PLR 202552014

IRS Approves Billboard Rents as Qualifying REIT Income

In a recent private letter ruling (PLR-113200-22), the IRS has ruled that income derived from outdoor advertising displays (billboards) qualifies as "rents from real property" under Section 856(d) for a Real Estate Investment Trust (REIT). This ruling confirms that a billboard operator can function as a REIT if it carefully segregates 'active' services (like installation and design) from 'passive' rental income. The taxpayer also secured a favorable ruling, ensuring that reimbursements under a cost-sharing arrangement will not be included in the reimbursed party’s gross income for purposes of Section 856(c)(2) and (3).

The Structure: Leasing Screens, Not Selling Ads

The recent Private Letter Ruling (PLR) focused on a taxpayer (structured as a limited liability company that elected to be taxed as a Real Estate Investment Trust, or REIT, under Sections 856 through 859) and its income from outdoor advertising displays. The taxpayer owned various types of outdoor advertising displays ("Displays"), including digital screens capable of showing multiple advertisements in a cycle ("Dynamic Displays"). Critically, the taxpayer represented that it had made an election under Section 1033(g)(3) to treat the Displays as real property. Section 1033(g)(3) allows taxpayers to elect to treat outdoor advertising displays as real property for all purposes of the tax code.

The taxpayer entered into rental agreements ("Rental Agreements") with users ("Tenants") for the right to place advertising on the Displays. These Rental Agreements specified which Display the content would appear on, the time period, and, for Dynamic Displays, the specific intervals. Each agreement stipulated the use of the same property for the entire term and a fixed charge ("Display Rents") paid periodically. Most agreements had terms spanning from one duration to another ("Long-Term Rental Agreements"), but the taxpayer also used shorter agreements ("Short-Term Rental Agreements") to fill available space between long-term rentals.

To manage these Short-Term Rental Agreements, the taxpayer engaged businesses ("Intermediaries") that match advertisers with available space on Dynamic Displays, using automated auctions or similar processes. The IRS treated commitments facilitated by Intermediaries as Rental Agreements for purposes of the ruling. The taxpayer represented that its business model focused on Long-Term Rental Agreements, and that income from Short-Term Rental Agreements would comprise only a de minimis portion of its gross income from renting Displays. Crucially, the taxpayer represented that all Short-Term Rental Agreements were contracts for the use of advertising space and not for the provision of services.

The Service Firewall: Avoiding the ITSI Trap

The taxpayer meticulously structured its operations to avoid running afoul of the rules regarding 'Impermissible Tenant Service Income' (ITSI). Under Section 856(d)(7), ITSI is income a Real Estate Investment Trust (REIT) receives for services provided to tenants, which generally does not qualify as "rents from real property." If ITSI exceeds 1% of the amount received from a property, all income from that property is disqualified as REIT rental income.

To navigate this, the taxpayer bifurcated its service offerings. The REIT directly (or through disregarded entities) performed "Services" limited to leasing activities, routine display maintenance, providing lighting/electricity, and basic security (video cameras). The IRS considered these "Services" customary for the displays in their respective markets and not primarily for the tenants' convenience.

Conversely, "Indirect Services" and "Other Services" were strictly outsourced. "Indirect Services," like advertisement installation, removal, replacement, and display operation scheduling/management, were handled by either a Taxable REIT Subsidiary (TRS) or an independent contractor as defined under Section 856(d)(3) – meaning the REIT received no income from the contractor. "Other Services," encompassing advertising material design, production, storage, and online campaign management, were similarly delegated to a TRS or independent contractor. This separation is crucial because Section 856(d) disqualifies rents if the REIT performs non-customary services for tenants, and using a TRS or independent contractor provides a safe harbor. The taxpayer emphasized that all Short-Term Rental Agreements were contracts for the use of advertising space and not for the provision of services.

IRS Analysis: Real Property Definitions and Cost-Sharing

Building on the separation of services, the IRS based its ruling on several key aspects of REIT law. First, the IRS determined that the billboard displays qualify as real property under Section 1033(g)(3), which allows taxpayers to elect to treat outdoor advertising displays as real property for tax purposes. As such, the income derived from renting the displays constituted "rent."

Second, the IRS addressed the potential issue of Impermissible Tenant Service Income (ITSI). Section 856(d)(7) defines ITSI as amounts received by the REIT for services furnished to tenants, potentially disqualifying the income as "rents from real property." However, because the taxpayer delegated active services like advertising material design and online campaign management to a Taxable REIT Subsidiary (TRS) or an independent contractor, these services were not attributed to the REIT. This arrangement adheres to the exception within Section 856(d)(7)(C), which states that services provided through a TRS or an independent contractor are not treated as furnished by the REIT itself.

Finally, the IRS considered the cost-sharing arrangement. Citing Rev. Rul. 84-138, which addresses cost-sharing between related entities, the IRS concluded that reimbursements for shared employee expenses and overhead were repayments of advances and not gross income to the REIT. This ruling confirms that these reimbursements are not included in the REIT's gross income for purposes of the REIT qualification tests under Section 856(c)(2) and (3).

In conclusion, this ruling offers a clear structural roadmap for outdoor advertising firms to potentially access REIT tax benefits, provided they adhere to the stipulations regarding service separation, independent contractors/TRS usage, and proper real property elections.