IRS issues new ruling on the treatment of parking, amenities and services revenue for REITs
If all necessary requirements are satisfied, a REIT can deduct dividends paid from taxable income, thereby reducing income subject to the corporate level income tax. Most REITs distribute their entire taxable income to shareholders and pay no corporate income tax at all.
Among the qualifications the Internal Revenue Service (IRS) sets for a corporation to maintain its REIT status are:
- At least 75% of the corporation’s assets must be real estate assets
- At least 75% of the corporation’s gross income must be derived from rents from real property, interest from mortgages secured by real property and sales of real estate assets
“Rents from real property” are “good income” for the 75% and 95% REIT gross income tests. Section 856(d)(1) of the Internal Revenue Code defines rent from real property to include charges for services customarily furnished or rendered in connection with the rental of real property, whether or not such charges are separately stated.
Regulation section 1.856-4(b)(1) provides that services furnished to tenants of a particular building will be treated as customary if, in the geographic area in which the building is located, tenants in buildings of a similar class are customarily provided with such service. To qualify as a service customarily furnished, the service must be furnished or rendered to the tenants of the REIT primarily for the benefit or convenience of the tenant, their guests, customers or subtenants. This is known as the geographic market test.
Section 856 (d)(2) (C) excludes impermissible tenant service income (ITSI) from the definition of rent from real property, making it “bad income” for the 75% and 95% REIT gross income tests. With respect to any real property, ITSI means any amount received or accrued directly or indirectly by the REIT for furnishing services to the property’s tenant or managing or operating the building, other than services rendered, management or operations through an independent contractor, from whom the REIT doesn’t derive any income, or a taxable REIT subsidiary (TRS). In addition, an amount isn’t treated as ITSI if the amount would be excluded from unrelated business taxable income (UBTI) under section 512(b)(3) if received by a tax-exempt organization.
It’s common for a REIT to offer parking facilities in connection with real property it owns. Income derived from parking facilities raises the question of whether it’s ITSI and therefore excluded from the calculation of rents from real property.
The conference report to the Tax Reform Act of 1986 revision to section 856(d) provides the following guidance on parking services: “A REIT may provide customary services in connection with the operation of parking facilities for the convenience of tenants of an office or apartment building or shopping center, provided that the parking facility is made available on an unreserved basis without charge to the tenants, their guests or customers. On the other hand, income from the rent of parking spaces on a reserve basis to tenants or income derived from the rental of parking spaces to the public wouldn’t be considered as rent from real property unless all services are performed by an independent contractor, in which case income from the renting of parking spaces would be treated as rent from real property.”
In 2004, the IRS issued its seminal, and only, revenue ruling addressing parking services offered by a REIT. Revenue Ruling 2004 –24, interpreting the conference report, the statutes and its regulations as they apply to parking facilities, provided guidance for three situations.
In situation one, the REIT owned office buildings, shopping centers and residential apartment complexes. Each property had parking facilities for tenants of the building, their guests, customers and subtenants. Each parking facility was located in or adjacent to a building occupied by the tenants and was appropriate in size for the number of tenants and their guests, customers and subtenants who were expected to use the facility. The parking facilities didn’t have attendants, and the REIT maintained, repaired and lit the parking facility. No other activities were performed in connection with the parking facilities.
The IRS ruled:
(1) The above-listed services rendered in this situation were activities customarily performed at parking facilities located in the geographic area and fell within the REIT’s fiduciary functions. Thus, they met the geographic test, and income would be treated as rents from real property.
(2) Each parking facility met the requirement that it be located in or adjacent to the building occupied by the REIT’s tenants and was appropriate in size for the number of tenants and their guests, customers and subtenants who are expected to use the facility. Therefore, the furnishing of an unattended parking facility meets the requirements that services be furnished to the REIT’s tenants, their guests, customers or subtenants.
In situation two, the facts were the same as situation one except that at some of the parking facilities, parking spaces were reserved for tenants’ use. The REIT assigned and marked the reserved spaces. Any reoccurring functions unique to the reserved spaces, such as enforcement, would be provided by an independent contractor.
Citing the 1986 conference report, the IRS ruled that unattended but reserved parking spaces, if operated by an independent contractor, wouldn’t prevent the income received by the REIT for furnishing parking facilities from qualifying as rents from real property.
In situation three, the facts were the same as situations one and two in that each parking facility was appropriate in size for the expected number of tenants and their guests, customers and subtenants. However, some of the parking facilities were available for use by the general public.
In addition, the parking facilities were managed by an independent contractor and had parking attendants who could park cars to achieve the maximum capacity of the parking facility or for reasons of safety and security.
The IRS ruled that the activities performed at the attended parking facilities were customary in the geographic market. The IRS also noted that the attended parking facilities were available for use not only by the REIT’s tenants and their guests, customers and subtenants but also by the general public.
Because of the proximity to the tenants and its appropriate size, it can reasonably be expected to be used primarily by the REIT’s tenants and their guests, customers and subtenants. For these reasons, the IRS ruled that the furnishing of the attended parking facility will be treated as meeting the requirement that the services be rendered to the REIT’s tenants, their guests, customers and subtenants.
In 2018, the IRS addressed the issue of whether making space and facilities available in apartment buildings is a service or an amenity. The former is subject to an ITSI analysis, and the latter is not. In PLR 201812009, the REIT owned luxury apartment buildings. The REIT provided many facilities to the tenants, such as a swimming pool, exercise room with equipment and a roof deck. The IRS ruled that making facilities available isn’t itself a service (on the other hand, staffing the facilities with a lifeguard, etc., could be such a service). Accordingly, ITSI doesn’t apply to the facilities.
The IRS also addressed whether basic repairs to kitchen appliances and light fixtures in tenants’ units creates ITSI. The REIT represented that these services were customary in the geographic area, were provided to all tenants and therefore didn’t constitute personal services to any particular tenant. Based on these representations, the IRS ruled that these services don’t create ITSI.
In PLR 202304003, the IRS addressed parking and other services furnished in an office building. A REIT was a partner in an operating partnership that owned interests in office buildings. Certain properties made available to the tenants included parking facilities, designated storage areas, fitness centers and certain “listed services.” In addition, certain third-party services were made available at some of the properties. The REIT represented that the properties are typical of Class A office buildings.
Four of the properties contain parking facilities available to tenants and their guests, customers and subtenants (tenants), as well as the general public, for a fee on an hourly, daily or monthly basis. The REIT represented that the number of available spaces in each of the parking facilities is appropriate in size for the expected number of tenants.
The REIT will engage either a TRS or an independent contractor (parking manager) to manage and oversee the operation of each of the parking facilities. The parking manager will employ all the employees, including the attendants who may occasionally provide minor incidental emergency services, solely for the purposes of safety, and to facilitate the efficient use of the parking spaces by moving vehicles in and out of parking spaces.
Based on the REIT’s representations, the IRS ruled that the size, use, management and operation of the parking facilities were comparable to those in the parking facility described in situation 3 of Revenue Ruling 2004-24. As such, the parking fees, including fees from the public, will be treated as rents from real property. The IRS also ruled that a TRS could be the parking manager, similar to its ruling in PLR 201341015.
In addition to parking, some of the properties owned by the REIT also provided a designated storage area to the tenant without charge. Consistent with PLR 201812009, but in the office situation, the IRS ruled that storage areas aren’t services but rather are amenities or facilities. As such, income attributable to making the designated storage areas available to all tenants of the property for no charge isn’t income from the provision of a service and therefore isn’t ITSI. This income will be treated as rent from real property.
The properties also had fitness centers available to the tenants. In some cases, the fitness centers were available at no charge, while other properties imposed a fee. The IRS also applied its reasoning in PLR 201812009 in holding that providing fitness facilities isn’t a service where the facilities are available for use by all tenants at no additional charge. Rather, they’re common areas, and income that’s purely attributable to making fitness centers available to all tenants isn’t income from the provision of a service and therefore isn’t ITSI. However, income from fitness centers requiring membership fees to use the facilities will not be treated as rents from real property.
All services performed at staffed fitness centers and towel service provided at unstaffed fitness centers will be provided by an independent contractor. Accordingly, any portion of the rent from the properties attributable to services provided by the independent contractor will not be treated as ITSI.
Lastly, the REIT provided various listed services to tenants at some of the locations, including routine replacement of lights, electrical maintenance, repairs to tenant spaces and interior signage. Similar to the facts in PLR 201812009, which involved an apartment building, the REIT represented that routine lighting, electrical maintenance, repair in tenant spaces and software applications are services customarily provided to tenants of Class A buildings located in the geographic market.
The REIT further represented that those services are provided to all tenants and aren’t personal services rendered to any particular tenant. Based on these representations, the IRS ruled that these services are services that would be excluded from UBTI if received by a tax-exempt entity and therefore aren’t ITSI. This ruling extends the analysis used in the apartment building context to an office property without creating ITSI.
The office property also had interior signage that will be controlled and maintained by an independent contractor. The REIT represented that any services provided in connection with the interior signs are customarily furnished or arranged for by property owners in connection with the leasing of space in Class A office buildings in the geographic market. Based on the taxpayer’s representation, the IRS ruled that the services wouldn’t create ITSI.
In conclusion, PLR 202304003 breaks new ground in the office context by applying the amenity vs service concept to office buildings, reiterates the factors necessary to meet Revenue Ruling 2004-24 and confirms that a TRS can provide the parking services.
Please contact your Mazars professional for additional information.