In Letter Ruling 201628020, the IRS ruled that amounts received by a real estate investment trust (REIT) from the provision of parking spaces in its parking garage, in part, to the tenants of the REIT's office building and, in part, to a third-party owner of an adjacent building under a long-term lease constitute qualifying rents from real property. Letter Ruling 201628021 appears to address the same facts as Letter Ruling 201628020 for another REIT investor in the partnerships described below, and it reaches a consistent conclusion.
Taxpayer, an entity that has elected to be taxed as a REIT, owns Building 1 through its interest in a partnership (Partnership 1). TRS1, a taxable REIT subsidiary of Taxpayer, owns Parking Garage through its interest in another partnership (Partnership 2).
Building 1, Building 2 (which is adjacent to Building 1), and Parking Garage make up the office park. Building 2 is owned by an unrelated third party, which originally built Building 1, Parking Garage, and Building 2 as one integrated office park and then subsequently sold Building 1 and Parking Garage. Parking Garage, a parking structure adjacent to Building 1, was built to accommodate the tenants of Building 1 and Building 2, as well their employees, customers, and guests.
In a prior year, the owners of Building 1, Building 2, and Parking Garage entered into an easement agreement, which requires the owner of Parking Garage to maintain the number of parking spaces required to satisfy the legal on-site parking requirements under the city municipal code and to make Parking Garage available for the nonexclusive use of the owners and occupants of Building 1 and Building 2. Except for a small number of reserved spaces, the garage is unreserved and unassigned. Use by the general public is de minimis.
The owner of Parking Garage has entered into an agreement with Operator to operate the Parking Garage. The garage has unmanned entrances and exits with electronic gates. One Operator employee is present during weekday business hours to ensure that everything is in order and there are no safety concerns. In a prior year, the owner of Building 2 entered into a long-term lease (parking lease) with the owner of Parking Garage under which the owner of Building 2 must lease between X and Y parking spaces within the Parking Garage and pay the owner of Parking Garage fixed, monthly rent. In a prior year, the owner of Building 2 also entered into a long-term agreement (storage agreement) with the owner of Parking Garage under which it leases storage space in the Parking Garage and pays the owner of Parking Garage fixed rent.
Taxpayer proposes to have Partnership 1 acquire Parking Garage from Partnership 2, subject to the easement agreement, the parking lease, the storage agreement, and all other obligations. Partnership 1 will continue to have Parking Garage operated by Operator in the same manner as before the proposed transaction. After the proposed transaction, the owner of Building 2 will be a tenant of Partnership 1 as a tenant of the Parking Garage.
Law and Analysis
To qualify as a REIT, an entity must derive at least 95% of its gross income from sources listed in Sec. 856(c)(2) and at least 75% of its gross income from sources listed in Sec. 856(c)(3). Rent from real property is a source listed under both Code sections. Sec. 856(d)(1) defines rents from real property to include rents from interests in real property, charges for services customarily rendered in connection with the rental of real property, and rent attributable to certain leased personal property.
Further, Regs. Sec. 1.856-4(b)(1) provides that, for purposes of Secs. 856(c)(2) and (c)(3), the term "rents from real property" includes charges for services customarily furnished or rendered in connection with the rental of real property, whether or not the charges are separately stated. Services rendered to tenants of a particular building are customary if, in the geographic market in which the building is located, tenants in buildings of a similar class are customarily provided with the service. The regulations list parking facilities as an example of services that are customarily furnished to the tenants of a particular class of buildings in many geographic marketing areas.
Rev. Rul. 2004-24 provides examples of three situations in which amounts received by a REIT for furnishing parking facilities at its rental properties will constitute qualifying rents from real property under Sec. 856(d). The analysis section of Rev. Rul. 2004-24 quotes from the conference report underlying the 1986 revision of Sec. 856(d) as follows:
The conferees intend, for example, that 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 facilities are made available on an unreserved basis without charge to the tenants and their guests or customers. On the other hand, the conferees intend that income derived from the rental of parking spaces on a reserved basis to tenants, or income derived from the rental of parking spaces to the general public, would not be considered to be rents from real property unless all services are performed by an independent contractor. Nevertheless, the conferees intend that the income from the rental of parking facilities properly would be considered to be rents from real property (and not merely income from services) in such circumstances if services are performed by an independent contractor. [Quoting 2 H.R. Conf. Rep't No. 841, 99th Cong., 2d Sess. II-220 (1986)]
In Letter Ruling 201628020, the IRS explained, in regard to the portion of Parking Garage made available to Building 1's tenants, employees, customers, and guests, as well as the general public, that (1) the aforementioned portion of Parking Garage "is appropriate in size" for the number of tenants of Building 1 and their guests, customers, and subtenants who are expected to use Parking Garage; and (2) the services provided are customary and most will be provided through an independent contractor. Accordingly, the IRS ruled that, consistent with Situation 3 of Rev. Rul. 2004-24, the Taxpayer's income from providing parking facilities to its Building 1 tenants will qualify as rents from real property.
The IRS explained, regarding the portion of the Parking Garage made available to the owner of Building 2, that (1) while the lease of parking spaces to the owner of Building 2 is not for the use of the entire Parking Garage, it is a lease for the use of a specified number of parking spaces within the Parking Garage and, consistent with the terms of the 1986 conference report, represents an agreement for the rental of real property; and (2) all the services provided in regard to the Parking Garage and storage space are customary and most of the services will be provided through an independent contractor. Accordingly, the IRS ruled that income derived by Taxpayer under the parking lease and storage agreement qualifies as rents from real property.
Letter Ruling 201628020 is of interest for at least two reasons. First, it addresses the "appropriate size" requirement of Rev. Rul. 2004-24 when a REIT's parking garage is subject to a preexisting easement agreement with an adjacent property that was developed as part of the same development plan with the REIT's property and was constructed to serve both properties.
Second, Letter Ruling 201628020 appears to be the first private letter ruling addressing a situation in which income received by a REIT under a lease of some parking spaces in a garage, but not all parking spaces, may constitute rents from the provision of real property space to a tenant, as contrasted with income from the provision of a service.
In general, the REIT provisions treat the income received by a REIT from making available parking spaces in a parking garage to tenants or third parties as income from the provision of a "service," unless the parking garage is master-leased to a third party under a lease agreement that is respected as a true lease for federal tax purposes. Letter Ruling 201628020 addresses specific and unique facts, and thus REITs and advisers will want to exercise caution in drawing any broad conclusions regarding the IRS's view on this matter.
Michael Dell is a partner at Ernst & Young LLP in Washington.
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