rr-98-60.pdf

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Part I
Section 856.--Definition of Real Estate Investment Trust
26 C.F.R. 1.856-1: Definition of a real estate investment trust.
Rev. Rul. 98-60
ISSUE
If a real estate investment trust (REIT) receives
"impermissible tenant service income" within the meaning of
§ 856(d)(7) of the Internal Revenue Code for services rendered by
the REIT to one or more tenants of a multi-tenant property, in
what situations will other amounts received by the REIT with
respect to the property continue to qualify as "rents from real
property" under § 856(d)?
FACTS
Situation 1
Y, a REIT that files its returns on a calendar year basis,
owns a high-rise apartment building, Building P. Building P has
100 apartments, of which 95 are standard, unfurnished apartments
rented on an annual basis. The remaining five apartments are
guest apartments. A guest apartment is a furnished apartment
available for lease on a short-term basis to guests of tenants.
Employees of Y render maid service in connection with the lease
of guest apartments. Y also provides heat and light to all of
the tenants in Building P. Y does not render any other services
to the tenants of Building P or engage in any other activity at

Building P that could give rise to impermissible tenant service
income.
For 1998, Y derives a total of $1,000x from all the tenants
of Building P, of which $90x is from visitors who rented guest
apartments. Of the $90x received from tenants of the guest
apartments, the amount received with respect to maid service is
$9x, which is greater than 150 percent of the direct costs of Y
in rendering the service. Of the $1,000x received from all the
tenants, the amount paid to Y for heat and light is $100x ($1x
for each unit, including the guest units), which also is greater
than 150 percent of the direct costs of Y for providing heat and
light. The amount of rent attributable to personal property
leased in connection with the rental of each guest apartment in
Building P for 1998 does not exceed 15 percent of the total rent
for such apartment attributable to both the real property and the
personal property as provided in § 856(d)(1).
Situation 2
The facts are the same as those in Situation 1 except that
Y derives $110x from visitors who rented guest apartments. Of
the $110x received from tenants of the guest apartments, the
amount received with respect to maid service is $11x, which is
greater than 150 percent of the direct costs of Y in rendering
the service.
LAW AND ANALYSIS
For an entity to qualify as a REIT, the entity must derive
at least 95 percent of its gross income from certain sources
described in § 856(c)(2) and at least 75 percent of its gross

income from certain sources described in § 856(c)(3). Rents from
real property are among the sources described in both § 856(c)(2)
and § 856(c)(3).
Section 856(d)(1) provides that rents from real property
include (subject to the exclusions in § 856(d)(2)): (i) rents
from interests in real property, (ii) charges for services
customarily furnished or rendered in connection with the rental
of real property (whether or not the charges are separately
stated), and (iii) rent attributable to personal property that is
leased under, or in connection with, a lease of real property,
but only if the rent attributable to the personal property for
the taxable year does not exceed 15 percent of the total rent for
the year attributable to both the real and personal property
leased under, or in connection with, the lease.
Section 856(d)(2)(C) (as modified by the Taxpayer Relief Act
of 1997) excludes from the definition of rents from real property
any impermissible tenant service income as defined in
§ 856(d)(7). Section 856(d)(7)(A) provides that impermissible
tenant service income means, with respect to any real or personal
property, any amount received or accrued directly or indirectly
by a REIT for furnishing or rendering services to the tenants of
the property or managing or operating the property.
Section 856(d)(7)(C)(i) excludes from impermissible tenant
service income amounts received for services furnished or
rendered, or management or operation provided, through an
independent contractor from whom the REIT itself does not derive
or receive any income.

Section 856(d)(7)(C)(ii) excludes from the definition of
impermissible tenant service income any amount that would be
excluded from unrelated business taxable income (UBTI) under
§ 512(b)(3) if received by an organization described in
§ 511(a)(2). Section 512(b)(3)(A)(i) excludes rents from real
property from UBTI. Section 1.512(b)-1(c)(5) of the Income Tax
Regulations provides, however, that payments for the occupancy of
space where services are also rendered to the occupant are not
rents from real property. Generally, services are considered
rendered to the occupant if they are primarily for the occupant’s
convenience and are other than those usually or customarily
rendered in connection with the rental of space for occupancy
only. Under § 1.512(b)-1(c)(5), the provision of maid service is
given as an example of a service that is considered rendered to
the occupant. Maid service provided by an employee of a REIT is,
therefore, an impermissible tenant service that gives rise to
impermissible tenant service income under § 856(d)(7).
Conversely, under § 1.512(b)-1(c)(5), the provision of heat and
light is given as an example of a service that is not considered
rendered to the occupant. Accordingly, the provision of heat and
light by a REIT is a permissible tenant service.
Section 1.512(b)-1(c)(5) taints all payments received under
a lease as other than rents from real property where any
impermissible tenant service is provided to the tenant.
Accordingly, a strict application of § 1.512(b)-1(c) in the
context of § 856(d)(7)(C)(ii) could cause all tenant service
income (that is, service income and income from management and

operations) derived under a lease to fail to qualify for this
exception where any impermissible tenant service is rendered to
the tenant. However, the legislative history discussing
§ 856(d)(7) indicates that only income attributable to
impermissible tenant services should be treated as impermissible
tenant service income after the application of § 856(d)(7)(C)(ii)
(unless § 856(d)(7)(B) applies). H.R. Conf. Rep. No. 105-220,
105th Cong., 1st Sess. 696 (1997) (AThe value of the
impermissible services may not exceed one percent of the gross
income from the property@ (emphasis added)). Accordingly, under
§ 856(d)(7)(C)(ii), an amount attributable to a service or
activity is excluded from impermissible tenant service income
unless the service or activity to which that amount relates would
cause the related rents to be treated as UBTI if received by an
organization described in § 511(a)(2).
Section 856(d)(7)(D) provides that the amount treated as
received for any service (or management or operation) must not be
less than 150 percent of the direct cost of the REIT in
furnishing or rendering the service (or providing the management
or operation).
Section 856(d)(7)(B) provides that, if the amount of
impermissible tenant service income with respect to a property
for any taxable year exceeds one percent of all amounts received
or accrued during such taxable year directly or indirectly by the
REIT with respect to the property, the impermissible tenant
service income of the REIT with respect to the property includes
all such amounts.

In Situation 1, the $9x attributable to the impermissible
tenant services rendered to tenants of the guest apartments is
impermissible tenant service income within the meaning of
§ 856(d)(7). Thus, pursuant to § 856(d)(2)(C), the $9x fails to
qualify as rents from real property. Because the provision of
heat and light is a permissible tenant service, no amount
attributable to this service (including amounts paid by tenants
of the guest units) is treated as impermissible tenant service
income in applying the one percent de minimis rule. The $9x of
impermissible tenant service income received by Y from Building P
for 1998 does not exceed one percent of the $1,000x received or
accrued directly or indirectly by Y with respect to Building P.
Therefore, the rendering of impermissible tenant services to
tenants of the guest apartments does not prevent otherwise
qualifying amounts received by Y from the tenants of Building P
(including tenants of the guest apartments) from qualifying as
rents from real property under § 856(d), and the total
impermissible tenant service income received with respect to
Building P is $9x.
In Situation 2, the $11x attributable to the impermissible
tenant services rendered to tenants of the guest apartments is
impermissible tenant service income within the meaning of
§ 856(d)(7). The $11x of impermissible tenant service income
received by Y from Building P for 1998 exceeds one percent of the
$1,000x received or accrued directly or indirectly by Y with
respect to Building P. Therefore, all $1,000x derived by Y from

Building P is impermissible tenant service income that, pursuant
to § 856(d)(2)(C), fails to qualify as rents from real property.
Rev. Rul. 72-353, 1972-2 C.B. 413, illustrates how
§ 856(d)(2)(A), which excludes rents derived under net profit
leases from the definition of rents from real property, is
applied in a multiple tenant situation. In Rev. Rul. 72-353, a
REIT leased office space in a building to 10 different tenants
under separate leases. Nine of the leases provided for a fixed-
sum rental. The tenth lease, however, provided for a rental
based on a percentage of the tenant's net profits.
Rev. Rul. 72-353 holds that the payments by the tenth tenant to
the REIT, which do not qualify as rents from real property, do
not prevent amounts paid to the REIT by the other tenants of the
office building that otherwise qualified as rents from real
property from so qualifying.
Section 856(d)(7)(B) allows a REIT to provide a limited
amount of impermissible tenant services with respect to property
without causing all of the income from the property to fail to
qualify as rents from real property. In the case of many of the
services that Congress intended to cover, it would be very
difficult to allocate the services to particular tenants.
Consistent with this intent, § 856(d)(7)(B) expressly applies on
a property-by-property basis. Consequently, the one-percent
limitation in that section is applied to aggregate amounts
received with respect to a property.
Rev. Rul. 72-353, which makes a determination under

§ 856(d)(2)(A) on a lease-by-lease basis, is distinguishable.
Section 856(d)(2)(A) relates to contingent rents determined by
reference to any person’s income or profits derived from a
property. In contrast to amounts allocable to tenant services,
the presence or absence of contingent rents can be determined on
a lease-by-lease basis in all cases.
HOLDING
(1) In Situation 1, only the $9x attributable to the
impermissible tenant services rendered to tenants of the guest
apartments fails to qualify as rents from real property.
(2) In Situation 2, all $1,000x of income derived from
Building P fails to qualify as rents from real property.
EFFECT ON OTHER REVENUE RULINGS
Rev. Rul. 72-353 is distinguished.
DRAFTING INFORMATION
The principal author of this revenue ruling is Eric E. Boody
of the Office of Assistant Chief Counsel (Financial Institutions
and Products). For further information regarding this revenue
ruling contact Mr. Boody on (202) 622-3960 (not a toll-free
call).