Recent Favorable REIT Private Letter Ruling
The IRS recently issued a letter ruling (PLR 201323016) regarding treatment of interests held by a “to be formed” corporation that will elect to be taxed as a “real estate investment trust” (REIT) for federal income tax purposes. This ruling appears to be the one requested by Hannon Armstrong Sustainable Infrastructure Capital, Inc. in anticipation of its recent IPO as a financing REIT. While the ultimate impact of the ruling is unclear, it may broaden the types of financing transactions REITs will be able to engage in.
As background, Code Section 856(c)(4) provides the “asset test” requirement for an eligible entity to be taxed as a REIT, which includes the requirement that, at the close of each quarter of the taxable year, at least 75% of the value of its total assets be represented by real estate assets, cash and cash items (including receivables), and Government securities.
Code Section 856(c)(2) provides, with respect to certain REIT “income test” requirements, that at least 95% of a REIT's gross income must be derived from, among other sources, “interest.” Code Section 856(c)(3) provides that at least 75% of a REIT's gross income must be derived from, among other sources, “interest on obligations secured by mortgages on real property or on interests in real property.”
Code Section 856(c)(5)(B) provides that “real estate assets” means, in part, real property (including interests in real property and interests in mortgages on real property) and shares (or transferable certificates of beneficial interest) in other real estate investment trusts that meet certain requirements.
The REIT in the ruling will finance structural improvements secured by the structural improvements and the underlying building or facility. The structural improvements are intended solely for the use of the building or facility and it is not the purpose of the structural improvements to operate a business. In addition, the structural improvements are located on the building or facility owner’s real property, are necessary for the building or facility to function, and would be included in the collateral or assets sold if the real property was financed or sold.
Although not mentioned in the redacted ruling made public by the IRS, it is believed that the “structural improvement” to which this ruling relates is a photovoltaic array located on the roof of or adjacent to the building.
The IRS concluded that the REIT’s collateral interest in the structural improvements, and the real property on to which it is installed, constitute interests in loans secured by the real property for purposes of Code Section 856(c)(5)(B).
In its analysis, the IRS relied in part on Revenue Ruling 73-425 which distinguished between a mortgage lien secured solely by a building in a total energy system (not an interest in real property) and one secured by the total energy system and the building itself (treated as an interest in real property). Another seemingly important requirement in the new ruling is that the structural improvements, i.e., solar equipment, be used solely to produce energy for the use of the building or facility and not to operate a business. Thus, it appears that this ruling will not support the classification of a solar farm constructed for the purposes of selling electricity to a utility or to an end user as a real estate asset for REIT purposes
© TROUTMAN SANDERS LLP. ADVERTISING MATERIAL. These materials are to inform you of developments that may affect your business and are not to be considered legal advice, nor do they create a lawyer-client relationship. Information on previous case results does not guarantee a similar future result. Follow Troutman Sanders on Twitter.