PLR provides favorable REIT income testing guidance regarding pipelines

April 2024

In brief

What happened?

In Private Letter Ruling 202410005 (the PLR), the IRS addressed the issue of whether certain amounts received by a real estate investment trust (the REIT) from agreements with unrelated parties for the use of certain pipelines indirectly owned by the REIT was qualifying income for purposes of the REIT income tests. The IRS held that the pipeline use fees were an amount received for the use of, or the right to use, real property and therefore qualified as rents from interests in real property for purposes of the REIT income tests.

Why is it relevant?

The IRS continues to show a willingness to issue favorable rulings to REITs that are providing the right to use non-traditional real estate assets.

Action items to consider

A REIT or taxpayer considering making a REIT election that holds energy infrastructure assets may want to consider seeking guidance from the IRS to determine how its infrastructure assets and, in particular, the manner in which it earns revenue from those assets, will impact its qualification as a REIT.

In detail

A REIT must meet certain requirements regarding the income it receives and the assets it holds. The income requirements must be met annually, while the asset requirements must be met quarterly. A REIT is restricted in the services it can provide, although it may provide more extensive services through an independent contractor (IK) or a taxable REIT subsidiary (TRS).

Pipeline use fees

The REIT in the PLR held an interest in a partnership subsidiary that owned oil and gas pipelines. The pipelines are regulated by commission and were constructed to connect certain oil fields to certain refineries. The REIT represented that the pipelines were inherently permanent structures and thus real estate assets. The pipelines also included some incidental personal property (e.g., meters, pumps, and compressors).

The partnership entered into pipeline use agreements with unrelated third parties (users) to utilize the pipelines to transfer product from a certain point on a pipeline to a certain oil refinery. The agreements included a minimum term commitment and users often utilized the pipelines, on a consistent and continuous basis, for extended periods.

The fee for the use of the pipeline (pipeline use fee) is based on the volume of product placed on a pipeline multiplied by a tariff rate set for such product. The REIT represented that the pipeline use fee did not depend, in whole or in part, on the income or profits of any user. The REIT also represented that, with respect to each pipeline, the pipeline use fees attributable to the pumps, compressors, meters, and other personal property used in connection with the reserved use of the pipeline did not exceed 15 percent of the total pipeline use fees attributable to both the real and personal property reserved for use by the users for the taxable year.

Users used a monthly nomination process that is governed by commission rules and regulations, whereby each user informed the partnership as to the kind and quantity of product the user intended to place on a particular pipeline for the following month. Provided that the aggregate of the nominated amounts met the minimum aggregate throughput requirement set by the partnership to maintain the optimal operation of each pipeline, each nominated amount became a confirmed amount. The partnership then reserved the relevant monthly capacity on that pipeline for that user’s confirmed amount. The REIT represented that the partnership would not confirm nominated amounts in excess of the total monthly capacity of any pipeline. The partnership was obligated to ensure that the capacity confirmed each month for each user was made available to that user.

The REIT represented that each user exclusively used the pipeline to satisfy their contractual obligation to deliver product extracted from a particular field to a point connected to the pipeline. The REIT further represented that the partnership did not oversell capacity on a pipeline.

The IRS held that the pipeline use fees were an amount received for the use of, or the right to use, real property of the REIT and qualified as rents from interests in real property for REIT income testing purposes. The IRS noted in its analysis that each user exclusively used the pipeline to deliver product during the applicable monthly nomination period; and the partnership agreed to accept and reserve capacity for the nominated products and amounts. In addition, the IRS further noted that amounts based on the volume of product placed on a pipeline was comparable to amounts received based upon a percentage of gross receipts.

Observation: The IRS’s holding that fees received for the use of the pipelines that are computed based on capacity or volume as qualifying REIT income is consistent with its rulings in earlier PLRs.

Observation: It is worth noting that the amounts that qualified as rents from real property in the PLR could potentially change each month by the volume of product placed on the pipeline by users each month based on the nomination process. This could be the reason that the IRS compared the pipeline use fees to percentage rents based on gross receipts.

Observation: Interestingly, the IRS also included a caveat for the first time in the conclusion section that the ruling did not apply to the extent that there was a change in the facts, including a change by the commission exercising its authority to require the REIT to change the manner in which it operates, suggesting the PLR’s application may be limited in scope.

Pipeline services

The partnership inspected and monitored the pipelines, marked the location of underground pipelines, and could test the product entering a pipeline to ensure the safety and integrity of the pipeline and the environment. The partnership also supervised and made decisions with respect to the construction, maintenance, and repair of the pipelines. Such construction, maintenance, or repair was performed by an IK from whom the REIT did not receive any income.

All other activities and services related to the pipelines were performed by a TRS or an IK, including scheduling use of the pipeline as well as operating, monitoring, maintaining, managing, and repairing any personal property associated with the pipelines. The REIT represented that the services provided to users were customarily provided to tenants of similar properties in the geographic market in which the pipelines were located. The REIT also represented that the TRS or IK received arm’s length compensation for performing the services for the partnership.

The IRS ruled that the activities and services performed by the partnership and by the TRS or IK did not give rise to impermissible tenant services income.

Observation: In line with other PLRs, personal property, such as pumps and compressors, appears to be viewed as personal property that is leased in connection with the lease of real property. This determination is noteworthy as the IRS is indicating that multiple users of a pipeline can not only lease capacity of the pipeline, but also personal property that is associated with such pipeline.

For a more detailed discussion on an earlier pipeline PLR addressing similar issues, access our prior Insight, PLR provides REIT income and asset testing guidance for a corporation owning storage terminal facilities (January 2024).

Contact us

Ed Geils

Ed Geils

Global and US Tax Knowledge Management Leader, PwC US

Follow us