REIT PLR clarifies that lack of assets and income in REIT’s initial year does not lead to REIT qualification failure

In brief

What happened?

In Private Letter Ruling 202440007 (PLR), the IRS issued a ruling to a corporation (taxpayer), which elected to be taxed as a real estate investment trust (REIT). The IRS held that the REIT income and asset testing requirements are met when, during the applicable testing periods, a REIT did not earn any income or hold any assets.   

Why is it relevant?    

This is the first PLR addressing whether a REIT failed or passed the REIT income or asset tests when, during the applicable periods, the REIT held no assets and/or earned no income. The ruling concludes that a REIT did not fail REIT income and asset testing requirements due to not holding any assets or earning any income.   

Action items to consider   

Taxpayers forming new REITs that have not yet acquired assets and/or will not generate gross income for any tax year may want to consider obtaining their own rulings for purposes of determining if they will pass the REIT gross income and asset tests in such years. 

Factual background  

The taxpayer was a corporation that elected to be taxed as a REIT in its initial tax year. Parent, a partnership for US federal income tax purposes, that had an ownership interest in the taxpayer, sought to issue equity to the taxpayer in exchange for cash to allow the taxpayer to acquire an interest in certain multi-family properties. However, due to investor and regulatory delays, the parent was unable to contribute the cash to the taxpayer until its second tax year. Thus, the taxpayer had no gross income from any source, and no assets, at any point prior to year two.   

The taxpayer engaged a firm to prepare its initial year tax return. The firm did not communicate any issues with the taxpayer’s ability to satisfy the tests for REIT qualification, and the taxpayer filed a Form 1120-REIT for its initial tax year showing zero dollars' worth of assets and zero dollars of total income. At a later date, another firm was engaged by parent to perform audit services for taxpayer who was qualified in REIT-related matters. The second firm advised the taxpayer that it was unclear whether a REIT could have satisfied the REIT tests if the REIT did not have any gross income or assets in a particular year and advised that the taxpayer would be precluded from electing REIT status for a five-year period if it did not qualify in its initial tax year. To resolve these issues, the taxpayer sought a ruling to be treated as if the taxpayer had not made a REIT election in that year, considering that the taxpayer did not earn any gross income or hold any assets during the initial tax year.