IRS Grants Extension for REIT to Elect Taxable REIT Subsidiary Status Due to Advisor Error

REIT’s $5M Gamble: How a Tax Advisor’s Mistake Nearly Cost a Fortune

The stakes couldn’t have been higher: a Real Estate Investment Trust (REIT) faced potential disqualification and a seven-figure tax bill after its tax advisor missed a critical election deadline. The error threatened to derail the REIT’s structure, exposing it to corporate-level taxation and penalties totaling over $5 million. In a rare act of leniency, the IRS granted an extension under Reg. § 301.9100-3, sparing the REIT from financial ruin—but the close call underscores the unforgiving nature of REIT compliance and the costly consequences of procedural missteps. The drama unfolded under the shadow of Section 856(l), which governs the election to treat a subsidiary as a Taxable REIT Subsidiary (TRS), a mechanism REITs rely on to operate non-qualifying businesses like hotels or casinos without jeopardizing their tax-advantaged status.

The Timeline: A Race Against the Clock and a Tax Advisor’s Misstep

The drama unfolded under the shadow of Section 856(l), which governs the election to treat a subsidiary as a Taxable REIT Subsidiary (TRS), a mechanism REITs rely on to operate non-qualifying businesses like hotels or casinos without jeopardizing their tax-advantaged status.

The Tax Director initially structured the acquisition of the Property under the assumption that the Hotel would be demolished immediately after purchase, rendering the structure compliant with REIT rules. On Date 4, the Tax Director drafted a plan in which Taxpayer would hold its interest in the Property through a series of LLCs, each classified as a disregarded entity or partnership. The Tax Director was aware that operating the Hotel would generate non-qualifying income under the gross income tests in Section 856(c)(2) and (3), but deemed the structure acceptable because the Hotel was not expected to remain operational post-acquisition.

By Date 5, the Tax Director learned that Taxpayer would continue operating the Hotel for several months after the acquisition, engaging Hotel Manager to oversee operations. Recognizing the flaw in the original structure, the Tax Director immediately sought external advice from Accounting Firm and Law Firm to restructure the deal. Accounting Firm, however, operated under a critical misconception: it mistakenly believed that a third party would indirectly invest in the Property and that Taxpayer’s ownership in Subsidiary 1 would be through a partnership. This misunderstanding shaped the firm’s subsequent advice.

With the acquisition closing imminent, the Tax Director and advisors scrambled to finalize a viable structure. On Date 6, the Tax Director urgently contacted Accounting Firm to address the change in circumstances, and on Date 7, a conference call was held with Accounting Firm and Law Firm to explore alternatives. The group briefly considered a TRS structure, where Subsidiary 1 would own the Hotel and Hotel Manager would qualify as an Eligible Independent Contractor (EIK) managing the property as a qualified lodging facility. However, the advisors acknowledged that additional due diligence would be required to confirm Hotel Manager’s EIK status, a process that could not be completed before the closing deadline.

Facing mounting time pressure, the Tax Director accepted Accounting Firm’s alternative recommendation: to avoid the TRS election altogether. On Date 8, the Tax Director finalized and distributed revised ownership charts, in which Taxpayer would directly own Subsidiary 1, which in turn would indirectly hold the Property through a cascade of disregarded entities. Accounting Firm and Law Firm signed off on the structure without analyzing whether Taxpayer’s use of the Temporary Investment of New Capital (TINC) Rule under Section 856(c)(5)(B) was appropriate. The TINC Rule allows a REIT to treat certain investments in stock as qualifying assets for the asset test, but only if the stock is held as a temporary investment and meets specific conditions.

The structure closed on Date 9, with Subsidiary 4 acquiring the Property. On Date 10, Subsidiary 1 filed a Form 8832 to be classified as a corporation for federal tax purposes, effective Date 1. Weeks later, on Date 11, during discussions with Auditing Firm, the Sponsor questioned whether Subsidiary 1 was wholly owned by Taxpayer and thus a Qualified REIT Subsidiary (QRS). Accounting Firm conducted a review and discovered that Taxpayer, in fact, owned 100% of Subsidiary 1—contrary to the firm’s earlier assumption that ownership was through a partnership. The realization was critical: if Taxpayer wholly owned Subsidiary 1, the Hotel’s operating income would flow directly to Taxpayer, generating non-qualifying income under Section 856(c)(2) and (3).

Accounting Firm admitted that if it had known Taxpayer would wholly own Subsidiary 1, it would have recommended conducting due diligence to confirm Hotel Manager’s EIK status and filing a TRS election effective Date 1. The firm’s failure to recognize the ownership structure earlier had led to a rushed decision to bypass the TRS election, a move made under intense time constraints. Months later, in Month, the Hotel ceased operations. By Date 12, the Sponsor engaged Accounting Firm to prepare a request for an extension of time to retroactively elect Subsidiary 1 as a TRS of Taxpayer.

The Question: Can a REIT Fix a Missed TRS Election After the Fact?

The Sponsor’s tax team sought an extension under Regulations § 301.9100-1 and § 301.9100-3 to retroactively elect Subsidiary 1 as a Taxable REIT Subsidiary (TRS) of Taxpayer effective Date 1. This election was critical because Hotel operations generated non-qualifying income under Section 856(c)(2) and (3), which require REITs to derive at least 75% and 95% of gross income, respectively, from qualifying sources such as rents from real property. The failure to make the TRS election meant the Hotel’s operating income risked tainting Taxpayer’s compliance with these tests, potentially disqualifying its REIT status.

The Sponsor’s tax director had initially structured the acquisition under the mistaken belief that the Hotel would not operate post-acquisition, but learned days before closing that Taxpayer would continue operating the Hotel for several months under a management agreement with Hotel Manager. Accounting Firm, retained to finalize the structure, advised against a TRS election due to uncertainty about whether Hotel Manager qualified as an eligible independent contractor (EIK) under Section 856(d)(9). Instead, Accounting Firm recommended a structure relying on the Temporary Investment of New Capital (TINC) Rule under Section 856(c)(5)(B), which allows certain stock investments to qualify as real estate assets temporarily. However, this approach failed to address the Hotel’s operating income, leaving Taxpayer exposed to non-qualifying income risks.

By Date 12, after the Hotel ceased operations and the flaw in the structure was identified, the Sponsor engaged Accounting Firm to prepare a private letter ruling request seeking relief for the missed TRS election. The request explicitly stated that Taxpayer and Subsidiary 1 were not seeking to alter their tax liability or use hindsight in requesting relief, but rather to correct a procedural error that threatened their REIT compliance.

The IRS’s Rationale: Reasonable Action, Good Faith, and No Harm to the Government

The IRS granted relief under Reg. § 301.9100-3—the regulation governing discretionary extensions for late regulatory elections—because the taxpayer demonstrated reasonable reliance on professional advice, acted in good faith, and caused no prejudice to the Government. The ruling hinged on four key factors explicitly addressed in the regulation: (1) the taxpayer’s reasonable reliance on advisors, (2) the absence of hindsight or intent to avoid taxes, (3) the lack of prejudice to the Government, and (4) the affidavits and representations submitted to substantiate the request.

The IRS’s analysis began with Reg. § 301.9100-3(a), which permits relief when the taxpayer establishes that the failure to make a timely election was due to reasonable action and good faith, and that granting relief would not prejudice the interests of the Government. The regulation defines "reasonable action and good faith" expansively, including scenarios where the taxpayer reasonably relied on a qualified tax professional who failed to advise or make the election. The taxpayer’s request explicitly cited Accounting Firm’s misstep in failing to file Form 8875, the TRS election form, as the root cause of the delay. The IRS accepted this explanation, noting that the taxpayer had no prior knowledge of the election requirement and acted promptly once the error was identified.

The IRS also emphasized the absence of hindsight in the taxpayer’s request. Under Reg. § 301.9100-3(b)(iii), a taxpayer is deemed to have acted reasonably if they were unaware of the necessity for the election despite exercising reasonable diligence. The taxpayer’s representations confirmed that they did not seek to alter their tax liability or exploit the late election for financial gain. Instead, they requested relief solely to correct a procedural flaw that threatened their REIT compliance. The IRS quoted the taxpayer’s statement verbatim: "Taxpayer and Subsidiary 1 were not seeking to alter their tax liability or use hindsight in requesting relief, but rather to correct a procedural error that threatened their REIT compliance." This lack of intent to manipulate tax outcomes was critical to the IRS’s decision.

The lack of prejudice to the Government further strengthened the taxpayer’s case. Under Reg. § 301.9100-3(c)(1), the IRS must determine whether granting relief would result in the taxpayer having a lower tax liability than if the election had been timely made. The taxpayer’s representations confirmed that the timely election would not have changed their tax position, as the TRS election was intended to maintain compliance rather than reduce liability. The IRS also noted that the taxable years affected by the election were still open under § 6501(a), meaning the Government retained the ability to assess any potential deficiencies. The regulation explicitly states that prejudice ordinarily exists if the taxable year is closed by the statute of limitations, but here, the years remained open, removing this barrier.

Finally, the IRS relied on the affidavits and penalties of perjury statements submitted by the taxpayer and its advisors. Reg. § 301.9100-3(e) requires the taxpayer to provide evidence, including affidavits, to substantiate their claims of reasonable cause and good faith. The taxpayer included detailed affidavits from the Sponsor and Accounting Firm, attesting to the miscommunication that led to the missed election and the prompt corrective action taken once the error was discovered. The IRS noted in its conclusion that the ruling was based on "information submitted and representations made by Taxpayer and Subsidiary 1 and accompanied by penalties of perjury statements executed by the appropriate parties." While the IRS did not verify the material independently, the sworn statements provided sufficient proof to satisfy the regulation’s requirements.

The IRS’s decision in PLR-120013-25 (dated 8/7/2026) serves as a blueprint for REITs facing similar procedural errors. The ruling underscores that reasonable reliance on advisors, prompt corrective action, and transparency with the IRS can mitigate the consequences of missed elections. However, it also warns that hindsight-driven requests or closed tax years will likely result in denial. For REITs and their advisors, the lesson is clear: document every election decision, verify professional advice, and act swiftly when errors are identified—or risk losing the opportunity for relief under Reg. § 301.9100-3.

The Implications: A Cautionary Tale for REITs and Their Advisors

The IRS’s decision in this PLR underscores three critical lessons for REITs and their advisors, each rooted in the specific facts of the case: a REIT’s missed Taxable REIT Subsidiary (TRS) election under Section 856(l) due to a tax advisor’s error, followed by a timely correction under Reg. § 301.9100-3. The ruling’s non-precedential nature does not diminish its value as a roadmap for navigating election pitfalls, but it also serves as a warning that discretion is not guaranteed.

First, the case highlights the risks of rushed structuring decisions and the cost of unverified advisor assumptions. The taxpayer’s error stemmed from relying on a tax advisor’s incorrect advice about the timeliness of Form 8875, the IRS form required to elect TRS status. The IRS granted relief under Reg. § 301.9100-3, which allows late elections if the taxpayer acted in good faith and the IRS is not prejudiced. However, the ruling’s narrow scope—limited to the timeliness of the filing—omits any opinion on whether the REIT otherwise qualified under subchapter M of chapter 1 of the Code or whether the TRS met the ownership requirements of Section 856(l)(1). For REITs, this means that even a technically correct election can unravel if the underlying structure fails other compliance tests, such as the 75% and 95% gross income tests under Section 856(c)(2) and (3) or the TINC rule under Section 856(c)(5)(B). The IRS’s silence on these issues in the PLR suggests that structural compliance cannot be an afterthought—it must be verified before elections are made.

Second, the case demonstrates the potential consequences of non-qualifying income and the narrow window for relief. If the TRS had generated service income that did not qualify as rent under Section 856(c)(2), the REIT could have faced disqualification for failing the income tests. The IRS’s refusal to opine on whether the TRS’s income was qualifying underscores that late elections do not cure structural flaws. For REITs operating hotels, data centers, or other service-intensive properties, this means proactive structuring is essential. A TRS can provide services like hotel operations, but only if those services are customary and not excessive, as clarified in IRS Revenue Ruling 2021-10. If a REIT’s TRS crosses that line—by, for example, operating a casino in a hotel—the income may taint the REIT’s qualification, regardless of whether the election was filed on time.

Finally, the ruling reinforces that Section 301.9100-3 relief is not a safety net. The IRS granted relief here because the taxpayer acted promptly to correct the error and demonstrated reasonable reliance on professional advice. But the ruling also warns that hindsight-driven requests or closed tax years will likely be denied. For REITs, this means documenting every election decision, verifying professional advice in real time, and acting within the 12-month window for automatic relief under Reg. § 301.9100-1. The case serves as a reminder that tax advisors are not infallible, and REITs must double-check assumptions—especially when structuring complex transactions like TRS elections or tenant-in-common (TIC) arrangements under Section 856(c)(5)(B).

For industries beyond real estate, the lesson is equally stark: missed elections, structural missteps, and unverified advice can have irreversible consequences. Whether in partnership formations, S-corporation elections, or international tax structuring, the IRS’s approach in this PLR—requiring good faith, prompt correction, and no prejudice to the government—is a template for relief. But it is not a substitute for due diligence. The PLR’s non-precedential status further emphasizes that each case turns on its facts, leaving no room for complacency. For REITs and their advisors, the message is clear: verify, document, and act fast—or risk losing the opportunity for relief entirely.