November 21, 2023 IRS rules on issues regarding assets and income from REIT's bulk liquid storage facilities
In PLR 202346008, a ruling obtained by professionals at EY, the IRS ruled on several issues concerning assets of and income from a taxpayer's bulk liquid storage facilities:
Facts Taxpayer, a corporation that intends to elect to be taxed as a real estate investment trust (REIT), owns bulk liquid storage terminal facilities and pipelines. The facilities include land owned or leased by Taxpayer, roadways, buildings, stationary docks, storage tanks and pipelines, as well as associated personal property such as pumps and compressors. Floating docks Some of Taxpayer's facilities include floating docks. The floating docks provide a route for tenants to access the facilities and protect docked vessels from damage by the elements. The floating docks are generally attached to poured concrete walkways on land, and to concrete, timber or steel bulkheads that retain contact with the land. The docks are permanently affixed to pilings that anchor the docks to the seabed or riverbed and allow the docks to move up or down with water level changes. Taxpayer represented that the pilings are inherently permanent structures, the floating docks are designed to remain in place indefinitely and moving the docks would be prohibitively costly. Storage fees Taxpayer has agreements with unrelated third-party users of the storage terminal facilities allowing the users to store and move their products through the facilities. An agreement will specify the amount of storage tank capacity reserved for a user but may or may not specify the tank in which a user's product will be stored. Users pay monthly storage fees that are based on the volume of capacity reserved by the user or by the volume of product stored. Where storage fees are based on the volume of product stored, users pay for a minimum volume commitment (even if the user uses less than this minimum reserved capacity) plus a fixed dollar amount multiplied by any additional capacity used that month. Taxpayer will (1) design, construct, inspect, maintain and repair the storage tanks and other real property assets at the facilities, (2) provide electricity and security, and (3) heat, cool, pressurize or circulate the products in the storage tanks as necessary to avoid damage to the tanks, pipes and stored products and to make storing a product more efficient. A taxable REIT subsidiary (TRS) of Taxpayer or an independent contractor from which Taxpayer derives no income (IK) will receive arm's-length compensation for performing all other activities and services, including operating, maintaining and repairing certain personal property. Pipeline use fees Taxpayer owns pipelines that provide a conduit or route for product to flow to and from certain storage terminal facilities. Taxpayer has agreements with unrelated third parties for the use of the pipelines. Such pipeline users pay fees based on the volume of product placed on the pipeline. A user must pay for a minimum volume commitment per month (even if the user uses less than this minimum reserved capacity) plus a fixed dollar amount multiplied by any additional capacity used that month. Taxpayer will design, construct, inspect, monitor, maintain and repair the pipelines and undertake other activities with respect to the pipelines that are consistent with its fiduciary duty to manage itself as a REIT. Taxpayer may also provide electricity and heat to certain pipelines as necessary to avoid damage to pipelines and the product in the pipelines. A TRS or IK will receive arm's-length compensation for performing all other activities and services, including scheduling use of the pipelines by the pipeline users and operating, monitoring, maintaining and repairing certain personal property. Docking fees Taxpayer has agreements with unrelated third-party users allowing the users to run pipeline across a storage terminal facility to a dock and use the dock to load and unload the user's product from vessels at the dock. Docking fees are generally calculated as a fixed monthly charge or a fixed dollar amount multiplied by the amount of product moved over the dock with a minimum volume commitment. Taxpayer will maintain and repair the docks and provide electricity and security. A TRS or IK will receive arm's-length compensation for performing all other activities and services, including all services in connection with a user's docking of vessels and loading or unloading the user's product at the docks. IRC Section 481(a) adjustment Taxpayer will file a Form 3115, Application for Change in Accounting Method, to treat certain storage tanks and associated assets as real property instead of personal property for purposes of depreciation. This will result in a positive adjustment under IRC Section 481(a) that will be includible in Taxpayer's taxable income. Remediation payment Taxpayer, through a disregarded subsidiary, purchased a property subject to an existing pollution remediation order. Subsequent to the acquisition, Taxpayer agreed to assume certain of the remediation obligations with respect to the property in exchange for a payment from the seller. The payment is calculated based on the net present value of the estimated remediation costs to be incurred by Taxpayer, a contingency fee and an amount intended to cover the risk of assuming the remediation liabilities. Taxpayer represented that the property undergoing remediation is real property for purposes of IRC Section 856 and substantially all income generated from the property will be qualifying income for purposes of IRC Sections 856(c)(2) and (c)(3). Taxpayer also represented that the payment does not reflect compensation for services provided to a third party or for remediating property not owned by Taxpayer. Insurance payment Because a hurricane caused extensive damage to three of Taxpayer's storage terminal facilities, Taxpayer will receive an insurance payment from its property insurer. Taxpayer will recognize income to the extent the payment exceeds Taxpayer's actual costs to repair and replace the storm-damaged property (i.e., to the extent Taxpayer chooses not to repair or replace certain of the damaged property). Law and analysis Floating docks 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 (which includes 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) defines "real property" as 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) lists 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) requires the following factors to 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 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). Storage fees, pipeline use fees and docking fees 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) defines the term "rents from real property" generally as the gross amounts received for the use of, or the right to use, the REIT's real property. Under IRC Section 856(d)(1), the term "rents from real property" includes: "(A) rents from interests in real property, (B) charges for services customarily furnished or rendered in connection with the rental of real property, whether or not such charges are separately stated, and (C) rent attributable to personal property leased under, or in connection with, a lease of real property, but only if the rent attributable to the personal property for the [tax] year does not exceed 15[%] of the total rent for the [tax] year attributable to both the real and personal property leased under, or in connection with, such lease." A service furnished to tenants of a particular building will be considered customary if, in the geographic market in which the building is located, the service is customarily provided to tenants in buildings of a similar class (Treas. Reg. Section 1.856-4(b)(1)). Under IRC Section 856(d)(2)(C), impermissible tenant service income (defined by IRC Section 856(d)(7)(A) as any amount received or accrued by the 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." Impermissible tenant service income does not include (1) payments received for services, management or operations provided through an IK or TRS, and (2) any payment that would be excluded from unrelated business taxable income under IRC Section 512(b)(3) if received by an organization described in IRC Section 511(a)(2) (IRC Section 856(d)(7)(C)). The IRS concluded that the amounts received by Taxpayer as storage fees, pipeline use fees and docking fees are received for the use of, or the right to use, Taxpayer's real property and therefore qualify as rents from real property for purposes of IRC Section 856(d). The IRS further concluded that the activities and services performed by Taxpayer and by a TRS or IK do not give rise to impermissible tenant service income. IRC Section 481(a) adjustment IRC Section 856(c)(5)(J) authorizes the IRS to determine, to the extent necessary to carry out the REIT provisions' purposes, 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) and ruled that the IRC Section 481(a) adjustment will not constitute gross income for purposes of the 95% and 75% income tests under IRC Section 856(c)(2) and (3), noting that the exclusion of the positive IRC Section 481(a) adjustment from Taxpayer's gross income, based on the facts and circumstances, did not interfere with congressional policy objectives in enacting the REIT provisions. Remediation payment The IRS exercised its discretionary authority under IRC Section 856(c)(5)(J) to rule that the remediation payment will not be treated as gross income for purposes of IRC Section 856(c)(2) and (3). In so ruling, the IRS focused on the facts that the remediation payment is intended to compensate Taxpayer for the cost of remediating its own property, and Taxpayer represented that the payment is not compensation for services provided to a third party or for remediating property not owned by Taxpayer. Insurance payment The IRS exercised its discretionary authority under IRC Section 856(c)(5)(J) to rule that the insurance payment will be treated as qualifying income for purposes of IRC Section 856(c)(2) and (c)(3), noting that Taxpayer represented that income attributable to the insurance payment is effectively payment for damaged real property that Taxpayer does not repair or replace (and therefore akin to a payment for the disposition of real property). Implications The IRS's conclusions in PLR 202346008 that floating docks secured to a seabed or riverbed by pilings 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) are consistent with PLRs 202237004, 202031001 and 201930003 (see Tax Alert 2022-1413). Similarly, the IRS's ruling in PLR 202346008 that storage fees, pipeline use fees and docking fees will be treated as rents from real property for purposes of IRC Section 856(c)(2) and (c)(3) is consistent with its rulings in PLR 202150014 (see Tax Alert 2021-2273), and reconfirms that payments for use of space that are calculated on the basis of capacity or volume qualify as rents from real property. The IRS has previously ruled that capacity-based payments for the right to use or occupy space in storage tanks or pipelines (PLR 202150014, PLR 201907001, Tax Alert 2019-0721), in a cold storage warehouse (e.g., PLR 202012003, Tax Alert 2020-1035), or on real property assets comprising a fiber optic system or DAS installation were qualifying rents from real property (e.g., PLRs 202132002 and PLR 202133003). While taxpayers with facts similar to those surrounding the remediation payment and insurance payment should consult with their tax advisors, these two rulings give taxpayers some indication of the IRS's current analysis regarding certain types of payments made to offset costs incurred with respect to a REIT's real property and certain insurance payments. ———————————————
Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor | ||||||||||||||
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