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In PLR 202409002, the IRS ruled that, to the extent a real estate investment trust's right to receive certain state brownfield redevelopment tax credits (Brownfield Credits) is a GAAP asset, the right constitutes a qualifying receivable for purposes of the 75% real estate investment trust (REIT) asset test. In addition, income attributable to the receipt or accrual of the Brownfield Credits is treated as qualifying income for purposes of the 95% and 75% REIT gross income tests.

Facts

Taxpayer is a REIT that indirectly owns an interest in a subsidiary partnership (JV), which owns land (Site) through a disregarded entity. JV incurred significant expenses in remediating adverse environmental conditions at the Site, rehabilitating the Site and constructing an office building on the Site (Redevelopment Work). Taxpayer represented that the Redevelopment Work expenditures related to the remediation, rehabilitation and development of real property within the meaning of Treas. Reg. Section 1.856-10.

JV leased the office building to unrelated third parties under leases that generate qualifying rents from real property for purposes of the 95% and 75% gross income tests. Taxpayer represented that substantially all the income derived from the Site (excluding income relating to the Brownfield Credits) is qualifying income for purposes of the REIT gross income tests.

In connection with the Redevelopment Work, Taxpayer claimed Brownfield Credits equal to a percentage of the costs of site preparation, tangible property (such as buildings) placed in service at the Site and on-site groundwater remediation. For each of Year 1, Year 2 and Year 3, the Brownfield Credits claimed by Taxpayer exceeded its state income tax liability. Under state law, such excess is treated as an overpayment of income tax. Taxpayer elected to receive a refund of the overpayment.

Law and analysis

IRC Section 856(c)(4)(A) requires at least 75% of the value of a REIT's total assets at the close of each quarter of its tax year to 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. 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.

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 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 constitutes 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 is 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 leases the Site to generate qualifying rents from real property and that substantially all of the income derived from the Site (excluding income from the Brownfield Credits) is qualifying for purposes of the REIT gross income tests.

Implications

PLR 202409002 is the latest ruling in which the IRS relied on its authority under IRC Section 856(c)(5)(J) to address incentive-type payments received or accrued by a REIT from a state or local jurisdiction in connection with the development of real property. For discussion of other rulings under IRC Section 856(c)(5)(J), see Tax Alerts 2023-0265 and 2024-0402. PLR 202409002 is also the eighth 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 202305009 (Tax Alert 2023-0265), 201845001 (Tax Alert 2019-0090), 201816001, 201816002, 201816003 (Tax Alert 2018-0960), 201518010 (Tax Alert 2015-0984) and 201428002 (Tax Alert 2014-1304).

Given the recently 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 202409002 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.