IRS Rules on REIT Loan Treatment in Joint Ventures Under § 856

IRS Greenlights REIT Loan Exclusions in Joint Ventures: What Taxpayers Need to Know

The IRS has issued a non-precedential Private Letter Ruling (PLR-117459-19) clarifying that loans between a REIT and its joint ventures—when attributable to the REIT’s capital interest—are excluded from the REIT’s asset tests under § 856(c)(4). The ruling resolves a longstanding ambiguity for REITs structured through joint ventures, confirming that loans to and from such ventures do not artificially inflate a REIT’s non-real estate asset exposure. For the real estate investment trust industry, this provides critical guidance on maintaining compliance with the 75% real estate asset test while engaging in joint venture financing.

The Taxpayer’s Dilemma: How Joint Venture Loans Threatened REIT Status

The taxpayer, a state-chartered corporation, had elected to be treated as a real estate investment trust (REIT) under § 856(a), a designation requiring strict compliance with asset, income, and organizational tests. Its primary business involved leasing space on multi-tenanted communications towers—structures the taxpayer classified as real property under § 1.856-10 of the Treasury Regulations, given their permanent affixation to land and integral role in telecommunications infrastructure. These towers, located domestically and internationally, generated rental income, the cornerstone of REIT qualification under § 856(c)(2).

To expand its operations, the taxpayer frequently entered into joint ventures (JVs) with third-party partners and its taxable REIT subsidiaries (TRSs), as defined under § 856(l). Each JV was structured as a partnership for federal tax purposes, with the taxpayer and its partners holding proportional equity interests. While these JVs facilitated the acquisition and development of additional communications sites, they also introduced a critical compliance risk: the taxpayer regularly extended loans to and borrowed funds from these JVs to finance site expansions. Each loan was memorialized by a promissory note and treated as indebtedness for tax purposes, arising solely from capital financing transactions—not operational activities.

The taxpayer’s structure faced scrutiny under § 856(c)(4), which mandates that at least 75% of a REIT’s assets must consist of real estate, cash, or government securities. Loans to or from JVs—if treated as non-real estate assets—risked inflating the taxpayer’s non-qualifying asset base, potentially pushing it out of compliance with the 75% real estate asset test. The loans in question were not receivables as defined under § 1.856-2(d)(1)(iii), but their classification as either real estate or non-real estate assets remained unresolved, creating a looming threat to the taxpayer’s REIT status. The dispute centered on whether these intercompany loans, though structured as debt, could be excluded from the asset test calculations when attributable to the REIT’s capital interest in the JVs.

The IRS’s Ruling: Loans Excluded from REIT Asset Tests—But With Limits

The IRS issued two rulings clarifying how intercompany loans between a REIT and its joint ventures (JVs) should be treated under the asset tests of § 856(c)(4). Both rulings relied on § 1.856-3(g), which requires REITs to account for their proportionate share of JV assets based on capital interests, and § 856(m), which governs the treatment of partnership debt in REIT asset calculations.

In the first ruling, the IRS held that loans to JVs attributable to the REIT’s capital interest are not treated as separate assets. Instead, the loans are disregarded for § 856(c) purposes because the REIT’s proportionate share of the JV’s assets—already including the financed property and income used to repay the loans—reflects the economic reality of the arrangement. The rationale hinges on the fact that the loans are not operational receivables but rather capital contributions in substance, aligned with the REIT’s equity stake.

The second ruling addressed loans from JVs to the REIT, treating the portion attributable to the REIT’s capital interest as held by the REIT itself. Under § 1.856-3(g), the IRS viewed this as a transaction between the REIT and itself, effectively excluding the deemed portion of the loan (including accrued interest) from the REIT’s asset calculations. The exclusion applies only to the extent the loan reflects the REIT’s capital interest, not to unrelated debt or operational financing.

The rulings impose critical limits: the exclusions apply solely to loans commensurate with the REIT’s capital interest in the JV and do not extend to receivables unrelated to real estate assets or operational financing. This preserves the integrity of the 75% real estate asset test while preventing double-counting of JV assets and liabilities in the REIT’s calculations.

Why This Ruling Matters: Implications for REITs and Joint Ventures

The IRS ruling clarifies how loans between a REIT and its joint venture (JV) partners are treated under § 856(c)(4), which requires REITs to hold at least 75% of their assets in real estate, cash, or government securities. The decision confirms that loans from a REIT to a JV—to the extent they reflect the REIT’s capital interest—are excluded from the REIT’s asset calculations under § 856(c)(4)(A) and (B). This aligns with § 856(m), which prevents REITs from inflating their real estate exposure through debt-financed partnership interests, and § 1.856-3(g), which governs the treatment of partnership assets and liabilities.

The ruling’s limits are critical. Only loans commensurate with the REIT’s capital stake in the JV qualify for exclusion; unrelated debt or operational financing does not. REITs that fail to structure loans strictly in accordance with this guidance risk misclassifying assets, potentially violating the 75% real estate test. For example, a REIT extending a loan to a JV that exceeds its proportional capital interest could inadvertently convert what should be a real estate asset into a disqualifying "other asset" under § 856(c)(4)(B).

While the ruling is non-precedential—meaning it applies only to the taxpayer and cannot be cited as precedent—REITs should still heed its implications. The IRS’s reasoning reflects broader enforcement trends, particularly in audits of joint ventures where debt structures blur the line between equity and financing. Taxpayers in similar structures should document their loan agreements meticulously to demonstrate compliance with § 856(m) and avoid scrutiny. The ruling also underscores the IRS’s willingness to scrutinize JV arrangements, making proactive structuring essential for REITs operating in this space.

Key Takeaways for Tax Practitioners: Navigating REIT Asset Tests

Tax practitioners advising REITs must prioritize precise structuring of loans to and from joint ventures to align with capital interests, ensuring compliance with § 856(m) and § 1.856-3(g). The IRS’s exclusion of certain loans from REIT asset tests hinges on their treatment as indebtedness under federal tax law, not equity—meaning loans must be documented as enforceable debt obligations with clear terms, interest rates, and repayment schedules. Practitioners should also recognize the ruling’s limitations: it is non-precedential and fact-specific, applying only to the taxpayer’s unique joint venture structure.

The IRS’s scrutiny of joint ventures underscores the need for meticulous documentation. Loans must be structured to avoid disguised equity, with recourse limited to the joint venture’s assets and not the REIT’s broader portfolio. Taxpayers should prepare for potential IRS challenges by maintaining contemporaneous records that demonstrate compliance with § 856(m), particularly in cases where loans are secured by real estate or structured as preferred equity. While this ruling provides temporary relief, future IRS guidance or litigation may refine the boundaries of permissible debt treatment, particularly as REITs increasingly engage in complex joint ventures involving digital infrastructure like cell towers. Proactive structuring and documentation remain essential to mitigate audit risk.