dock storage leases generally do not allocate to tenants a specifically identified spot in a racking structure or on the land but do guarantee a specified amount of storage space in the dry dock storage facility.
Taxpayer represented that the indoor dry dock storage facilities and the outdoor affixed racking structures are inherently permanent structures for purposes of Treas. Reg. Section 1.856-10(d)(2) and that the blocks and movable racking structures for outdoor storage are personal property. Taxpayer further represented that the rent attributable to personal property leased under or in connection with a lease of dry dock storage space will not exceed 15% of the total rent for the tax year attributable to the real and personal property under the lease.
A taxable REIT subsidiary (TRS) or an independent contractor from whom Taxpayer derives no income (IK) will move boats into and out of the dry dock storage facilities (except where boats are stored on tenant-owned trailers). No other services are provided in connection with the storage fee, but boat owners may request dry dock services, such as boat maintenance and repairs. A TRS or IK will perform, and separate fees will be charged for, such dry dock services.
The cabins are generally owned and managed by OP, which provides cabin guests with linens and basic toiletries and cleans the cabins when guests leave. The cabin guests are generally not the same parties that lease boat slips or drydock storage space from OP. Taxpayer represented that the income it receives from the cabins will be treated as nonqualifying income for purposes of the REIT gross income tests under IRC Sections 856(c)(2) and (3).
Business interruption insurance proceeds
OP carries BII to replace lost revenue if damages from a natural disaster temporarily shut down a marina for repairs. A BII policy is triggered if (1) revenue-generating assets are damaged; (2) ingress or egress to the property is blocked; or (3) the supply of critical utilities to the property is blocked or interrupted. Taxpayer received BII proceeds as a result of two natural events. Taxpayer represented that the purpose of BII proceeds is to make the claimant whole by replacing revenue lost as a result of the triggering event. Thus, the amount of BII proceeds is calculated by reducing lost revenue by the amount of the claimant's typical expenses that were not incurred due to the marina closure. Taxpayer further represented that OP claimed BII proceeds that related only to lost revenue that would otherwise constitute qualifying income under IRC Sections 856(c)(2) and (3), and that Taxpayer's TRSs separately claimed BII proceeds related to lost revenue other than rental revenue.
Each of the marinas includes some or all of the following amenities: a swimming pool, an exercise room, tennis courts, locker rooms, a tenant lounge or walking trails (Amenities), which are available to all tenants and their guests at no additional cost. Taxpayer represented that the property with cabins does not have any Amenities. OP provides cleaning and maintenance services with respect to the Amenities and engages either an IK or a TRS to provide lifeguards for swimming pools at the properties. Taxpayer represented that these services are customarily furnished in connection with providing Amenities at marinas located in the geographic area in which the properties are located.
Law and analysis
At least 75% of the value of a REIT's total assets at the close of each quarter of its tax year must consist of real estate assets, cash and cash items (including receivables), and government securities (IRC Section 856(c)(4)(A)). Real estate assets include real property, including interests in real property, interests in mortgages on real property and shares in other qualified REITs (Treas. Reg. Section 1.856-3(b)(1)).
Treas. Reg. Section 1.856-10(b) and (d) provide that "real property" means land and improvements to land in the form of inherently permanent structures. An inherently permanent structure (1) is one that is affixed to the land, including by weight; (2) serves a passive function, such as to contain, support, shelter, cover, protect, or provide a conduit or route; and (3) does not serve an active function, such as to manufacture, create, produce, convert, or transport. Treas. Reg. Section 1.856-10(d)(2)(iii)(B) provides a list of assets that may qualify as inherently permanent structures if they are permanently affixed. Stationary docks (but not floating docks) are included in the list. Treas. Reg. Section 1.856-10(d)(2)(iv) provides that the following factors must be considered when evaluating whether an asset that serves a passive function and is not otherwise listed in Treas. Reg. Section 1.856-10(d)(2)(iii)(B) qualifies as an inherently permanent structure:
After evaluating the specific facts and circumstances at issue, the IRS concluded that Taxpayer's floating docks, whether secured to the seabed or lake bottom by pilings or by winches and cables, constitute real property under Treas. Reg. Section 1.856-10(b) and, therefore, are real estate assets under IRC Section 856(c)(4) and (5).
Dry dock storage
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) provides that the term "rents from real property" generally means the gross amounts received for the use of, or the right to use, real property of the REIT.
The IRS concluded that although tenants do not have a right of entry to the dry dock storage facilities (other than where boats are stored on tenant-owned trailers) and do not have the right to use a specifically enumerated space in a facility, amounts received for the use of space in both the indoor and outdoor dry dock boat storage facilities will be treated as rents from real property for purposes of IRC Section 856(d).
A TRS is defined in IRC Section 856(l)(1) as a corporation directly or indirectly owned by a REIT that jointly elects with the REIT to be treated as a TRS. A TRS may not directly or indirectly manage a lodging facility (IRC Section 856(l)(3)).
Although one of Taxpayer's marinas includes cabins (which, together with any areas reserved for cabin guests, the IRS determined constituted a lodging facility), the IRS concluded that the cabins did not change the nature of the rest of the marina. The PLR states that the "characterization of a separately identifiable item of property that is rented and used independently of the greater property on which the item of property is physically located should not dictate the characterization of the greater property." Therefore, the IRS ruled that the presence of the cabins will not cause the other marina assets to be treated as lodging facilities.
IRC Section 856(c)(5)(J) authorizes the IRS to determine, to the extent necessary to carry out the purposes of the REIT provisions, 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 IRS exercised its discretionary authority under IRC Section 856(c)(5)(J) to rule that the BII proceeds will be treated as qualifying income for purposes of IRC Sections 856(c)(2) and (3), noting that doing so does not interfere with Congressional policy objectives of ensuring that REITs primarily derive income from passive sources and not from the conduct of a trade or business. In so ruling, the IRS observed that the Taxpayer represented that OP's BII proceeds related only to lost revenue that would otherwise constitute qualifying income under IRC Sections 856(c)(2) and (3).
Amenities and related services
Under IRC Section 856(d)(2)(C), impermissible tenant service income (ITSI) (defined by IRC Section 856(d)(7)(A) as any amount received or accrued by a 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." ITSI, however, does not include (1) payments for services, management or operation provided through an IK or a TRS or (2) any amount 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)).
IRC Section 512(b)(3) provides in part that rents from real property are excluded from the computation of UBTI. Under Treas. Reg. Section 1.512(b)-1(c)(5), payments for the use or occupancy of rooms and other space where services are also rendered to the occupant, such as in hotels, boarding houses, tourist camps, parking lots, warehouses, storage garages, etc., do not constitute rent from real property. Services are generally considered rendered to an occupant if they are primarily for the occupant's convenience and are not usually or customarily rendered in connection with the rental of rooms or other space for occupancy only.
The IRS explained that only income attributable to providing a service is analyzed when determining whether a taxpayer has ITSI. Although certain services may be provided at the Amenities, the Amenities themselves are not services. Therefore, the IRS concluded that income attributable to making available to all tenants at no additional cost a space such as one of the Amenities is not income from the provision of a service.
The IRS then separately analyzed the services provided at the Amenities. Because the Amenities are common areas available for use by all marina tenants and their guests, income from cleaning and maintaining the Amenities is income that would be excluded from UBTI. In addition, the lifeguard services are provided by an IK or TRS. Accordingly, the IRS ruled that neither income attributable to the Amenities themselves nor income attributable to the services provided in connection with the Amenities constitute ITSI and, therefore, 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).
The IRS previously addressed indoor dry dock storage facilities in PLR 201930003 and PLR 202031001,
but concluded for the first time in PLR 202237004 that amounts received for leasing outdoor dry dock storage space to tenants for boat storage will be treated as rents from real property for purposes of IRC Section 856(d), including where tenants store boats on tenant-owned boat trailers rather than on racks provided by OP. The IRS also concluded that BII proceeds will be treated as qualifying income for purposes of the REIT income tests under the IRS's discretionary IRC Section 856(c)(5)(J) authority. While taxpayers should consult with their tax advisors if considering similar facts, these two rulings give taxpayers some indication of the IRS's current analysis regarding payments for outdoor storage space and certain types of insurance proceeds.
Similar to PLR 201930003 and PLR 202031001, however, the IRS concluded in PLR 202237004 that floating docks secured to a seabed or lake bottom by pilings or winches and cables constitute real property under Treas. Reg. Section 1.856-10(b) and, therefore, are real estate assets under IRC Section 856(c)(4) and (5) (see Tax Alert 2019-1751). The IRS also concluded in these prior rulings that the presence of cabins at one marina did not cause the other marina assets to be treated as lodging facilities.
Additionally, the IRS previously concluded, as it did in PLR 202237004, that income attributable to amenities and services provided in connection with the amenities did not constitute ITSI. In PLR 201944011, the IRS concluded that although services may be provided in shower facilities at a marina, the facilities themselves were not services and, therefore, income attributable to making the facilities available to tenants at no additional cost was not ITSI (see Tax Alert 2019-2062). Similarly, the IRS concluded in PLR 201812009 that although services may be provided in certain apartment community facilities (e.g., a swimming pool, an exercise room, laundry rooms, sports courts, a tenant lounge, a business center, etc.), income attributable to making the facilities available to tenants was not ITSI because the facilities themselves were not services (see Tax Alert 2018-0737).