Yesterday morning, the Treasury Department finalized regulations defining real property for a real estate investment trust (a REIT).1 The final regulations did not accept most of the comments that were received, so the final regulations are quite similar to the proposed regulations (which in turn were intended to reflect ruling practice), though some provisions were tightened or clarified.

There were, however, a few significant changes from the proposed regulations, including a change to Example 11, which describes how to take account of an above-market lease in valuing real estate. The most significant change, however, addresses whether a structural component of a building (for example, solar equipment that supplies the needs of the building) can be held in a different capacity than the building. The proposed regulations required the structural component to be held in an "equivalent interest" to the building or other inherently permanent structure. The final regulations allow the structural component to be owned by someone who does not own the building, provided that the taxpayer owning the structural component has a real property interest in the space.

As a result of this change, solar equipment that is on top of a building (supplying energy to the building) may be able to qualify as real property in the hands of a REIT, even though the owner of the solar equipment does not own the building – provided the REIT has a lease of the space on which the solar equipment is located, and provided that the other requirements of the regulations with respect to real property for a REIT are met.

In particular, the Internal Revenue Service is considering whether additional guidance is necessary regarding when a distinct asset that produces electricity that services a building may be sold to third parties. In the interim, the preamble to the regulation discusses situations where the IRS will not treat the transfer of excess electricity to a third party as affecting REIT qualification.

Footnotes

1 Published in the Federal Register, August 31, 2016, 81 FR 59849. Available at https://www.gpo.gov/fdsys/pkg/FR-2016-08-31/pdf/2016-20987.pdf.  The regulations are generally effective for taxable years beginning after August 31, 2016, but may be relied on for earlier quarters.

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