February 10, 2023 IRS rules that REIT's right to receive state brownfield tax credits is qualifying asset resulting in qualifying income
In PLR 202305009, the IRS ruled that to the extent a real estate investment trust's (REIT) right to receive certain state brownfield redevelopment tax credits (Brownfield Credits) is a GAAP asset, the right will constitute a qualifying receivable for purposes of the 75% asset test. In addition, income attributable to the receipt or accrual of the Brownfield Credits will be treated as qualifying income for purposes of the 95% and 75% REIT gross income tests. Facts Taxpayer, a limited liability company that intends to elect to be taxed as a REIT under IRC Section 856, owns land (Site) through a disregarded entity. Taxpayer will incur significant expenses in remediating adverse environmental conditions at the Site and rehabilitating and developing the Site for its future intended use (Project). Taxpayer represented that these expenditures relate to real property within the meaning of Treas. Reg. Section 1.856-10. As a result of Taxpayer's remediation, rehabilitation and development of the Site, Taxpayer is eligible for Brownfield Credits equal to a percentage of the costs of Site preparation, tangible property (such as buildings) placed in service at the Site and groundwater remediation. Taxpayer expects the Brownfield Credits to exceed its state income tax liability and under state law, this excess would be treated as an overpayment of income tax (not as an abatement or refund of real property tax). Taxpayer will elect to receive a refund of the overpayment. After the Project is completed, Taxpayer will lease space at the Site to unrelated third parties to generate rents from real property for purposes of the 95% and 75% gross income tests. Taxpayer represented that it expects substantially all of the income derived from the Site (excluding income relating to the Brownfield Credits) to be qualifying income for purposes of the REIT gross income tests. Law IRC Section 856(c)(4)(A) requires that at least 75% of the value of a REIT's total assets at the close of each quarter of its tax year consist of real estate assets, cash and cash items (including receivables), and government securities. Treas. Reg. Section 1.856-2(d)(1) defines "receivables" as those that arise in the ordinary course of a REIT's operation, excluding receivables purchased from another person. Treas. Reg. Section 1.856-2(d)(3) defines "total assets" of a REIT as the gross assets of the REIT determined in accordance with GAAP. 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 and abatements and refunds of real property taxes. 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 and abatements and refunds of real property taxes. IRC Section 856(c)(5)(J) authorizes the IRS to use its discretion to determine 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. Analysis The IRS concluded that Taxpayer's right to receive the Brownfield Credits arises in the ordinary course of Taxpayer's operations within the meaning of Treas. Reg. Section 1.856-2(d)(1) because the credits are from the development of real property in connection with Taxpayer's leasing business and Taxpayer will not purchase the credits from another person. Accordingly, the IRS ruled that to the extent Taxpayer's right to receive the Brownfield Credits is a GAAP asset, the right will constitute a qualifying receivable for purposes of the 75% asset test. The IRS also exercised its discretionary authority under IRC Section 856(c)(5)(J) to rule that income attributable to the receipt or accrual of the Brownfield Credits will be treated as qualifying income for purposes of the 95% and 75% gross income tests. The IRS noted that this treatment is consistent with the Congressional purpose of limiting the beneficial tax treatment of the REIT rules to passive income from real estate sources, rather than income from the active conduct of a trade or business involving real estate. In so ruling, the IRS observed that Taxpayer represented that it intends to lease the Site to generate qualifying rents from real property and that it expects substantially all of the income derived from the Site (excluding income relating to the Brownfield Credits) to be qualifying for purposes of the REIT gross income tests. Implications Given the recent increased focus on clean energy, along with the passage of the Inflation Reduction Act, it is good news that the IRS continues to take a favorable view under the REIT income and asset tests of incentives, such as Brownfield Credits, that a REIT receives in connection with developing real property that will be held for the production of qualifying rental income. The income test conclusion in PLR 202305009 is based on the IRS's exercise of its discretionary authority under IRC Section 856(c)(5)(J). Thus, REITs with similar situations will want to consider whether to seek their own rulings. PLR 202305009 is the latest IRS ruling to address incentive-type payments received or accrued by a REIT from a state (or jurisdiction thereof) in connection with developing real property. In the following rulings, as in PLR 202305009, the IRS ruled, under its IRC Section 856(c)(5)(J) authority, that incentive-type payments (including refundable tax credits) related to the development and/or remediation of real property that is expected to produce qualifying rents will constitute qualifying income for purposes of the REIT income tests. See PLRs 201929014 and 201929015 (Tax Alert 2019-1383) addressing the receipt of a grant payment relating to the development of a shopping center; PLR 201910002 (Tax Alert 2019-0822) addressing the receipt of an incentive payment relating to the development of a multi-use rental real estate project; PLR 201845001 (Tax Alert 2019-0090) addressing the receipt or accrual of refundable brownfield tax credits relating to the development of rental property; PLR 201841002 (Tax Alert 2018-2069) addressing the receipt of a grant relating to the redevelopment of rental property; PLRs 201816001, 201816002 and 201816003 (Tax Alert 2018-0960), addressing the receipt of payments relating to the development of a retail shopping center; PLR 201716043 (Tax Alert 2017-0717), addressing the receipt of grant payments relating to the development of a mixed-use rental property; PLR 201518010 (Tax Alert 2015-0984), addressing receipt of refundable state tax credits relating to development of apartment complexes and intended to enhance private-sector cleanups of brownfields and reduce development pressure on greenfields; and PLR 201428002 (Tax Alert 2014-1304) addressing the receipt of refundable state tax credits relating to the development of retail buildings. Also, see PLRs 202005017 and 202005018 (Tax Alert 2020-0340) and PLR 201948006 (Tax Alert 2019-2160), in which the IRS exercised its discretionary authority under IRC Section 856(c)(5)(J) to rule that income attributable to the receipt of "transferable" state tax credits from a governmental entity related to the REIT's development of real property expected to produce qualifying rents will constitute qualifying income for purposes of the REIT income tests. In addition, in PLR 201742018 (Tax Alert 2017-1803), the IRS ruled, under its IRC Section 856(c)(5)(J) authority, that incentive payments received by a REIT from a utility company in connection with the installation of a solar PV system on the roof of the REIT's retail property will be considered qualifying income for purposes of the REIT income tests. In PLRs 201816001, 201816002 and 201816003 (Tax Alert 2018-0960) (noted above with respect to their rulings based on IRC Section 856(c)(5)(J)), the IRS also ruled that income attributable to the receipt of a refundable tax credit constituted a refund of real property taxes under IRC Sections 856(c)(2)(E) and (c)(3)(E), and thus qualifying income for purposes of the 95% and 75% income tests, when the credit was "tied to" the payment of real property taxes. In addition, in PLR 200403023, the IRS ruled that amounts received by a REIT from a municipality as reimbursement for certain costs incurred by the REIT in redeveloping a property (and in which the reimbursement was limited to the incremental real property tax assessed against development site) would be treated as an abatement and refund of taxes on real property under IRC Section 856(c)(2)(E). PLR 202305009 is also the seventh PLR in which the IRS has concluded that a REIT's right to receive an incentive-type payment (including a refundable tax credit) constitutes a "receivable arising in the ordinary course of a REIT's operation" within the meaning of Treas. Reg. Section 1.856-2(d)(1)(iii), and thus, is a qualifying asset for purposes of the 75% asset test. See PLRs 201854001, 201816001, 201816002, 201816003, 201518010 and 201428002. ———————————————
Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor | ||||||||
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