In PLRs 202510011 and 202510012, rulings obtained by professionals at EY, the IRS ruled that payments made by airlines for the use of airport terminal space are qualifying rents from real property for purposes of the real estate investment trust (REIT) gross income tests under IRC Section 856(c)(2) and (c)(3). The IRS also concluded under IRC Section 856(c)(5)(J)(ii) that deemed interest income on an IRC Section 467 deemed prepaid rent loan will be treated as qualifying income for purposes of the 75% income test under IRC Section 856(c)(3).

Facts

Taxpayers, which are limited liability companies that elected to be taxed as REITs, own interests in Partnership, which was formed to develop a new passenger terminal (Terminal) at an international airport (Property).

Public agency lease, assignment agreement, design build agreement

Under a lease agreement (Lease), Public Agency leases to Partnership land, buildings and improvements at the Property, including existing structures and the Terminal that will be constructed (Leased Premises). Under the Lease, Partnership agreed to design and construct the Terminal on the Leased Premises and to lease the Terminal from Public Agency. Partnership also agreed to design and construct storm drains, electrical duct banks, upgrades to a light rail system and truck barriers (Off-Premises Facilities), which will not be part of the Leased Premises.

Under an assignment agreement, Partnership assigned its rights and obligations with respect to the Off-Premises Facilities to its corporate subsidiary, which is a taxable REIT subsidiary (TRS) of each Taxpayer, in exchange for a payment that will be treated as in-kind rent paid by Partnership to Public Agency under the Lease.

Under another agreement (Design Build Agreement), Partnership and TRS will engage an independent contractor within the meaning of IRC Section 856(d)(3) from whom Taxpayers will not derive or receive any income (IK) to design and construct the Terminal and the Off-Premises Facilities, respectively, in exchange for arm's length fees. Partnership's expenses under the Design Build Agreement will also be treated as in-kind rent paid by Partnership to Public Agency under the Lease.

The Lease is an IRC Section 467 rental agreement that includes prepaid rent and a deemed IRC Section 467 loan made by Partnership to Public Agency (Prepaid Rent Loan). As the principal of the Prepaid Rent Loan amortizes, Partnership will recognize deemed interest on the Prepaid Rent Loan (Prepaid Rent Loan Interest) and will deduct rental expenses according to the IRC Section 467 proportional-rental-accrual-method schedule set forth in the Lease.

Airline user agreements

Airlines with flights departing from and arriving at Terminal gates (Airline Users) will enter into agreements (Airline User Agreements) with Partnership, under which the Airline Users will lease shared common space and, in some cases, exclusive space (such as VIP check-in space, office space, support area space and/or specific lounge space) in Terminal from Partnership. Common space available to all Airline Users and their employees, patrons and guests will include Terminal gates, ramps and taxiways; the building structure; the federal inspection service facility; passageways; public areas; retail halls; meet-and-greet areas; pedestrian, vehicle and aircraft access, ingress and egress rights; and rights to use Terminal utilities and other services. The common space will exclude any exclusive space leased to an Airline User, space leased to retailers¹ and space used by government agencies.

All Airline Users will also have the right to use shared personal property in the common space, including check-in desks and kiosks; computer equipment and check-in software; baggage scales and tag printers; passenger boarding bridges; ramp equipment; display systems for flight and baggage information; and baggage handling systems (Common Equipment).

Airline Users' flight schedules are determined for multiple months (Scheduling Season) at a time. Partnership allocates gate slots among Airline Users based on their flight schedules for the upcoming Scheduling Season. An Airline User's allocated gate slots represent its allocated portion of leased common space during that Scheduling Season because the Airline User and its guests and customers will use the common space in connection with the Airline User's scheduled flights. The gate allocation schedule is a binding contractual obligation of Partnership to each Airline User. Taxpayers represented that they will not oversell capacity of the common space.

Airline rents

Under an Airline User Agreement, an Airline User will make monthly payments to Partnership in exchange for the right to use the common space and Common Equipment (Common Space Charge) and, where applicable, exclusive space (Exclusive Space Charge, and collectively with the Common Space Charge, Airline Rents).

The Common Space Charge is calculated as the product of (1) a specific dollar amount adjusted for inflation and (2) the number of passengers that depart on the Airline User's flights from Terminal (Enplaned Passengers) in a given month. Partnership took historical cancellations and projected Enplaned Passengers into account in determining the dollar amount used to calculate the Common Space Charge. Taxpayers made representations regarding flight cancellations in recent years and the actual number of Enplaned Passengers compared to projected Enplaned Passengers. Taxpayers also represented that they are unaware of any Airline User having zero Enplaned Passengers in a given month (other than where an Airline User ceased operating at the Property or a governmental agency prevented it from operating). Therefore, an Airline User's Common Space Charge each month will be at least a specified percentage of the projected Common Space Charge based on the Airline User's flight schedule for that month.

The Exclusive Space Charge payable by an Airline User that leases exclusive space is calculated as the product of a specific dollar amount adjusted for inflation per square foot of leased space and, where applicable, a percentage of the Airline User's gross revenue from granting a third party access to exclusive lounge space.

Taxpayers represented that the Airline Rents do not depend on the income or profits of any person from the Leased Premises, and under each Airline User Agreement, the rent attributable to leased personal property, including the Common Equipment, will not exceed 15% of the total rent for the tax year for both the real and personal property leased under the Airline User Agreement.

Services

Partnership will provide, or will engage TRS or an IK to provide, usual and customary services, such as utilities, security, cleaning, repairs and maintenance of the common space leased by Airline Users; removal of trash from the common space; and snow removal from ramps and sidewalks. Partnership will engage TRS or an IK to operate, maintain and repair the Common Equipment; provide skycap services; assist passengers with disabilities; assist passengers in the baggage claim area; and provide operations management services. Taxpayers represented that the services provided by Partnership, TRS or an IK are customarily provided to airline tenants of other large international airports in the United States in connection with the rental of real property. Airline Users must procure services that are integral to their business operations, such as deicing, fueling and cleaning airplanes and providing ticket and gate agents.

Law and analysis

IRC Section 856(c)(2) requires a REIT to derive at least 95% of its gross income from certain types of income, including rents from real property and interest. IRC Section 856(c)(3) requires a REIT to derive at least 75% of its gross income from certain types of income, including rents from real property and interest on obligations secured by real property.

Airline rents

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), the definition of "rents from real property" does not include impermissible tenant service income (ITSI) (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). ITSI 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 (UBTI) under IRC Section 512(b)(3) if received by an organization described in IRC Section 511(a)(2) (IRC Section 856(d)(7)(C)).

Based on the facts and representations provided by Taxpayers, the IRS ruled that the Airline Rents qualify as rents from real property within the meaning of IRC Section 856(d) for purposes of the REIT gross income tests under IRC Section 856(c)(2) and (3).

The IRS also concluded that the services provided by Partnership, TRS or an IK should not give rise to ITSI and should not cause any portion of the Airline Rents to fail to qualify as rents from real property under IRC Section 856(d). This conclusion was based on the facts that those services are usually and customarily rendered in connection with the rental of common space in airport terminals and are not tailored to the needs of any particular Airline User; additionally, they either (1) would not result in UBTI under IRC Section 512(b)(3) if received by an organization described in IRC Section 511(a)(2), or (2) will be provided by TRS or an IK.

Prepaid rent loan interest

IRC Section 467(a) requires a lessor and lessee under an IRC Section 467 rental agreement to take into account for tax purposes the sum of (1) the rent that accrues during the tax year under IRC Section 467(b), and (2) interest for the year on unpaid amounts taken into account under IRC Section 467(a) for prior tax years.

Under Treas. Reg. Section 1.467-1(c), an IRC Section 467 rental agreement is generally a rental agreement that has increasing or decreasing rents or deferred or prepaid rents.

Treas. Reg. Section 1.467-1(e)(3) provides that IRC Section 467 interest on an IRC Section 467 loan is treated as interest for all purposes of the Internal Revenue Code.

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 ruled under IRC Section 856(c)(5)(J)(ii) that Taxpayers' income from the Prepaid Rent Loan Interest will be considered qualifying income under IRC Section 856(c)(3). Prepaid Rent Loan Interest, the IRS explained, is interest that constitutes qualifying income for purposes of the 95% income test under IRC Section 856(c)(2), but not for purposes of the 75% income test under IRC Section 856(c)(3). Treating the Prepaid Rent Loan Interest as qualifying income does not interfere with or impede Congress's objectives in enacting the REIT income tests, the IRS continued, because the Prepaid Rent Loan is created by Partnership's in-kind prepayment of rent for an interest in real property (the leasehold interest in the Leased Premises); additionally, the IRS noted, the Airline Rents that will be received as a result of leasing the Leased Premises to Airline Users qualify as rents from real property for REIT purposes.

Implications

PLRs 202510011 and 202510012 are the first PLRs to address the REIT income test treatment of amounts received by a REIT from airlines for the use of space in an airport terminal. The Airline Rents described in the PLRs are based on the volume of passengers departing from an Airline User's gates during a given month, and so are not dissimilar from other volume-based rents the IRS has previously concluded qualify as rents from real property within the meaning of IRC Section 856(d). For example, in PLR 202410005, the IRS ruled that pipeline-use fees will be treated as rents from real property for purposes of the REIT gross income tests (see Tax Alert 2024-0627). The pipeline-use fees in PLR 202410005 were not subject to a minimum volume commitment. Instead, Taxpayer's representations regarding pipeline users' contractual obligations and economic compulsion to use the pipelines, and pipeline users' actual use of the pipelines, supported the IRS's conclusion that the pipeline-use fees qualified as rents from real property for purposes of IRC Section 856(c)(2) and (c)(3). Similarly, the Taxpayers in PLRs 202510011 and 202510012 provided representations regarding the historical volume of flights and departing passengers, such that an Airline User's actual Common Space Charge would be at least a specified percentage of the projected Common Space Charge each month.

PLRs 202510011 and 202510012 are also the first PLRs to address the REIT income test treatment of deemed interest received by a REIT under a deemed IRC Section 467 loan made by the REIT to its tenant. While concluding that the deemed interest qualified as interest income for purposes of IRC Section 856(c)(2), the IRS stated that the deemed interest was not qualifying interest under IRC Section 856(c)(3) (i.e., the IRS concluded that the deemed interest was not interest on obligations secured by real property). However, given that the deemed IRC Section 467 loan is created by the REIT's prepayment for the use of real property that the taxpayers will then use to generate qualifying rents from real property, the IRS used its discretionary authority under IRC Section 856(c)(5)(J)(ii) to treat the deemed interest as qualifying income for purposes of IRC Section 856(c)(3).

The PLRs do not address the treatment of the deemed IRC Section 467 loan for purposes of the REIT asset tests under IRC Section 856(c)(4). While taxpayers with facts similar to those surrounding the deemed IRC Section 467 loan should consult with their tax advisors, these two rulings give taxpayers some indication of the IRS's current thinking on deemed interest received by a REIT under a deemed IRC Section 467 loan.