IRS backtracks on REIT rent treatment in letter ruling

Section 865(d)(2)(A) states that the term “rents from real property” does not include “any amount received or accrued, directly or indirectly, with respect to any real or personal property, if the determination of such amount depends in whole or in part on the income or profits derived by any person from such property (except that any amount so received or accrued shall not be excluded from the term ‘rents from real property’ solely by reason of being based on a fixed percentage or percentages of receipts or sales).”

The 2013 PLR concerned a proposed transaction by a large casino organization, whereby a REIT would separate its real estate assets (“PropCo”) from its casino operations (“OpCo”), and the OpCo would pay rents to the PropCo REIT based on a calculation of OpCo’s adjusted revenue. The 2013 PLR provided that this arrangement and calculation would not prevent the rents from qualifying as “rents from real property” under section 865(d)(2)(A).

In the lease arrangement, OpCo’s rent to PropCo increased each year based upon the lesser of a fixed percentage of the prior year’s base rent or on a calculation tied to “adjusted revenue,” defined as “the net revenue of the lessee minus expenses other than (i) interest expense, (ii) income tax expense, (iii) depreciation and amortization expense, (iv) rent expense, and (v) certain other expenses,” amongst other escalation provisions.

In the February 4 ruling, the IRS stated that “adjusted revenue’ is not equivalent to “receipts or sales” but is, rather than, a measure of “income or profits” of the lessee. Therefore, receipt of amounts pursuant to the “adjusted revenue” calculation resulted in the disqualification of all rents under section 865(d)(2)(A). The IRS further stated that the previous treatment of these arrangements as qualifying rents “is not in accord with the current views of the service.”

Conclusion

While private letter rulings (PLRs) are not precedential by statute (section 6110(k)(3)), a fact that the IRS always points out in its PLRs, the IRS apparently thought the 2013 PLR was of such importance that it needed to overrule a position
taken in a prior PLR, acknowledging taxpayers’ use of PLRs as guidance. 
While REITs are subject to a multitude of requirements, the requirement that a REIT’s rents qualify as “rents from real property” is of critical importance. The February 4 ruling means that REIT taxpayers and their advisors will need to carefully consider lease arrangements to ensure that rents derived under leases tied to lessee operations are not considered derived based on income or profits, but rather receipts or sales. 

Please contact the Mazars REIT practice for more information surrounding this important development.

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.