Service addresses REIT's temporary investment of new capital.

• Author: Fisher, Mark
• Position: Real estate investment trusts

In Letter Ruling 200740004, the Service determined that a real estate investment trust (REIT) qualified for the "temporary investment of new capital" rules for purposes of the REIT income and asset tests when the REIT loaned the proceeds of its public debt offering to its operating partnership (OP) and the OP, in turn, temporarily invested the proceeds in stock and debt instruments. The Service also ruled that the loan from the REIT to the OP (and the interest received by the REIT thereon) is ignored for purposes of the REIT asset and income tests, to the extent of the REIT's capital interest in the OP.

Facts

A REIT is the OP's managing partner and owns a certain percentage of its outstanding common units. The OP owns and operates numerous real properties throughout the United States through a variety of partnerships and disregarded entities.

The REIT raised capital through a public offering of senior convertible debentures. Under certain circumstances, these debentures are convertible into REIT common stock. The net proceeds from these debentures were loaned to the OP for convertible OP debt, with terms that substantially mirror the debentures. The OP will ultimately use these proceeds to acquire real estate and to fund working capital; in the interim, the OP has temporarily invested the proceeds in stock and debt instruments (including money market funds) during the one-year period beginning on the date on which the REIT received the net proceeds from the debentures.

The REIT intends to raise additional capital through another public offering of additional convertible senior debentures with terms similar to those already issued. The REIT intends to use the proceeds to fund the OP's operations by similarly loaning the net proceeds to the OP. The OP will temporarily invest the proceeds in stock and debt instruments (including money market funds) during the one-year period beginning on the date the REIT receives the net proceeds.

Neither debt will be secured by an interest in real property, and the REIT represents that these debts will be treated as indebtedness for federal income tax purposes.

Analysis

Under Sec. 856(c)(2), a REIT must derive at least 95% of its gross income from specific sources, including dividends, interest, and rents from real property. Under Sec. 856(c)(3), a REIT must also derive at least 75% of its gross income from certain real estate sources, including rents from real property and "qualified temporary investment...