The IRS issued new proposed regulations for the definition of real property for REIT purposes, updating the original 1962 regulations. The proposed regulations come in the wake of news reports criticizing the IRS for allowing too many taxpayers to convert to REIT status and a temporary moratorium (since lifted) on private letter rulings regarding the conversion of operating entities with substantial real estate assets to REITs. The regulations provide a framework to analyze the types of assets that qualify as real property for the REIT asset tests. The regulations are limited to asset testing and explicitly do not cover the types of income that qualify as good real estate income for REITs.
The proposed regulations define real property to include land, inherently permanent structures, and structural components. For each major type of asset, the regulations provide lists of assets that qualify as real property. If an asset is not identified in one of the lists, the regulations also provide a “facts and circumstances” test to determine whether the asset satisfies the REIT test. The proposed regulations also identify certain types of intangible assets that are real property or interests in real property for REIT purposes.
Facts & Circumstances Test:
For assets that are not specifically identified, the regulations list the following facts and circumstances that should be taken into account to determine whether the asset qualifies as real property:
(A) The manner, time, and expense of installing and removing the distinct asset;
(B) Whether the distinct asset is designed to be moved;
(C) The damage that removal of the distinct asset would cause to the item itself or to the inherently permanent structure to which it is affixed;
(D) Whether the distinct asset serves a utility-like function with respect to the inherently permanent structure;
(E) Whether the distinct asset serves the inherently permanent structure in its passive function;
(F) Whether the distinct asset produces income from consideration for the use or occupancy of space in or upon the inherently permanent structure;
(G) Whether the distinct asset is installed during construction of the inherently permanent structure;
(H) Whether the distinct asset will remain if the tenant vacates the premises; and
(I) Whether the owner of the real property is also the legal owner of the distinct asset.
The proposed regulations also provide several illustrative examples to show how the new definitions are intended to work in practice.
Effective Date: Because the IRS views the regulations as only a clarification of existing law and not a significant modification, they are proposed to be effective for the calendar quarters beginning after they are published as final.