Final regulations clarify definition of real property for REITs.

• Author: Arumi, Cristina
• Position: Real estate investment trusts

The IRS issued final regulations (T.D. 9784) clarifying the definition of real property for purposes of the real estate investment trust (REIT) provisions. The regulations went into effect Aug. 31, 2016, and adopt, with modifications, the proposed regulations (REG-150760-13), which were published in the Federal Register on May 14, 2014.

Background

Sec. 856(c)(4)(A) requires at least 75% of the value of the REIT's total assets to consist of real estate assets (which include real property), cash and cash items, and government securities at the close of each quarter of the REIT's tax year. In addition, Sec. 856(c)(3) requires at least 75% of a REIT's annual gross income to consist of rents from real property and certain other prescribed sources of real estate-related income.

Before T.D. 9784, the definition of real property found in Regs. Sec. 1.856-3 (d) consisted of one paragraph that was promulgated in 1962. The IRS issued several revenue rulings between 1969 and 1975, and many private letter rulings in recent years, addressing whether certain assets qualify as real property.

Treasury and the IRS realized the need to update the guidance on the definition of real property under Secs. 856 through 859 and issued proposed regulations on May 14, 2014, to define real property for purposes of those sections. Regs. Sec. 1.856-10 has now been finalized and went into effect Aug. 31, 2016. Regs. Sec. 1.856-3(d) has been modified and now references Regs. Sec. 1.856-10 for the definition of real property.

Final Regulations

Like the proposed regulations, the final regulations define real property to include land and improvements to land. "Improvements to land" are further defined to include inherently permanent structures and their structural components.

Land

The final regulations retain the proposed regulations' definition of land. Land is defined to include the land parcel, as well as the water and air space superjacent to land, and natural products and deposits that are unsevered from the land. Natural products and deposits (such as crops, water, ores, and minerals) cease to be land when they are severed, extracted, or removed from the land.

Inherently Permanent Structures

The final regulations retain the proposed regulations' definition for inherently permanent structures with some clarifications. The final regulations define inherently permanent structures as "any permanently affixed building or other permanently affixed structure" (emphasis added). If the affixation is expected to last indefinitely, based on all of the facts and circumstances, the affixation is considered to be permanent. However, any distinct asset serving an "active function," such as an item of machinery or equipment, does not qualify as a building or other inherently permanent structure.

As with the proposed regulations, the final regulations explain that an asset must serve a passive function, such as to "contain, support, shelter, cover, or protect," rather than an active function, such as to "manufacture, create, produce, convert, or transport" to qualify as an inherently permanent structure. In the preamble to the final regulations, the IRS acknowledges that the term transport could describe both "passive conduits used for transportation and machines that push or pull items through or along a conduit." Treasury and the IRS intend the term transport to mean to cause to move. Therefore, the final regulations clarify that providing a conduit (e.g., a pipeline or an electrical wire) or route (e.g., a road or a railroad track) is a permitted passive function of another inherently permanent structure. The IRS goes on to clarify in the preamble to the final regulations that assets, such as machinery and equipment, that may serve active and passive...