In PLR 202550015, a ruling obtained by professionals at EY, the IRS ruled that amounts received by a real estate investment trust (REIT) from third parties and taxable REIT subsidiaries (TRS) for using warehouse space constitute qualifying rents from real property under IRC Section 856(d) for purposes of the REIT gross income tests under IRC Sections 856(c)(2) and (c)(3) (Income Tests). Among other issues, the IRS also addressed the tax treatment of the REIT's and its TRS's co-ownership of mobile storage containers, the use of the containers in their respective business activities, and payments for usage that exceeds a party's ownership share of the containers.

Facts

Taxpayer is a corporation that intends to elect to be taxed as a REIT. Taxpayer's primary business (Storage Business) is providing space in warehouses to unrelated parties (Tenants) for storing household goods in exchange for a fixed monthly fee (Storage Fee). Taxpayer provides electricity, security and temperature control at the warehouses (Facility Services), which are customarily furnished to tenants of similar properties in the relevant geographic markets.

Taxpayer requires Tenants to load their goods into mobile storage units (Containers) provided by Taxpayer. Each Container is then stored in a space (Slot) in a warehouse. The Storage Fee is a specified dollar amount per Slot, which may be adjusted when the storage agreement is renewed to reflect fair-market-value rent. Tenants do not have direct access to their stored goods and do not have a designated Slot during the term of their storage agreement. Taxpayer does not oversell storage capacity.

Taxpayer represented that the Slots are real property within the meaning of Treas. Reg. Section 1.856-10(b) and the total payments attributable to Containers and any other personal property leased to Tenants under storage agreements at a warehouse will not exceed 15% of the total rent for the tax year attributable to both the real and personal property leased under the storage agreements.

A taxable REIT subsidiary (TRS) of Taxpayer (Services TRS) will move all Containers into and out of the Slots at each warehouse (Handling Service) in exchange for an arm's-length payment by Taxpayer. The Handling Service is customarily provided to tenants of warehouses in the relevant geographic markets. Services TRS will also deliver Containers to and from Tenants' locations and the warehouses for loading and unloading (Delivery Service) and may (1) pack and/or load and unload Tenants' goods (Packing and Loading Service) and/or (2) facilitate Tenants' access to their goods during the term of their storage agreements (Access Service) in exchange for separately stated fees.

Cotenant TRS activities

Another TRS of Taxpayer (Cotenant TRS) will lease Containers to customers (Customers) to use at Customers' locations (Customer-Site Leasing). Cotenant TRS will also earn revenue from (1) transportation and consulting services related to long-distance moves by Tenants, (2) providing contents protection to Tenants, and (3) selling packing supplies to Tenants (Other Activities). Other than engaging Services TRS to deliver Containers to and from Customers' locations, Cotenant TRS will use its own employees to perform, bear all costs of, and earn all revenue from all other activities related to the Customer-Site Leasing and Other Activities.

Container co-ownership

Under state law, Taxpayer and Cotenant TRS will hold legal title to the Containers as cotenants and will enter into a co-ownership agreement giving Taxpayer and Cotenant TRS each an undivided interest in the Containers as tenants in common. The agreement will reflect each party's ownership stake in the Containers (Container Interest Percentage) based on a good-faith estimate of the party's expected use of the Containers in its respective activities. The parties will share the cost of the Containers and report their allocable shares of Container depreciation in accordance with their Container Interest Percentages. Under the co-ownership agreement, each party is legally entitled to retain 100% of the revenue generated by that party's use of the Containers in its business. Thus, the parties will only share in the ownership of and right to use the Containers and not in the revenue generated by their use of the Containers.

Sometimes, however, one party will have to pay the other party an arm's-length daily rental rate for excess Container usage (Excess Usage Payment) as defined in the agreement.

Space leased to TRSs

Taxpayer will lease outdoor Slots on the grounds of its warehouses to Cotenant TRS for storing Containers used by Cotenant TRS in its Customer-Site Leasing business and Other Activities. Taxpayer will also lease office space at each warehouse to the Services TRS. Taxpayer represented that (1) at least 90% of the leased space at a warehouse will be leased to persons other than the TRSs and other related persons and (2) lease payments made by the TRSs will be comparable to rents paid by any third-party lessee for comparable space at the applicable warehouse; where there is no such third-party lessee, lease payments will be at arm's length and substantially comparable to rents paid for comparable space in the same geographic area.

Cost-sharing agreement

Employees in Taxpayer's human resources, legal, accounting and other administrative departments are expected to provide services to Taxpayer, Services TRS and Cotenant TRS. Under a cost-sharing agreement, Services TRS and Cotenant TRS will reimburse Taxpayer for their allocable shares of the employee costs and other shared costs (e.g., overhead and utilities) without a markup. Taxpayer will not be in the business of receiving compensation for the types of services reimbursed under the cost-sharing agreement.

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.

Treas. Reg. Section 1.856-4(a) defines the term "rents from real property" generally as the gross amounts received for the use of, or the right to use, the REIT's real property. Under IRC Section 856(d)(1), "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 which is leased under, or in connection with, a lease of real property," with certain limitations.

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 a TRS or an independent contractor under IRC Section 856(d)(3) from which the REIT does not derive or receive any income (IK), and (2) any payment that would be excluded from unrelated business taxable income under IRC Section 512(b)(3) (UBTI) if received by an organization described in IRC Section 511(a)(2) (IRC Section 856(d)(7)(C)).

Storage Fees are rents from real property

The IRS concluded that the Storage Fees are rents from real property under IRC Section 856(d) for purposes of the Income Tests.

Taxpayer's gross income from Cotenant TRS's use of Containers will be any Excess Usage Payments

In considering the tax treatment of Taxpayer's and Cotenant TRS's co-ownership of the Containers, the IRS looked to Revenue Ruling 82-61, in which two utilities (X and Z) owned an electric generating facility as cotenants. Z sold its 50% undivided interest in the facility to Y and leased it back from Y. The lease provided that Y would receive fixed rent from Z without regard to the profits and losses from the facility, and Y would not share in the power generated by the facility or bear expenses of the facility. In the ruling, the IRS respected the arrangement between X and Y as co-owners of the facility, not partners. X realized income from the facility's business activities, and Y received rent from its tenant. The ruling did not require X or Y to recognize any portion of the income of the other party from its separate use of the co-owned property.

The IRS stated that Revenue Ruling 82-61 "demonstrates that cotenants may agree that each may use the jointly owned property in its own business and retain the proceeds therefrom (whether income from operations or rental income) and that such an agreement may be respected for federal income tax purposes." Accordingly, the IRS concluded that Taxpayer's gross income from Cotenant TRS's use of Containers will be any Excess Usage Payments received from Cotenant TRS for its use of Containers in excess of its allotted usage in a tax year. Such gross income will be non-qualifying for purposes of the Income Tests as any excess Containers leased to Cotenant TRS will not be leased in connection with a lease of real property.

TRS lease income is rents from real property

Based on Taxpayer's representations regarding the TRS leases, and provided the 90% threshold under the TRS limited rental exception of IRC Section 856(d)(8)(A) is met, the IRS concluded that payments received by Taxpayer under the TRS leases will be treated as qualifying rents from real property under the limited TRS rental exception.

Amounts received under the cost-sharing agreement are not gross income for Income Test purposes

The IRS reasoned that the cost-sharing agreement among Taxpayer, Services TRS and Cotenant TRS was similar to the situation described in Revenue Ruling 84-138, in which a regulated investment company (RIC) and its wholly owned subsidiary shared facilities and certain personnel. The parties agreed that the RIC would pay all general and administrative overhead expenses, including personnel expenses, and the subsidiary would reimburse the RIC for its proportionate share of the expenses on an arm's length basis. The IRS concluded that the reimbursements to the RIC in the revenue ruling were "merely repayments of advances made on behalf of the subsidiary," so the reimbursements were not included in the RIC's gross income under IRC Section 61 and were not gross income for purposes of the RIC gross income test under IRC Section 851(b)(2).

On this basis, the IRS concluded that payments received by Taxpayer from Services TRS and Cotenant TRS under the cost-sharing agreement will not be considered gross income under IRC Section 61, including for purposes of the Income Tests.

Implications

PLR 202550015 is the first private letter ruling in which the IRS has addressed the co-ownership by a REIT and its TRS of property used in each party's respective business. While the Taxpayer represented that under applicable state law neither party would have a claim against, or right to share in, the revenues attributable to Containers used by the other party, the IRS confirmed that such state law rights would be respected for federal income tax purposes. Taxpayers contemplating similar arrangements should therefore consider applicable state law, as well as the possibility of obtaining their own ruling.

In addition, PLR 202550015 is similar to other recent private letter rulings in which the IRS has determined that certain tenant services could be provided under a lease, while other services appear not to have been viewed as provided in connection with the rental of real property, thereby requiring tenants to contract directly with a TRS or IK. See PLRs 202552014 (outdoor advertising displays); 202520010 (cold storage); 202530005 (outdoor industrial storage) (Tax Alert 2025-1602); 202413004 (outdoor industrial storage) (Tax Alert 2024-0702).