IRS Revenue Ruling
2001-29

Code Secs. 355, 856)

<<FULL TEXT>>

26 CFR 1.355-3: Active conduct of a trade or business.
(Also: section 856)

REIT and section 355(b) active conduct of a trade or business. A REIT
can be engaged in the active conduct of a trade or business within the
meaning of section 355(b) of the Code solely by virtue of functions with
respect to rental activity that produces income qualifying as rents from
real property within the meaning of section 856(d) of the Code.


REV. RUL. 2001-29

ISSUE

Can a real estate investment trust (REIT) be engaged in the active
conduct of a trade or business within the meaning of section 355(b) of the
Internal Revenue Code solely by virtue of functions with respect to rental
activity that produces income qualifying as rents from real property
within the meaning of section 856(d)?


LAW AND ANALYSIS

Sections 355(a)(1)(C) and (b) require that both the distributing and
controlled corporations be engaged, immediately after a distribution, in
the active conduct of a trade or business that has been actively conducted
throughout the five year period ending on the date of the distribution.
Section 1.355-3(b)(2)(iii) of the Income Tax Regulations provides that the
determination of whether a trade or business is actively conducted is made
from all the facts and circumstances. Generally, a corporation is treated
as actively conducting a trade or business only if it performs active and
substantial management and operational functions. Generally, activities
performed by the corporation do not include activities performed by
persons outside the corporation, including independent contractors.
However, a corporation may satisfy the active trade or business test
through the activities it performs itself, even though some of its
activities are performed by others. For an illustration of active and
substantial management and operational functions in the context of the
rental of real property, see generally Rev. Rul. 79-394, 1979-2 C.B. 141,
as amplified by Rev. Rul. 80-181, 1980-2 C.B. 121.

In Rev. Rul. 73-236, 1973-1 C.B. 183, X, an unincorporated domestic
trust qualifying as an association taxable as a corporation under section
7701(a)(3), was engaged for more than five years in the sale of real
estate that it developed and improved, and in the leasing of buildings
that it constructed. In order to raise capital, X intended to convert to a
REIT, as defined in section 856. In order to satisfy certain requirements
of section 856, X had to dispose of property that it held primarily for
sale to customers in the ordinary course of business. To accomplish this,
X transferred this property to Y, a newly formed corporation, in exchange
for all of the Y stock, which X distributed to its beneficiaries pro rata.
Immediately following the Y stock distribution and as part of an overall
plan, X elected REIT status. In order to ensure that it would meet the
requirements of section 856(c), X managed and operated its real estate
leasing operations through independent contractors so as to qualify all of
its rental income as "rents from real property" within the meaning of
section 856(d). Section 856(d)(3), as in effect when Rev. Rul. 73-236 was
issued, excluded from the term "rents from real property" amounts received
with respect to such property "if the real estate investment trust
furnishes or renders services to the tenants of such property, or manages
or operates such property, other than through an independent contractor
from whom the trust itself does not derive or receive any income." (In
1976, this provision was redesignated section, 856(d)(2)(C). See Tax
Reform Act of 1976, Pub. L. No. 94-455, section 1604(b), 90 Stat. 1520,
1749 (1976).)

The only issue that Rev. Rul. 73-236 considered was whether X, after
the distribution and while qualifying as a REIT under section 856, was
engaged in the active conduct of a trade or business within the meaning of
section 355(b). Because X's rental activities conducted as a REIT were
designed to qualify all of its rental income as "rents from real property"
within the meaning of section 856(d), Rev. Rul. 73-236 concluded that X
did not directly perform substantial management and operational activities
and, therefore, that X was not engaged in an active trade or business
within the meaning of section 355(b) immediately after the distribution of
the Y stock.

Section 663 of the Tax Reform Act of 1986, Pub. L. No. 99-514, 100
Stat. 2085, 2302 (1986), amended section 856(d)(2)(C). Under the statute,
as amended, amounts that would qualify as rents from real property under
section 512(b)(3) if received by an organization described in section
511(a)(2) are not excluded from rents from real property under section
856(d)(2)(C). Section 512(b)(3) excludes rents from real property from
unrelated business taxable income. Section 1.512(b)-1(c)(5) interprets
section 512(b)(3) to permit an organization to treat rental income as
rents from real property even if, in connection with the rental activity,
it furnishes certain services that are not primarily for the convenience
of the occupant and are usually or customarily rendered in connection with
the rental of real property. Such services include, for example, the
furnishing of heat and light; the cleaning of public entrances, exits,
stairways, and lobbies; and the collection of trash. Consequently, as a
result of the 1986 amendment, a REIT is permitted to perform activities
that can constitute active and substantial management and operational
functions with respect to rental activity that produces income qualifying
as rents from real property under section 856(d).


HOLDING

A REIT can be engaged in the active conduct of a trade or business
within the meaning of section 355(b) solely by virtue of functions with
respect to rental activity that produces income qualifying as rents from
real property within the meaning of section 856(d).


EFFECT ON OTHER REVENUE RULING

Rev. Rul. 73-236 is obsoleted.

The obsolescence of Rev. Rul. 73-236, which denied section 355
treatment to a distribution of stock by a C corporation that converted to
a REIT because the REIT was not engaged in the active conduct of a trade
or business, does not imply a view as to whether a distribution of stock
involving a REIT election by the distributing or controlled corporation
would otherwise satisfy the requirements of section 355, including the
corporate business purpose requirement of section 1.355-2(b).


DRAFTING INFORMATION

The principal author of this revenue ruling is Richard Passales of the
Office of Associate Chief Counsel (Corporate). For further information
regarding this revenue ruling, contact Mr. Passales at (202) 622-7530 (not
a toll-free call).

<<END RULING>>

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