May 2, 2023
IRS again rules that certain independent retirement living facilities focusing on residents' convenience and social lives are not health care facilities under REIT rules
In two substantially similar private letter rulings (202317017 and 202317018), the IRS ruled that certain independent retirement living facilities (Facilities) owned indirectly by a real estate investment trust (REIT) are not "health care facilities" under IRC Section 856(e)(6)(D)(ii). In addition, the IRS ruled that the REIT's taxable REIT subsidiary (OpCo TRS) is not precluded from directly or indirectly operating or managing the Facilities. Furthermore, the IRS ruled that OpCo TRS subcontracting the provision of certain services to residents (Resident Services) to a third-party independent contractor in the business of providing resident services (Operator) 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). Finally, the IRS ruled that the lease of Facility space to unrelated third-party businesses (Commercial Tenants), some of whom provide in-home health and personal care services, will not cause the Facilities themselves to be viewed as directly providing such services.
Taxpayer, a REIT, will own interests in the Facilities through entities treated as partnerships for federal income tax purposes. The Facilities are age-restricted residences marketed as "Independent Retirement Living." The Facilities generally offer amenities such as a common dining area, an activity room, guest accommodations, a lounge with a large-screen TV, community grounds, and, in some instances, a library and/or a chapel. The hallways and common bathroom areas of the Facilities are generally equipped with handrails.
A Facility resident (Resident) enters into a lease agreement with an initial term, continuing month-to-month thereafter, which entitles the Resident to individual living quarters within a Facility and Resident Services in exchange for fixed monthly payments. Each lease specifically stipulates that the Resident is responsible for his or her own personal and health care needs. Before a Resident moves in, the Facilities may interview the prospective Resident to confirm that he or she is capable of performing the activities of daily living.
The following Resident Services are provided at the Facilities and included in the monthly rent (i.e., are not separately stated):
Taxpayer represented that the Resident 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 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 do not require employees to have any medical training, and do not conduct preventative health screening, monitor the Residents' medical needs, supervise Residents' oxygen equipment, or provide for a streamlined resident transfer program to a facility with higher health care options. Additionally, the Facilities do not require a Resident to obtain consent from the Facility before the Resident contracts with third parties for in-home or other health-care services. The Facilities also do not keep "Do Not Resuscitate" forms on file. The Facilities do not have 24-hour on-site staff to monitor the Residents, though Facility staff may call 911 in the event of an emergency and follow instructions provided by the 911 operator.
Under a management contract, OpCo TRS is responsible for providing the Resident Services, as well as certain back-office services. OpCo TRS subcontracted its obligations under the management contract to Operator.
The Facilities typically also lease two to three small commercial spaces to Commercial Tenants. It is common for the Commercial Tenants to be beauty salon or in-home health and personal care service providers used by the Residents. The Commercial Tenants lease these locations in part because of the proximity to potential customers fitting the Residents' profile but do not exclusively serve the Residents and are open to and reasonably accessible by the general public. The Taxpayer does not actively seek out Commercial Tenants that provide in-home health and personal care services, provide any assurances in marketing materials that a Facility will have Commercial Tenants that provide in-home health and personal care services, or encourage or refer Residents to use a particular Commercial Tenant. The Commercial Tenants enter into standard fixed-payment lease agreements with initial terms of a certain number of years, with automatic month-to-month renewals. Taxpayer represented that the rent received from the Commercial Tenants qualifies as rents from real property for purposes of IRC Section 856(d)(1). Furthermore, the rent received from the Commercial Tenants is de minimis when compared to the total rent received from the Residents and Commercial Tenants combined.
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) 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 taxable REIT subsidiary (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.
IRC Section 856(l)(1) defines TRS to mean, with respect to a REIT, a corporation (other than a REIT) if (i) the REIT directly or indirectly owns stock in the corporation, and (ii) the REIT and corporation jointly elect to treat the corporation as a TRS of the REIT.
IRC Section 856(l)(3)(A) does not consider any corporation that directly or indirectly operates or manages a health care facility (as defined in IRC Section 856(e)(6)(D)(ii)) to be 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 are not health care facilities under IRC Section 856(e)(6)(D)(ii); as a result, the direct or indirect operation or management of the Facilities by OpCo TRS will not prevent OpCo TRS from being treated as a TRS of Taxpayer under IRC Section 856(l)(3)(A).
While the Facilities offer amenities and services found in congregate care facilities, the IRS noted that the amenities and services provided at the Facilities focus on the Residents' convenience and social lives. The absence of medical personnel, health screenings and monitoring, and transfer programs, along with affirmative requirements that Residents be responsible for their own health care needs, further support the view that the Facilities do not have a health care focus. Therefore, the IRS concluded that, considering all the facts and circumstances, the Resident Services provided at the Facilities are not focused on the health and well-being of the Residents.
Furthermore, the mere presence of Commercial Tenants within the Facilities, some of which may offer in-home health and personal care services to Residents, will not cause the Facilities to be viewed as furnishing services that emphasize the health and well-being of the Residents. The Facilities do not coordinate, exercise control over, or otherwise support or direct the Commercial Tenants. Taxpayer does not seek out in-home health and personal care service businesses as Commercial Tenants, and the sole relationship between Taxpayer and Commercial Tenants is that of a landlord and tenant (whose rent at a Facility is de minimis compared to the total combined rent received from Residents and Commercial Tenants).
Finally, the IRS ruled (in accordance with IRC Section 856(d)(7)(C)(i) and Revenue Ruling 2002-38) that Operator's and Emergency Operator's provision of Resident Services, including those 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).
PLRs 202317017 and 202317018 are the fifth and sixth private letter rulings in which the IRS has ruled, based on the surrounding facts and circumstances, that certain senior independent living facilities are not "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 are "congregate care facilities," a term that is not defined in the Internal Revenue Code or the Treasury regulations. In PLRs 202317017 and 202317018, the IRS determined that the Facilities were not congregate care facilities because the services furnished to Residents are focused on providing a "convenient and social living environment" and "not the health and well-being" of Residents. Furthermore, the mere presence of Commercial Tenants who provide in-home health and personal care services does not alter that analysis for the Facilities if an appropriate arm's-length relationship exists between the Commercial Tenant and Facility (e.g., the Commercial Tenant is accessible by the general public, and the Facility does not coordinate or exercise control over the Commercial Tenant). See also PLRs 202226002 (age-restricted independent living communities "are not focused on the health and well-being of the residents") (Tax Alert 2022-1045), 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 are "congregate care facilities" and, thus, "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 (senior independent living facilities provide services "specially targeted to monitor and help improve the health and well-being of its 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 (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 2011-2003).
REITs investing in senior independent living facilities will need to determine whether the facility is or is not a "congregate care facility." If the facility is a congregate care facility, the REIT may not engage its TRS to provide operation or management services at the facility. The REIT, however, can consider leasing the 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 is not a congregate care facility, a TRS may be engaged to operate or manage the facility (and, as in PLRs 202317017 and 202317018, subcontract its obligations to a third-party independent contractor).
While the IRS to date has not provided a bright-line test for determining whether a particular senior independent living facility is a health care facility for purposes of IRC Section 856(e)(6)(D)(ii), PLRs 202317017 and 202317018 provide additional insight on the IRS's holistic approach when considering whether a senior independent living facility falls outside of the definition of a "congregate care facility."
Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor