REIT income inclusion for carbon emission offsets

Internal Revenue Code Sections 856 (c)(2) and (3) and (d)(1) provide that rents from real property are treated as qualifying income for purposes of the 75% and 95% gross income tests.

Regulation Section 1.856-4(a)(1) generally provides that the rent from real property means the gross amounts received for the use of, or the right to use, real property.

Section 856 (c)(5)(J) provides that the IRS is authorized to determine whether certain items not otherwise included under Code Sections (c )2 and (3) may be either treated as qualifying gross income for these purposes or not included in gross income for these purposes.

IRS analysis

The REIT is issued the Offsets as a result of agreeing to, and complying with, certain land restrictions that satisfy the registry standards for carbon sequestration at the Site. The REIT represented that such land use restrictions could be recorded as easements under local law. For these reasons, the offsets are akin to receiving payment for granting an easement for a term of years with respect to the property which has been treated as rent in the non-REIT context.

In addition, the IRS concluded that such treatment did not interfere with Congress’s objectives in enacting the REIT gross income provisions. Accordingly, the IRS concluded that the Offsets should be treated as qualifying rental income for purposes of the gross income tests under Sections 856 (c) (2) and (3).

Mazars’ insight

The IRS used its authority to hold that the offsets would be treated as qualified REIT gross income even though it did not clearly fall into an enumerated category of qualified REIT gross income.  The IRS reached this conclusion based on the connection of the Restrictions to the use of real property.

Note that the REIT represented that any gain would not be treated as qualifying income from the sale of real property. However, the gain may be minimal since the basis of the Offset would equal the estimated FMV on issuance.

Please contact your Mazars professional for additional information.

The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.