IRS Revenue Procedure
2002-22

Code Secs. 267, 511, 512, 707, 761, 856 ....



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26 CFR 601.201: Rulings and determination letters.
(Also Part I, sections 267, 511, 512, 707, 761, 856, 1031, 1361; 1.761-1,
1.761-2; 301.7701, 301.7701-2, 301.7701-3, 301.7701-4.)


REV. PROC. 2002-22

SECTION 1. PURPOSE

This revenue procedure specifies the conditions under which the
Internal Revenue Service will consider a request for a ruling that an
undivided fractional interest in rental real property (other than a
mineral property as defined in section 614) is not an interest in a
business entity, within the meaning of section 301.7701-2(a) of the
Procedure and Administration Regulations.

This revenue procedure supersedes Rev. Proc. 2000-46 (2000-2 C.B. 438),
which provides that the Service will not issue advance rulings or
determination letters on the questions of whether an undivided fractional
interest in real property is an interest in an entity that is not eligible
for tax-free exchange under section 1031(a)(1) of the Internal Revenue
Code and whether arrangements where taxpayers acquire undivided fractional
interests in real property constitute separate entities for federal tax
purposes under section 7701. This revenue procedure also modifies Rev.
Proc. 2002-3 (2002-1 I.R.B. 117) by removing these issues from the list of
subjects on which the Service will not rule. Requests for advance rulings
described in Rev. Proc. 2000-46 that are not covered by this revenue
procedure, such as rulings concerning mineral property, will be considered
under procedures set forth in Rev. Proc. 2002-1 (2002-1 I.R.B. 1) (or its
successor).


SECTION 2. BACKGROUND

Section 301.7701-1(a)(1) provides that whether an organization is an
entity separate from its owners for federal tax purposes is a matter of
federal law and does not depend on whether the entity is recognized as an
entity under local law. Section 301.7701-1(a)(2) provides that a joint
venture or other contractual arrangement may create a separate entity for
federal tax purposes if the participants carry on a trade, business,
financial operation, or venture and divide the profits therefrom, but the
mere co-ownership of property that is maintained, kept in repair, and
rented or leased does not constitute a separate entity for federal tax
purposes.

Section 301.7701-2(a) provides that a business entity is any entity
recognized for federal tax purposes (including an entity with a single
owner that may be disregarded as an entity separate from its owner under
section 301.7701-3) that is not properly classified as a trust under
section 301.7701-4 or otherwise subject to special treatment under the
Internal Revenue Code. A business entity with two or more members is
classified for federal tax purposes as either a corporation or a
partnership.

Section 761(a) provides that the term "partnership" includes a
syndicate, group, pool, joint venture, or other unincorporated
organization through or by means of which any business, financial
operation, or venture is carried on, and that is not a corporation or a
trust or estate.

Section 1.761-1(a) of the Income Tax Regulations provides that the term
"partnership" means a partnership as determined under sections 301.7701-1,
301.7701-2, and 301.7701-3.

The central characteristic of a tenancy in common, one of the
traditional concurrent estates in land, is that each owner is deemed to
own individually a physically undivided part of the entire parcel of
property. Each tenant in common is entitled to share with the other
tenants the possession of the whole parcel and has the associated rights
to a proportionate share of rents or profits from the property, to
transfer the interest, and to demand a partition of the property. These
rights generally provide a tenant in common the benefits of ownership of
the property within the constraint that no rights may be exercised to the
detriment of the other tenants in common. 7 Richard R. Powell, Powell on
Real Property sections 50.01-50.07 (Michael Allan Wolf ed., 2000).

Rev. Rul. 75-374 (1975-2 C.B. 261) concludes that a two-person
co-ownership of an apartment building that was rented to tenants did not
constitute a partnership for federal tax purposes. In the revenue ruling,
the co-owners employed an agent to manage the apartments on their behalf;
the agent collected rents, paid property taxes, insurance premiums, repair
and maintenance expenses, and provided the tenants with customary
services, such as heat, air conditioning, trash removal, unattended
parking, and maintenance of public areas. The ruling concludes that the
agent's activities in providing customary services to the tenants,
although imputed to the co-owners, were not sufficiently extensive to
cause the co-ownership to be characterized as a partnership. See also Rev.
Rul. 79-77 (1979-1 C.B. 448), which did not find a business entity where
three individuals transferred ownership of a commercial building subject
to a net lease to a trust with the three individuals as beneficiaries.

Where a sponsor packages co-ownership interests for sale by acquiring
property, negotiating a master lease on the property, and arranging for
financing, the courts have looked at the relationships not only among the
co-owners, but also between the sponsor (or persons related to the
sponsor) and the co-owners in determining whether the co-ownership gives
rise to a partnership. For example, in Bergford v. Commissioner, 12 F.3d
166 (9th Cir. 1993), seventy-eight investors purchased "co-ownership"
interests in computer equipment that was subject to a 7-year net lease. As
part of the purchase, the co-owners authorized the manager to arrange
financing and refinancing, purchase and lease the equipment, collect rents
and apply those rents to the notes used to finance the equipment, prepare
statements, and advance funds to participants on an interest-free basis to
meet cash flow. The agreement allowed the co-owners to decide by majority
vote whether to sell or lease the equipment at the end of the lease.
Absent a majority vote, the manager could make that decision. In addition,
the manager was entitled to a remarketing fee of 10 percent of the
equipment's selling price or lease rental whether or not a co-owner
terminated the agreement or the manager performed any remarketing. A
co-owner could assign an interest in the co-ownership only after
fulfilling numerous conditions and obtaining the manager's consent.

The court held that the co-ownership arrangement constituted a
partnership for federal tax purposes. Among the factors that influenced
the court's decision were the limitations on the co-owners' ability to
sell, lease, or encumber either the co-ownership interest or the
underlying property, and the manager's effective participation in both
profits (through the remarketing fee) and losses (through the advances).
Bergford, 12 F.3d at 169-170. Accord Bussing v. Commissioner, 88 T.C. 449
(1987), aff'd on reh'g, 89 T.C. 1050 (1987); Alhouse v. Commissioner, T.C.
Memo. 1991-652.

Under section 1.761-1(a) and sections 301.7701-1 through 301.7701-3, a
federal tax partnership does not include mere co-ownership of property
where the owners' activities are limited to keeping the property
maintained, in repair, rented or leased. However, as the above authorities
demonstrate, a partnership for federal tax purposes is broader in scope
than the common law meaning of partnership and may include groups not
classified by state law as partnerships. Bergford, 12 F.3d at 169. Where
the parties to a venture join together capital or services with the intent
of conducting a business or enterprise and of sharing the profits and
losses from the venture, a partnership (or other business entity) is
created. Bussing, 88 T.C. at 460. Furthermore, where the economic benefits
to the individual participants are not derivative of their co-ownership,
but rather come from their joint relationship toward a common goal, the
co-ownership arrangement will be characterized as a partnership (or other
business entity) for federal tax purposes. Bergford, 12 F.3d at 169.


SECTION 3. SCOPE

This revenue procedure applies to co-ownership of rental real property
(other than mineral interests) (the Property) in an arrangement classified
under local law as a tenancy-in-common.

This revenue procedure provides guidelines for requesting advance
rulings solely to assist taxpayers in preparing ruling requests and the
Service in issuing advance ruling letters as promptly as practicable. The
guidelines set forth in this revenue procedure are not intended to be
substantive rules and are not to be used for audit purposes.


SECTION 4. GUIDELINES FOR SUBMITTING RULING REQUESTS

The Service ordinarily will not consider a request for a ruling under
this revenue procedure unless the information described in section 5 of
this revenue procedure is included in the ruling request and the
conditions described in section 6 of this revenue procedure are satisfied.
Even if sections 5 and 6 of this revenue procedure are satisfied, however,
the Service may decline to issue a ruling under this revenue procedure
whenever warranted by the facts and circumstances of a particular case and
whenever appropriate in the interest of sound tax administration.

Where multiple parcels of property owned by the co-owners are leased to
a single tenant pursuant to a single lease agreement and any debt of one
or more co-owners is secured by all of the parcels, the Service will
generally treat all of the parcels as a single "Property." In such a case,
the Service will generally not consider a ruling request under this
revenue procedure unless: (1) each co-owner's percentage interest in each
parcel is identical to that co-owner's percentage interest in every other
parcel, (2) each co-owner's percentage interests in the parcels cannot be
separated and traded independently, and (3) the parcels of property are
properly viewed as a single business unit. The Service will generally
treat contiguous parcels as comprising a single business unit. Even if the
parcels are not contiguous, however, the Service may treat multiple
parcels as comprising a single business unit where there is a close
connection between the business use of one parcel and the business use of
another parcel. For example, an office building and a garage that services
the tenants of the office building may be treated as a single business
unit even if the office building and the garage are not contiguous.

For purposes of this revenue procedure, the following definitions
apply. The term "co-owner" means any person that owns an interest in the
Property as a tenant in common. The term "sponsor" means any person who
divides a single interest in the Property into multiple co-ownership
interests for the purpose of offering those interests for sale. The term
"related person" means a person bearing a relationship described in
section 267(b) or 707(b)(1), except that in applying section 267(b) or
707(b)(1), the co-ownership will be treated as a partnership and each
co-owner will be treated as a partner. The term "disregarded entity" means
an entity that is disregarded as an entity separate from its owner for
federal tax purposes. Examples of disregarded entities include qualified
REIT subsidiaries (within the meaning of section 856(i)(2)), qualified
subchapter S subsidiaries (within the meaning of section 1361(b)(3)(B)),
and business entities that have only one owner and do not elect to be
classified as corporations. The term "blanket lien" means any mortgage or
trust deed that is recorded against the Property as a whole.


SECTION 5. INFORMATION TO BE SUBMITTED

.01 Section 8 of Rev. Proc. 2002-1 outlines general requirements
concerning the information to be submitted as part of a ruling request,
including advance rulings under this revenue procedure. For example, any
ruling request must contain a complete statement of all facts relating to
the co-ownership, including those relating to promoting, financing, and
managing the Property. Among the information to be included are the items
of information specified in this revenue procedure; therefore, the ruling
request must provide all items of information and conditions specified
below and in section 6 of this revenue procedure, or at least account for
all of the items. For example, if a co-ownership arrangement has no
brokerage agreement permitted in section 6.12 of this revenue procedure,
the ruling request should so state. Furthermore, merely submitting
documents and supplementary materials required by section 5.02 of this
revenue procedure does not satisfy all of the information requirements
contained in section 5.02 of this revenue procedure or in section 8 of
Rev. Proc. 2002-1; all material facts in the documents submitted must be
explained in the ruling request and may not be merely incorporated by
reference. All submitted documents and supplementary materials must
contain applicable exhibits, attachments, and amendments. The ruling
request must identify and explain any information or documents required in
section 5 of this revenue procedure that are not included and any
conditions in section 6 of this revenue procedure that are or are not
satisfied.

.02 REQUIRED GENERAL INFORMATION AND COPIES OF DOCUMENTS AND
SUPPLEMENTARY MATERIALS. Generally the following information and copies of
documents and materials must be submitted with the ruling request:

(1) The name, taxpayer identification number, and percentage fractional
interest in Property of each co-owner;

(2) The name, taxpayer identification number, ownership of, and any
relationship among, all persons involved in the acquisition, sale, lease
and other use of Property, including the sponsor, lessee, manager, and
lender;

(3) A full description of the Property;

(4) A representation that each of the co-owners holds title to the
Property (including each of multiple parcels of property treated as a
single Property under this revenue procedure) as a tenant in common under
local law;

(5) All promotional documents relating to the sale of fractional
interests in the Property;

(6) All lending agreements relating to the Property;

(7) All agreements among the co-owners relating to the Property;

(8) Any lease agreement relating to the Property;

(9) Any purchase and sale agreement relating to the Property;

(10) Any property management or brokerage agreement relating to the
Property; and

(11) Any other agreement relating to the Property not specified in this
section, including agreements relating to any debt secured by the Property
(such as guarantees or indemnity agreements) and any call and put options
relating to the Property.


SECTION 6. CONDITIONS FOR OBTAINING RULINGS

The Service ordinarily will not consider a request for a ruling under
this revenue procedure unless the conditions described below are
satisfied. Nevertheless, where the conditions described below are not
satisfied, the Service may consider a request for a ruling under this
revenue procedure where the facts and circumstances clearly establish that
such a ruling is appropriate.

.01 TENANCY IN COMMON OWNERSHIP. Each of the co-owners must hold title
to the Property (either directly or through a disregarded entity) as a
tenant in common under local law. Thus, title to the Property as a whole
may not be held by an entity recognized under local law.

.02 NUMBER OF CO-OWNERS. The number of co-owners must be limited to no
more than 35 persons. For this purpose, "person" is defined as in section
7701(a)(1), except that a husband and wife are treated as a single person
and all persons who acquire interests from a co-owner by inheritance are
treated as a single person.

.03 NO TREATMENT OF CO-OWNERSHIP AS AN ENTITY. The co-ownership may not
file a partnership or corporate tax return, conduct business under a
common name, execute an agreement identifying any or all of the co-owners
as partners, shareholders, or members of a business entity, or otherwise
hold itself out as a partnership or other form of business entity (nor may
the co-owners hold themselves out as partners, shareholders, or members of
a business entity). The Service generally will not issue a ruling under
this revenue procedure if the co-owners held interests in the Property
through a partnership or corporation immediately prior to the formation of
the co-ownership.

.04 CO-OWNERSHIP AGREEMENT. The co-owners may enter into a limited
co-ownership agreement that may run with the land. For example, a
co-ownership agreement may provide that a co-owner must offer the
co-ownership interest for sale to the other co-owners, the sponsor, or the
lessee at fair market value (determined as of the time the partition right
is exercised) before exercising any right to partition (see section 6.06
of this revenue procedure for conditions relating to restrictions on
alienation); or that certain actions on behalf of the co-ownership require
the vote of co-owners holding more than 50 percent of the undivided
interests in the Property (see section 6.05 of this revenue procedure for
conditions relating to voting).

.05 VOTING. The co-owners must retain the right to approve the hiring
of any manager, the sale or other disposition of the Property, any leases
of a portion or all of the Property, or the creation or modification of a
blanket lien. Any sale, lease, or re-lease of a portion or all of the
Property, any negotiation or renegotiation of indebtedness secured by a
blanket lien, the hiring of any manager, or the negotiation of any
management contract (or any extension or renewal of such contract) must be
by unanimous approval of the co-owners. For all other actions on behalf of
the co-ownership, the co-owners may agree to be bound by the vote of those
holding more than 50 percent of the undivided interests in the Property. A
co-owner who has consented to an action in conformance with this section
6.05 may provide the manager or other person a power of attorney to
execute a specific document with respect to that action, but may not
provide the manager or other person with a global power of attorney.

.06 RESTRICTIONS ON ALIENATION. In general, each co-owner must have the
rights to transfer, partition, and encumber the co-owner's undivided
interest in the Property without the agreement or approval of any person.
However, restrictions on the right to transfer, partition, or encumber
interests in the Property that are required by a lender and that are
consistent with customary commercial lending practices are not prohibited.
See section 6.14 of this revenue procedure for restrictions on who may be
a lender. Moreover, the co-owners, the sponsor, or the lessee may have a
right of first offer (the right to have the first opportunity to offer to
purchase the co-ownership interest) with respect to any co-owner's
exercise of the right to transfer the co-ownership interest in the
Property. In addition, a co-owner may agree to offer the co-ownership
interest for sale to the other co-owners, the sponsor, or the lessee at
fair market value (determined as of the time the partition right is
exercised) before exercising any right to partition.

.07 SHARING PROCEEDS AND LIABILITIES UPON SALE OF PROPERTY. If the
Property is sold, any debt secured by a blanket lien must be satisfied and
the remaining sales proceeds must be distributed to the co-owners.

.08 PROPORTIONATE SHARING OF PROFITS AND LOSSES. Each co-owner must
share in all revenues generated by the Property and all costs associated
with the Property in proportion to the co-owner's undivided interest in
the Property. Neither the other co-owners, nor the sponsor, nor the
manager may advance funds to a co-owner to meet expenses associated with
the co-ownership interest, unless the advance is recourse to the co-owner
(and, where the co-owner is a disregarded entity, the owner of the
co-owner) and is not for a period exceeding 31 days.

.09 PROPORTIONATE SHARING OF DEBT. The co-owners must share in any
indebtedness secured by a blanket lien in proportion to their undivided
interests.

.10 OPTIONS. A co-owner may issue an option to purchase the co-owner's
undivided interest (call option), provided that the exercise price for the
call option reflects the fair market value of the Property determined as
of the time the option is exercised. For this purpose, the fair market
value of an undivided interest in the Property is equal to the co-owner's
percentage interest in the Property multiplied by the fair market value of
the Property as a whole. A co-owner may not acquire an option to sell the
co-owner's undivided interest (put option) to the sponsor, the lessee,
another co-owner, or the lender, or any person related to the sponsor, the
lessee, another co-owner, or the lender.

.11 NO BUSINESS ACTIVITIES. The co-owners' activities must be limited
to those customarily performed in connection with the maintenance and
repair of rental real property (customary activities). See Rev. Rul.
75-374 (1975-2 C.B. 261). Activities will be treated as customary
activities for this purpose if the activities would not prevent an amount
received by an organization described in section 511(a)(2) from qualifying
as rent under section 512(b)(3)(A) and the regulations thereunder. In
determining the co-owners' activities, all activities of the co-owners,
their agents, and any persons related to the co-owners with respect to the
Property will be taken into account, whether or not those activities are
performed by the co-owners in their capacities as co-owners. For example,
if the sponsor or a lessee is a co-owner, then all of the activities of
the sponsor or lessee (or any person related to the sponsor or lessee)
with respect to the Property will be taken into account in determining
whether the co-owners' activities are customary activities. However,
activities of a co-owner or a related person with respect to the Property
(other than in the co-owner's capacity as a co-owner) will not be taken
into account if the co-owner owns an undivided interest in the Property
for less than 6 months.

.12 MANAGEMENT AND BROKERAGE AGREEMENTS. The co-owners may enter into
management or brokerage agreements, which must be renewable no less
frequently than annually, with an agent, who may be the sponsor or a
co-owner (or any person related to the sponsor or a co-owner), but who may
not be a lessee. The management agreement may authorize the manager to
maintain a common bank account for the collection and deposit of rents and
to offset expenses associated with the Property against any revenues
before disbursing each co-owner's share of net revenues. In all events,
however, the manager must disburse to the co-owners their shares of net
revenues within 3 months from the date of receipt of those revenues. The
management agreement may also authorize the manager to prepare statements
for the co-owners showing their shares of revenue and costs from the
Property. In addition, the management agreement may authorize the manager
to obtain or modify insurance on the Property, and to negotiate
modifications of the terms of any lease or any indebtedness encumbering
the Property, subject to the approval of the co-owners. (See section 6.05
of this revenue procedure for conditions relating to the approval of lease
and debt modifications.) The determination of any fees paid by the
co-ownership to the manager must not depend in whole or in part on the
income or profits derived by any person from the Property and may not
exceed the fair market value of the manager's services. Any fee paid by
the co-ownership to a broker must be comparable to fees paid by unrelated
parties to brokers for similar services.

.13 LEASING AGREEMENTS. All leasing arrangements must be bona fide
leases for federal tax purposes. Rents paid by a lessee must reflect the
fair market value for the use of the Property. The determination of the
amount of the rent must not depend, in whole or in part, on the income or
profits derived by any person from the Property leased (other than an
amount based on a fixed percentage or percentages of receipts or sales).
See section 856(d)(2)(A) and the regulations thereunder. Thus, for
example, the amount of rent paid by a lessee may not be based on a
percentage of net income from the Property, cash flow, increases in
equity, or similar arrangements.

.14 LOAN AGREEMENTS. The lender with respect to any debt that encumbers
the Property or with respect to any debt incurred to acquire an undivided
interest in the Property may not be a related person to any co-owner, the
sponsor, the manager, or any lessee of the Property.

.15 PAYMENTS TO SPONSOR. Except as otherwise provided in this revenue
procedure, the amount of any payment to the sponsor for the acquisition of
the co-ownership interest (and the amount of any fees paid to the sponsor
for services) must reflect the fair market value of the acquired
co-ownership interest (or the services rendered) and may not depend, in
whole or in part, on the income or profits derived by any person from the
Property.


SECTION 6. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 2000-46 is superseded. Rev. Proc. 2002-3 is modified by
removing sections 5.03 and 5.06.


SECTION 7. DRAFTING INFORMATION

The principal authors of this revenue procedure are Jeanne Sullivan and
Deane Burke of the Office of Associate Chief Counsel (Passthroughs and
Special Industries). For further information regarding this revenue
procedure, contact Ms. Sullivan or Mr. Burke at (202) 622-3070 (not a
toll-free call).

<<END RULING>>



 

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