With apologies to The Rolling Stones, the IRS’s Private Letter Ruling 202440007 shows that though you can’t always get what you want, sometimes you get what you need. The taxpayer sought a ruling that it be treated as if it did not make a REIT election in Year 1 because it did not have any gross income or assets in Year 1. The “zero over zero” issue was raised as a potential problem by a later audit of its parent entity. The IRS denied the request to be treated as not making a REIT election in Year 1, but also ruled that the taxpayer did not fail the REIT gross income or asset tests for Year 1. Thus, the taxpayer’s REIT election in Year 1 was successful, and the potential problem was resolved.

In general, a REIT must derive at least 95% of its gross income from certain passive sources and at least 75% of its gross income from certain real estate related sources. Similarly, at least 75% of the value of a REIT’s assets must be attributable to certain real estate related assets. The uncertainty that has troubled practitioners and taxpayers is whether these tests are dollar amount tests or fraction tests. The statute does not mention fractions, but the Treasury regulations do include the words “numerator” and “denominator.” When a REIT has zero gross income and assets, zero divided by zero is infinity, not 100%, which creates the uncertainty. Fortunately for this taxpayer, the IRS ruled that the tests require applying 75% or 95%, as applicable, to the total gross income or assets and comparing the resulting dollars. As the IRS stated in the ruling, “75% of $0 equals $0.” As a result, the taxpayer did not fail the REIT gross income or asset tests in Year 1, even though it had $0 gross income and $0 assets. This conclusion makes sense because the legislative history behind the gross income and asset tests focuses on the source or nature of a REIT’s gross income or assets, rather than whether it has any income or assets in the first place.

Although this ruling is welcome news, as a private letter ruling, it may only be relied on by the taxpayer to which it was granted. It is easy to avoid this uncertainty by making sure that a REIT has some qualifying income producing assets in its first tax year. If the REIT’s core asset does not produce income (such as a property in development), the REIT can purchase some publicly traded REIT stock or mortgage backed securities. A REIT could also take advantage of the qualified temporary investment rules to produce qualifying gross income and assets. These techniques avoid the “zero over zero” issue altogether (keep in mind that opening a bank account to enter into these transactions can sometimes take weeks—start early!).