Final Regs Clarify Definition of Real Property for REITs (T.D. 9784)

CCH Tax Day Report

The IRS has issued final regulations to clarify the definition of real property for purposes of the real estate investment trust (REIT) provisions of Code Secs. 856 through 859. The new regulations define real property to include land, inherently permanent structures and structural components. The final regulations generally adopt the proposed regulations issued in NPRM REG-150760-13, which was published on May 14, 2014.

Prior to the effective date of these regulations, the definition of real property was contained in Reg. §1.856-3(d). Under the final regulations, Reg. §1.856-3(d) is revised to redirect readers to Reg. §1.856-10 for the definition of real property. Reg. §1.856-10 is added to provide more specific guidance on what types of assets would be considered “real property” for purposes of the REIT rules.

As components of the definition of real property, Reg. §1.856-10 defines the following:

Land includes water and air space superjacent to land and natural products and deposits that are unsevered from the land.

Improvements to land include inherently permanent structures (IPSs) and their structural components. Where an improvement includes natural products of the land that remain unsevered (e.g., shrubs planted in the ground), the improvement is considered part of the land for purposes of these regulations. However, if an improvement includes a distinct asset (e.g., a bench), that asset is analyzed under the factors for an IPS to determine if it is real property.

Inherently permanent structures include buildings and other inherently permanent structures (OIPSs). To qualify as an OIPS under the regulations, a structure must serve a passive function (e.g., contain, support, shelter, cover or protect), and not serve an active function (e.g., manufacture, create, produce, convert or transport). For purposes of the regulations, the term “transport” means to cause to move, which is a prohibited active function of an OIPS. The regulations allow that providing a conduit (e.g., pipeline or electrical wire) or route (e.g. road or railroad track) is a permitted passive function of an OIPS. Assets that serve both passive and active functions are excluded from the definition of an IPS, because of the requirement that an IPS may not serve an active function. The regulations state that a “building” encloses a space within its walls and is covered by a roof.

– A commentator pointed out that outdoor sports stadiums, amphitheaters or unenclosed parking garages that are affixed to land or other IPSs may fail to qualify as buildings under the regulations. Although the Treasury and the IRS conceded that these structures may fail to qualify as buildings, the preamble pointed to the definition of OIPSs in Reg. §1.856-10(d)(2)(iii) as a more appropriate classification of these structures. To qualify as an IPS, an affixation must be permanent. To be considered “permanent,” a distinct asset must be permanently affixed to the land and reasonably expected to last indefinitely based on all the facts and circumstances.

– A structural component under Reg. §1.856-10(d)(3)(i) is any distinct asset that is a constituent part of and integrated into an IPS, serves the IPS in its passive function, and, even if capable of producing income other than consideration for the use or occupancy of space, does not produce or contribute to the production of such income. Moreover, a distinct asset qualifies as a structural component only if the REIT holds its interest in the distinct asset together with a real property interest with respect to the space in the IPS that the distinct asset serves.

– An intangible asset is real property or an interest in real property if the asset derives its value from real property or an interest in real property, is inseparable from that real property or interest in real property, and does not produce or contribute to the production of income other than consideration for the use or occupancy of space. Intangible assets that are related to services and that are separable from real property do not qualify as real property.

The regulations apply to tax years that begin after August 31, 2016. For purposes of applying the first sentence of the flush language in Code Sec. 856(c)(4) to a quarter in a tax year that begins after August 13, 2016, these final regulations apply in determining whether the taxpayer met the requirements of Code Sec. 856(c)(4) at the close of prior quarters. Taxpayer may rely on the final regulations for quarters that end before the applicability date.

T.D. 9784, 2016FED ¶47,043

Other References:

Code Sec. 856

CCH Reference – 2016FED ¶26,504

CCH Reference – 2016FED ¶26,510F

Tax Research Consultant

CCH Reference – TRC RIC: 6,072.05

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