In PLR 202506007, the IRS ruled that a real estate investment trust's (REIT) allocable share of management fee payments received from a partnership and by the partnership from disregarded entities of the REIT will be treated under IRC Section 856(c)(5)(J)(i) as not constituting gross income for purposes of the REIT 95% and 75% gross income tests. Accordingly, the REIT's allocable share of management fee income will not adversely affect its compliance with the income tests. The IRS also ruled that the agreements under which the management fees are paid are excluded from the REIT's assets for purposes of the REIT asset tests.

Facts

Taxpayer, a corporation that elected to be taxed as a REIT, owns a portion of the equity in an entity classified as a partnership for US federal income tax purposes (Investment Partnership). Taxpayer's wholly owned taxable REIT subsidiary (TRS) owns the remaining equity in Investment Partnership, which owns and earns rental income from wireless and broadcast communications systems (Telecommunication Assets). Taxpayer also owns non-US entities that are disregarded from Taxpayer for US federal income tax purposes (Non-US DREs). The Non-US DREs own and earn rental income from Telecommunication Assets located outside of the United States.

Taxpayer provides operational support to Investment Partnership for the Telecommunication Assets in the United States and foreign countries. Taxpayer represents that Investment Partnership uses the operational support for its own business in the management of Investment Partnership and for the Non-US DREs, but not for any unrelated third party. Taxpayer also represents that it provides the operational support to Investment Partnership as part of its and its directors' fiduciary duty to manage the REIT and is not rendering or furnishing any services to tenants or managing or operating the Telecommunication Assets.

Under an agreement between Taxpayer and Investment Partnership (Partnership Payment Agreement), Investment Partnership may make payments to Taxpayer for the operational support provided by Taxpayer (Partnership Payments). Taxpayer represents that it will treat the portion of the Partnership Payments attributable to TRS's interest in Investment Partnership as non-qualifying income for purposes of the REIT income tests.

Investment Partnership performs certain management activities for the Non-US DREs and provides the operational support received from Taxpayer to the Non-US DREs. Taxpayer represents that the management activities and operational support provided to the Non-U.S. DREs by Investment Partnership are part of Taxpayer's and its directors' fiduciary duty to manage the REIT if performed by Taxpayer, as distinguished from rendering or furnishing services to tenants or managing or operating the properties. Under an agreement between Investment Partnership and the Non-US DREs (DRE Payment Agreement), the Non-US DREs may make payments to Investment Partnership for the operational support and management activities provided to them (DRE Payments).

Taxpayer represents that the Partnership Payment Agreement and DRE Payment Agreement (Intercompany Payment Agreements) are not treated as assets under generally accepted accounting principles (GAAP) and do not appear on Taxpayer's financial statements (and would not appear even if the GAAP financial statements were prepared on a separate company basis).

Law and analysis

Rulings 1 and 2: The Partnership Payments and the DRE Payments (Intercompany Payments) allocable to Taxpayer are excluded from Taxpayer's gross income for purposes of the REIT income tests under IRC Section 856(c)(5)(J)(i).

IRC Section 856(c)(2) requires a REIT to derive at least 95% of its gross income (excluding gross income from prohibited transactions) from dividends; interest; rents from real property; certain gains from the sale of stock, securities and real property; abatements and refunds of taxes on real property; and certain other sources of income.

IRC Section 856(c)(3) requires a REIT to derive at least 75% of its gross income (excluding gross income from prohibited transactions) from rents from real property; interest on obligations secured by real property; gain from the sale or other disposition of real property; dividends from REIT stock; gain from the sale of REIT stock; abatements and refunds of taxes on real property; and certain other sources of income.

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.

Under Treas. Reg. Section 1.856-3(g), a REIT that is a partner in a partnership is deemed to own its proportionate share of each of the assets of the partnership and to be entitled to the income of the partnership attributable to that share for purposes of applying the asset and income tests.

The IRS reasoned that because the Intercompany Payments are derived from income that is already included in Taxpayer's gross income, including Taxpayer's share of the Intercompany Payments in Taxpayer's gross income would cause the amounts to be "counted twice" for purposes of the REIT income tests. The IRS also explained that Taxpayer's gross income attributable to the Intercompany Payments represents an amount that Taxpayer, as a partner in Investment Partnership, is "charging itself" for functions Taxpayer could perform directly without adverse tax consequences. Accordingly, the IRS concluded that excluding Taxpayer's allocable share of Intercompany Payments from Taxpayer's gross income for purposes of the REIT income tests is consistent with the purposes of the REIT provisions of the tax code.

Ruling 3: The Intercompany Payment Agreements are excluded from Taxpayer's assets for purposes of the REIT asset tests.

Under IRC Section 856(c)(4)(A), at least 75% of a REIT's total assets at the close of each calendar quarter must be represented by real estate assets, cash and cash items (including receivables), and government securities.

Under Treas. Reg. Section 1.856-2(d)(3), the term "total assets" for this purpose means the gross assets of the REIT determined in accordance with GAAP.

Taxpayer represented that the Intercompany Payment Agreements are not assets for GAAP purposes and would not be shown as assets even if the GAAP financial statements were prepared on a separate company basis. Accordingly, the IRS concluded that the Intercompany Payment Agreements are excluded from Taxpayer's total assets for purposes of IRC Section 856(c)(4) to the extent they are not assets of Taxpayer for GAAP purposes.

Implications

PLR 202506007 is the third private letter ruling (PLR) issued during the past decade in which the IRS ruled under IRC Section 856(c)(5)(J) that a REIT may exclude, for purposes of the 95% and 75% income tests, its allocable share of management fee income derived from income that is already included in the REIT's gross income. See PLRs 202102002 (Tax Alert 2021-0314) and 201620001 (Tax Alert 2016-0906).

In years predating the enactment of IRC Section 856(c)(5)(J) (which applies to tax years beginning after July 30, 2008), the IRS issued numerous PLRs involving "self-charged management fees." Those PLRs concerned a REIT that (1) owned a significant interest in a partnership that owned rental real property, and (2) provided management services to the partnership in consideration for fees. The IRS concluded that the REIT may disregard the portion of the fee income received from the partnership that was attributable to the REIT's capital interest in the partnership for purposes of the income tests, while the portion of the fee income that was attributable to the other partners' interests in the partnership was treated as nonqualifying income. See PLRs 199952084, 9808011, 9701028, 9646027, 9552038, 9535014, 9521010, 9515005, 9502037, 9452032, 9431005, 9428018 and 9343027. The IRS's rationale for these rulings was similar to that in PLRs 202506007, 202102002 and 201620001 — the management fees are already reflected in the REIT's allocable share of rents derived by the partnership or are "self-charged" (i.e., fees for services provided by the REIT to its own properties or itself).

In addition, the IRS has issued several "self-charged loan" PLRs in which the IRS concluded that a REIT may ignore the "self-charged" portion of a loan (and related interest income) to a partnership (in which the REIT is a significant partner) for purposes of applying the asset and income tests to avoid a double counting of income and assets. See PLRs 201118015, 200740004, 200234054 and 9514006.

Finally, the IRS has issued several "self-charged rent" PLRs concluding that a REIT may ignore its allocable share of rental income from a "lessor partnership" to avoid a "double-counting" of income to the extent of the REIT's allocable share of related rental deductions of the "lessee partnership" for purposes of the income tests. See PLRs 201407011, 201204006, 200705019 and 200405007 (PLR 201407011 contains a recital of IRC Section 856(c)(5)(J) but does not expressly indicate that the ruling was given under the IRS's discretionary authority under IRC Section 856(c)(5)(J)).