Tax advisors to REITs have long pondered the metaphysical question of whether a REIT with no assets or income in its first year can pass the requisite REIT asset and income tests to qualify as a REIT. In a recent private letter ruling, the IRS responded in the affirmative.

For an entity to qualify as a REIT, at least 75% of its total assets must be “real estate” assets. Additionally, the entity must derive at least 95% of its income from certain passive sources and at least 75% of its income from certain real estate sources.

In Private Letter Ruling 202440007 (the “PLR”), a parent company formed an entity expecting to infuse it with capital shortly thereafter so that the entity could purchase specific multifamily properties. However, the parent was unable to timely transfer the capital, leaving the entity with zero assets and income at the end of the year. The entity received conflicting tax advice on whether it would qualify as a REIT with no assets or income, raising the question as to whether the REIT election it had already made was valid. The entity requested a ruling from the IRS to ignore its REIT election for that year. The IRS denied the entity’s request because it concluded that a REIT with zero assets and income in its first year does not fail the REIT asset or income tests, as 75% or 95% of zero is zero. The IRS, citing legislative history and Treasury Regulations 1.856-2(c), explained that these tests focus on the nature of a REIT’s assets and source of its income and not on whether the REIT actually has assets or income.

Historically, taxpayers facing the long unanswered question of whether a REIT with no assets or income in its first year can qualify as a REIT often avoided electing REIT status in that first year or purchased public REIT stock in the interim solely to ensure qualification. The PLR provides some comfort to similarly situated taxpayers, although it is important to note that a PLR may not be cited as precedential authority. Newly-formed REITs that find themselves in the unplanned position of having zero assets or income in a given year should consult their tax advisors regarding the implications of this PLR.