Treatment of carbon emission units for REIT

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In Private Letter Ruling (“PLR”) 201751011 issued on December 22, 2017, the Internal Revenue Service (“IRS”) revoked and modified parts of PLR 201123003 issued on March 4, 2011 regarding the treatment of carbon emission units (“Units”) for a real estate investment trust (“REIT”). The IRS held that:

  • Under Income Tax Regulations Section 1.856-10(f),1 the Units do not qualify as real estate assets for the asset test under Sections 856(c)(5) and 856(c)(4)(A) because the Units can be sold separately from the land to which they relate.
  • When accrued, the fair market value of the Units should be included in gross income as qualifying income for the income test under Sections 856(c)(2) and (c)(3).
  • Sale of the Units is not qualifying income for the income tests under Sections 856(c)(2) and (c)(3) because the Units do not qualify as real estate assets.
  • Consistent with Revenue Procedure 2017-3, the IRS did not rule on whether the Units were held primarily for sale to customers in the ordinary course of a trade or business, the sale of which could potentially result in income from a prohibited transaction under Section 857(b)(6).


Takeaways from the PLR 201751011

  • PLR 201751011’s modification and revocation of PLR 201123003 is a direct response to the definition of intangible assets included with the regulations addressing the definition of real estate assets. The regulations prospectively revoke any previously issued PLR that is inconsistent with these regulations. 
  • The ruling highlights that particular care should be taken with regard to whether real estate intangibles are qualifying assets, particularly if the assets can be separated from the underlying real estate. In the case of the Units, the ability to separate them from the underlying real estate and sell as a separate asset caused the IRS to change its position and revoke the previously favorable qualifying real estate asset treatment. REITs with similar real estate intangibles should consider the potential impact a non-qualifying classification would have on their asset and income tests.
  • This ruling also highlights that REITs that have previously obtained or relied upon PLRs prior to the asset test regulations need to determine whether the PLRs would have been automatically revoked. As a practical matter, the IRS would likely have notified taxpayers if it has determined that a ruling that they were granted was inconsistent with the regulations, although no such contact is required.

Background on PLR 201751011


PLR 201751011 involves a REIT that is primarily engaged in activities associated with timberland operation and management. The REIT owns, leases, or manages timberland and real estate located outside of the United States (“US”). The REIT participates, through international subsidiaries treated for US tax purposes as partnerships and disregarded entities, respectively, in an Emissions Trading Program (the “Program”). Under the Program, the foreign government allocates Units, representing one metric ton of carbon dioxide removed from the atmosphere, to certain forest owners at no cost. If the forest owner harvests its trees without planting sufficient replacement trees, the Units must be surrendered. The Units compensate the forest owner for the imposed land use restriction and can be held for future use or sold on the country’s or international unit registries.

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Prior ruling on Carbon Emission Units

The same taxpayer in PLR 201751011 had previously received rulings on in PLR 201123003 in which the IRS held that the Units were inextricably linked to real estate as the intangible assets are issued standing timber on the land. Accordingly, the IRS ruled that the Units were qualifying real estate assets, the grant of the Units would be qualifying income, that the subsequent sale of the Units would be qualifying income, and that the sale of the Units was not subject to the prohibited transaction tax.

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Intangible assets as real estate

Section 856(c)(5)(B) defines real estate assets but does not explicitly address intangible assets. Prior to 2016, REITs largely had to look to guidance in PLRs and court cases to determine whether intangible assets were qualifying assets for purposes of the asset tests and whether any related income was qualifying for purposes of the income tests.

The IRS released final regulations on August 31, 2016 clarifying the definition of real estate assets under Section 856(c)(5)(B). Pursuant to Income Tax Regulations Section 1.856-10(f), an intangible asset, including an intangible asset established under GAAP as a result of a real estate asset acquisition, is generally a real estate asset if it derives its value and is inseparable from real property or an 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. Above-market leases and land use permits are given as examples of qualifying real estate assets while a license to operate a business is cited as not being real estate asset.

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New ruling on Carbon Emission Units

PLR 201751011 revisited PLR 201123003 in light of the newly released regulations. As a result of the guidance in the new regulations stating that a qualifying intangible must be inseparable from real property and that it cannot produce income unrelated to the use or occupancy of space, the Units were deemed to no longer be qualifying real estate assets as they can be sold separately from the forest land to which they relate. The previous rulings in PLR 201123003 were predicated on the interpretation that the Units were qualifying real estate assets, therefore new analysis was required to address implications for the REIT income tests related to the Units.

With regard to whether the value of the Units awarded to the REIT should be qualifying income for purposes of the REIT income tests, the IRS found that the Units serve as an offset for the loss in value of the land held by the REIT due to land use restrictions imposed by the local country’s Forestry Program. The IRS determined that the receipt of the Units are akin to the receipt of income for granting an easement with respect to the REIT’s real property as opposed to the actual sale of the real property. The IRS then utilized the authority granted to it under Code § 856(c)(5)(J) to conclude that the value of the Units will be considered qualifying income under Section 856(c)(2) or (c)(3) upon the earliest of the Units being earned, received, or due.

As already noted, PLR 201751011 states that the Units do not qualify as real estate assets starting with any tax year beginning after enactment of the new regulations on August 31, 2016. Therefore the IRS concluded that any income realized upon sale of the Units is not qualifying income for REIT income test purposes. It is interesting to note that the IRS reached different conclusions with respect to the income earned on the receipt of the Units as opposed to the income attributable to the sale of the Units.

The IRS also revoked its ruling in PLR 201123003 stating that income from the sale of the Units is not income from a prohibited transaction. The IRS noted that its policy is to not ordinarily issue rulings related to whether property is held primarily for sale to customers in the ordinary course of a trade or business and presumably determined that there was the facts in this particular case did not warrant the type of facts on which it would issue a ruling.

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Adam Feuerstein

Principal, National Real Estate Tax Technical Leader, PwC US

David Leavitt

US Real Estate Tax Technical Co-Leader, PwC US

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