IRS rules for first time that REIT’s income from markup on electricity from EV charging stations is rents from real property

Editor: Susan M. Grais, CPA, J.D., LL.M.

In IRS Letter Ruling 202530005, the Service ruled that payments received by a real estate investment trust (REIT) for the use of space at outdoor industrial storage facilities and providing certain services and amenities constitute rents from real property under Sec. 856(d) for purposes of the REIT gross–income tests under Secs. 856(c)(2) and (c)(3) (income tests).

The ruling marks the first time the IRS addressed whether a REIT’s markup on electricity drawn from electric vehicle charging stations (EV stations) constitutes rents from real property.

Facts

The taxpayer, a limited liability company that intends to elect to be taxed as a REIT, has acquired and plans to acquire outdoor industrial storage facilities (properties). The properties will generally be paved, fenced, and lit. The taxpayer represented that the properties will consist of real property under Regs. Sec. 1.856–10.

Storage agreements: The taxpayer will enter into agreements (storage agreements) with unrelated third parties (tenants) for the use of space at the properties. The properties mainly provide outdoor industrial storage space for tenant equipment. A storage agreement for outdoor industrial storage space will reserve a specified amount of space at a property for the tenant and may allocate a specific storage space to a particular tenant. Where properties are near each other within a metropolitan area, a storage agreement may provide that a tenant’s allocated amount of storage space may be available at any such property.

Some indoor industrial space at the properties is also available. A storage agreement for indoor industrial space will reserve a specific space associated with one or more docking bays in a large open warehouse for the tenant. Tenants will handle their own cargo in the indoor industrial space using their own equipment.

The storage agreements will have a specified term and generally automatically renew on a monthly basis. Tenants will pay a fixed fee (storage fee) for the right to use their leased space regardless of whether they use the space. The taxpayer may increase storage fees based on market conditions, such as inflation, upon renewal of a storage agreement.

Certain services:The taxpayer will design the properties and perform certain services customarily provided at similar properties in the same geographic area as the properties, including inspecting, maintaining, and repairing the properties and checking that no equipment is stored at a property without a valid storage agreement. The taxpayer may also provide security via cameras, guards, or both, and tenants will enter and exit properties via a gate with key code or electronic device access.

Tenants will generally move their own equipment into and out of their storage spaces. Where it is possible to stack tenant equipment, the tenant will deliver the equipment to a staging area at the property, and employees of a taxable REIT subsidiary (TRS) or an independent contractor from which the taxpayer derives no income (IK) will move the equipment to the appropriate area inside the property to store it efficiently. The taxpayer represented that this service is customary and will be provided to all tenants with stackable equipment.

A TRS or IK may offer other services (additional services) at a property, such as (1) truck and trailer inspections and (2) fueling, washing, and maintenance of tenant trucks and equipment. Tenants will directly contract with and pay the TRS or IK for the additional services. The taxpayer represented that it will not receive rent from an IK providing additional services, derive any income from the additional services, or bear any cost of providing the additional services.

Electricity and EV stations:The taxpayer will engage a utility provider that is an IK to provide utility services, such as electricity for (1) lighting the properties and (2) tenant use in storage areas to power and charge tenant equipment, including via EV stations. The taxpayer represented that it will install EV stations only at properties where EV stations are customary at similar properties in the relevant geographic area. The EV stations will be within the fenced areas of the properties and will have connection mechanisms designed for powering and charging tenant equipment, not smaller personal vehicles. Therefore, the EV stations will not be available to or accessible by the general public.

The taxpayer may charge higher storage fees for storage spaces near electricity sources, including EV stations. The taxpayer will also charge tenants for electricity drawn from EV stations and may charge a markup on the electricity. The taxpayer represented that the markup on electricity drawn via EV stations represents a return on the costs of installing the EV stations and the ongoing costs of administering and maintaining the EV stations. The letter ruling defines storage fees plus amounts paid by tenants for electricity provided through EV stations, including any markup, as “total rents.”

Amenities: A property may include amenities, such as restrooms, shower facilities, and weigh stations, which will be available to all tenants of that property. Access to amenities at some properties will be available to tenants at no charge (included amenities). The only services provided by the taxpayer in connection with the included amenities will be customary utilities, cleaning, and basic maintenance. Such services will be included in the storage fee, will be provided to all tenants, and will not be personal services provided to any particular tenants.

At other properties, the taxpayer may charge tenants a separate fee for access (access fee) to an amenity (access fee amenities). The taxpayer represented that a TRS or IK will provide all utilities, cleaning, and maintenance for the access fee amenities. The taxpayer will not treat access fees as qualifying rents from real property for purposes of the income tests.

Parking:Properties may have unattended parking areas that will be appropriate in size for the number of tenants (and their guests, customers, and subtenants) expected to use storage space at the property. Tenants will not pay an additional charge for parking, and the only activities performed in connection with the parking areas will be routine maintenance, repair, and electricity for lighting.

TRS lease:The taxpayer will lease any space necessary to perform additional services at a property, as well as a specified amount of storage space, to its TRS (TRS lease). The TRS will sublease portions of the storage space to third parties on a shorter–term basis. The taxpayer represented that TRS payments for the use of space at a property will be substantially comparable to storage fees paid by tenants for comparable space; if no comparable space is leased to a tenant, TRS payments will be substantially comparable to payments for similar space leased to unrelated parties in the same geographic area.

Law and analysis

Sec. 856(c)(2) requires a REIT to derive at least 95% of its gross income from specified sources of passive income, including rents from real property. Sec. 856(c)(3) further requires a REIT to derive at least 75% of its gross income from specified sources of real estate—source income, including rents from real property.

Regs. Sec. 1.856–4(a) defines the term “rents from real property” generally as the gross amounts received for the use of, or the right to use, the REIT’s real property. Under Sec. 856(d)(1), the term “rents from real property” includes: “(A) rents from interests in real property, (B) charges for services customarily furnished or rendered in connection with the rental of real property, whether or not such charges are separately stated, and (C) rent attributable to personal property which is leased under, or in connection with, a lease of real property, but only if the rent attributable to the personal property for the taxable year does not exceed 15 percent of the total rent for the taxable year attributable to both the real and personal property leased under, or in connection with, such lease.” A service furnished to tenants of a particular building will be considered customary if, in the geographic market in which the building is located, the service is customarily provided to tenants in buildings of a similar class (Regs. Sec. 1.856–4(b)(1)).

Under Sec. 856(d)(2)(C), the definition of “rents from real property” does not include impermissible tenant service income (ITSI) (defined by Sec. 856(d)(7)(A) as any amount received or accrued by the REIT for services furnished or rendered to tenants or for managing or operating the property). ITSI also does not include (1) payments received for services, management, or operations provided through an IK or TRS and (2) any payment that would be excluded from unrelated business taxable income under Sec. 512(b)(3) (UBTI) if received by an organization described in Sec. 511(a)(2) (Sec. 856(d)(7)(C)). Further, Sec. 856(d)(7)(B) specifies that if the amount of ITSI with respect to a property for any tax year exceeds 1% of all amounts received or accrued during such tax year directly or indirectly by the REIT with respect to such property, the ITSI of the REIT will include all of the amounts received or accrued with respect to the property.

Storage fees are rents from real property:The taxpayer represented that (1) storage fees will not depend on the income or profits of any person; (2) rent attributable to leased personal property under each storage agreement will not exceed 15% of the total rent for the tax year for both the real and personal property leased under the storage agreement; and (3) ITSI will not exceed 1% of all amounts received or accrued from a property during a tax year. Given these representations and the terms of the storage agreements, the IRS concluded that the portion of storage fees received for the use of space at the properties are rents from real property under Sec. 856(d) for purposes of the income tests. In so concluding, the IRS noted that tenants reserving an amount of space that is not “specifically identified” at a property would not alter the conclusion.

Income from certain services is rents from real property:The IRS stated that designing properties is a fiduciary duty of the REIT. It further noted that the portion of storage fees attributable to the taxpayer’s routine inspection, maintenance, and repair, as well as to the taxpayer’s provision of security at the properties — services that the taxpayer represented are customarily provided to tenants of similar properties in the same geographic area — would be excluded from UBTI if received by an organization described in Sec. 511(a)(2). In addition, the taxpayer represented that the service of stacking tenant equipment to maximize storage space is customarily provided to tenants of similar properties in the same geographic area and will be performed by a TRS or IK. Accordingly, the income from all such services, as well as for the taxpayer’s designing the properties, will not be treated as ITSI and will constitute rents from real property under Sec. 856(d) for purposes of the income tests, the IRS ruled.

The taxpayer represented that the TRS or IK will directly provide and bill additional services to tenants and that the taxpayer will not derive any income from the additional services or bear any cost of providing the additional services. Based on this, the IRS concluded that the availability of the additional services will not result in ITSI and will not cause any portion of total rents to fail to quality as rents from real property within the meaning of Sec. 856(d) for purposes of the income tests.

Income from electricity and the EV stations is rents from real property:With respect to providing electricity through an IK to light the properties and power and charge tenant equipment, the taxpayer represented that providing electricity and light is a utility service customarily provided to tenants of similar properties in the same geographic area. The IRS reasoned that the portion of rents from the properties attributable to the routine provision of lighting and electricity would be excluded from UBTI if received by an organization described in Sec. 511(a)(2). Accordingly, the income from such services will not be treated as ITSI and will constitute rents from real property under Sec. 856(d) for purposes of the income tests.

The IRS further stated that the service provided by an EV station is electricity and reasoned that charging for electricity drawn by a tenant or subtenant is analogous to submetering utilities, which is a customary service under Regs. Sec. 1.856–4(b)(1). The Service concluded that any income from the provision of electricity to tenants via EV stations, including any markup, will not be considered ITSI and will constitute rents from real property under Sec. 856(d) for purposes of the income tests. This conclusion was based on the following facts and taxpayer representations:

• The taxpayer will install EV stations only at properties where EV stations are customary at similar properties in the relevant geographic area;
• The EV stations’ connection mechanisms are suitable for tenant equipment and not personal vehicles;
• The EV stations will be located within the fenced perimeter of the properties;
• The EV stations will not be available to or accessible by the general public; and
• The markup on electricity drawn via EV stations represents a return on the costs of installing the EV stations and the ongoing costs of administering and maintaining the EV stations.

Income from included amenities is rents from real property:The IRS concluded that income from making included amenities available to the tenants is not income from providing a service and therefore will not be treated as ITSI; as such, it will constitute rents from real property under Sec. 856(d) for purposes of the income tests. In addition, income attributable to the services provided in connection with the included amenities (i.e., utilities, cleaning, and maintenance) would be excluded from UBTI if received by an organization described in Sec. 511(a)(2) and therefore will not be treated as ITSI; as such, it will constitute rents from real property under Sec. 856(d) for purposes of the income tests.

Access fees and income from services at access fee amenities are not ITSI:Based on the taxpayer’s representation that a TRS or IK will provide utilities for, and clean and maintain, the access fee amenities, the IRS concluded that income from such services will not be ITSI and will not cause any portion of total rents to fail to qualify as rents from real property under Sec. 856(d) for purposes of the income tests. The IRS also concluded that the access fees will not be ITSI and will not cause any portion of total rents to fail to qualify as rents from real property under Sec. 856(d) for purposes of the income tests.

Parking income is rents from real property:In Rev. Rul. 2004–24, the IRS addressed three situations in which a REIT’s income from making parking spaces available in a parking facility located at the REIT’s rental property qualified as income from providing customary services and thus qualifying rents from real property under Sec. 856(d). In Situation 1 of the revenue ruling, the IRS stated that income received by a REIT from providing unattended parking facilities to its rental property’s tenants and their guests, customers, and subtenants constituted rents from real property when (1) the parking facility was located in or adjacent to the rental property; (2) the parking facility was appropriate in size for the number of tenants and their guests, customers, and subtenants who were expected to use the facility; (3) the parking facility did not have parking attendants; and (4) the REIT’s activities performed in connection with the parking facilities were limited to maintenance, repairs, lighting, and fiduciary functions, such as dealing with taxes and insurance. Based on the taxpayer’s representations regarding parking areas at the properties and their similarities to Situation 1 of Rev. Rul. 2004–24, the IRS concluded in the letter ruling that amounts received by the taxpayer attributable to parking will qualify as rents from real property under Sec. 856(d).

TRS lease income is rents from real property:Under Sec. 856(d)(8)(A), payments to a REIT by its TRS for the use of space at a property are not excluded from rents from real property as related–party rent if (1) at least 90% of the property’s leased space is rented to parties other than TRSs and related parties described in Sec. 856(d)(2)(B), and (2) payments by the TRS are substantially comparable to rents paid by other tenants for comparable space.

Based on the taxpayer’s representations regarding the TRS lease, and provided that at least 90% of a property’s leased space is leased to persons other than TRSs or other related parties, the IRS concluded that payments received by the taxpayer under the TRS lease will be treated as qualifying rents from real property under the limited TRS rental exception.

Implications

Letter Ruling 202530005 is the second ruling to address payments received by a REIT for the use of outdoor industrial storage space at paved and fenced parking/storage lots for tenants’ equipment, including trucks and equipment that tenants may be able to move into and out of the space without assistance. As in Letter Ruling 202413004, the IRS concluded that such payments are rents from real property under Sec. 856(d) for purposes of the income tests. The conclusions in Letter Rulings 202530005 and 202413004 are also similar to that in Letter Ruling 202237004, in which the IRS concluded that payments received by a REIT for the use of space in outdoor dry dock storage facilities, including facilities at which tenants moved boats on tenant–owned trailers into and out of the storage area, would not be treated as other than rents from real property under Sec. 856(d).

Letter Ruling 202530005 is also notable as the first ruling to address the treatment of a markup charged on electricity drawn by a REIT’s tenants and subtenants from EV stations for purposes of the income tests. The IRS previously concluded in Letter Ruling 202413004 that amounts received by a REIT for making EV stations available and providing electricity via EV stations to tenants and their guests and customers constitute rents from real property for purposes of the income tests where the REIT (1) did not intend to charge EV station access fees or a markup on electricity drawn from the EV station and (2) expected public use of the EV stations to be de minimis. In contrast, in Letter Ruling 202530005, the IRS emphasized that the EV stations will not be available to, or accessible by, the general public in ruling that any income from providing electricity to tenants via EV stations, including any markup on such electricity, will not be considered ITSI and will constitute rents from real property under Sec. 856(d) for purposes of the income tests.

REITs that receive payments for the use of EV stations at their rental properties should consult with their tax advisers and may consider seeking their own rulings on these issues. It will be interesting to see if (and how) the IRS addresses variations on this fact pattern in any subsequent rulings involving EV stations — for example, a fact pattern in which a REIT charges a markup on electricity drawn via EV stations that may be accessible by the public.

Like Letter Ruling 202413004, Letter Ruling 202530005 states that the taxpayer will not treat amenity access fees as rents from real property for purposes of the income tests. Letter Ruling 202530005 also concludes that access fees will not give rise to ITSI and will not cause any portion of the taxpayer’s total rents (i.e., the taxpayer’s otherwise qualifying rents from real property) to fail to qualify as rents from real property under Sec. 856(d) for purposes of the income tests. REITs earning revenue from similar fees may wish to consult with their tax advisers as to the appropriate treatment of such income for purposes of the income tests.

Editor

Susan M. Grais, CPA, J.D., LL.M., is a managing director (retired) at Ernst & Young LLP in Washington, D.C.

For additional information about these items, contact thetaxadviser@aicpa.org.

Contributors are members of or associated with Ernst & Young LLP.