In PLR 202550016, the IRS ruled that income received by a real estate investment trust (REIT) from the sale of a "zoning density bonus" certificate (Certificate) constitutes qualifying income for purposes of the REIT gross income tests under IRC Section 856(c)(2) and (c)(3) (Income Tests). The IRS determined that the Certificate is sufficiently tied to real property, supporting the treatment of income from the sale of the Certificate as qualifying REIT income.

Facts

Taxpayer, a limited liability company that has elected to be taxed as a REIT, is the direct and indirect owner of a mixed-income apartment building (Project), which includes both market-rate units and affordable units. The affordable units are treated as a single-building project for purposes of the low-income housing tax credit under IRC Section 42 (LIHTC). The Project received a LIHTC allocation from a state agency under Taxpayer's long-term commitment to low-income housing with respect to the Project.

A city agency operates a voluntary program (City Housing Program) offering "zoning density bonuses" or "floor area compensation" to developers that permanently set aside units for qualifying tenants in LIHTC buildings. Taxpayer entered into a regulatory agreement with the city agency committing to permanently set aside the affordable units for qualifying low-income residents as part of the City Housing Program. In return, Taxpayer received the Certificate, which could be (1) used in construction of the Project or another project in an adjacent district or (2) sold to unrelated developers. The Certificate is designed to compensate a developer for the loss of future rental income due to the permanent affordability commitment.

Taxpayer sold a portion of the Certificate to a third-party developer and contributed another portion to a wholly owned subsidiary that elected to be treated as a taxable REIT subsidiary. Taxpayer sought a ruling that income from the sale of the remaining portion of the Certificate would be considered qualifying income for purposes of the Income Tests.

Law and analysis

IRC Section 856(c)(2) requires a REIT to derive at least 95% of its gross income from specified sources, including rents from real property, dividends, interest and gains from the sale of real property. IRC Section 856(c)(3) requires at least 75% of gross income to be derived from real estate sources, including rents and gains from real property.

Under IRC Section 856(d)(1), the term "rents from real property" includes rents from interests in real property, charges for services customarily furnished in connection with the rental of real property and rent attributable to personal property that is leased in connection to the real property if certain conditions are met. Further, Treas. Reg. Section 1.856-4(a)(1) generally defines the term "rents from real property" to mean the gross amounts received for the use of, or the right to use, the REIT's 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 Income Tests may nevertheless be (1) disregarded for purposes of the Income Tests; or (2) treated as qualifying income for purposes of the Income Tests.

While income from the Certificate is not listed as a qualifying source of income under IRC Section 856(c)(2) or (c)(3), the IRS noted that the Certificate is intended to compensate the owner for the loss of future market-rate rents and is inextricably tied to both the affordable units as well as the future residential building using the extra density rights provided in the Certificate. Given the Certificate's close connection to real property and the rental of real property, the IRS concluded that treating income derived from the sale of the Certificate as qualifying income for purposes of the Income Tests is consistent with the purposes of the REIT provisions.

Accordingly, citing its discretionary authority under IRC Section 856(c)(5)(J), the IRS concluded that Taxpayer's income from the sale of the Certificate will be considered qualifying income for purposes of the Income Tests.

Implications

PLR 202550016 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 by a REIT from a state or local jurisdiction in connection with the development of real property. The IRS continues to take a favorable view under the REIT Income Tests for incentives a REIT receives to develop real property that will produce qualifying rental income. The conclusion in PLR 202550016, however, 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 seeking their own rulings.

For discussion of other rulings under IRC Section 856(c)(5)(J), see PLR 202405001 (Tax Alert 2024-0402) addressing incentive arrangements in the form of municipal bonds and reimbursement of property taxes related to development of real property; PLR 202409002 (Tax Alert 2024-0524), PLR 202305009 (Tax Alert 2023-0265) and PLR 201845001 (Tax Alert 2019-0090) addressing the receipt or accrual of refundable brownfield tax credits relating to the development of rental property; PLRs 202005017 and 202005018 (Tax Alert 2020-0340) addressing the receipt of transferable tax credits relating to the rehabilitation of hazardous waste site into mixed-use real estate development; PLRs 201929014 and 201929015 (Tax Alert 2019-1383) addressing the receipt of a grant payment to develop a shopping center; PLR 201910002 (Tax Alert 2019-0822) addressing the receipt of an incentive payment to develop a multi-use rental real estate project; PLR 201841002 (Tax Alert 2018-2069) addressing the receipt of a grant to redevelop rental property; PLRs 201816001, 201816002 and 201816003 (Tax Alert 2018-0960), addressing the receipt of payments to develop a retail shopping center; PLR 201716043 (Tax Alert 2017-0717), addressing the receipt of grant payments to develop a mixed-use rental property; PLR 201518010 (Tax Alert 2015-0984), addressing receipt of refundable state tax credits for development of apartment complexes and intended to enhance private-sector cleanups of brownfields and reduce development pressure on greenfields; and PLR 201428002 (Tax Alert 2014-1304) addressing the receipt of refundable state tax credits for the development of retail buildings.