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which it receives gross rent of $500,000 independent contractor requires that for the year 1962. The trust owns 15 per- the relationship between the two be an cent of the total assets of an unincor- arm's-length relationship. The indeporated subtenant. The rent paid by pendent contractor must be adequately this subtenant for the taxable year is compensated for any services which are $50,000. Therefore, $10,000 (50,000/ performed for the trust. Compensation 500,000x$100,000) of the rent paid to the to an independent contractor detertrust does not qualify as "rents from mined by reference to an unadjusted real property". Where the real estate

percentage of gross rents will generally investment trust receives, directly or

be considered to be adequate where the indirectly, any amount of rent from

percentage is reasonable taking into any person in which it owns any propri

account the going rate of compensation etary interest, the trust shall submit,

for managing similar property in the at the time it files its return for the

same locality, the services rendered, taxable year (or before June 1, 1962,

and other relevant factors. The indewhichever is later), a schedule setting

pendent contractor must not be an emforth

ployee of the trust (i.e., the manner in (i) The name and address of such per

which he carries out his duties as indeson and the amount received as rent

pendent contractor must not be subject from such person; and

to the control of the trust). Although (ii) If such person is a corporation,

the cost of services which are customthe highest percentage of the total combined voting power of all classes of

arily rendered or furnished in connec

tion with the rental of real property its stock entitled to vote, and the highest percentage of the total number of

may be borne by the trust, the services shares of all classes of its outstanding

must be furnished or rendered through stock, owned by the trust at any time

an independent contractor. Furtherduring the trust's taxable year; or

more, the facilities through which the (iii) If such person is not a corpora

services are furnished must be maintion, the highest percentage of the

tained and operated by an independent trust's interest in the assets or net

contractor. For example, if a heating profits of such person, owned by the

plant is located in the building, it must trust at any time during its taxable

be maintained and operated by an indeyear.

pendent contractor. To the extent that (5) Furnishing of services or manage

services (other than those customarily ment of property must be through an

furnished or rendered in connection independent contractor—(i) In general.

with the rental of real property) are No amount received or accrued, di

rendered to the tenants of the property rectly or indirectly, with respect to

by the independent contractor, the cost any real property (or any personal

of the services must be borne by the property leased under, or in connection independent contractor, separate with, the real property) qualifies as

charge must be made for the services, "rents from real property” if the real

the amount of the separate charge estate investment trust furnishes or

must be received and retained by the renders services to the tenants of the independent contractor, and the indeproperty or manages or operates the pendent contractor must be adequately property, other than through an inde- compensated for the services. pendent contractor from whom the (ii) Trustee or director functions. The trust itself does not derive or receive trustees or directors of the real estate any income. The prohibition against

investment trust are not required to the trust deriving or receiving any in- delegate or contract out their fiduciary come from the independent contractor duty to manage the trust itself, as disapplies regardless of the source from tinguished from rendering or furwhich the income was derived by the nishing services to the tenants of its independent contractor. Thus, for ex- property or managing or operating the ample, the trust may not receive any property. Thus, the trustees or direcdividends from the independent con- tors may do all those things necessary, tractor. The requirement that the in their fiduciary capacities, to mantrust not receive any income from an age and conduct the affairs of the trust

a

a

itself. For example, the trustees or di- shares in the trust at any time during rectors may establish rental terms, such taxable year. choose tenants, enter into and renew (c) If the independent contractor is leases, and deal with taxes, interest, not a corporation such statement shall and insurance, relating to the trust's set forth the highest percentage of any property. The trustees or directors interest in its assets or net profits may al

make capital expenditures owned at any time during its taxable with respect to the trust's property (as year by any person owning shares in defined in section 263) and may make the trust at any time during such taxdecisions as to repairs of the trust's

able year. property (of the type which would be (6) Amounts based on income or profits deductible under section 162), the cost of subtenants. (i) Except as provided in of which may be borne by the trust. paragraph (b)(6)(ii) of this section, if a (iii) Independent contractor defined.

trust leases real property to a tenant The term "independent contractor”

under terms other than solely on means

fixed sum rental (for example, a per(a) A person who does not own, di

centage of the tenant's gross receipts),

and the tenant subleases all or a part rectly or indirectly, at any time during the trust's taxable year more than 35

of such property under an agreement percent of the shares in the real estate

which provides for a rental based in investment trust, or

whole or in part on the income or prof(b) A person,

its of the sublessee, the entire amount

of the rent received by the trust from (1) If a corporation, not more than 35

the prime tenant with respect to such percent of the total combined voting

property is disqualified as “rents from power of whose stock (or 35 percent of

real property”. the total shares of all classes of whose

(ii) Erception. For taxable years bestock), or

ginning after October 4, 1976, section (2) If not a corporation, not more

856(d)(4) provides an exception to the than 35 percent of the interest in whose

general rule that amounts received or assets or net profits is owned, directly

accrued, directly or indirectly, by a or indirectly, at any time during the real estate investment trust do not trust's taxable year by one or more

qualify as rents from real property if persons owning at any time during

the determination of the amount desuch taxable year 35 percent or more of

pends in whole or in part on the income the shares in the trust.

or profits derived by any person from (iv) Information required. The real es

the property. This exception applies tate investment trust shall submit

where the trust rents property to a tenwith its return for the taxable year (or ant (the prime tenant) for a rental before June 1, 1962, whichever is later) which is based, in whole or in part, on a statement setting forth the name and a fixed percentage or percentages of address of each independent con- the receipts or sales of the prime tentractor; and

ant, and the rent which the trust re(a) The highest percentage of the out- ceives or accrues from the prime tenstanding shares in the trust owned at ant pursuant to the lease would not any time during its taxable year by qualify as “rents from real property such independent contractor and by solely because the prime tenant reany person owning at any time during ceives or accrues from subtenants (insuch taxable year any shares of stock cluding concessionaires) rents or other or interest in the independent con- amounts based on the income or profits tractor.

derived by a person from the property. (6) If the independent contractor is a Under the exception, only a proporcorporation such statement shall set tionate part of the rent received or acforth the highest percentage of the crued by the trust does not qualify as total combined voting power of its “rents from real property". The prostock and the highest percentage of the portionate part of the rent received or total number of shares of all classes of accrued by the trust which is nonits stock owned at any time during its qualified is the lesser of the following taxable year by any person owning two amounts:

shall be substituted for "50 percent" in section 318(a) (2)(C) and (3)(C). (Sec. 856(d)(4) (90 Stat. 1750; 26 U.S.C. 856(d)(4)); sec. 856(e)(5) (88 Stat. 2113; 26 U.S.C. 856(e)(5)); sec. 856(1)(2) (90 Stat. 1751; 26 U.S.C. (856(f)(2)); sec. 856(g)(2) (90 Stat. 1753; 26 U.S.C. 856(g)(2)); sec. 858(a) (74 Stat. 1008; 26 U.S.C. 858(a)); sec. 859(C) (90 Stat. 1743; 26 U.S.C. 859(c)); sec. 859(e) (90 Stat. 1744; 26 U.S.C. 859(e)); sec. 6001 (68A Stat. 731; 26 U.S.C. 6001); sec. 6011 (68A Stat. 732; 26 U.S.C. 6011); sec. 6071 (68A Stat. 749, 26 U.S.C. 6071); sec. 6091 (68A Stat. 752; 26 U.S.C. 6091); sec. 7805 (68A Stat. 917; 26 U.S.C. 7805), Internal Revenue Code of 1954)) (T.D. 6598, 27 FR 4085, Apr. 28, 1962, as amended by T.D. 6969, 33 FR 12000, Aug. 23, 1968; T.D. 7767, 46 FR 11266, Feb. 6, 1981)

(A) The rent received or accrued by the trust from the prime tenant pursuant to the lease, that is based on a fixed percentage or percentages of receipts or sales, or

(B) The product determined by multiplying the total rent which the trust receives or accrues from the prime tenant pursuant to the lease by a fraction, the numerator of which is the rent or other amount received by the prime tenant that is based, in whole or in part, on the income or profits derived by any person from the property, and the denominator of which is the total rent or other amount received by the prime tenant from the property. For example, assume that a real estate investment trust owns land underlying a shopping center. The trust rents the land to the owner of the shopping center for an annual rent of $10x plus 2 percent of the gross receipts which the prime tenant receives from subtenants who lease space in the shopping center. Assume further that, for the year in question, the prime tenant derives total rent from the shopping center of $100x and, of that amount, $25x is received from subtenants whose rent is based, in whole or in part, on the income or profits derived from the property. Accordingly, the trust will receive a total rent of $12x, of which $2x is based on a percentage of the gross receipts of the prime tenant. The portion of the rent which is disqualified is the lesser of $2x (the rent received by the trust which is based on a percentage of gross receipts), or $3x, ($12x multiplied by $25x/$100x). Accordingly, $10x of the rent received by the trust qualifies as "rents from real property” and $2x does not qualify.

(7) Attribution rules. Paragraphs (2) and (3) of section 856(d) relate to direct or indirect ownership of stock, assets, or net profits by the persons described therein. For purposes of determining such direct or indirect ownership, the rules prescribed by section 318(a) (for determining the ownership of stock) shall apply except that "10 percent"

$ 1.856-5 Interest.

(a) In general. In computing the percentage requirements in section 856(c) (2)(B) and (3)(B), the term "interest” includes only an amount which constitutes compensation for the use or forbearance of money. For example, a fee received or accrued by a lender which is in fact a charge for services performed for a borrower rather than a charge for the use of borrowed money is not includable as interest.

(b) Where amount depends on income or profits of any person. Except as provided in paragraph (d) of this section, any amount received or accrued, directly or indirectly, with respect to an obligation is not includable as interest for purposes of section 856(c) (2)(B) and (3)(B) if, under the principles set forth in paragraphs (b)(3) and (6)(i) of $1.8564, the determination of the amount depends in whole or in part on the income or profits of any person (whether or not derived from property secured by the obligation). Thus, for example, if in accordance with a loan agreement an amount is received or accrued by the trust with respect to an obligation which includes both a fixed amount of interest and a percentage of the borrower's income or profits, neither the fixed interest nor the amount based upon the percentage will qualify as interest for purposes of section 856(c) (2)(B) and (3)(B). This paragraph and paragraph (d) of this section apply only

to amounts received or accrued in tax- cost of improvements or developments able years beginning after October 4, shall be determined as of the date on 1976, pursuant to loans made after May which a commitment to make the loan 27, 1976. For purposes of the preceding becomes binding on the trust. If the sentence, a loan is considered to be trust does not make the construction made before May 28, 1976, if it is made loan but commits itself to provide pursuant to a binding commitment en- long-term financing following completered into before May 28, 1976.

tion of construction, the loan value of (c) Apportionment of interest—(1) In

the real property is determined by general. Where a mortgage covers both

using the principles for determining real property and other property, an

the loan value for a construction loan. apportionment of the interest income

Moreover, if the mortgage on the real must be made for purposes of the 75

property is given as additional security percent requirement of section

(or as a substitute for other security) 856(c)(3). For purposes of the 75-percent

for the loan after the trust's commitrequirement, the apportionment shall

ment is binding, the real property loan be made as follows:

value is its fair market value when it (i) If the loan value of the real prop

becomes security for the loan (or, if erty is equal to or exceeds the amount

earlier, when the borrower makes a of the loan, then the entire interest in

binding commitment to add or subcome shall be apportioned to the real

stitute the property as security). property.

(3) Amount of loan. For purposes of (ii) If the amount of the loan exceeds the loan value of the real property,

this paragraph, the amount of the loan then the interest income apportioned

means the highest principal amount of to the real property is an amount equal

the loan outstanding during the tax

able year. to the interest income multiplied by a fraction, the numerator of which is the

(d) Exception. Section 856(1)(2) proloan value of the real property, and the

vides an exception to the general rule denominator of which is the amount of

that amounts received, directly or indithe loan. The interest income appor

rectly, with respect to an obligation do tioned to the other property is an

not qualify as "interest" where the deamount equal to the excess of the total

termination of the amounts depends in interest income over the interest in

whole or in part on the income or profcome apportioned to the real property.

its of any person. The exception applies (2) Loan value. For purposes of this

where the trust receives or accrues, paragraph, the loan value of the real

with respect to the obligation of its property is the fair market value of the

debtor, an amount that is based in property, determined as of the date on

whole or in part on a fixed percentage which the commitment by the trust to

or percentages of recei or sales of make the loan becomes binding on the

the debtor, and the amount would not trust. In the case of a loan purchased

qualify as interest solely because the by the trust, the loan value of the real

debtor has receipts or sale proceeds property is the fair market value of the

that are based on the income or profits property, determined as of the date on of any person. Under this exception which the commitment by the trust to

only a proportionate part of the purchase the loan becomes binding on

amount received or accrued by the the trust. However, in the case of a trust fails to qualify as interest for construction loan or other loan made purposes of the percentage-of-income for purposes of improving or developing requirements of section 856(c) (2) and real property, the loan value of the real (3). The proportionate part of the property is the fair market value of the amount received or accrued by the land plus the reasonably estimated trust that is non-qualified is the lesser cost of the improvements or develop- of the following two amounts: ments (other than personal property) (1) The amount received or accrued which will secure the loan and which by the trust from the debtor with reare to be constructed from the proceeds spect to the obligation that is based on of the loan. The fair market value of a fixed percentage or percentages of rethe land and the reasonably estimated ceipts or sales, or

(2) The product determined by multi- (b) Property eligible for the election (1) plying by a fraction the total amount Rules relating to acquisitions. In general, received or accrued by the trust from the trust must acquire the property the debtor with respect to the obliga- after December 31, 1973, as the result of tion. The numerator of the fraction is having bid in the property at forethe amount of receipts or sales of the closure, or having otherwise reduced debtor that is based, in whole or in the property to ownership or possespart, on the income or profits of any sion by agreement or process of law, person and the denominator is the

after there was default (or default was total amount of the receipts or sales of

imminent) on a lease of the property the debtor. For purposes of the pre

(where the trust was the lessor) or on ceding sentence, the only receipts or

an indebtedness owed to the trust sales to be taken into account are

which the property secured. Forethose taken into account in deter

closure property which secured an inmining the payment to the trust pursuant to the loan agreement.

debtedness owed to the trust is ac

quired for purposes of section 856(e) on (Sec. 856(d)(4) (90 Stat. 1750; 26 U.S.C. the date on which the trust acquires 856(d)(4)); sec. 856(e)(5) (88 Stat. 2113; 26

ownership of the property for Federal U.S.C. 856(e)(5)); sec. 856(1)(2) (90 Stat. 1751; 26

income tax purposes. Foreclosure propU.S.C. (856(1)(2)); sec. 856(g)(2) (90 Stat. 1753; 26 U.S.C. 856(g)(2)); sec. 858(a) (74 Stat. 1008;

erty which a trust owned and leased to 26 U.S.C. 858(a)); sec. 859(C) (90 Stat. 1743; 26

another is acquired for purposes of secU.S.C. 859(c)); sec. 859(e) (90 Stat. 1744; 26 tion 856(e) on the date on which the U.S.C. 859(e)); sec. 6001 (68A Stat. 731; 26 trust acquires possession of the propU.S.C. 6001); sec. 6011 (68A Stat. 732; 26 U.S.C.

erty from its lessee. A trust will not be 6011); sec. 6071 (68A Stat. 749, 26 U.S.C. 6071);

considered to have acquired ownership sec. 6091 (68A Stat. 752; 26 U.S.C. 6091); sec. 7805 (68A Stat. 917; 26 U.S.C. 7805), Internal

of property for purposes of section Revenue Code of 1954)

856(e) where it takes control of the

property as a mortgagee-in-possession (T.D. 7767, 46 FR 11268, Feb. 6, 1981)

and cannot receive any profit or sus$1.856-6 Foreclosure property.

tain any loss with respect to the prop(a) In general. Under section 856(e) a

erty except as a creditor of the mortreal estate investment trust may make

gagor. A trust may be considered to an irrevocable election to treat as

have acquired ownership of property "foreclosure property” certain real

for purposes of section 856(e) even property (including interests in real

through legal title to the property is property), and any personal property

held by another person. For example, incident to the real property, acquired

where, upon foreclosure of a mortgage by the trust after December 31, 1973.

held by the trust, legal title to the This section prescribes rules relating

property is acquired in the name of a to the election, including rules relating

nominee for the exclusive benefit of to property eligible for the election.

the trust and the trust is the equitable This section also prescribes rules relat- owner of the property, the trust will be ing to extensions of the general two

considered to have acquired ownership year period (hereinafter the “grace pe- of the property for purposes of section riod") during which property retains 856(e). Generally, the fact that under its status as foreclosure property, as local law the mortgagor has a right of well as rules relating to early termi- redemption after foreclosure is not relnation of the grace period under sec- evant in determining whether the trust tion 856(e)(4). The election to treat has acquired ownership of the property property as foreclosure property does for purposes of section 856(e). Property not alter the character of the income is not ineligible for the election solely derived therefrom (other than for pur- because the property, in addition to seposes of section 856(C)(2)(F) and (3)(F)), curing an indebtedness owed to the For example, if foreclosure property is trust, also secures debts owed to other sold, the determination of whether it is creditors. Property eligible for the property described in section 1221(1) election includes a building or other will not be affected by the fact that it improvement which has been conis foreclosure property.

structed on land owned by the trust

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