IRS Rules Subpart F Income Is Qualifying Income for REIT Testing Purposes in PLR 201605005
February 24, 2016
In a recent private letter ruling favorable to REITs, the IRS determined that subpart F income generated by a REIT’s foreign subsidiaries is qualifying income for purposes of the 95% gross income test imposed under the Internal Revenue Code (“Code”). Under the IRS rationale, passive income generated by the REIT’s Controlled Foreign Corporations (“CFCs”) and Passive Foreign Investment Corporations (“PFICs”) comported with the spirit of the income test by ensuring the REIT’s income is generated from passive activities.
Under the facts of the ruling, the taxpayer is a U.S. corporation that elected REIT classification for tax purposes. The taxpayer operates in the commercial timberland sector and profits from the harvest and sale of timber and the long-term appreciation of its timberland properties. The taxpayer operated internationally through a number of foreign subsidiaries and holding companies. A number of the foreign subsidiaries were Qualified REIT Subsidiaries (“QRSs”), partnerships or disregarded entities. The taxpayer had jointly elected Taxable REIT Status (“TRS”) with other foreign subsidiaries that are corporations for federal income tax purposes. Per the ruling, the taxpayer expected its TRSs to be either (i) CFCs with respect to which the taxpayer will be a U.S. shareholder, (ii) PFICs for which the taxpayer has made or intends to make elections under the Code to treat as Qualified Electing Funds (“QEFs”), or (iii) PFICs for which the taxpayer has not made a mark-to-market election and which are not pedigreed QEFs with respect to the taxpayer.
As subpart F income is passive (e.g., income derived from interest, dividends, rents from real property), the IRS observed that the inclusion of such income will not interfere with or impede the congressional policy objectives of the 95% gross income test.
Foreign investors interested in investing in United States real estate through a REIT will note that this ruling creates potential structuring opportunities. Readers further interested in the interplay between the Subpart F income rules and the 95% gross income test or the recent private letter ruling are encouraged to consult with their tax advisor.