IRS Clears the Way for REIT Merrymaking
- Nov 25, 2019
Are you thinking about hosting a holiday party for your tenants? A real estate investment trust (“REIT”) considering such an event may have more to think about than just finding the right hors d'oeuvres and dance-worthy band. Whenever a REIT offers a service or amenity to its tenants, the possibility of generating impermissible tenant service income (“ITSI”) must be considered.
Generally, ITSI is income generated by a REIT when it provides non-customary services to its tenants. ITSI is excluded from the definition of “rents from real property.” More importantly, if ITSI exceeds 1% of the income generated by a property, all income from that property will be treated as income other than rents from real property. This treatment could cause the REIT to fail its annual gross income tests, thereby threatening its REIT status. ITSI can result from the provision of services, even in circumstances when tenants are not charged. Since the value of a service may not be entirely clear, the floor on such amount would equal 150% of the REIT’s direct cost of furnishing such service.
Does this mean that REITs would be wise to shun holiday celebrations altogether? Fortunately, the IRS has recently reiterated favorable guidance on the issue. In PLR 201812009, a REIT described “marketing services” offered to tenants to “enhance its ability to attract new tenants and keep existing tenants.” Among the marketing services listed were seasonal holiday parties and social events such as a tasting event, breakfast and happy hour. The REIT represented that the marketing services are customarily furnished or rendered in connection with the rental of real property in luxury apartment buildings located in the geographic area where the properties are located. Furthermore, the REIT represented that the marketing services are provided to all tenants and do not constitute personal services rendered to any particular tenant. The IRS concluded that the marketing services did not give rise to ITSI.
The IRS came to a similar favorable decision in PLR 9436025, in which it reasoned that occasional continental breakfasts and holiday parties were more in the nature of marketing activities rather than services offered to tenants. In PLR 200052028, the IRS also concluded that occasional complimentary continental breakfasts provided to tenants would not be treated as generating ITSI. In this ruling, the IRS does not appear to utilize a marketing rationale as in the two previous examples, instead relying on the fact that the practice was customary in similar properties in the geographic market.
While a PLR may not be used by other taxpayers as precedent, these rulings when viewed together, do provide insight into IRS reasoning. Assuming that the occasional tenant event is customary in the asset class and geographical market, these rulings can provide a REIT with a degree of confidence, while hanging the garland for this year’s holiday celebration. It should be noted that the characteristics of any event as being occasional and customary are subjective, and a careful analysis should be considered before reaching a conclusion. Since many property owners are constantly trying to differentiate themselves from competitors, take care in offering these services, since a non-customary service at one property could jeopardize a REIT’s status.
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Sarah Hallock is a Tax Senior Manager in the Real Estate Services Group, with over 15 years of public accounting experience.
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