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In PLR 202304003, the IRS ruled that a real estate investment trust's (REIT) provision of certain customary services and amenities to tenants of its office properties and the availability of certain third-party services will not result in ITSI or cause otherwise qualifying amounts received by the REIT to be excluded from 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 REIT's share of parking revenues will be treated as rents from real property under IRC Section 856(d).

Facts

Taxpayer, a publicly-held REIT, owns interests through its operating partnership and other subsidiary partnerships in certain Class A office properties (the Properties). Taxpayer intends to make some or all of the following services and amenities available to the Properties' tenants.

Parking facilities

Certain Properties include parking facilities (Parking Facilities) available for a fee to tenants, their guests, customers and subtenants, and the general public. The Parking Facilities are available on an unreserved basis and are appropriate in size for the expected number of tenants and their guests, customers and subtenants. Taxpayer intends to engage a taxable REIT subsidiary (TRS) or an independent contractor from whom Taxpayer derives no income (IK) to operate the Parking Facilities in exchange for arm's-length compensation. The TRS or IK will sometimes move vehicles into and out of parking spaces solely for safety purposes and to facilitate the efficient use of space within a Parking Facility and may occasionally provide minor, incidental or emergency services, such as jump-starting a car or changing a tire.

Designated storage areas

Certain Parking Facilities have designated areas where tenants may store bicycles, scooters and other small vehicles for no charge (Designated Storage Areas).

Fitness centers

Certain Properties contain fitness facilities with exercise equipment, saunas, steam rooms, showers and locker rooms (Fitness Centers). Some Fitness Centers may be available only to tenants, while others may be open to the public. At Fitness Centers that charge a monthly membership fee, Taxpayer may offer discounts to certain tenants. Taxpayer will not treat any membership fees as rents from real property for purposes of IRC Section 856(d).

Taxpayer will engage an IK to maintain and operate staffed Fitness Centers, including providing all services to patrons, such as teaching exercise classes and supplying clean towels. For unstaffed Fitness Centers, which will be open solely to tenants of the relevant Property, Taxpayer will perform only maintenance, cleaning and security services and will engage an IK to supply clean towels. No other services will be offered at unstaffed Fitness Centers.

Listed services

Taxpayer will provide certain services at some or all of the Properties, including (1) routine lighting and electrical maintenance and repairs in the tenant space, (2) organic waste refrigeration and containment, (3) interior digital signage, and (4) a building software application (Listed Services). Taxpayer represented that the Listed Services are customarily furnished or arranged by landlords in connection with leasing space in Class A office buildings in the city in which the Properties are located and are not personal services rendered to any particular tenant.

Provision of routine lighting and electrical maintenance and repairs: The lighting and electrical work (e.g., repairing or replacing light fixtures, light bulbs and outlets) does not involve any tenant-specific modifications or upgrades, but rather represents routine maintenance and repair performed for building safety reasons.

Organic waste refrigeration and containment service: This service involves the building-wide, temporary storage of organic waste produced by tenants to prevent odors from escaping the waste storage areas.

Interior digital signage: These signs are built into a Property and display content designed to enhance the Property's atmosphere, as well as to provide information about Property attractions and tenant businesses. Under their leases, some tenants may have the right to display their company names and logos on certain signs. The signs will be maintained by an IK and all content displayed will be produced and controlled by an IK.

Software application: Taxpayer will make a software application available to tenants at no charge. The software will give tenants access to information about the Properties, as well as health and safety advisories. The software will also enable tenants to communicate with building staff, gain access to a Property via automated entry access points equipped with QR codes, facial recognition capability or similar technology, order food from vendors at a Property, and, where available, reserve parking spaces and book fitness center appointments. Local businesses will be allowed to advertise on the software application, but Taxpayer will not be involved in or bear the cost of any offered promotions or discounts. An IK will maintain and operate the software.

Third-party services

IKs will offer certain services (Third-Party Services) directly to tenants at certain Properties, and tenants will directly compensate the IKs. Specifically, a bicycle attendant will assist tenants with minor repairs and maintenance of their bicycles in the Designated Storage Areas, and IKs at staffed Fitness Centers may offer additional services, such as personal training or massages, for additional fees. Taxpayer will derive no income from the IKs' Third-Party Services.

Law

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, among other things, charges for services customarily rendered to tenants (IRC Section 856(d)(1)(B)). Services are considered customary if, in the geographic market in which the particular building is located, tenants in buildings of a similar class are customarily provided with the service (Treas. Reg. Section 1.856-4(b)(1)).

Under IRC Section 856(d)(2)(C), ITSI is excluded from the definition of "rents from real property." IRC Section 856(d)(7)(A) defines ITSI as any amount received or accrued by a REIT for services furnished or rendered to tenants or for managing or operating the property. ITSI 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), in part, excludes rents from real property 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 spaces where services are 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 renting rooms or other spaces for occupancy only.

In Revenue Ruling 2004-24, the IRS addressed three situations in which a REIT's income from making parking spaces available in a parking facility located at the REIT's rental property qualified as income from providing customary services, and thus qualifying rents from real property under IRC Section 856(d).

In Situation 3 of Revenue Ruling 2004-24, the IRS concluded that income received by a REIT from providing parking facilities to its rental property's tenants and the general public constituted rents from real property when (1) the parking facility was located in or adjacent to the rental property; (2) the parking facility was appropriate in size for the number of tenants and their guests, customers and subtenants who were expected to use the facility, and was made available for those parties and the general public; (3) the parking garage was operated by an IK from whom the REIT received no income; and (4) all services provided by the IK (and the REIT) were customary under the applicable services tests.

Analysis

Parking facilities

The IRS ruled that Taxpayer's share of parking revenues derived from the Parking Facilities will qualify as rents from real property for purposes of the 75% and 95% gross income tests under IRC Sections 856(c)(2) and 856(c)(3) because the size, use, management and operation of the Parking Facilities are comparable to those of the parking facilities described in Situation 3 of Revenue Ruling 2004-24. The IRS noted that Taxpayer's use of a TRS (rather than an IK) to operate the Parking Facilities does not change the analysis.

Designated storage areas and fitness centers

The IRS explained that although certain services may be provided at the Designated Storage Areas and the Fitness Centers, Taxpayer's income attributable solely to making these common areas available to all tenants of a Property at no additional charge is not income from the provision of a service and, therefore, is not ITSI. The IRS further concluded that the portion of rents attributable to Taxpayer's maintenance, cleaning and security services in the unstaffed Fitness Centers is not ITSI because the income would be excluded from UBTI under IRS Section 512(b)(3) if received by an organization described in IRS Section 511(a)(2). Because IKs will provide the towel services at the unstaffed Fitness Centers and all services at the staffed Fitness Centers, any portion of the rents attributable to those services is not ITSI. Accordingly, the IRS ruled that Taxpayer's provision of the Designated Storage Areas and the Fitness Centers, as well as the services provided in such areas, will not cause otherwise qualifying amounts received by Taxpayer to be excluded from rents from real property under IRC Section 856(d).

Listed services

The IRS concluded that the portion of rents attributable to the routine lighting and electrical maintenance and repair work and the organic waste refrigeration and containment is not ITSI because the income would be excluded from UBTI under IRS Section 512(b)(3) if received by an organization described in IRS Section 511(a)(2). Because IKs will develop, control and maintain the interior signs and software application, any portion of the rents attributable to those services is not ITSI. Accordingly, the IRS ruled that Taxpayer's provision of the Listed Services will not cause otherwise qualifying amounts received by Taxpayer to be excluded from rents from real property under IRC Section 856(d).

Third-party services

The IRS concluded that the availability of the Third-Party Services to tenants will not result in ITSI and, therefore, will not cause otherwise qualifying amounts received by Taxpayer to be excluded from rents from real property under IRC Section 856(d), because (1) IKs will separately bill and be paid by tenants for the services, and (2) Taxpayer will bear no direct costs of, nor derive any income from, the provision of those services.

Implications

PLR 202304003 is the first IRS ruling since PLR 200510002 to focus on the treatment of income attributable to multiple services other than parking furnished to tenants of REIT-owned office buildings. As REITs modernize their properties to attract and retain tenants, it is important to keep in mind that new services, such as organic waste refrigeration and containment and the building software application, may become customary for one class of properties (e.g., Class A office buildings) before another or in one geographic market (e.g., a large metropolitan market) before another.

In addition, PLR 202304003 is the first ruling in which the IRS has concluded in the context of an office property that the availability of common areas to all tenants at no additional charge does not constitute the provision of a service and therefore does not result in ITSI. The IRS concluded in PLR 201812009 that income from making certain apartment community facilities (e.g., a swimming pool, an exercise room, laundry rooms, sports courts, a tenant lounge, a business center, etc.) available to tenants was not ITSI because the facilities themselves were not services, though services may be provided in the facilities (see Tax Alert 2018-0737). The IRS has issued similar rulings in the context of amenities provided at marinas (PLR 202237004, Tax Alert 2022-1413; PLR 201944011, Tax Alert 2019-2062).

Finally, the ruling on the Parking Facilities provides helpful insight into the IRS's views on applying Revenue Ruling 2004-24 to a REIT's engagement of its TRS to operate a parking facility at the REIT's rental real property. Specifically, the IRS concluded that Taxpayer's use of a TRS, rather than an IK, to operate the Parking Facilities does not change its analysis of whether parking revenues will be treated as rents from real property under IRC Section 856(d). This is consistent with the IRS's prior conclusion in PLR 201341015 (see Tax Alert 2013-2325).

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Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor