On Nov. 9, 2022, the IRS ruled in Private Letter Ruling (PLR) 202305009 that the right of a real estate investment trust (REIT) to receive Brownfield Redevelopment Tax Credits (Brownfield Credits) treated as a receivable on its balance sheet in accordance with generally accepted accounting principles (GAAP), will be considered a qualifying receivable for purposes of the 75% asset test.
Moreover, income attributable to the Brownfield Credits will be treated as qualifying income for purposes of the 95% and 75% REIT gross income tests.
The taxpayer is a limited liability company electing to be treated as a REIT. The taxpayer intends to redevelop a project site and will incur significant environmental remediation costs in connection therewith. The taxpayer represents that these expenditures are related to real property, as referenced in Treasury Regulations Section 1.856-10.
Due to the remediation and development of the project site, the taxpayer is eligible for state Brownfield Credits. The Brownfield Credits will offset the taxpayer’s state income tax liability and will not be an abatement or offset to real property taxes.
As a REIT, it’s not anticipated that the taxpayer will have a significant tax liability and therefore the credits are expected to be in excess of its income tax liability. Thus, the taxpayer will receive a refund of the credits. None of the anticipated Brownfield Credits will be purchased from a third party.
Following the project’s completion, the taxpayer intends to lease space at the project site to unrelated third parties to generate rents from real property for purposes of the 95% and 75% gross income tests under Internal Revenue Code (IRC) Sections 856(c)(2) and (3). The taxpayer further represents that it expects substantially all the income aside from the Brownfield Credits income to qualify under the REIT gross income tests.
The law and analysis
IRC Section 856(c)(2) requires at least 95% of a REIT’s gross income be derived from specified passive income sources, including rents from real property, and abatements and refunds of real property taxes. In addition, IRC Section 856(c)(3) requires at least 75% of a REIT’s gross income to be derived from specified real estate sources, including rents from real property, and abatements and refunds of real property taxes.
Under IRC Section 856(c)(5)(j), the IRS is authorized to determine whether income not otherwise qualifying under Sections (c)(2) and (3) is either disregarded for purposes of the 95% and 75% tests or considered qualifying income for purposes of the tests.
IRC Section 856(c)(4) requires a qualifying REIT to have at least 75% of the value of its total assets to consist of real estate, cash and cash items (including receivables), and government securities. Treasury Regulations Section 1.856-2(d)(1) defines “receivables” as those arising in the ordinary course of operations, excluding receivables purchased from third parties.
The IRS ruling concluded that to the extent the credit is reported on its balance sheet as a GAAP asset, the right to receive the Brownfield Credits will be treated as a “receivable” under IRC Section 856(c)(4), as it arises from the development of real property intended to be leased and will not be acquired via purchase.
In addition, based on the taxpayer’s representations that it intends to lease the project site to generate real property rents and further expects substantially all the income to be qualifying REIT income, the IRS used its discretion under Section 856 (c)(5)((j) to rule the Brownfield Credit income be treated as qualifying income for purposes of the 95% and 75% tests.
The ruling follows a recent trend of the IRS using its (c )(5)(J) discretion to rule favorably on incentives like Brownfield Credits under the REIT asset and income tests in association with the development of real property held for the production of qualifying rental income.
Future treatment consistent with the foregoing is likely critical in the current economic and political environment, in which ESG strategy is becoming an increasingly important component of companies’ mission and vision statements. For example, the Inflation Reduction Act of 2022 allows REITs to sell ITCs regarding solar energy and treat the income as not recognized for taxable income and REIT gross income test purposes.
Contact us if you have any questions about this new tax development.