In a private letter ruling (PLR 201428002) released on April 2, the IRS ruled that a real estate investment trust's (REIT) right to receive a state franchise tax refund constitutes a receivable arising in the REIT's ordinary course of operations.

To qualify as a REIT, a corporation must meet the asset tests under Section 856(c)(4) and the income tests under Sections 856(c)(2) and (3).

The asset tests under Section 856(c)(4) include a test that the total assets of a REIT, at the close of each quarter, must consist of at least 75% of "qualifying assets" including real estate assets, cash and cash items (including receivables), and government securities. The term "total assets" means gross assets of the REIT determined according to GAAP.

The income tests under Sections 856(c)(2) and (3) provide that a REIT must derive "qualifying income" as follows:

  • At least 95% of its gross income must come from certain specified sources including abatement and refunds of real property taxes.
  • At least 75% of its gross income must come from certain specified sources including abatement and refunds of real property taxes.

The IRS has authority under Section 856(c)(5)(J) to determine whether income that isn't specified in Sections 856(c)(2) and (3) constitutes qualifying income.

In PLR 201428002, a REIT owned a mixed-use real estate development indirectly through partnership interests. The REIT was eligible to claim two types of state tax credits pertaining to its remediation of contamination, construction and operation of the development project.

Under the state tax law, the credits were deemed an overpayment of the state franchise tax and refundable. For GAAP purposes, the REIT recorded unpaid claims for the credits as receivables.

The amount of one of the credits was determined based on a percentage of certain expenditures incurred by the REIT, and the amount of the other credit was determined based on the benefit period, employment and real property taxes related to the REIT's activities on the project.

The IRS ruled that the REIT's receivables for the credits were qualifying assets because the receivables arose in the ordinary course of the REIT's operations as owner and lessor of the project under Treas. Reg. Sec. 1.856-2(d)(1)(iii).

The IRS also ruled that the income that could be attributed to the credits was qualifying income. Specifically, the income that could be attributed to the second credit represented a refund of real property taxes under Section 856(c)(2)(E), and the income that could be attributed to the first credit was ruled to be qualifying income pursuant to the IRS's authority to determine qualifying income under Section 856(c)(5)(J)(ii).

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