In PLR 202520010 , a ruling obtained by professionals at EY, the IRS ruled that amounts received from tenants of a real estate investment trust's (REIT) temperature-controlled warehouses for temperature reduction, tempering, blast freezing, rapid tempering and handling services do not constitute impermissible tenant service income (ITSI). In addition, the income will qualify as rents from real property under IRC Section 856(d) for purposes of the REIT gross income tests under IRC Section 856(c)(2) and (3) if the services are provided in connection with the rental of real property that otherwise produces qualifying rents from real property.

The IRS also ruled that (1) income from the REIT's positive IRC Section 481(a) adjustment will not constitute gross income for purposes of IRC Section 856(c)(2) and (c)(3) under IRC Section 856(c)(5)(J)(i); and (2) payments from the REIT's taxable REIT subsidiary (TRS) for a lease of warehouse space will qualify as rents from real property under the limited TRS rental exception of IRC Section 856(d)(8)(A).

Facts

Taxpayer, a publicly traded REIT, and its operating partnership and other subsidiaries (collectively, Company Group), provide tenants with space in Company Group's temperature-controlled warehouses to store tenants' goods at specified temperatures. Taxpayer represented that the contracts with tenants produce qualifying rents from real property under IRC Section 856(d).¹ Company Group also provides temperature reduction, tempering, blast freezing, rapid tempering and handling services in the warehouses. Taxpayer engages its TRSs to perform the handling services in exchange for an arm's length amount.

Temperature reduction and tempering, respectively, gradually lower or raise the temperature of goods by placing a tenant's pallet of goods in a warehouse room or area set to a temperature that is lower or higher than that of the goods. The temperature of the room or area gradually freezes or warms the goods until they are at the appropriate temperature for storage.

Company Group uses traditional blast cell systems or quick freeze technology systems (collectively, Rapid Freezing Systems) to provide blast freezing services to rapidly freeze goods. The traditional blast cell system method involves placing a tenant's pallet of goods in a room with high velocity air flow that rapidly lowers the temperature of the goods. The quick freeze technology system provides blast freezing via high-speed fans and a sealing system integrated into the racking structure in the general cold storage area of a warehouse. Rapid tempering (with blast freezing, Rapid Services) rapidly warms goods using a Rapid Freezing System set at a temperature higher than that of the goods. After the Rapid Services are complete, a TRS moves the frozen or tempered goods to a general temperature-controlled storage room or area of the warehouse.

Electricity powers the temperature control systems that are integrated into the warehouses to provide temperature reduction, tempering and Rapid Services (collectively, Temperature Services). Warehouse rooms and areas are set at specified temperatures and are not adjusted for each tenant. Charges for the Temperature Services are related to the costs of equipment and electricity required to maintain the desired temperature in each area.

Because tenants do not have access to Company Group's warehouses for safety and liability reasons, TRSs provide all tenants with handling services, including loading, unloading and moving tenants' pallets into, out of and around the warehouses. Tenants are charged for handling at an hourly rate based on the cost of labor and equipment used to provide the handling services. The Rapid Services require an extra handling charge because goods must be moved once they reach the desired temperature.

Taxpayer represented that (1) the Temperature Services and handling are customarily provided in cold storage facilities in the geographic markets where Company Group's warehouses are located; (2) temperature control and electricity are customarily rendered in connection with the operation or maintenance of the warehouses and are not rendered primarily for the convenience of tenants; and (3) the fees for the Temperature Services and handling do not depend, in whole or in part, on the income or profits of any person from the property.

Company Group may lease warehouse space to a TRS for the TRS to conduct its operations. Taxpayer made representations consistent with the limited TRS rental exception under IRC Section 856(d)(8)(A), but with the caveat that there may be no leased space in the warehouse that is comparable to the space leased to the TRS, in which case the rents paid by the TRS will be substantially comparable to rents paid for comparable space leased by unrelated tenants at other, similar warehouses in the same geographic area.

Law and analysis

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, among other things, charges for services customarily rendered to tenants in connection with the rental of real property (IRC Section 856(d)(1)(B)). Services are considered customary if, in the geographic market in which the particular building is located, tenants in buildings of a similar class are customarily provided with the service (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 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 for services, management or operations provided through an independent contractor 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)). IRC Section 512(b)(3) excludes rents from real property from UBTI, and Treas. Reg. Section 1.512(b)-1(c)(5) provides that payments for the occupancy of space where services are also "rendered to the occupant" are not rents from real property.

Noting that providing Temperature Services is similar to providing heat, which is listed in Treas. Reg. Section 1.512(b)-1(c)(5) as a service that is not considered rendered to the occupant under IRC Section 512, the IRS concluded that income from providing the Temperature Services would be excluded from UBTI under IRC Section 512(b)(3) if received by an organization described in IRC Section 511(a)(2). The IRS also emphasized that the handling services provided by a TRS are necessary because tenants do not have direct access to their stored pallets or have exclusive use of defined space. Thus, based on the facts and Taxpayer's representations, the IRS ruled that amounts received by Company Group for providing the Temperature Services, and for the handling services performed by a TRS, do not constitute ITSI. Further, if these services are provided in connection with the rental of real property that otherwise produces qualifying rents from real property (which Taxpayer represented and the IRS previously ruled for Taxpayer), such amounts will qualify as rents from real property for purposes of IRC Section 856(c)(2) and (3).

The IRS also ruled that (1) income from the REIT's positive IRC Section 481(a) adjustment will not constitute gross income for purposes of IRC Section 856(c)(2) and (c)(3) under IRC Section 856(c)(5)(J)(i); and (2) based on Taxpayer's representations, payments from Taxpayer's TRS for a lease of warehouse space will qualify as rents from real property under the limited TRS rental exception of IRC Section 856(d)(8)(A).

Implications

PLR 202520010 is the fifth ruling in which the IRS has addressed REIT qualification issues related to the ownership and operation of cold storage warehouses. See PLRs 200027034 and 199904019 (ruling, prior to the issuance of Treas. Reg. Section 1.856-10, that cold storage warehouses and central refrigeration systems are real property and thus qualify as real estate assets for REIT asset test purposes). The IRS first addressed the treatment of income from cold storage qualifying as "rents from real property" under IRC Sections 856(c)(2) and (3) in PLR 200428019.

The description and analysis of the cold storage services in PLR 202520010 appear similar to those in PLR 202012003 but with significantly fewer redactions. As noted in Tax Alert 2020-1035, the taxpayer in PLR 202012003 would not provide any services to tenants in connection with their leases of warehouse space other than an undisclosed customary service (which appears to be "freezing" goods for tenants) made available "through the provision of power and electricity." In addition, as in PLR 202520010, a TRS or independent contractor would perform all handling services. Thus, while PLR 202520010 may or may not be the first ruling to address all of the Temperature Services described above, the largely unredacted text provides other taxpayers and their advisors more insight into the IRS's current analysis of such services provided in connection with the lease of cold storage warehouse space to tenants.