Developers are constantly looking for ways to find capital for their energy development projects. They have solicited all sorts of capital, including banks, angel investors, private equity investors, private development bonds, and other sources. One other potential source of capital for certain types of projects is a Real Estate Investment Trust (REIT). A recent IRS private ruling discusses the limitations and potential viability of REITs for funding energy development projects.
The ruling involved a wireless and broadcast infrastructure company (Taxpayer) that elected to be taxed as a REIT. Taxpayer along with its taxable REIT subsidiaries (Group) owned a global portfolio of communication sites, such as freestanding and rooftop antenna towers. Group acquired, developed, and leased antenna space at its communication sites to various tenants, including wireless telecom providers, radio, and television broadcast companies and paging companies.
As part of its lease arrangements, Taxpayer installed on-site power generators that solely supply the telecom sites when the local power grid is offline or where local power may not be available on reasonable or predictable terms. In the areas of Taxpayer’s leased sites, it is usual and customary for telecom site lessors to provide on-site power generation.
Through its lease arrangements, Taxpayer charges its tenants for such power generation. But the charges are not based on the income or profits of any person.
The Tax Code imposes strict limitations on the types of income to be generated by REITs. A substantial percent of gross income must be derived from “rents from real property” (Rental Income). This limitation generally causes the greatest impediment on the generation of energy by REITs.
Rental Income includes, among other things, (i) rents from interests in real property and (ii) charges for services customarily furnished or rendered in connection with the rental of real property. Charges for services must be customarily furnished or rendered in connection with the rental of real property. For example, providing electricity as a service will be permissible in areas where it is customary for lessors to furnish electricity or other utilities to tenants.
Rental Income Includes On-Site Generation for Telecom Sites
Based on the facts of this ruling, the Service concluded that the income generated by the on-site generation of power would qualify as Rental Income. It reasoned that a responsible lessor of telecom sites in the relevant areas would customarily provide on-site power generation to its telecom tenants, due to the limited availability of reliable or affordable power. It also analogized Taxpayer’s on-site generation to a landlord’s provision of heat and light to occupants. The regulations generally do not treat income from such utility services as impermissible income under the REIT rules. Accordingly, income derived from telecom tenants for Taxpayer’s on-site generation would qualify as Rental Income.