On February 4, 2022, the IRS released a private letter ruling revoking its prior approval of certain lease payments as “rents from real property” for purposes of the REIT income tests.

Lease payments generally qualify under the REIT income tests if they are determined based on gross receipts or sales, but not income or profits.

In 2013, the IRS had issued PLR 201337007, which concluded that annual adjustments to a lessee’s payment obligations that were based on the lessee’s revenue did not prevent the lease payments from being treated as “rents from real property” and thus good income for REIT qualification purposes. In revoking this aspect of its prior ruling, the IRS noted that the revenue adjustments in the relevant leases were based on the lessee’s revenue minus all expenses, other than interest expense, income taxes, depreciation and amortization, rent, and certain other expenses (effectively, “EBITDAR”). Although an EBITDAR adjustment could be viewed as an adjustment based on the lessee’s capacity to pay rent, in PLR 202205001, the IRS held that revenue, as adjusted pursuant to the leases, was akin to income or profits rather than gross receipts or sales. In its partial revocation, the IRS stated that the qualifying income conclusion was not in accord with its current views.

While the ruling’s conclusion will not apply retroactively to the taxpayer to whom it was issued, other REITs that have modelled lease payment and adjustment provisions after the 2013 ruling may be questioning whether best practices would include restructuring their lease payments in line with current IRS thinking to protect their REIT qualification.