Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 75-52

1975-1 C.B. 198

Sec. 856

IRS Headnote

Real estate investment trust; rents from property managed by coowner. A specified annual payment (accumulated if not paid) received by a real estate investment trust out of the net rental income from real property it coowns with an unrelated corporation, under an agreement that the corporation manage the property, receive no management fee, but retain the net income that exceeds the payment to the trust, does not qualify as "rents from real property" under section 856(d) of the Code.

Full Text

Rev. Rul. 75-52

Advice has been requested whether, under the circumstances described below, a payment received by a real estate investment trust from the rental of real property of which the trust and an unrelated corporation are coowners qualifies as "rents from real property" under section 856(d) of the Internal Revenue Code of 1954 where the corporation manages the property.

An unincorporated trust, otherwise qualifying as a real estate investment trust under section 856 of the Code, and an unrelated corporation purchased, as tenants in common, real property and entered into an agreement which provides that the corporation is responsible for the management of the property. The trust contributed 100x dollars and the corporation 85x dollars toward the purchase of the property. The costs of managing the property are shared by the parties to the extent of five percent of the gross receipts from the property; all additional costs are payable by the corporation. The trust has an exclusive right to the first 9x dollars of the annual net rental income, and the corporation is entitled to the remainder. If the yearly net rental income is less than 9x dollars, the trust's right to this amount accumulates. Should the corporation default in paying operating expenses or in paying the trust its required portion of rental income for more than one year, the trust has the exclusive right to select other management. On sale of the property, which cannot take place within four years without the trust's permission, the corporation is to receive 80 percent of the profits of sale and the trust is to receive 20 percent.

Section 856(d)(3) of the Code provides, in part, that the term "rents from real property" includes rents from interests in real property but does not include any amount received or accrued, directly or indirectly, with respect to any real property, if the real estate investment trust furnishes or renders services to the tenants of such property, or manages or operates such property, other than through an independent contractor from whom the trust itself does not derive or receive any income.

Section 1.856-4(b)(3)(i)(d) of the Income Tax Regulations provides, in part, that the requirement that the trust not receive any income from an independent contractor requires that the relationship between the two be an arm's-length relationship, and the independent contractor must be adequately compensated for any services which are performed for the trust.

Rev. Rul. 74-353, 1974-2 C.B. 200, holds that income received by a real estate investment trust from the rental of real property of which the trust and an unrelated corporation are coowners is not disqualified as "rents from real property" under section 856(d)(3) of the Code by reason of the corporation's distribution of electricity to the tenants and retention of the entire proceeds. In that Revenue Ruling, the property was managed by an independent contractor, not the corporation, but the corporation had the exclusive right, under an agreement with the local utility company, to distribute electricity to the tenants. The trust and the corporation each received one half of the income from the real property, but the corporation received all of the income from the submetering of electricity. The trust received no additional income or rights from the coowner because the corporation was entitled to receive submetering income.

Consequently, an unrelated coowner of property with a real estate investment trust may manage such property as an independent contractor so long as the real estate investment trust does not derive any income that is attributable to the management services performed by the managing coowner.

In the instant case, the trust and the corporation share in the profits from the property. If the corporation did not manage the property, the coowners would have to hire an outside manager and pay a commercial fee for its services as one of the costs of operating the property. Thus, to the extent that the corporation manages the property and receives less than the commercial management fee, independent of its share of the profits, the net rental income from the property is increased. Since the trust receives the first 9x dollars of net rentals and since the agreement does not provide for compensation for the corporation's services, other than a profit-sharing arrangement, the independent contractor is not adequately compensated for its services and the trust derives income that is attributable to the management services performed by an independent contractor.

Accordingly, it is held that the annual payment received or receivable by the trust in the instant case does not qualify as "rents from real property" under section 856(d) of the Code.