Final Transferability Regulations Address REIT Issues

Although little was changed from the temporary and proposed regulations released in June 2023, the Final Transfer Regulations did provide two notable clarifications for REITs that hold eligible credits for transfer.

The 75% Asset Test

In general, REITs are entities that own or finance income-producing real property in various industry sectors. Traditionally designed for investors who want to make passive investments in real estate, REITs are subject to various organizational and operating requirements under the Code. Among other requirements, at the close of each calendar quarter, at least 75% of the value of a REIT’s total assets must be represented by real estate assets, cash and cash items (including receivables), and government securities (the “75% asset test”). REITs are also subject to additional asset tests with respect to certain non-government securities that they hold, but those tests are beyond the scope of this client alert. For more information on this topic, visit our REITs page. A REIT is not subject to U.S. federal corporate income tax to the extent it distributes 100% of its taxable income to its shareholders. In general, REITs generate income by financing or leasing real estate and collecting rent or interest.

The Final Transfer Regulations provide that, with respect to the 75% asset test, REITs should not include the value of the eligible credit in either the numerator or denominator when calculating the percentage of qualifying assets in relation to the total assets. In other words, the eligible credits are disregarded for purposes of the 75% asset test and should not be included in either the total assets of the REIT or as a qualifying asset. The Final Transfer Regulations apply regardless of whether a REIT ultimately transfers the credits.

The Prohibited Transaction Safe Harbor

REITs are subject to a 100% prohibited transaction tax on any net income derived from a “prohibited transaction.” A prohibited transaction is a sale or other disposition of property held primarily for sale to customers in the ordinary course of the REIT’s trade or business. A determination of whether a sale is a prohibited transaction is generally based on a facts and circumstances analysis. However, the Code provides a safe harbor for REITs pursuant to which a disposition will not be treated as a prohibited transaction. The safe harbor requires:

• The REIT to have held the property for at least two years,
• The aggregate expenditures includable in the basis of the property made by the REIT during the two-year period preceding the date of the sale do not exceed 30% of the net selling price of the property,
• Either (i) the REIT does not make more than seven sales of property, (ii) the aggregate adjusted bases of the property sold during the taxable year does not exceed 10% of the aggregate bases of all of the total assets of the REIT as of the beginning of the taxable year, (iii) the fair market value of the property sold during the taxable year does not exceed 10% of the fair market value of all of the assets of the REIT as of the beginning of the taxable year, (iv) (A) the aggregate adjusted bases of all such property sold by the REIT during the year did not exceed 20% of the aggregate adjusted bases of all property of the REIT at the beginning of the year and (B) the average annual percentage of properties sold by the REIT compared to all the REIT’s properties (measured by adjusted bases) in the current and two prior years did not exceed 10%, or (v) (A) the aggregate fair market value of all such property sold by the REIT during the year did not exceed 20% of the aggregate fair market value of all property of the REIT at the beginning of the year and (B) the average annual percentage of properties sold by the REIT compared to all the REIT’s properties (measured by fair market value) in the current and two prior years did not exceed 10%,
• The REIT to have held the property for at least two years for the production of rental income (in the case of property that consists of land or improvements),
• If the seven sales requirement above has not been met, substantially all of the marketing and development expenditures with respect to the property to have been made through an independent contractor or a taxable REIT subsidiary.

The Final Transfer Regulations provide that if a REIT chooses to sell its eligible tax credits, the credit (or portion thereof) that is sold is not considered a “sale” for purposes of the prohibited transaction tax safe harbor. The preamble to the Final Transfer Regulations reasons that the sale of eligible credits should not burden the sales of real property by the REIT by counting such sales to the total number or dollar amount of sales permitted under the safe harbor.

The Final Transfer Regulations did not address whether the sale of energy for purposes of sections 45 and 45Y would be considered a dealer sale under the prohibited transaction rules. Instead, the preamble directed taxpayers to analyze this issue on a facts and circumstances basis unless the scenario fits within the “net metering” safe harbor established by the preamble to the 2016 final regulations defining “real property” for purposes of the REIT asset tests (T.D. 9784). The net metering safe harbor provides generally that a prohibited transaction will not result in any taxable year in which (1) the quantity of excess electricity transferred to the utility company during the taxable year from energy-producing distinct assets that serve an inherently permanent structure does not exceed (2) the quantity of electricity purchased from the utility company during the taxable year to serve the inherently permanent structure.

Implications

The Final Transfer Regulations provide welcome certainty on asset test and prohibited transaction tax issues for REITs that desire to engage in energy credit transfers. As more REITs engage in energy efficient improvements at their properties, or even adopt an investment strategy focused entirely on renewables, their participation in the energy credit marketplace will be of increasing importance, and the Final Transfer Regulations will allow such REITs to do so without significant limitation.

¹ The transfer election was enacted as part of the Inflation Reduction Act of 2022 (the “IRA”), which provided that, for taxable years beginning after December 31, 2022, “eligible taxpayers” could elect to transfer all or a portion of certain tax credits to an unrelated taxpayer in exchange for cash. “Eligible taxpayers” are essentially all U.S. taxpayers that are not “applicable entities” as defined in Code section 6417(d)(1), and include taxpayers that have U.S. employment tax or excise tax obligations even if they do not have a U.S. income tax obligation.

The tax credits generally eligible to transfer include: the alternative fuel vehicle refueling property credit (Code section 30C); the production tax credit (“PTC”) (Code section 45) for facilities originally placed in service after December 31, 2022; the carbon oxide sequestration credit (Code section 45Q) for facilities originally placed in service after December 31, 2022; the zero-emission nuclear power production credit (Code section 45U); the clean hydrogen production credit (Code section 45V) for facilities originally placed in service after December 31, 2022; the advanced manufacturing production credit (Code section 45X); the investment tax credit (“ITC”) (Code section 48); the technology neutral ITC (Code section 48E) and PTC (Code section 45Y); the clean fuel production credit (Code section 45Z); and the qualifying advanced energy projects credit (Code section 48C).

The Final Transfer Regulations are effective 60 days after publication in the Federal Register (April 30, 2024).