REIT subsidiary may provide tenants with noncustomary services.

A joint venture partnership between a taxable real estate investment trust (REIT) subsidiary (TRS) and an independent contractor of the REIT may provide noncustomary services to the REIT's tenants without causing the rent pay-merits to fail to qualify as rents from real property for purposes of Sec. 856(d).

Facts

R Corp. is a REIT that owns and operates rental apartment properties in several major metropolitan areas. R formed T, a wholly owned corporation, to provide services to its tenants. R and T filed Form 8875, Taxable REIT Subsidiary Election, to jointly elect for T to be treated as a TRS of R, effective as of T's formation. The services T provides to the tenants are not customarily provided to tenants of rental apartment properties in the metropolitan areas of R's properties.

X Corp. is unrelated to either R or T. X qualifies as an independent contractor under Sec. 856(d)(3)(B). X provides various services to R's tenants and tenants of other rental apartments in the same areas. X's services are noncustomary in the areas of R's properties and are primarily for the tenants' convenience.

X and T formed P, an entity treated as a partnership for Federal income tax purposes, to provide the noncustomary services formerly separately provided to R's tenants by X or T. X and T made equal capital contributions to P. X and T share in all items of P's income, gain, loss and deduction in proportion to their capital contributions. R's tenants contract directly with P for services. R does not receive any payments related to the services from P, X or the tenants. R receives quarterly dividends from T.

Analysis

A REIT 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). "Rents from real property" are among the sources listed in both of those provisions. 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. However, Sec. 856(d)(2)(C) excludes "impermissible tenant service income" from the definition.

Sec. 856(d)(7)(A) defines "impermissible tenant service income" to include amounts received or accrued directly or indirectly by a REIT for services the REIT furnished or rendered to the tenants. If impermissible tenant service income from a property for any tax year exceeds 1% of all amounts received or accrued directly or indirectly by the REIT during the tax year from the property, Sec. 856(d)(7)(B) provides that impermissible tenant service income shall include all amounts received or accrued from the property for the tax year.

Under Sec. 856(d)(7)(C)(i), services furnished or rendered through a TRS or an independent contractor from whom the REIT does not derive or receive any income are not treated as furnished, rendered or provided by the REIT for purposes of Sec. 856(d) (7)(A). Thus, services rendered by a TRS do not give rise to impermissible tenant service income; services rendered by an independent contractor do not give rise to impermissible tenant service income if the REIT does not receive or derive income from the independent contractor.

R's tenants contract directly with P to perform noncustomary services and R does not receive directly any service payments from P. Also, R does not directly or indirectly receive income from X, an independent contractor. R may indirectly receive this income as dividends from T, R's subsidiary, because T is entitled to its share of income from the performance of services in proportion to its interest in P.

Under Sec. 856(d)(7)(A), amounts received directly or indirectly by a REIT for services furnished to tenants constitute impermissible tenant service income. However, Sec. 856 (d)(7)(C)(i) provides an exception for services furnished through a TRS; R's only interest in P is through T, a TRS. Thus, the services provided by P are treated as provided by T to the extent of T's interest in P, and R will not be treated as providing impermissible tenant services to its tenants.

REV. RUL. 2003-86, IRB 2003-32,290

IN THIS DEPARTMENT

Employee Benefits & Pension

* ISO income includible in AMTI on transfer of purchased shares: TAM 200338010; TAM 200338011 *; Paul A. Tanner, 5th Cir. *; p.765.

Real Estate

* REIT subsidiary may provide tenants with noncustomary services: Rev. Rul. 2003-86; p. 766.

The reports of cases, rulings, etc., herein, except for the Reflections, are edited versions of the Relevant court opinion, published rulings, etc.

* This development, concerning related matters, is covered in the Reflections to the report of the principal item.