[Federal Register Volume 81, Number 169 (Wednesday, August 31, 2016)]
[Rules and Regulations]
[Pages 59849-59865]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-20987]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9784]
RIN 1545-BM05


Definition of Real Estate Investment Trust Real Property

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations that clarify the 
definition of real property for purposes of the real estate investment 
trust provisions of the Internal Revenue Code (Code). These final 
regulations provide guidance to real estate investment trusts and their 
shareholders.

DATES: Effective date: These regulations are effective on August 31, 
2016.
    Applicability date: For dates of applicability, see Sec.  1.856-
10(h).

FOR FURTHER INFORMATION CONTACT: Julanne Allen of the Office of 
Associate Chief Counsel (Financial Institutions and Products) at (202) 
317-6945 (not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains amendments to the Income Tax Regulations (26 
CFR part 1) relating to real estate investment trusts (REITs). Section 
856 of the Code defines a REIT by setting forth various requirements. 
One of the requirements for a taxpayer to qualify as a REIT is that at 
the close of each quarter of the taxable year at least 75 percent of 
the value of its total assets is represented by real estate assets, 
cash and cash items (including receivables), and Government securities. 
See section 856(c)(4). Section 856(c)(5)(B) defines real estate assets 
to include real property (including interests in real property and 
interests in mortgages on real property). Section 856(c)(5)(C) defines 
interests in real property to include fee ownership and co-ownership of 
``land or improvements thereon.'' Prior to these final regulations, 
Sec.  1.856-3(d) of the Income Tax Regulations, promulgated in 1962 in 
TD 6598 (the 1962 Regulations), defined real property for purposes of 
the regulations under sections 856 through 859. Under Sec.  1.856-3(d) 
of the 1962 Regulations, the term real property means land or 
improvements thereon, such as buildings or other inherently permanent 
structures thereon (including items which are structural components of 
such buildings or structures). In addition, the term ``real property'' 
includes interests in real property. Local law definitions will not be 
controlling for purposes of determining the meaning of the term ``real 
property'' as used in section 856 and the regulations thereunder. The 
term includes, for example, the wiring in a building, plumbing systems, 
central heating, or central air-conditioning machinery, pipes or ducts, 
elevators or escalators installed in the building, or other items which 
are structural components of a building or other permanent structure. 
The term does not include assets accessory to the operation of a 
business, such as machinery, printing press, transportation equipment 
which is not a structural component of the building, office equipment, 
refrigerators, individual air-conditioning units, grocery counters, 
furnishings of a motel, hotel, or office building, etc., even though 
such items may be termed fixtures under local law.
    The IRS issued revenue rulings between 1969 and 1975 addressing 
whether certain assets qualify as real property for purposes of section 
856. Specifically, the published rulings address whether assets such as 
railroad properties,\1\ mobile home units permanently installed in a 
planned community,\2\ air rights over real property,\3\ interests in 
mortgage loans secured by total energy systems,\4\ and mortgage loans 
secured by microwave transmission property \5\ qualify as either real 
property or interests in real property under section 856. After these 
published rulings were issued, REITs invested in various types of 
assets that are not directly addressed by the regulations or the 
published rulings, and some of these REITs received letter rulings from 
the IRS concluding that certain of these various assets qualified as 
real property. A letter ruling, however, may not be relied upon by 
taxpayers other than the taxpayer that received the letter ruling \6\ 
and is limited to its particular facts. The Treasury Department and the 
IRS recognized the need to provide updated published guidance on the 
definition of real property under sections 856 through 859. On May 14, 
2014, the Treasury Department and the IRS published in the Federal 
Register a notice of proposed rulemaking (REG-150760-13 at 79 FR 27508) 
(NPRM) to define ``real property'' solely for purposes of sections 856 
through 859 and provisions that reference the definition of real 
property in section 856 and the regulations thereunder.
---------------------------------------------------------------------------

    \1\ Rev. Rul. 69-94 (1969-1 CB 189).
    \2\ Rev. Rul. 71-220 (1971-1 CB 210).
    \3\ Rev. Rul. 71-286 (1971-2 CB 263).
    \4\ Rev. Rul. 73-425 (1973-2 CB 222).
    \5\ Rev. Rul. 75-424 (1975-2 CB 269).
    \6\ Rev. Proc. 2016-1 (2016-1 IRB 1), section 11.02; see section 
6110(k)(3) of the Code.
---------------------------------------------------------------------------

    Written and electronic comments responding to the NPRM were 
received. The written comments are available for public inspection at 
http://www.regulations.gov or upon request. A public hearing was held 
on September 18, 2014.
    After consideration of all the comments, these final regulations 
adopt the proposed regulations as revised by this Treasury decision.\7\ 
The comments and revisions are discussed in this preamble.
---------------------------------------------------------------------------

    \7\ Under section 856(c)(2) and (3), in order for an entity to 
qualify as a REIT, certain prescribed percentages of that entity's 
gross income must be derived from certain types of income (which 
include ``rents from real property'' and ``interest on obligations 
secured by mortgages on real property or on interests in real 
property''). The definition of real property in these final 
regulations applies for purposes of section 856(c)(2) and (3), but 
these final regulations provide neither explicit nor implicit 
guidance regarding whether various types of income are described in 
section 856(c)(2) and (3).
---------------------------------------------------------------------------

Summary of Comments and Explanation of Revisions

I. The Definition of Land

    The proposed regulations defined the term ``land'' to include water 
and air space superjacent to land and natural products and deposits 
that are unsevered from the land. A commenter requested clarification 
that land includes water space and air space above ground that the 
taxpayer does not own. For example, a taxpayer may own a building and 
purchase air rights superjacent to one or more neighboring buildings to 
enhance the value of the building the taxpayer owns, or a taxpayer may 
purchase air rights in anticipation of using those rights to facilitate 
the future acquisition or development of property. The Treasury 
Department and the IRS agree that air space or water space superjacent 
to land each qualify as land even if the taxpayer owns only the air 
space or water space and does not own an interest in the underlying 
land. The proposed regulations stated that superjacent water and air 
space qualify as land, and these final regulations retain the language 
of the proposed regulations.

[[Page 59850]]

II. The Definition of Improvements to Land

    The proposed regulations generally defined the term ``improvements 
to land'' to mean inherently permanent structures (IPSs) and their 
structural components. A commenter recommended that these final 
regulations clarify that clearing, grading, landscaping, and earthen 
dams should be treated as improvements to land. The Treasury Department 
and the IRS believe that, to the extent these assets are distinct 
assets that have value apart from the land, the REIT must analyze these 
assets separately under these final regulations. For example, if 
landscaping includes shrubs planted in the ground, the shrubs are 
within the definition of land in these final regulations so long as the 
shrubs remain unsevered natural products of the land. If, however, 
landscaping includes a bench that is a distinct asset, the bench is 
analyzed under the factors for an IPS in these final regulations to 
determine whether the bench is real property.

III. The Definition of IPS

A. Passive Function Requirement and Active Function Prohibition

1. In General
    Under the proposed regulations, IPSs include buildings and other 
inherently permanent structures (OIPSs). To qualify as an OIPS under 
the proposed regulations, a structure must serve a passive function, 
such as contain, support, shelter, cover, or protect, and not serve an 
active function, such as manufacture, create, produce, convert, or 
transport. Commenters suggested that use of the terms active and 
passive may cause confusion because, for example, REITs may 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 produce income qualifying as rents from real property 
within the meaning of section 856(d).\8\
---------------------------------------------------------------------------

    \8\ See Rev. Rul. 2001-29 (2001-1 CB 1348).
---------------------------------------------------------------------------

    During the hearing, a commenter stated that REITs may perform 
certain services and that the requirement that an IPS serve a passive 
function may be at odds with this permissible activity. This commenter 
suggested that the requirement be revised to: (1) State that OIPSs 
serve a real estate-related function; (2) require that the asset not 
primarily contribute to the production of income other than for the 
use, occupancy, or financing of space; or (3) not include the terms 
passive and active when describing permissible and prohibited 
functions. Other commenters suggested that the function of a distinct 
asset not be considered in determining whether the distinct asset is an 
OIPS. These commenters maintained that inherent permanence should be 
the only requirement for a distinct asset to qualify as an OIPS.
    These final regulations do not adopt these suggestions. These final 
regulations address whether the asset itself has a passive function, 
not whether the asset is used in an active trade or business or whether 
income from the asset is income from an active trade or business. The 
requirement in the proposed regulations and in these final regulations 
that an asset serve a passive function is intended to be a more precise 
statement of the distinction previously set forth in Sec.  1.856-3(d) 
of the 1962 Regulations, which treated as real property certain passive 
assets but not assets accessory to the operation of a business, 
including machinery. The Treasury Department and the IRS believe that 
the terms passive and active, when taken together with the examples in 
these final regulations, appropriately clarify and illustrate the 
permissible functions of an OIPS. The passive function requirement 
neither prohibits a tenant from using a passive asset, such as an 
office building, in the tenant's active business nor limits a REIT's 
ability to perform either the services excepted under section 
856(d)(7)(C)(ii) or the trustee or director functions permitted by 
Sec.  1.856-4(b)(5)(ii).
    The Treasury Department and the IRS believe that the commenters' 
suggested real estate-related standard is circular and might support 
real property treatment for assets that serve active functions. 
Further, the Treasury Department and the IRS do not agree that inherent 
permanence alone is a sufficient basis for a distinct asset to be 
treated as an IPS. For example, the Treasury Department and the IRS 
continue to believe that some inherently permanent assets, such as 
large, heavy machinery, do not qualify as real property for purposes of 
section 856.
    A commenter suggested replacing the passive function requirement 
with a test that focuses on an asset's human factor, which the 
commenter defined as whether, and the extent to which, human 
involvement is needed for an asset to function. This commenter 
contended that human involvement is a characteristic of an active 
function and, therefore, should be taken into account in determining 
whether a particular asset is active or passive. The Treasury 
Department and the IRS disagree and continue to believe that machinery, 
including automated machinery that functions with little or no human 
involvement, does not qualify as real property for purposes of section 
856.
2. Transport as a Prohibited Active Function
    The proposed regulations listed transport as an active function. 
Commenters noted that this active function differs from the other four 
active functions (manufacture, create, produce, and convert) that 
involve changing the physical nature or character of a commodity or 
good. Commenters also suggested that some of the assets on the list of 
types of OIPSs in the proposed regulations, such as railroad tracks and 
tunnels, help to transport a good or a commodity.\9\
---------------------------------------------------------------------------

    \9\ Commenters also noted that several assets listed as 
structural components, such as elevators and escalators, transport 
objects or occupants of a building. A structural component may have 
an active function if the structural component serves the passive 
function of the IPS of which it is constituent.
---------------------------------------------------------------------------

    The Treasury Department and the IRS agree that the term transport 
could be interpreted to describe functions of both passive conduits 
used for transportation and machines that push or pull items through or 
along a conduit. The Treasury Department and the IRS intend the term 
transport to mean to cause to move, and these final regulations retain 
transport as a prohibited active function of an OIPS. To provide 
clarity, these final regulations include providing a conduit (such as 
in the case of a pipeline or electrical wire) or route (as in the case 
of a road or railroad track) as a permitted passive function of an 
OIPS.
3. Assets With Both Active and Passive Functions
    In addition to other requirements, Sec.  1.856-10(d)(2)(i) of the 
proposed regulations stated that a distinct asset that serves an active 
function, such as machinery or equipment, is not a building or OIPS.
    Commenters suggested that solar panels can perform dual functions, 
including a passive function (that is, to shelter) and an active 
function (that is, to convert (energy)). Commenters stated that solar 
panels may be used to protect pastures, parking lots, buildings, and 
other structures from the detrimental effects of solar radiation and to 
manage temperature through shading. The structures to which solar 
panels are attached--or even into which they are integrated--may 
qualify as IPSs under the proposed regulations.
    The Treasury Department and the IRS note that the example given by 
the

[[Page 59851]]

commenters presumes that the solar panel structure is a single distinct 
asset that serves a passive function of sheltering and an active 
function of converting energy for sale to third parties. If this were 
the case, the solar panel structure would fail to qualify as an IPS 
under Sec.  1.856-10(d)(2)(i) of the proposed regulations as a result 
of the structure's active function. If, however, a solar panel 
structure is composed of multiple distinct assets, then each of those 
distinct assets would be analyzed under the proposed regulations to 
determine whether it qualifies as an IPS or as a structural component 
of an IPS.\10\ Because these final regulations retain the requirement 
that an IPS not serve an active function, machinery and equipment that 
may serve both passive and active functions are excluded from the 
definition of an IPS.
---------------------------------------------------------------------------

    \10\ A similar analysis was applied to the solar energy site 
assets in Sec.  1.856-10(g), Example 8, of the proposed regulations.
---------------------------------------------------------------------------

B. Definition of Building

    Section 1.856-10(d)(2)(ii)(A) of the proposed regulations stated 
that a building encloses a space within its walls and is covered by a 
roof. Examples given in Sec.  1.856-10(d)(2)(ii)(B) of the proposed 
regulations were permanently affixed houses, apartments, hotels, 
factory and office buildings, warehouses, barns, enclosed garages, 
enclosed transportation stations and terminals, and stores.
    During the hearing, a commenter stated that for appraisal purposes, 
buildings are considered to be buildings regardless of their 
permanence. This commenter suggested that these final regulations 
should adopt standards published by an appraisal organization to define 
real property.
    Section 1.856-3(d) of the 1962 Regulations indicates that inherent 
permanence is important in determining whether a structure qualifies as 
real property. A tent, for example, may satisfy the portion of the 
definition of a building in the proposed regulations that referenced 
enclosing within its walls a space that is covered by a ``roof,'' but 
the impermanent nature of the tent would prevent it from qualifying as 
a building for purposes of section 856. The purposes of definitions 
used by appraisal organizations, which focus on valuation, differ from 
the purposes of definitions used for REIT qualification purposes. For 
example, although both permanent and impermanent property may be 
appraised, permanence is of crucial importance in defining real 
property for REIT qualification purposes. Therefore, these final 
regulations do not adopt standards published by an appraisal 
organization.
    Another commenter urged the Treasury Department and the IRS to 
change the definition of building in these final regulations so that 
the definition does not depend on whether a space is completely 
enclosed by its walls and covered by a roof. The commenter stated that 
even an outdoor sports stadium or amphitheater and an unenclosed 
parking garage that are permanently affixed to land or another IPS may 
fail to qualify as buildings under the proposed regulations.
    The Treasury Department and the IRS agree that these structures may 
fail to meet the definition of building under the proposed regulations. 
The Treasury Department and the IRS believe, however, that many outdoor 
sports stadiums, amphitheaters, and unenclosed parking garages would 
satisfy the definition of an OIPS in Sec.  1.856-10(d)(2)(iii) of the 
proposed regulations and that this definition is more appropriate for 
these structures. Therefore, the definition of building in the proposed 
regulations is retained in these final regulations.

C. Clarification of the Term Indefinitely

    The proposed regulations stated that, to qualify as an IPS, a 
distinct asset must be permanently affixed and that if the affixation 
is reasonably expected to last indefinitely based on all the facts and 
circumstances, the affixation is considered permanent.
    Commenters indicated that the term indefinitely as used in 
determining whether an asset is an IPS was unclear. A commenter 
suggested using an asset's useful life as an alternate to indefinitely. 
The Treasury Department and the IRS have concluded that relying on the 
useful life of an asset as the measure for permanence would have the 
effect of treating certain impermanent assets as real property. For 
example, if an asset has a useful life of two years, it would be 
inappropriate for the asset to be treated as permanently affixed solely 
because the asset was reasonably expected to remain in place for two 
years.
    Another commenter provided the example of a REIT that constructs a 
building on land on which the REIT holds a 99-year ground lease. Upon 
expiration of the lease, the building is subject to removal. In this 
case, the building may not be on the land in 100 years. Another 
commenter provided the example of a building that is subject to 
condemnation and that will be torn down in the future.
    Another commenter suggested that whether an asset is inherently 
permanent should be based upon an objective analysis of the physical 
nature of the manner of affixation, rather than on a particular 
taxpayer's subjective intent. This commenter recommended that if the 
manner of affixation is of a permanent nature and is consistent with 
the distinct asset remaining in place indefinitely based on all the 
facts and circumstances, the affixation is considered permanent. 
Commenters also urged the Treasury Department and the IRS to provide a 
statement in the preamble to these final regulations that indefinitely 
does not mean forever but rather means for the foreseeable future.
    The Treasury Department and the IRS do not intend the term 
indefinitely to mean forever. The proposed regulations stated that 
whether affixation is reasonably expected to last indefinitely is based 
on all the facts and circumstances. Section 1.856-10(d)(2)(iv) provides 
factors that must be taken into account to determine whether a distinct 
asset is an IPS if that distinct asset is not included in the lists of 
types of buildings in Sec.  1.856-10(d)(2)(ii)(B) or types of OIPSs in 
Sec.  1.856-10(d)(2)(iii)(B). These factors provide additional guidance 
on the meaning of permanent affixation. The primary focus of these 
factors is on the nature of the distinct asset and the affixation, 
including the manner in which the distinct asset is affixed, whether 
the distinct asset is designed to be removed, the damage that removal 
would cause, and the time and expense required to move the distinct 
asset. Although one factor includes any circumstances that suggest the 
expected period of affixation is not indefinite and provides as an 
example a lease that requires or permits removal of the distinct asset 
upon the expiration of the lease, the determination of whether a 
distinct asset is an IPS is based on all of the facts and 
circumstances.
    These final regulations do not adopt these suggestions and, because 
the Treasury Department and the IRS do not believe additional guidance 
regarding inherent permanence is necessary, retain the definition of 
IPS as proposed.

D. Suggested Presumption for Structures With a Certificate of Occupancy 
or Similar License

    A commenter agreed that state or local definitions of property 
should not control for purposes of the definition of real property 
under section 856, but suggested that when a certificate of occupancy 
or similar license or certification is granted with respect to a 
structure, the structure be presumed to

[[Page 59852]]

constitute real property for purposes of section 856 unless the facts 
and circumstances clearly indicate that the structure is not permanent.
    Local law standards for a certificate of occupancy or similar 
license or certification might be inconsistent with the definition of 
real property for purposes of section 856. For example, local law might 
permit issuance of a certificate of occupancy for a tent that is not 
inherently permanent. In addition, this presumption might lead to 
inconsistent results. For example, two identical assets located in 
localities that use different standards for licensing might be treated 
differently for purposes of section 856 because a certificate of 
occupancy has been granted to one of the assets and not to the other. 
For these reasons, we believe the suggested presumption would create 
confusion and administrative difficulty, and, therefore, these final 
regulations do not adopt this comment.

IV. The Definition of Structural Component

A. Income Produced by a Structural Component

    In generally defining the term structural component, Sec.  1.856-
10(d)(3)(i) of the proposed regulations stated, in part, that a 
structural component is any distinct asset that is a constituent part 
of and integrated into an IPS, serves the IPS in its passive function, 
and, even if capable of producing income other than consideration for 
the use or occupancy of space, does not produce or contribute to the 
production of such income.
    A commenter requested that the words ``and related services'' be 
added to the language of Sec.  1.856-10(d)(3)(i). If that request were 
adopted, structural components would include assets that serve the IPS 
and even if capable of producing income other than consideration for 
the use or occupancy of space and related services, do not produce or 
contribute to the production of such income (emphasis added to indicate 
commenter's suggested language). The commenter stated that REITs use 
property such as the systems that supply utilities to a building to 
provide services to tenants. The commenter explained that a REIT may 
receive additional compensation to cover utilities that the REIT 
provides to the tenant when the tenant uses space in the building 
outside of specified business hours.
    The Treasury Department and the IRS have concluded that the 
definition of structural component in the proposed regulations 
adequately accounts for the concerns raised by the commenter, and 
accordingly these final regulations do not incorporate the commenter's 
suggested revision.
    B. Proposed Utility Safe Harbor for Structural Components
    A commenter recommended that these final regulations adopt a safe 
harbor for distinct assets that provide utilities to IPSs. The 
commenter recognized that the utility-like function aspect of the 
definition in the proposed regulations underscores the importance of 
that type of structural component and suggested that a distinct asset 
that serves a utility-like function with respect to an IPS should be 
conclusively presumed to be a structural component of that IPS.
    The Treasury Department and the IRS note that the list of types of 
structural components in the proposed regulations included several 
utility-like systems, such as plumbing systems, central heating and 
air-conditioning systems, fire suppression systems, central 
refrigeration systems, and humidity control systems. The Treasury 
Department and the IRS may add other systems that satisfy the factors 
in Sec.  1.856-10(d)(3)(iii) to the structural component list through 
future guidance published in the Internal Revenue Bulletin. The 
proposed regulations differentiated systems that perform utility-like 
functions from other distinct assets to permit analysis of these 
systems as a whole. Under the proposed regulations, once it has been 
determined that an asset or assets function as a utility-like system, 
the system is analyzed as a distinct asset basing the determination of 
whether the system is real property on all of the facts and 
circumstances and using the factors listed under Sec.  1.856-
10(d)(3)(iii) for structural components. A system or asset that 
provides a utility but that does not qualify as a structural component 
under the facts and circumstances test under Sec.  1.856-10(d)(3)(iii) 
(for example, a window air-conditioning unit) is not a structural 
component.
    Because the Treasury Department and the IRS believe that the 
factors listed under Sec.  1.856-10(d)(3)(iii) for structural 
components are important to the analysis of systems that provide a 
utility-like function these final regulations decline to adopt the 
blanket rule suggested by the commenter.

C. The Equivalent Interest Requirement for Structural Components

    Section 1.856-10(d)(3)(i) of the proposed regulations stated that a 
distinct asset is a structural component if the interest held therein 
is included with an equivalent interest held by the taxpayer in the IPS 
to which the structural component is functionally related. Commenters 
suggested that the equivalent interest requirement for structural 
components be deleted or amended because the requirement: (1) Is 
inconsistent with industry practices and an asset should qualify as a 
structural component even if the REIT owns the asset but leases from 
another party the building served by the structural component; (2) may 
negatively affect investment in energy efficient and renewable energy 
assets; (3) was not explained in the proposed regulations and seemingly 
serves no tax policy purpose; and (4) is contrary to congressional 
intent, case law, and the treatment of structural components by the IRS 
in other contexts.
    The Treasury Department and the IRS intended that the equivalent 
interest requirement in the proposed regulations ensure that an asset 
did not qualify as a structural component unless that asset served real 
property in which the REIT also had an interest. The Treasury 
Department and the IRS set forth a similar requirement in Rev. Rul. 73-
425, which addresses notes secured by a total energy system. Rev. Rul. 
73-425 holds that obligations secured by a mortgage covering a total 
energy system and the building that the system served qualify as real 
estate assets. The revenue ruling also holds that an obligation secured 
only by the total energy system does not qualify as a real estate 
asset.
    The Treasury Department and the IRS believe that, to treat an asset 
as a structural component, a REIT must hold its interest in the 
structural component together with a real property interest with 
respect to the space in the IPS that the structural component serves. 
For example, a central air-conditioning system is a machine that does 
not separately qualify as an IPS. A central air-conditioning system 
that is wholly owned by a REIT may, however, qualify as a structural 
component if the REIT also holds a real property interest, such as a 
leasehold interest, with respect to the space in the IPS served by the 
central air-conditioning system. Limiting the definition of structural 
component to assets that serve an IPS in which the REIT has a real 
property interest is consistent with the statutory requirement that 
REITs invest in real property or interests in real property.
    For these reasons, these final regulations provide that a distinct 
asset qualifies as a structural component only if the REIT holds its 
interest in the distinct asset together with a real property interest 
with respect to the space in the IPS that the distinct asset serves. In 
addition, as illustrated by Rev.

[[Page 59853]]

Rul. 73-425, for a mortgage that is secured by a structural component 
to qualify as a real estate asset under these final regulations, the 
mortgage also must be secured by the IPS served by the structural 
component.

D. Suggested Standard for Structural Components

    Section 1.856-10(3)(i) of the proposed regulations defined a 
structural component to include a distinct asset that serves the IPS in 
its passive function, and, even if capable of producing income other 
than consideration for the use or occupancy of space, does not produce 
or contribute to the production of such income. Section 1.856-
10(d)(3)(ii) of the proposed regulations furnished a list of distinct 
assets that are structural components. The proposed regulations also 
stated that a distinct asset that was not on this list might still be a 
structural component based on all of the facts and circumstances. In 
particular, the proposed regulations required the factors listed under 
Sec.  1.856-10(d)(3)(iii) to be taken into account.
    A commenter suggested that the standard for a structural component 
should be revised so that a structural component is defined as a 
distinct asset that is intended to protect, preserve, secure, or 
support the safe operation of the IPS. The commenter suggested that 
satisfying this standard should be sufficient to determine if a 
distinct asset is a structural component and, therefore, the structural 
component factor test under Sec.  1.856-10(d)(3)(iii) of the proposed 
regulations is unnecessary.
    These final regulations do not adopt the commenter's suggestion 
because the standard suggested would in some circumstances unduly limit 
the functions a structural component may serve and in other 
circumstances unduly expand the functions a structural component may 
serve. The Treasury Department and the IRS do not believe this 
modification is necessary given these final regulations' requirement 
that a structural component serve the IPS to which the structural 
component is constituent in the IPS's passive function. In addition, 
the Treasury Department and the IRS have concluded that adopting a 
standard that takes into account a taxpayer's intent regarding an asset 
may lead to inconsistent results because different taxpayers may have 
different intentions regarding the same type of distinct asset.

V. Requested Additions to the Lists of Qualifying Assets

A. General Suggestions

    Sections 1.856-10(d)(2)(ii)(B), 1.856-10(d)(2)(iii)(B), and 1.856-
10(d)(3)(ii) of the proposed regulations furnished lists of types of 
distinct assets that would qualify as buildings, OIPSs, and structural 
components, respectively. A commenter requested that certain other 
distinct assets be included on these lists. These other distinct assets 
included car charging stations, healthcare facilities, storage 
facilities, timber, electrical distribution and redundancy systems, 
telecommunication systems, and equipment comprising a building 
management system.
    The Treasury Department and the IRS have considered the proposed 
additions to the lists of qualifying assets and believe that the 
proposed regulations already addressed the tax treatment of certain of 
these assets, such as storage facilities and timber. In addition, the 
Treasury Department and the IRS are not persuaded that the other assets 
will in all cases satisfy the relevant definition. Therefore, these 
final regulations do not include these suggested additions to the lists 
of qualifying assets.

B. Additions to the Lists for Types of IPSs

1. Additions to the List for Types of Buildings
    Commenters suggested adding motels, casinos, health care 
facilities, storage facilities, greenhouses, enclosed stadiums, 
enclosed shopping malls, museums, municipal buildings, other housing 
(such as assisted living), parking garages (whether or not fully 
enclosed), and mixed-use properties combining one or more of the 
foregoing to the list for buildings under Sec.  1.856-10(d)(2)(ii)(B) 
of the proposed regulations.
    These assets would not always qualify as buildings as defined under 
the proposed regulations and in these final regulations. For example, 
casinos may be on an unaffixed barge or riverboat, health care 
facilities may be in tents, storage facilities may include movable 
pods, and greenhouses may be structures that are not permanently 
affixed. Unenclosed parking garages were not within the definition of a 
building under the proposed regulations but were included in the list 
of types of OIPSs in Sec.  1.856-10(d)(2)(iii)(B) of the proposed 
regulations (which included permanently affixed parking facilities). 
Museums may exist on unaffixed boats, in a room inside a building, or 
in the open air.
    A mixed-use building would still qualify as a building because it 
encloses space within its walls and is covered by a roof. On the other 
hand, a mixed-use property comprised of several structures would 
require a separate analysis of each structure. The suggestions to 
include municipal buildings and assisted-living facilities focus on the 
use, rather than the type, of structure. In addition, office buildings, 
apartments, and houses were already included on the proposed 
regulations' list.
    A distinct asset not on the list may nevertheless qualify as a 
building, because the list for types of buildings in the proposed 
regulations is not exclusive. Moreover, many of the requested assets 
are already included in that list. For these reasons, these final 
regulations do not include all the requested assets on the list for 
types of buildings. However, these final regulations include as types 
of buildings permanently affixed motels, enclosed stadiums and arenas, 
and enclosed shopping malls.
2. Additions to the List for Types of OIPSs
    Some commenters requested certain assets be added to the list under 
Sec.  1.856-10(d)(2)(iii)(B) of the proposed regulations for types of 
OIPSs, including energy storage components, solar photovoltaic (PV) 
panels, related wiring and functionally related transformers, power 
conditioning equipment, and electrical power inverters and related 
wiring.
    The Treasury Department and the IRS have determined that adding 
these assets to the list for types of OIPSs is not warranted. Inclusion 
of these assets would be inconsistent with the requirements that OIPSs 
serve a passive function and do not serve an active function.\11\ 
Therefore, these final regulations do not include these assets on the 
list for types of OIPSs.
---------------------------------------------------------------------------

    \11\ Depending on all the facts and circumstances, however, some 
or all of these assets may qualify as structural components of an 
IPS.
---------------------------------------------------------------------------

C. Additions to the List for Types of Structural Components

    One commenter suggested that the list under Sec.  1.856-
10(d)(3)(ii) of the proposed regulations for types of structural 
components should include special flooring for data centers. The 
proposed regulations stated that customization of a distinct asset in 
connection with the rental of space in or on an IPS to which the 
distinct asset relates does not affect whether the

[[Page 59854]]

distinct asset qualifies as a structural component. The list of types 
of structural components in Sec.  1.856-10(d)(3)(ii) of the proposed 
regulations included permanent coverings of floors. The commenter's 
suggestion of specifically including special flooring in a data center 
is an example of customization of a distinct asset in connection with 
the rental of space in an IPS. These final regulations, like the 
proposed regulations, permit the customization of distinct assets in 
connection with the rental of space in or on an IPS, provided that the 
customized asset is integrated into the IPS and is held together with a 
real property interest in the space in the IPS that is served by the 
asset. Accordingly, these final regulations do not include special 
flooring in a data center on the list of types of structural 
components.
    Another commenter recommended that the list for types of structural 
components be expanded to include solar energy generating and heating 
systems and related energy storage equipment. The Treasury Department 
and the IRS do not believe that solar energy generating and heating 
systems and related energy storage equipment necessarily satisfy the 
definition of structural components in Sec.  1.856-10(d)(3) of the 
proposed regulations but rather believe these assets should be analyzed 
using all the facts and circumstances and taking into account the 
factors provided in Sec.  1.856-10(d)(3)(iii) of these final 
regulations. For these reasons, these final regulations do not adopt 
the recommendation.

VI. Recommended Changes to the Factor Lists in Sec.  1.856-
10(d)(2)(iii) and (3)(iv) of the Proposed Regulations

A. Recommended Change to the Factors Used To Determine Whether a 
Distinct Asset Is an IPS

    The proposed regulations listed factors to be considered in 
determining whether a distinct asset (other than a type of building or 
type of OIPS listed in Sec.  1.856-10(d)(2)(ii)(B) of the proposed 
regulations or Sec.  1.856-10(d)(2)(iii)(B) of the proposed 
regulations, respectively) is an IPS. One factor is whether there are 
any circumstances that suggest the expected period of affixation is not 
indefinite (for example, a lease that requires or permits removal of 
the distinct asset upon the expiration of the lease).
    One commenter stated that buildings constructed on land subject to 
a long-term ground lease arguably would not satisfy this factor. 
Another commenter stated that removal provisions are common in 
commercial leases and, as a practical matter, such provisions may not 
be determinative as to whether the asset is ultimately removed by the 
lessee at the expiration of the lease. This commenter recommended that 
the factor be changed to any circumstance that suggests the manner of 
affixation is temporary in nature rather than permanent.
    As previously discussed in this preamble, for purposes of section 
856, the Treasury Department and the IRS do not intend the term 
indefinitely to mean forever. Whether a distinct asset qualifies as an 
IPS depends on all the facts and circumstances including an analysis of 
the factors in Sec.  1.856-10(d)(2)(iv). For these reasons, this factor 
is not modified in these final regulations.

B. Recommended Change to the Factors Used To Determine Whether a 
Distinct Asset Is a Structural Component

    For distinct assets other than those listed in Sec.  1.856-
10(d)(3)(ii) of the proposed regulations as structural components, the 
proposed regulations listed factors under Sec.  1.856-10(d)(3)(iii) 
that must be taken into account in determining whether the distinct 
asset qualifies as a structural component of an IPS. One of those 
factors was whether the owner of the property was also the legal owner 
of the distinct asset. A commenter noted that a REIT may have a 
leasehold interest in real property and may own a structural component 
that it installs as part of the real property. An example provided by 
the commenter is a REIT that leases the shell of a building and then 
engages independent contractors to complete internal build-outs to 
customize the shell of the building into a shopping mall.
    The Treasury Department and the IRS have considered this comment, 
along with the comments received regarding the equivalent interest 
requirement, as discussed in this preamble. Accordingly, these final 
regulations require that, for a distinct asset to be a structural 
component, a REIT must hold a legally enforceable real property 
interest in the space in the IPS that the structural component serves.

VII. Intangible Assets

A. Intangibles Derived From the Trade or Business of Earning Revenues 
for the Use of Real Property or Related Services

    Under Sec.  1.856-10(f) of the proposed regulations, an intangible 
asset is real property or an interest in real property if the asset 
derives its value from real property or an interest in real property, 
is inseparable from that real property or interest in real property, 
and does not produce or contribute to the production of income other 
than consideration for the use or occupancy of space. Commenters 
requested inclusion of intangible assets derived from services that 
produce income other than consideration for the use or occupancy of 
space, which would include workforce-in-place and customer-based 
intangibles. The Treasury Department and the IRS believe that 
intangible assets that are separable from real property or an interest 
in real property should not qualify as real property. The final 
regulations clarify that intangible assets that are related to services 
and that are separable from the real property do not qualify as real 
property.

B. In-Place Above and Below-Market Leases

    Commenters requested that intangible assets related to in-place 
above-market leases in which the REIT is the lessor and below-market 
leases in which the REIT is the lessee be treated as qualifying real 
property. Under section 856(c)(5)(C), a lease of land or improvements 
thereon is an interest in real property and, therefore, a lease of land 
or improvements thereon is a real estate asset under section 
856(c)(5)(B). A lease of real property that produces both rents from 
real property under section 856(d)(1) and other income that does not so 
qualify is, in part, an interest in real property under section 
856(c)(5)(C) and, in part, an asset other than an interest in real 
property. To the extent the portion of the lease that is an interest in 
real property has value, that portion is a real estate asset under 
section 856(c)(5)(B). These final regulations have been modified to 
clarify that an intangible asset may be, in part, an interest in real 
property and, in part, an asset other than an interest in real 
property. In addition, these final regulations include an example 
illustrating the application of these final regulations to an in-place 
above-market lease that produces both income that qualifies as rents 
from real property under section 856(d)(1) and other income that does 
not so qualify.

C. Intangible Assets That Result From Mergers, Certain Business 
Combinations, and Stock or Asset Acquisitions

    Section 1.856-10(f)(1) of the proposed regulations generally 
defined an intangible asset to include certain intangible assets 
established under generally accepted accounting principles (GAAP) as a 
result of an acquisition of real property or an interest in real 
property. Commenters noted that intangible assets may result

[[Page 59855]]

from mergers, certain business combinations, and stock or asset 
acquisitions. The commenters urged that the final regulations 
acknowledge that REITs may acquire intangible assets in both asset and 
stock transactions.
    The proposed regulations used the acquisition of real property or 
an interest in real property as an example of a type of transaction in 
which an intangible asset may be established under GAAP. Under Sec.  
1.856-2(d)(3), the term total assets means the gross assets of the REIT 
determined in accordance with GAAP. Thus, an intangible asset that, in 
accordance with GAAP, results from a merger, business combination, or 
stock or asset acquisition may qualify as real property. Because the 
proposed regulations did not preclude real property treatment of 
intangible assets resulting from mergers, certain business 
combinations, or stock or asset acquisitions, the Treasury Department 
and the IRS have concluded that no change is necessary to the final 
regulations to accommodate the commenter's concern.

D. Use Permits and Leases Requiring Property To Be Operated for a 
Specific Use

    Section 856(c)(5)(C) defines interests in real property to include 
leaseholds of land or improvements thereon. Section 1.856-10(f)(2) of 
the proposed regulations stated that, if a license, permit, or other 
similar right solely for the use, enjoyment, or occupation of land or 
an IPS is in the nature of a leasehold or easement, that right 
generally is an interest in real property. However, a license or permit 
to engage in or operate a business generally is not real property or an 
interest in real property because the license or permit produces or 
contributes to the production of income other than consideration for 
the use or occupancy of space.
    Section 1.856-10(g), Example 12, of the proposed regulations 
concluded that a special use permit from a government that, under 
governmental regulations, was not a lease of the land but was a permit 
to use the land for a cell tower was an interest in real property. 
Section 1.856-10(g), Example 13, of the proposed regulations 
illustrated that a license from a government to operate a casino in a 
specific building is a license to engage in the business of operating a 
casino and is not real property.
    A commenter noted that many leases require property to be operated 
for a specific use. A property owner has an interest in requiring its 
property to be operated for its intended purpose. The commenter 
suggested that a specific-purpose lease should not be excluded from the 
definition of real property as an operating license.
    The Treasury Department and the IRS generally agree that a 
requirement in a lease agreement that property be operated for a 
specific use does not cause the lease to fail to be treated as an 
interest in real property. A specific use requirement in a lease is 
distinguishable from a license or permit to operate a business. Such a 
requirement is generally a term or condition of a lease requiring that 
real property be used in the manner permitted by the property owner or 
landlord and does not constitute a separate grant by a governmental 
entity of the right to operate a business. Example 12 concludes that a 
special use permit to use land for a specific purpose, a cell tower, is 
an interest in real property. Consistent with Example 13, if the 
special use permit in Example 12 included a governmental authorization 
required to conduct a business that would produce income other than 
consideration for the use or occupancy of space, that portion of the 
special use permit would not be real property for purposes of these 
rules. Therefore, the Treasury Department and the IRS do not believe 
that any change in the proposed regulations is needed to address the 
commenter's concern.

E. Treatment of Intangible Assets in Another Context

    A commenter noted that goodwill is not considered real property for 
appraisal purposes. The commenter recommended that goodwill be 
characterized as something other than real property, but nevertheless 
be provided the same tax treatment as real property. The Treasury 
Department and the IRS do not agree with this recommendation. Section 
856 governs the determination of whether an asset is real property for 
REIT qualification purposes. Under Sec.  1.856-2(d)(3), the gross 
assets of the REIT are determined in accordance with GAAP. Therefore an 
asset determined in accordance with GAAP, such as GAAP goodwill, must 
for purposes of sections 856 through 859 be accounted for either as 
real property or as property that is not real property. Although 
section 856(c)(5)(J)(ii) permits the Secretary to determine that an 
item of income that is not otherwise qualifying REIT income is 
considered as gross income that is qualifying REIT income, section 856 
does not include a similar provision to permit an asset that is not 
otherwise real property to be treated as real property.

VIII. Procedural and Administrative Matters

A. Previously Issued Letter Rulings

    A commenter requested that the final regulations provide that 
taxpayers may continue to rely on previously issued letter rulings. 
Section 11.04 of Rev. Proc. 2016-1 \12\ states that a letter ruling may 
be revoked or modified by the issuance of temporary or final 
regulations that are inconsistent with that letter ruling. Accordingly, 
to the extent a previously issued letter ruling is inconsistent with 
these final regulations, the letter ruling is revoked prospectively 
from the applicability date of these final regulations.
---------------------------------------------------------------------------

    \12\ Rev. Proc. 2016-1, 2016-1 I.R.B. at 59.
---------------------------------------------------------------------------

B. Revised Applicability Date and Election To Apply These Final 
Regulations to Earlier Quarters

    The proposed regulations' applicability date was for calendar 
quarters beginning after the date that the proposed regulations are 
published as final regulations in the Federal Register. Commenters 
requested that the final regulations apply to taxable years beginning 
after the date that final regulations are published in the Federal 
Register and that taxpayers be permitted to apply the final regulations 
to earlier taxable years and quarters.
    The Treasury Department and the IRS understand that an 
applicability date based on a calendar quarter may have unintended 
consequences in applying the gross income tests in section 856(c)(2) 
and (3) because those tests apply on an annual basis. For example, for 
rents to qualify as rents from interests in real property, the asset 
from which the rents are derived must qualify as real property. An 
asset that qualifies as real property before the applicability date, 
but not on or after the applicability date, would generate rents from 
real property only during quarters before the applicability date. These 
final regulations adopt this suggestion and apply to taxable years that 
begin after the date that the final regulations are published as final 
regulations in the Federal Register. In addition, because the Treasury 
Department and the IRS intend these final regulations generally to be a 
clarification of current law, taxpayers are permitted to rely on the 
final regulations for periods beginning on or before the applicability 
date. The applicability date for these final regulations is discussed 
further in this preamble in the ``Applicability Date'' section.

[[Page 59856]]

IX. Interaction of the Definition of Real Property for Purposes of 
Sections 856 Through 859 With Other Code Provisions

A. Interaction of the Final Regulations With Other Provisions That 
Cross-Reference the Definition of Real Property for REIT Purposes

    A commenter noted that Sec.  1.860G-2(a)(4) references the 
definition of real property found in Sec.  1.856-3(d) of the 1962 
Regulations for purposes of determining whether an obligation is 
``principally secured by an interest in real property'' for regulated 
mortgage investment conduit qualification purposes. The proposed 
regulations were proposed to revise Sec.  1.856-3(d) to read as 
follows: ``See Sec.  1.856-10 for the definition of real property.'' To 
the extent other Treasury regulations reference the definition of real 
property in Sec.  1.856-3(d), Sec.  1.856-3(d), as proposed in the NPRM 
and as amended by these final regulations, directs taxpayers to apply 
the definition found in Sec.  1.856-10.

B. Reconciling Definitions of Real Property

    The preamble to the proposed regulations discussed various Code 
provisions in which the term real property appears. Noting the diverse 
contexts and varying legislative purposes of the Code provisions in 
which the term real property appears, the Treasury Department and the 
IRS requested comments on the extent to which the various meanings of 
real property that appear in the Treasury regulations should be 
reconciled.
    Several commenters were concerned that the term real property has 
different meanings as the term is applied for purposes of different 
Code provisions, which could lead to confusion and inconsistent 
treatment of taxpayers. A commenter noted that there is no Federal 
definition of real property and suggested that another Code provision's 
restrictions on the use of real property should not preclude a REIT 
from investing in or financing such real property so long as the 
property is otherwise inherently permanent. Another commenter noted 
that under section 197, certain intangible assets are amortized as 
separate assets not associated with another asset. A third commenter 
requested clarification that the final regulations apply only to the 
definition of real property for purposes of sections 856 through 859, 
so that there is no conflict between the REIT provisions and other 
provisions of the Code that govern the investment tax credit and 
depreciation.
    As discussed in the preamble to the proposed regulations, in 
drafting the proposed regulations, the Treasury Department and the IRS 
sought to balance (1) the general principle that common terms used in 
different provisions should have common meanings with (2) the 
particular policies underlying the definition used in the REIT 
provisions. These final regulations retain the language in Sec.  1.856-
10(a) of the proposed regulations stating that Sec.  1.856-10 provides 
definitions for purposes of part II, subchapter M, chapter 1 of the 
Code. This language addresses the commenters' concerns by limiting the 
application of the definition of real property under these final 
regulations to sections 856 through 859.

X. Environmental Concerns

    Some commenters suggested that the proposed regulations would 
encourage building in, on, or above water, which these commenters 
suggested is dangerous to water ecosystems and fish habitats. The 
commenters also suggested that the aftermath of hurricanes such as 
Katrina and Sandy should have demonstrated to the Government that 
development near or on water is dangerous to humans and extremely 
costly.
    Neither section 856 nor the regulations thereunder override any 
environmental rules or regulations that may restrict development in 
these areas. In defining land, the Treasury Department and the IRS have 
concluded that it is important to include water space superjacent to 
land because rights to this water space are analytically 
indistinguishable from rights to air space superjacent to land, which, 
as discussed in this preamble, are treated as real property. See Rev. 
Rul. 71-286.

XI. Renewable Energy

A. Consequence of Net Metering on an Asset's Qualification as Real 
Property

    Under Sec.  1.856-10(d)(3)(i) of the proposed regulations, to 
qualify as real property, a structural component must serve an IPS and, 
even if capable of producing income other than consideration for the 
use or occupancy of space, must not produce or contribute to the 
production of such income. The preamble to the proposed regulations 
indicated that the Treasury Department and the IRS are considering 
guidance to address the treatment of any income earned when a system 
that provides electricity to an IPS held by a REIT also transfers 
excess electricity to a utility company. Commenters questioned whether 
a structural component would maintain its qualification as real 
property if the structural component served an IPS in its passive 
function but also produced a product, such as electricity, that was 
provided to third parties. One commenter suggested that the relevant 
test should be whether or not the property has net sales of electricity 
to the grid. Another commenter noted that the amount of electricity a 
building may net meter is regulated by the marketplace because utility 
companies often limit the percentage or amount of electricity that a 
building may net meter.
    The Treasury Department and the IRS are considering whether 
additional guidance is necessary to address the circumstances under 
which a distinct asset that serves an IPS may produce electricity that 
is also sold to third parties and qualify as a structural component of 
the IPS for REIT purposes. Until additional guidance is published in 
the Internal Revenue Bulletin, in any taxable year in which (1) the 
quantity of excess electricity transferred to the utility company 
during the taxable year from such distinct assets does not exceed (2) 
the quantity of electricity purchased from the utility company during 
the taxable year to serve the IPS, the IRS (x) will not treat the 
transfer of such excess electricity as affecting the qualification of 
such distinct assets as structural components of the IPS for REIT 
purposes, (y) will exercise its authority under section 856(c)(5)(J)(i) 
to treat any income resulting from the transfer of such excess 
electricity as not constituting gross income for purposes of section 
856(c)(2) and (3), and (z) will not treat any net income resulting from 
the transfer of such excess electricity as constituting net income 
derived from a prohibited transaction under section 857(b)(6).

B. Qualification of Renewable Energy Credits as Real Property for 
Purposes of Sections 856 Though 859

    Commenters requested that the final regulations address the 
qualification of renewable energy credits (RECs) as real property. 
Renewable energy credits are credits issued to a provider of renewable 
energy and may be freely bought and sold. The owner of a system that 
produces renewable energy may sell RECs without selling the system or 
the electricity produced by the system.
    Because RECs are intangible assets, the Treasury Department and the 
IRS have determined that RECs should be analyzed as such under Sec.  
1.856-10(f) of these final regulations. Thus, RECs do not qualify as 
intangible real property assets under these final regulations because 
RECs may be sold separately

[[Page 59857]]

from any real property to which they relate.

C. Treatment of Renewable Energy Assets as Real Property as a Matter of 
Public Policy

    Commenters urged the Treasury Department and the IRS to allow REITs 
to invest in solar energy sites as a means of furthering clean energy 
objectives. These commenters requested that investors in solar energy 
have the same access to REIT financing as investors in conventional 
energy sources such as natural gas, oil, and other fossil and electric 
energy property. Other commenters noted that private investment would 
be encouraged by treating certain electricity generating assets as real 
property.
    Congress has not provided for solar energy assets to be treated 
differently from other assets for purposes of determining whether the 
assets qualify as real property under the REIT provisions. For this 
reason, the final regulations do not adopt this suggestion.

D. Treatment of Sunlight and Wind Rights as Interests in Land

    Commenters suggested that sunlight used to power a solar energy 
site should be considered either real property or an interest in real 
property. One commenter analogized sunlight and wind to rights to air 
space, suggested that a REIT should be allowed to sell the rights to 
the sunlight or wind enjoyed on its property to third parties, and 
further suggested that a REIT should be able to treat income from the 
sale of such rights as qualifying income. This commenter posited that 
the process used to convert sunlight into electricity is analogous to 
the process inherent in fruit-bearing plants, which are discussed in 
Sec.  1.856-10(g), Example 1, of the proposed regulations, and that the 
sunlight, like the plants in Example 1, should be treated as real 
property. Another commenter characterized sunlight as a resource 
analogous to oil, gas, and mineral resources inherent in land.
    The Treasury Department and the IRS agree that a REIT may lease the 
air space superjacent to its land, which is an interest in its land, 
and may allow its tenants access to sunlight and wind. The Treasury 
Department and the IRS, however, are not aware of an approach that 
could be used to enable a REIT to rent or grant an interest in sunlight 
or wind separate from its interest in the land or the air space 
superjacent to the land. Therefore, these final regulations do not 
adopt these suggestions.

E. Qualification of a Concentrating Solar Power System and its 
Associated Assets as Real Property for Purposes of Sections 856 Trough 
859

    A commenter suggested that a concentrating solar power system uses 
assets that differ from PV panels to harvest solar energy. This 
commenter suggested that a concentrating solar power system, including, 
for example, a parabolic trough system, should be considered real 
property under these final regulations.
    The Treasury Department and the IRS have concluded that this type 
of system is comprised of many distinct assets that may serve different 
functions. As illustrated in Sec.  1.856-10(g), Examples 8 and 9, these 
distinct assets may be analyzed using the standards provided in the 
final regulations for OIPSs and structural components. Accordingly, 
concentrating solar power systems and their associated assets are not 
added to the lists of qualifying assets in these final regulations.

XII. Examples

    Section 1.856-10(g) of the proposed regulations provided thirteen 
examples illustrating the application of the proposed regulations in a 
variety of factual scenarios.

A. References to Net Leases

    Each of Sec.  1.856-10(g), Examples 1, 5, 6, 7, 8, and 10, of the 
proposed regulations stated that the REIT enters into a long term, 
triple-net lease of property. A commenter noted that the term ``net 
lease'' is not defined for purposes of section 856 and, therefore, may 
encompass different economic arrangements, the variations in which are 
not relevant to whether property is real property. The commenter 
further contended that many REITs do not net lease their assets. The 
commenter suggested that if it is necessary to describe the underlying 
facts, the term ``lease'' is sufficient and avoids the implication that 
a REIT must net lease its asset.
    Each of Examples 1, 5, 6, 7, 8, and 10 of the proposed regulations 
stated that the assets are net leased to avoid any potential 
implication that the REIT is operating the property. Examples 1, 5, 6, 
7, 8, and 10 are revised in these final regulations to provide that the 
REIT neither operates the property nor provides services to the lessee.

B. Example 4

    Section 1.856-10(g), Example 4, of the proposed regulations 
analyzed whether a bus shelter is an IPS. One commenter suggested that 
Example 4 be deleted because it was uncertain if a REIT would make a 
section 1033(g) \13\ election with respect to the bus shelter. 
Additionally, the commenter was not aware of any REIT that leases or 
intends to lease bus shelters to a transit authority and believed that 
such shelters are rarely relocated. For these reasons, the commenter 
recommended that the example be stricken. No commenters, however, 
disagreed with the conclusion in the example.
---------------------------------------------------------------------------

    \13\ Section 1033(g)(3) provides that a taxpayer may elect to 
treat property that constitutes an outdoor advertising display as 
real property for purposes of chapter 1 of the Code.
---------------------------------------------------------------------------

    The Treasury Department and the IRS believe that Example 4 is 
helpful because it describes a structure that is not permanently 
affixed and thus does not qualify as an IPS under the standards 
provided in the regulations. Therefore, these final regulations do not 
adopt this suggestion.

C. Example 6

    Section 1.856-10(g), Example 6, of the proposed regulations 
illustrated the definition of structural component in the context of a 
data center. One commenter suggested changes to Example 6 including 
clarification that the electrical system and telecommunication 
infrastructure systems are (1) embedded in significant part within the 
walls and floors of the building, (2) would be difficult to remove, and 
(3) are intended to remain in place indefinitely. Although suggestions 
(1) and (2) would clarify the example and would not affect the analysis 
or conclusion of the example, suggestion (3) is not relevant because 
the structural component factors in Sec.  1.856-10(d)(3)(ii)(B) of the 
proposed regulations do not include the intent of the owner of the 
asset. Accordingly, these final regulations revise Example 6 to 
accurately reflect the integration of these assets into the data center 
building.\14\
---------------------------------------------------------------------------

    \14\ For consistency and clarity, similar revisions have been 
made to other examples illustrating the definition of structural 
component.
---------------------------------------------------------------------------

    Another commenter suggested that cross-connects used in a data 
center should not be considered real property because the cross-
connects produce income that is not for the use or occupancy of space 
and this income is significant in comparison to the income produced by 
other assets in a data center. Example 6 did not, and was not intended 
to, address every distinct asset that may be part of a data center. 
Distinct assets that are not addressed in the example may be analyzed 
by applying the standards set forth in the proposed regulations. 
Accordingly, no

[[Page 59858]]

change was made to the final regulation in response to this comment.

E. Example 8

    Section 1.856-10(g), Example 8, of the proposed regulations 
analyzed a solar energy site that includes land, photovoltaic modules 
(PV modules), mounts and an exit wire. The solar energy site was 
triple-net leased to an operator who uses the assets to produce and 
transmit energy to an electrical power grid for sale to third parties. 
The example concluded that the land, mounts, and exit wire qualify as 
real property and that the PV modules do not qualify as IPSs because 
they convert solar energy into electricity, which is an active 
function.
    One commenter requested that the Treasury Department and the IRS 
update Example 8 to include an analysis of inverters, which the 
commenter contended serve an active function compared to PV modules, 
which the commenter contended are relatively passive. Another commenter 
elaborated on the function of the PV modules, above ground wiring, and 
inverters. The commenter proposed adding language to Example 8 to state 
that these assets have no moving parts and are therefore passive.
    The Treasury Department and the IRS have concluded that PV modules 
and inverters that are used in the generation of energy for sale to 
third parties do not qualify as IPSs under the proposed regulations. 
The Treasury Department and the IRS do not believe the inclusion of 
above ground wiring in Example 8, which already analyzes an exit wire, 
is necessary to illustrate the application of the rules in Sec.  1.856-
10 to above ground wiring. For these reasons, the final regulations do 
not adopt these suggestions.

F. Example 9

    Section 1.856-10(g), Example 9, of the proposed regulations 
described a solar energy site similar to the solar energy site in 
Example 8, except that the solar energy site in Example 9 is mounted on 
land adjacent to an office building owned by the REIT. Other than 
occasional transfers of electricity to the grid, the solar energy site 
in Example 9 serves only the REIT's office building to which it is 
constituent. The solar energy site in Example 9 of the proposed 
regulations qualifies as a structural component.
    A commenter recommended revisions to the statements in Example 9 
that the solar energy site was (1) designed specifically for the 
particular office building of which it is a part and (2) expensive and 
time consuming to install and remove. The commenter stated that most 
materials used for solar rooftop and other smaller-scale installations 
are mass-produced and standardized and can be removed and reinstalled 
without major complications or damage. These final regulations revise 
Example 9 to state that the size and other specifications of the solar 
energy system were established to serve the needs of the office 
building and that no facts indicate that the solar energy system will 
not remain in place indefinitely.
    Another commenter requested clarification of the term 
``occasionally transfers.'' This commenter recommended changing 
``occasionally transfers'' to ``regularly transfers'' in describing the 
transfer of energy from the solar energy site to a utility company. As 
discussed in section XI.A. of this preamble, the Treasury Department 
and the IRS are considering whether additional guidance is necessary to 
address this commenter's concern. Until the issuance of such additional 
guidance, the Treasury Department and the IRS (1) will not treat the 
transfer of the excess electricity as affecting the qualification of 
the distinct assets as structural components of the IPS for REIT 
purposes, (2) will exercise its authority under section 856(c)(5)(J)(i) 
to treat any income resulting from the transfer of the excess 
electricity as not constituting gross income for purposes of section 
856(c)(2) and (3), and (3) will not treat any net income resulting from 
the transfer of the excess electricity as constituting net income 
derived from a prohibited transaction under section 857(b)(6).
    A commenter noted that even when a building uses all of the solar 
electricity produced by a solar energy site, such as the one in Example 
9, the tenant of the building may earn income through the sale of RECs 
awarded under a local renewable portfolio standard. The Treasury 
Department and the IRS believe that income earned by a tenant from RECs 
in this situation would not affect the qualification of the solar 
energy site as a structural component. The tax consequences of income 
earned by a REIT from RECs are beyond the scope of this guidance.
    Another commenter requested that Example 9 be modified to address 
wind facilities rather than solar facilities. The Treasury Department 
and the IRS believe that the components of wind facilities may 
similarly be analyzed using the standards provided in Sec.  1.856-
10(d)(3) of the proposed regulations. For these reasons, the final 
regulations do not adopt these recommendations.

G. Example 10

    Section 1.856-10(g), Example 10, of the proposed regulations 
addressed application of the proposed regulations to a pipeline 
transmission system. Distinct assets of the pipeline transmission 
system include underground pipelines, storage tanks, valves, vents, 
meters, and compressors. The example stated that the pipeline 
transmission system serves a passive function, containing oil, and an 
active function, transporting oil. The example further stated that, 
even though the pipeline transmission system serves an active function, 
a distinct asset within the system may nevertheless be an IPS if that 
asset does not perform an active function.
    One commenter noted that whether the entire system performs an 
active function is not relevant because the system is composed of 
distinct assets, each of which must be separately analyzed. The 
Treasury Department and the IRS believe that Example 10 is helpful 
because it demonstrates that a distinct asset within a system may still 
qualify as an IPS, or a structural component thereof, even though the 
system serves an active function.
    As discussed in section III.A.2. of this preamble, these final 
regulations include providing a conduit or route as a permitted passive 
function and retain transport, which has been clarified to mean cause 
to move, as a prohibited active function. The Treasury Department and 
the IRS have revised Example 10 to illustrate that the pipelines in 
Example 10 serve the passive function of providing a conduit.
    Another commenter suggested revising Example 10 so that the 
pipeline transmission system transports natural gas rather than oil and 
suggested changing the vents and valves to isolation valves and vents, 
pressure control valves, relief valves, and pressure regulating 
stations. The commenter also suggested that Example 10 be revised to 
apply the factors set forth in the regulations to determine whether 
these assets are structural components. These final regulations 
incorporate this commenter's suggestions.
    In addition, commenters argued that the compressors within a 
pipeline transmission system are analogous to elevators and escalators 
within a building, with the function of moving things or people within 
an IPS. One commenter noted that compressors may be viewed as 
performing a propelling function. Another commenter suggested that 
elevators and escalators serve a building by enabling access to taller

[[Page 59859]]

buildings, higher levels of occupancy, and more efficient usage. 
Another commenter suggested that compressors enable the efficient use 
of space within a pipeline.
    To qualify as a structural component, a distinct asset must serve 
an IPS in its passive function. The compressors that transport natural 
gas through the pipeline transmission system in Example 10 do not serve 
the underground pipelines in their passive function of providing a 
conduit but rather cause the natural gas to move through the conduit, 
which is an active function. For this reason, these final regulations 
do not adopt these suggestions.

H. Example 11

    Section 1.856-10(g), Example 11, of the proposed regulations 
addressed whether goodwill established under GAAP as a result of the 
acquisition of stock of a corporation that owned a hotel qualifies as 
real property for purposes of sections 856 through 859. This example 
stated that the amount of the acquisition cost allocated to the hotel 
was limited to the hotel's depreciated replacement cost. The example 
also stated that the difference between the amount paid for the 
acquired corporation's stock and the depreciated replacement cost of 
the hotel was treated as goodwill attributable to the acquired hotel. 
The Treasury Department and the IRS have been advised that depreciated 
replacement cost is no longer the standard under GAAP for valuing 
property such as the hotel. The Treasury Department and the IRS have 
therefore removed this example.

I. Example 13

    Section 1.856-10(g), Example 13, of the proposed regulations 
addressed whether a license to operate a casino is real property. 
Example 13 concluded that because the license permits the holder to 
engage in the business of operating a casino the license is not real 
property even though the license applies only to the REIT's building 
and cannot be transferred to another location.
    One commenter stated that in some foreign jurisdictions, a casino 
license may be more in the nature of a zoning permit that may be 
transferred to a subsequent buyer. This commenter suggested that a 
license that runs with the land is more in the nature of a zoning 
permit. The commenter recommended either deleting Example 13 or 
revising it to distinguish transferable zoning-based or similar real 
estate-based licenses.
    Another commenter noted that the permitted use of a facility for 
gaming purposes may enhance its value as real estate, apart from the 
value of the gaming license itself. The commenter also remarked that 
zoning laws frequently restrict gaming activities or liquor sales to 
particular geographical areas or locations, which restrictions, in 
general, favorably affect the value of real estate in these areas or 
locations.
    These final regulations do not adopt these recommendations. Under 
Sec.  1.856-10(f) of the proposed regulations, whether a license runs 
with the land is not dispositive in determining whether the license is 
real property for purposes of sections 856 through 859. The valuation 
of real property, including any effect that zoning may have on the 
value of real property, are beyond the scope of these final 
regulations.

J. Additional Examples

    The Treasury Department and the IRS received requests to add 
additional examples to the final regulations.
    Section VII.B. of this preamble describes comments received 
requesting clarification that intangible assets related to in-place 
above-market leases in which the REIT is the lessor and below-market 
leases in which the REIT is the lessee be treated as qualifying real 
property. As discussed in section VII.B., these final regulations 
include Sec.  1.856-10(g), Example 11, which illustrates the 
application of these final regulations to an in-place above-market 
lease that produces both rents from real property under section 
856(d)(1) and other income that does not qualify as rents from real 
property under section 856(d)(1).
    A commenter suggested adding an example applying these final 
regulations to an electric transmission and distribution system. The 
Treasury Department and the IRS believe that the distinct assets of an 
electric transmission and distribution system are similar in many 
respects to the distinct assets of the solar energy site addressed by 
Sec.  1.856-10(g), Example 8 of the proposed regulations, and may be 
analyzed using the standards provided in Sec.  1.856-10(d)(2) and (3) 
of the proposed regulations. Accordingly, these final regulations 
adequately address the distinct assets that may be part of an 
electrical transmission and distribution system.
    Another commenter suggested that the final regulations include an 
example illustrating the components of an in-ground swimming pool. (The 
proposed regulations listed the pool itself as an OIPS.) The Treasury 
Department and the IRS are not aware that there have been significant 
questions concerning whether the various components qualify as real 
property. Therefore, these final regulations do not include an example 
addressing whether these components qualify as real property for 
purposes of sections 856 through 859.

XIII. Additional Comments

A. Potential Tax Inequality Among Taxpayers

    Three commenters viewed the proposed regulations as a substantial 
expansion of the definition of real property. The Treasury Department 
and the IRS believe that the proposed regulations and these final 
regulations generally clarify existing law. These commenters also 
called for equal application of the tax laws and appear to believe that 
REITs are a vehicle that some corporations use to avoid taxes. The REIT 
structure was established by Congress in 1960, and it is not within the 
scope of these final regulations to change the REIT structure as these 
commenters suggest.

B. Clarification That Buildings Can Be on or Inside of Other Buildings 
or IPSs

    A commenter requested that the final regulations clarify that 
buildings can be on or inside of other buildings or IPSs. The Treasury 
Department and the IRS believe that this comment was adequately 
addressed by the proposed regulations, which provided that the 
affixation of an IPS (which may be a building) may be to land or to 
another IPS. In addition, Sec.  1.856-10(g), Example 3, concludes that 
a large sculpture inside an office building qualifies as an IPS. A 
building inside another building is not analytically different from the 
sculpture inside the building in Example 3. Accordingly, the proposed 
regulations, as finalized by this Treasury decision, adequately address 
this commenter's concern.

C. Qualification of Appurtenances and Zoning and Similar Rights

    A commenter suggested that appurtenances should be included in the 
definition of land. The commenter suggested that real estate law 
provides that an appurtenance encompasses easements and rights of way 
over another's land to access one's own land. In addition, this 
commenter suggested that zoning and similar rights should be included 
in the definition of real property.
    Taxpayers should apply Sec.  1.856-10(f)(2) of these final 
regulations, which addresses the treatment of rights for the use, 
enjoyment, or occupation of land, to determine whether an appurtenance

[[Page 59860]]

qualifies as real property for purposes of sections 856 through 859. 
Zoning rights may increase the value of real property. Consistent with 
Sec.  1.856-2(d)(3), if a zoning right is considered a separate asset 
under GAAP, then the zoning right should be analyzed as an intangible 
asset under section 1.856-10(f) of these final regulations.

D. Additional Comments

    A commenter suggested that the final regulations address the 
definition of rents from real property, eliminate the standard 
requiring that total assets be based on GAAP, and regulate the type of 
services that a taxable REIT subsidiary may provide. These issues are 
beyond the scope of these final regulations.
Effective/Applicability Date
    These final regulations apply to taxable years that begin after 
August 31, 2016. Under section 856(c)(4), whether a taxpayer loses 
status as a REIT in one quarter may depend on whether the taxpayer 
satisfied section 856(c)(4) at the close of one or more prior quarters. 
For purposes of applying the first sentence of the flush language in 
section 856(c)(4) to a quarter in a taxable year that begins after 
August 31, 2016, these final regulations apply in determining whether 
the taxpayer met the requirements of section 856(c)(4) at the close of 
prior quarters. Taxpayers may rely on these final regulations for 
quarters that end before the applicability date.
Special Analyses
    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It also has been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations, and because the regulations do not impose a 
collection of information on small entities, the Regulatory Flexibility 
Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of 
the Internal Revenue Code, the proposed regulations preceding these 
final regulations were submitted to the Chief Counsel for Advocacy of 
the Small Business Administration for comment on their impact on small 
business. No comments were received.
Drafting Information
    The principal author of these regulations is Julanne Allen, Office 
of Associate Chief Council (Financial Institutions and Products). 
However, other personnel from the Treasury Department and the IRS 
participated in their development.
Statement of Availability of IRS Documents
    The IRS revenue rulings and revenue procedure cited in this 
preamble are published in the Internal Revenue Bulletin (or Cumulative 
Bulletin) and are available from the Superintendent of Documents, U.S. 
Government Publishing Office, Washington, DC 20402, or by visiting the 
IRS Web site at www.irs.gov.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Section 1.856-3(d) is revised to read as follows:


Sec.  1.856-3  Definitions.

* * * * *
    (d) Real property. See Sec.  1.856-10 for the definition of real 
property. A regulation that adopts the definition of real property in 
this paragraph is to be interpreted as if it had referred to Sec.  
1.856-10.
* * * * *

0
Par. 3. Section 1.856-10 is added to read as follows:


Sec.  1.856-10  Definition of real property.

    (a) In general. This section provides definitions for purposes of 
part II, subchapter M, chapter 1 of the Internal Revenue Code. 
Paragraph (b) of this section defines real property, which includes 
land as defined under paragraph (c) of this section and improvements to 
land as defined under paragraph (d) of this section. Improvements to 
land include inherently permanent structures as defined under paragraph 
(d)(2) of this section and structural components of inherently 
permanent structures as defined under paragraph (d)(3) of this section. 
Paragraph (e) of this section provides rules for determining whether an 
item is a distinct asset for purposes of applying the definitions in 
paragraphs (b), (c), and (d) of this section. Paragraph (f) of this 
section identifies intangible assets that are real property or 
interests in real property. Paragraph (g) of this section provides 
examples illustrating the rules of paragraphs (b) through (f) of this 
section. Paragraph (h) of this section provides the effective/
applicability date for this section.
    (b) Real property. The term real property means land and 
improvements to land. Local law definitions are not controlling for 
purposes of determining the meaning of the term real property.
    (c) Land. Land includes water and air space superjacent to land and 
natural products and deposits that are unsevered from the land. Natural 
products and deposits, such as crops, water, ores, and minerals, cease 
to be real property when they are severed, extracted, or removed from 
the land. The storage of severed or extracted natural products or 
deposits, such as crops, water, ores, and minerals, in or upon real 
property does not cause the stored property to be recharacterized as 
real property.
    (d) Improvements to land--(1) In general. The term improvements to 
land means inherently permanent structures and their structural 
components.
    (2) Inherently permanent structure--(i) In general. The term 
inherently permanent structure means any permanently affixed building 
or other permanently affixed structure. Affixation may be to land or to 
another inherently permanent structure and may be by weight alone. If 
the affixation is reasonably expected to last indefinitely based on all 
the facts and circumstances, the affixation is considered permanent. A 
distinct asset that serves an active function, such as an item of 
machinery or equipment, is not a building or other inherently permanent 
structure.
    (ii) Building--(A) In general. A building encloses a space within 
its walls and is covered by a roof.
    (B) Types of buildings. Buildings include the following distinct 
assets if permanently affixed: Houses; apartments; hotels; motels; 
enclosed stadiums and arenas; enclosed shopping malls; factory and 
office buildings; warehouses; barns; enclosed garages; enclosed 
transportation stations and terminals; and stores.
    (iii) Other inherently permanent structures--(A) In general. Other 
inherently permanent structures serve a passive function, such as to 
contain, support, shelter, cover, protect, or provide a conduit or a 
route, and do not serve an active function, such as to manufacture, 
create, produce, convert, or transport.

[[Page 59861]]

    (B) Types of other inherently permanent structures. Other 
inherently permanent structures include the following distinct assets 
if permanently affixed: Microwave transmission, cell, broadcast, and 
electrical transmission towers; telephone poles; parking facilities; 
bridges; tunnels; roadbeds; railroad tracks; transmission lines; 
pipelines; fences; in-ground swimming pools; offshore drilling 
platforms; storage structures such as silos and oil and gas storage 
tanks; and stationary wharves and docks. Other inherently permanent 
structures also include outdoor advertising displays for which an 
election has been properly made under section 1033(g)(3).
    (iv) Facts and circumstances determination. If a distinct asset 
(within the meaning of paragraph (e) of this section) does not serve an 
active function as described in paragraph (d)(2)(iii)(A) of this 
section and is not otherwise listed in paragraph (d)(2)(ii)(B) or 
(d)(2)(iii)(B) of this section or in guidance published in the Internal 
Revenue Bulletin (see Sec.  601.601(d)(2)(ii) of this chapter), the 
determination of whether that asset is an inherently permanent 
structure is based on all the facts and circumstances. In particular, 
the following factors must be taken into account:
    (A) The manner in which the distinct asset is affixed to real 
property;
    (B) Whether the distinct asset is designed to be removed or to 
remain in place indefinitely;
    (C) The damage that removal of the distinct asset would cause to 
the item itself or to the real property to which it is affixed;
    (D) Any circumstances that suggest the expected period of 
affixation is not indefinite (for example, a lease that requires or 
permits removal of the distinct asset upon the expiration of the 
lease); and
    (E) The time and expense required to move the distinct asset.
    (3) Structural components--(i) In general. The term structural 
component means any distinct asset (within the meaning of paragraph (e) 
of this section) that is a constituent part of and integrated into an 
inherently permanent structure, serves the inherently permanent 
structure in its passive function, and, even if capable of producing 
income other than consideration for the use or occupancy of space, does 
not produce or contribute to the production of such income. If 
interconnected assets work together to serve an inherently permanent 
structure with a utility-like function (for example, systems that 
provide a building with electricity, heat, or water), the assets are 
analyzed together as one distinct asset that may be a structural 
component. A structural component may qualify as real property only if 
the real estate investment trust (REIT) holds its interest in the 
structural component together with a real property interest in the 
space in the inherently permanent structure served by the structural 
component. A mortgage secured by a structural component is a real 
estate asset only if the mortgage is also secured by a real property 
interest in the inherently permanent structure served by the structural 
component. If a distinct asset is customized in connection with the 
rental of space in or on an inherently permanent structure to which the 
asset relates, the customization does not affect whether the distinct 
asset is a structural component.
    (ii) Types of structural components. Structural components include 
the following distinct assets and systems if integrated into the 
inherently permanent structure and held together with a real property 
interest in the space in the inherently permanent structure served by 
that distinct asset or system: Wiring; plumbing systems; central 
heating and air-conditioning systems; elevators or escalators; walls; 
floors; ceilings; permanent coverings of walls, floors, and ceilings; 
windows; doors; insulation; chimneys; fire suppression systems, such as 
sprinkler systems and fire alarms; fire escapes; central refrigeration 
systems; security systems; and humidity control systems.
    (iii) Facts and circumstances determination. If an interest in a 
distinct asset (within the meaning of paragraph (e) of this section) is 
held together with a real property interest in the space in the 
inherently permanent structure served by that distinct asset and that 
asset is not otherwise listed in paragraph (d)(3)(ii) of this section 
or in guidance published in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2)(ii) of this chapter), the determination of whether that 
asset is a structural component is based on all the facts and 
circumstances. In particular, the following factors must be taken into 
account:
    (A) The manner, time, and expense of installing and removing the 
distinct asset;
    (B) Whether the distinct asset is designed to be moved;
    (C) The damage that removal of the distinct asset would cause to 
the item itself or to the inherently permanent structure to which it is 
affixed;
    (D) Whether the distinct asset serves a utility-like function with 
respect to the inherently permanent structure;
    (E) Whether the distinct asset serves the inherently permanent 
structure in its passive function;
    (F) Whether the distinct asset produces income from consideration 
for the use or occupancy of space in or upon the inherently permanent 
structure;
    (G) Whether the distinct asset is installed during construction of 
the inherently permanent structure; and
    (H) Whether the distinct asset will remain if the tenant vacates 
the premises.
    (e) Distinct asset--(1) In general. A distinct asset is analyzed 
separately from any other assets to which the asset relates to 
determine if the asset is real property, whether as land, an inherently 
permanent structure, or a structural component of an inherently 
permanent structure.
    (2) Facts and circumstances. The determination of whether a 
particular separately identifiable item of property is a distinct asset 
is based on all the facts and circumstances. In particular, the 
following factors must be taken into account:
    (i) Whether the item is customarily sold or acquired as a single 
unit rather than as a component part of a larger asset;
    (ii) Whether the item can be separated from a larger asset, and if 
so, the cost of separating the item from the larger asset;
    (iii) Whether the item is commonly viewed as serving a useful 
function independent of a larger asset of which it is a part; and
    (iv) Whether separating the item from a larger asset of which it is 
a part impairs the functionality of the larger asset.
    (f) Intangible assets--(1) In general. To the extent that an 
intangible asset, including an intangible asset established under 
generally accepted accounting principles (GAAP) as a result of an 
acquisition of real property or an interest in real property, derives 
its value from real property or an interest in real property, is 
inseparable from that real property or interest in real property, and 
does not produce or contribute to the production of income other than 
consideration for the use or occupancy of space, the intangible asset 
is real property or an interest in real property.
    (2) Licenses and permits. A license, permit, or other similar right 
that is solely for the use, enjoyment, or occupation of land or an 
inherently permanent structure and that is in the nature of a leasehold 
or easement generally is an interest in real property. A license or 
permit to engage in or operate a business is not real property or an 
interest in real property if the

[[Page 59862]]

license or permit produces or contributes to the production of income 
other than consideration for the use or occupancy of space.
    (g) Examples. The following examples demonstrate the rules of this 
section. Examples 1 and 2 illustrate the definition of land as provided 
in paragraph (c) of this section. Examples 3 through 10 illustrate the 
definition of improvements to land as provided in paragraph (d) of this 
section. Finally, Examples 11 through 13 illustrate whether certain 
intangible assets are real property or interests in real property as 
provided in paragraph (f) of this section.

    Example 1.  Natural products of land. A is a REIT. REIT A owns 
land with perennial fruit-bearing plants. REIT A leases the fruit-
bearing plants to a tenant and grants the tenant an easement to 
enter the land to cultivate the plants and to harvest the fruit. The 
lease and easement are long-term and REIT A provides no services to 
the tenant. The unsevered plants are natural products of the land 
and are land within the meaning of paragraph (c) of this section. 
The tenant annually harvests fruit from the plants. Upon severance 
from the land, the harvested fruit ceases to qualify as land. 
Storage of the harvested fruit upon or within real property does not 
cause the harvested fruit to be real property.
    Example 2.  Water space superjacent to land. REIT B leases a 
marina from a governmental entity. The marina is comprised of U-
shaped boat slips and end ties. The U-shaped boat slips are spaces 
on the water that are surrounded by a dock on three sides. The end 
ties are spaces on the water at the end of a slip or on a long, 
straight dock. REIT B rents the boat slips and end ties to boat 
owners. The boat slips and end ties are water space superjacent to 
land that is land within the meaning of paragraph (c) of this 
section and, therefore, are real property.
    Example 3.  Indoor sculpture. (i) REIT C owns an office building 
and a large sculpture in the atrium of the building. The sculpture 
measures 30 feet tall by 18 feet wide and weighs five tons. The 
building was specifically designed to support the sculpture, which 
is permanently affixed to the building by supports embedded in the 
building's foundation. The sculpture was constructed within the 
building. Removal would be costly and time consuming and would 
destroy the sculpture. The sculpture is reasonably expected to 
remain in the building indefinitely. The sculpture does not 
manufacture, create, produce, convert, transport, or serve any 
similar active function.
    (ii) The sculpture is not an asset listed in paragraph 
(d)(2)(iii)(B) of this section, and, therefore, the sculpture is an 
asset that must be analyzed to determine whether it is an inherently 
permanent structure using the factors provided in paragraph 
(d)(2)(iv) of this section. The sculpture--
    (A) Is permanently affixed to the building by supports embedded 
in the building's foundation;
    (B) Is not designed to be removed and is designed to remain in 
place indefinitely;
    (C) Would be damaged if removed and would damage the building to 
which it is affixed;
    (D) Will remain affixed to the building after any tenant vacates 
the premises and will remain affixed to the building indefinitely; 
and
    (E) Would require significant time and expense to move.
    (iii) The factors described in this paragraph (g) Example 3 
(ii)(A) through (E) all support the conclusion that the sculpture is 
an inherently permanent structure within the meaning of paragraph 
(d)(2) of this section and, therefore, is real property.
    Example 4.  Bus shelters. (i) REIT D owns 400 bus shelters, each 
of which consists of four posts, a roof, and panels enclosing two or 
three sides. REIT D enters into a long-term lease with a local 
transit authority for use of the bus shelters. Each bus shelter is 
prefabricated from steel and is bolted to the sidewalk. Bus shelters 
are disassembled and moved when bus routes change. Moving a bus 
shelter takes less than a day and does not significantly damage 
either the bus shelter or the real property to which it was affixed.
    (ii) The bus shelters are not permanently affixed enclosed 
transportation stations or terminals and do not otherwise meet the 
definition of a building in paragraph (d)(2)(ii) of this section nor 
are they listed as types of other inherently permanent structures in 
paragraph (d)(2)(iii)(B) of this section. Therefore, the bus 
shelters must be analyzed to determine whether they are inherently 
permanent structures using the factors provided in paragraph 
(d)(2)(iv) of this section. The bus shelters--
    (A) Are not permanently affixed to the land or an inherently 
permanent structure;
    (B) Are designed to be removed and are not designed to remain in 
place indefinitely;
    (C) Would not be damaged if removed and would not damage the 
sidewalks to which they are affixed;
    (D) Will not remain affixed after the local transit authority 
vacates the site and will not remain affixed indefinitely; and
    (E) Would not require significant time and expense to move.
    (iii) The factors described in this paragraph (g) Example 4 
(ii)(A) through (E) all support the conclusion that the bus shelters 
are not inherently permanent structures within the meaning of 
paragraph (d)(2) of this section. Although the bus shelters serve a 
passive function of sheltering, the bus shelters are not permanently 
affixed, which means the bus shelters are not inherently permanent 
structures within the meaning of paragraph (d)(2) of this section 
and, therefore, are not real property.
    Example 5.  Cold storage warehouse. (i) REIT E owns a 
refrigerated warehouse (Cold Storage Warehouse). REIT E enters into 
a long-term lease with a tenant. REIT E neither operates the Cold 
Storage Warehouse nor provides services to its tenant. The tenant 
uses the Cold Storage Warehouse to store perishable products. 
Certain components and utility systems that are integrated into the 
Cold Storage Warehouse have been customized to accommodate the 
tenant's need for refrigerated storage space. For example, the Cold 
Storage Warehouse has customized freezer walls and a central 
refrigeration system. Freezer walls within the Cold Storage 
Warehouse are specifically designed to maintain the desired 
temperature within the Cold Storage Warehouse. The freezer walls and 
central refrigeration system comprise a series of interconnected 
assets that work together to serve a utility-like function within 
the Cold Storage Warehouse, were installed during construction of 
the building, and will remain in place when the tenant vacates the 
premises. The freezer walls and central refrigeration system were 
designed to remain permanently in place.
    (ii) Walls and central refrigeration systems are listed as 
structural components in paragraph (d)(3)(ii) of this section and, 
therefore, are real property. The customization of the freezer walls 
does not affect their qualification as structural components of REIT 
E's Cold Storage Warehouse within the meaning of paragraph (d)(3) of 
this section. Therefore, the freezer walls and central refrigeration 
system are structural components of REIT E's Cold Storage Warehouse.
    Example 6.  Data center. (i) REIT F owns a building that it 
leases to a tenant under a long-term lease. REIT F neither operates 
the building nor provides services to its tenant. To accommodate the 
particular requirements for housing computer servers, certain 
interior components and utility systems within the building have 
been customized to provide a higher level of functionality than a 
conventional office building. These customized systems are owned by 
REIT F and include an electrical distribution and redundancy system 
(Electrical System), a central heating and air-conditioning system, 
a telecommunication infrastructure system, an integrated security 
system, a fire suppression system, and a humidity control system 
(each, a System). In addition, the space for computer servers in 
REIT F's building has been constructed with raised flooring that is 
integrated into the building to accommodate the Systems. Each System 
is comprised of a series of interconnected assets that work together 
to serve a utility-like function within the building. The Systems 
are integrated into the office building, were installed during 
construction of the building, and will remain in place when the 
tenant vacates the premises. Each of the Systems was customized to 
enhance the capacity of the System in connection with the rental of 
space within the building.
    (ii) The central heating and air-conditioning system, integrated 
security system, fire suppression system, and humidity control 
system are listed as structural components in paragraph (d)(3)(ii) 
of this section and, therefore, are real property. The customization 
of these Systems does not affect the qualification of these Systems 
as structural components of REIT F's building within the meaning of 
paragraph (d)(3) of this section. Therefore, these Systems are 
structural components of REIT F's building.

[[Page 59863]]

    (iii) In addition to wiring and flooring, which are listed as 
structural components in paragraph (d)(3)(ii) of this section and, 
therefore, are real property, the Electrical System and 
telecommunication infrastructure system include equipment used to 
ensure that the tenant is provided with uninterruptable, stable 
power and telecommunication services. The Electrical System and 
telecommunication infrastructure system are not listed in paragraph 
(d)(3)(ii) of this section, and, therefore, they must be analyzed to 
determine whether they are structural components of the building 
using the factors provided in paragraph (d)(3)(iii) of this section. 
The Electrical System and telecommunication infrastructure system--
    (A) Are embedded within the walls and floors of the building and 
would be costly to remove;
    (B) Are not designed to be moved and are designed specifically 
for the particular building of which they are a part;
    (C) Would not be significantly damaged upon removal and, 
although removing them would damage the walls and floors in which 
they are embedded, their removal would not significantly damage the 
building;
    (D) Serve a utility-like function with respect to the building;
    (E) Serve the building in its passive functions of containing, 
sheltering, and protecting computer servers;
    (F) Produce income as consideration for the use or occupancy of 
space within the building;
    (G) Were installed during construction of the building; and
    (H) Will remain in place when the tenant vacates the premises.
    (iv) The factors described in this paragraph (g) Example 6 
(iii)(A), (B), and (D) through (H) all support the conclusion that 
the Electrical System and telecommunication infrastructure system 
are structural components of REIT F's building within the meaning of 
paragraph (d)(3) of this section and, therefore, are real property. 
The factor described in this paragraph (g) Example 6 (iii)(C) would 
support a conclusion that the Electrical System and 
telecommunication infrastructure system are not structural 
components. However this factor does not outweigh the factors 
supporting the conclusion that the Electric System and 
telecommunication infrastructure system are structural components.
    Example 7. Partitions. (i) REIT G owns an office building that 
it leases to tenants under long-term leases. REIT G neither operates 
the office building nor provides services to its tenants. Partitions 
are owned by REIT G and are used to delineate space between tenants 
and within each tenant's space. The office building has two types of 
interior, non-load-bearing drywall partition systems: a conventional 
drywall partition system (Conventional Partition System) and a 
modular drywall partition system (Modular Partition System). Neither 
the Conventional Partition System nor the Modular Partition System 
was installed during construction of the office building. 
Conventional Partition Systems are comprised of fully integrated 
gypsum board partitions, studs, joint tape, and covering joint 
compound. Modular Partition Systems are comprised of assembled 
panels, studs, tracks, and exposed joints. Both the Conventional 
Partition System and the Modular Partition System reach from the 
floor to the ceiling.
    (ii) Depending on the needs of a new tenant, the Conventional 
Partition System may remain in place when a tenant vacates the 
premises. The Conventional Partition System is integrated into the 
office building and is designed and constructed to remain in areas 
not subject to reconfiguration or expansion. The Conventional 
Partition System can be removed only by demolition, and, once 
removed, neither the Conventional Partition System nor its 
components can be reused. Removal of the Conventional Partition 
System causes substantial damage to the Conventional Partition 
System itself but does not cause substantial damage to the building.
    (iii) Modular Partition Systems are typically removed when a 
tenant vacates the premises. Modular Partition Systems are not 
designed or constructed to remain permanently in place. Modular 
Partition Systems are designed and constructed to be movable. Each 
Modular Partition System can be readily removed, remains in 
substantially the same condition as before, and can be reused. 
Removal of a Modular Partition System does not cause any substantial 
damage to the Modular Partition System itself or to the building. 
The Modular Partition System may be moved to accommodate the 
reconfigurations of the interior space within the office building 
for various tenants that occupy the building.
    (iv) The Conventional Partition System is comprised of walls 
that are integrated into an inherently permanent structure, and thus 
are listed as structural components in paragraph (d)(3)(ii) of this 
section. The Conventional Partition System, therefore, is real 
property.
    (v) The Modular Partition System is not integrated into the 
building and, therefore, is not listed in paragraph (d)(3)(ii) of 
this section. Thus, the Modular Partition System must be analyzed to 
determine whether it is a structural component using the factors 
provided in paragraph (d)(3)(iii) of this section. The Modular 
Partition System--
    (A) Is installed and removed quickly and with little expense;
    (B) Is designed to be moved and is not designed specifically for 
the particular building of which it is a part;
    (C) Is not damaged, and the building is not damaged, upon its 
removal;
    (D) Does not serve a utility-like function with respect to the 
building;
    (E) Serves the building in its passive functions of containing 
and protecting the tenants' assets;
    (F) Produces income only as consideration for the use or 
occupancy of space within the building;
    (G) Was not installed during construction of the building; and
    (H) Will not remain in place when a tenant vacates the premises.
    (vi) The factors described in this paragraph (g) Example 7 
(v)(A) through (D), (G) and (H) all support the conclusion that the 
Modular Partition System is not a structural component of REIT G's 
building within the meaning of paragraph (d)(3) of this section and, 
therefore, is not real property. The factors described in this 
paragraph (g) Example 7 (v)(E) and (F) would support a conclusion 
that the Modular Partition System is a structural component. These 
factors, however, do not outweigh the factors supporting the 
conclusion that the Modular Partition System is not a structural 
component.
    Example 8.  Solar energy site. (i) REIT H owns a solar energy 
site, among the components of which are land, photovoltaic modules 
(PV Modules), mounts and an exit wire. REIT H enters into a long-
term lease with a tenant for the solar energy site. REIT H neither 
operates the solar energy site nor provides services to its tenant. 
The mounts support the PV Modules. The racks are affixed to the land 
through foundations made from poured concrete. The mounts will 
remain in place when the tenant vacates the solar energy site. The 
PV Modules convert solar photons into electric energy (electricity). 
The exit wire is buried underground, is connected to equipment that 
is in turn connected to the PV Modules, and transmits the 
electricity produced by the PV Modules to an electrical power grid, 
through which the electricity is distributed for sale to third 
parties.
    (ii) REIT H's PV Modules, mounts, and exit wire are each 
separately identifiable items. Separation from a mount does not 
affect the ability of a PV Module to convert photons to electricity. 
Separation from the equipment to which it is attached does not 
affect the ability of the exit wire to transmit electricity to the 
electrical power grid. The types of PV Modules and exit wire that 
REIT H owns are each customarily sold or acquired as single units. 
Removal of the PV Modules from the mounts that support them does not 
damage the function of the mounts as support structures and removal 
is not costly. The PV Modules serve the active function of 
converting photons to electricity. Disconnecting the exit wire from 
the equipment to which it is attached does not damage the function 
of that equipment, and the disconnection is not costly. The PV 
Modules, mounts, and exit wire are each distinct assets within the 
meaning of paragraph (e) of this section.
    (iii) The land is real property as defined in paragraph (c) of 
this section.
    (iv) The mounts are designed and constructed to remain in place 
indefinitely, and they have a passive function of supporting the PV 
Modules. The mounts are not listed in paragraph (d)(2)(iii)(B) of 
this section, and, therefore, the mounts are assets that must be 
analyzed to determine whether they are inherently permanent 
structures using the factors provided in paragraph (d)(2)(iv) of 
this section. The mounts--
    (A) Are permanently affixed to the land through the concrete 
foundations or molded concrete anchors (which are part of the 
mounts);
    (B) Are not designed to be removed and are designed to remain in 
place indefinitely;
    (C) Would be damaged if removed;
    (D) Will remain affixed to the land after the tenant vacates the 
premises and will remain affixed to the land indefinitely; and

[[Page 59864]]

    (E) Would require significant time and expense to move.
    (v) The factors described in this paragraph (g) Example 8 
(iv)(A) through (E) all support the conclusion that the mounts are 
inherently permanent structures within the meaning of paragraph 
(d)(2) of this section and, therefore, are real property.
    (vi) The PV Modules convert solar photons into electricity that 
is transmitted through an electrical power grid for sale to third 
parties. The conversion is an active function. Thus, the PV Modules 
are items of machinery or equipment and therefore are not inherently 
permanent structures within the meaning of paragraph (d)(2) of this 
section and, so, are not real property. The PV Modules do not serve 
the mounts in their passive function of providing support; instead, 
the PV Modules produce electricity for sale to third parties, which 
is income other than consideration for the use or occupancy of 
space. Thus, the PV Modules are not structural components of REIT 
H's mounts within the meaning of paragraph (d)(3) of this section 
and, therefore, are not real property.
    (vii) The exit wire is buried under the ground and transmits the 
electricity produced by the PV Modules to the electrical power grid. 
The exit wire was installed during construction of the solar energy 
site and is designed to remain permanently in place. The exit wire 
is permanently affixed and is a transmission line, which is listed 
as an inherently permanent structure in paragraph (d)(2)(iii)(B) of 
this section. Therefore, the exit wire is real property.
    Example 9.  Solar-powered building. (i) REIT I owns a solar 
energy site similar to that described in Example 8, except that REIT 
I's solar energy site assets (Solar Energy Site Assets) are mounted 
on land adjacent to an office building owned by REIT I. REIT I 
leases the office building and the solar energy site to a single 
tenant. REIT I does not operate the office building or the solar 
energy site and does not provide services to its tenant. Although 
the tenant occasionally transfers excess electricity produced by the 
Solar Energy Site Assets to a utility company, the Solar Energy Site 
Assets are designed and intended to produce electricity only to 
serve the office building. The size and specifications of the Solar 
Energy Site Assets were designed to be appropriate to serve only the 
electricity needs of the office building. Although the Solar Energy 
Site Assets were not installed during construction of the office 
building, no facts indicate either that the Solar Energy Site Assets 
will not remain in place indefinitely or that they may be removed if 
the tenant vacates the premises.
    (ii) With the exception of the occasional transfers of excess 
electricity to a utility company, the Solar Energy Site Assets serve 
the office building to which they are adjacent, and, therefore, the 
Solar Energy Site Assets are analyzed to determine whether they are 
a structural component using the factors provided in paragraph 
(d)(3)(iii) of this section. The Solar Energy Site Assets--
    (A) Are expensive and time consuming to install and remove;
    (B) Were designed with the size and specifications needed to 
serve only the office building;
    (C) Will be damaged, but will not cause damage to the office 
building, upon removal;
    (D) Serve a utility-like function with respect to the office 
building;
    (E) Serve the office building in its passive functions of 
containing, sheltering, and protecting the tenant and the tenant's 
assets;
    (F) Produce income from consideration for the use or occupancy 
of space within the office building;
    (G) Were not installed during construction of the office 
building; and
    (H) Will remain in place when the tenant vacates the premises.
    (iii) The factors described in this paragraph (g) Example 9 
(ii)(A) through (C) (in part), (ii)(D) through (F), and (ii)(H) all 
support the conclusion that the Solar Energy Site Assets are a 
structural component of REIT I's office building within the meaning 
of paragraph (d)(3) of this section and, therefore, are real 
property. The factors described in this paragraph (g) Example 9 
(ii)(C) (in part) and (ii)(G) would support a conclusion that the 
Solar Energy Site Assets are not a structural component, but these 
factors do not outweigh the factors supporting the conclusion that 
the Solar Energy Site Assets are a structural component.
    (iv) The result in this Example 9 would not change if, instead 
of the Solar Energy Site Assets, solar shingles were used as the 
roof of REIT I's office building. Solar shingles are roofing 
shingles like those commonly used for residential housing, except 
that they contain built-in PV modules. The solar shingle 
installation was specifically designed and constructed to serve only 
the needs of REIT I's office building, and the solar shingles were 
installed as a structural component to provide solar energy to REIT 
I's office building (although REIT I's tenant occasionally transfers 
excess electricity produced by the solar shingles to a utility 
company). The analysis of the application of the factors provided in 
paragraph (d)(3)(ii) of this section would be similar to the 
analysis of the application of the factors to the Solar Energy Site 
Assets in this paragraph (g) Example 9 (ii) and (iii).
    Example 10. Pipeline transmission system. (i) REIT J owns a 
natural gas pipeline transmission system that provides a conduit to 
transport natural gas from unrelated third-party producers and 
gathering facilities to unrelated third-party distributors and end 
users. REIT J enters into a long-term lease with a tenant for the 
pipeline transmission system. REIT J neither operates the pipeline 
transmission system nor provides services to its tenant. The 
pipeline transmission system is comprised of underground pipelines, 
isolation valves and vents, pressure control and relief valves, 
meters, and compressors. Although the pipeline transmission system 
as a whole serves an active function (transporting natural gas), one 
or more distinct assets within the system may nevertheless be 
inherently permanent structures that do not themselves perform 
active functions. Each of these distinct assets was installed during 
construction of the pipeline transmission system and will remain in 
place when the tenant vacates the pipeline transmission system. Each 
of these assets was designed to remain permanently in place.
    (ii) The pipelines are permanently affixed and are listed as 
other inherently permanent structures in paragraph (d)(2)(iii)(B) of 
this section. Therefore, the pipelines are real property.
    (iii) Isolation valves and vents are placed at regular intervals 
along the pipelines to isolate and evacuate sections of the 
pipelines in case there is need for a shut-down or maintenance of 
the pipelines. Pressure control and relief valves are installed at 
regular intervals along the pipelines to provide overpressure 
protection. The isolation valves and vents and pressure control and 
relief valves are not listed in paragraph (d)(3)(ii) and, therefore, 
must be analyzed to determine whether they are structural components 
using the factors provided in paragraph (d)(3)(iii) of this section. 
The isolation valves and vents and pressure control and relief 
valves--
    (A) Are time consuming and expensive to install and remove from 
the pipelines;
    (B) Are designed specifically for the particular pipelines for 
which they are a part;
    (C) Will sustain damage and will damage the pipelines if 
removed;
    (D) Do not serve a utility-like function with respect to the 
pipelines;
    (E) Serve the pipelines in their passive function of providing a 
conduit for natural gas;
    (F) Produce income only from consideration for the use or 
occupancy of space within the pipelines;
    (G) Were installed during construction of the pipelines; and
    (H) Will remain in place when the tenant vacates the premises.
    (iv) The factors described in this paragraph (g) Example 10 
(iii)(A) through (C) and (iii)(E) through (H) support the conclusion 
that the isolation valves and vents and pressure control and relief 
valves are structural components of REIT J's tanks or pipelines 
within the meaning of paragraph (d)(3) of this section and, 
therefore, are real property. The factor described in this paragraph 
(g) Example 10 (iii)(D) would support a conclusion that the 
isolation valves and vents and pressure control and relief valves 
are not structural components, but this factor does not outweigh the 
factors that support the conclusion that the isolation valves and 
vents and pressure control and relief valves are structural 
components.
    (v) Meters are used to measure the natural gas passing into or 
out of the pipeline transmission system for purposes of determining 
the end users' consumption. Over long distances, pressure is lost 
due to friction in the pipeline transmission system. Compressors are 
required to add pressure to transport natural gas through the 
entirety of the pipeline transmission system. The meters and 
compressors do not serve the tanks or pipelines in their passive 
function of providing a conduit for the natural gas, and are used in 
connection with the production of income from the sale and 
transportation of natural gas, rather than as consideration for the 
use or occupancy of space within the pipelines. The meters and 
compressors are not structural components within the meaning of 
paragraph (d)(3) of this section and, therefore, are not real 
property.

[[Page 59865]]

    Example 11.  Above-market lease. REIT K acquires an office 
building from an unrelated third party subject to a long-term lease 
with a single tenant under which the tenant pays above-market rents. 
The above-market lease is an intangible asset under GAAP. Seventy 
percent of the value of the above-market lease asset is attributable 
to income from the long-term lease that qualifies as rents from real 
property, as defined in section 856(d)(1). The remaining thirty 
percent of the value of the above-market lease asset is attributable 
to income from the long-term lease that does not qualify as rents 
from real property. The portion of the value of the above-market 
lease asset that is attributable to rents from real property (here, 
seventy percent) derives its value from real property, is 
inseparable from that real property, does not produce or contribute 
to the production of income other than consideration for the use or 
occupancy of space, and, therefore, is an interest in real property 
under section 856(c)(5)(C) and a real estate asset under section 
856(c)(5)(B). The remaining portion of the above-market lease asset 
does not derive its value from real property and, therefore, is not 
a real estate asset.
    Example 12.  Land use permit. REIT L receives a special use 
permit from the government to place a cell tower on Federal 
Government land that abuts a federal highway. Government regulations 
provide that the permit is not a lease of the land, but is a permit 
to use the land for a cell tower. Under the permit, the government 
reserves the right to cancel the permit and compensate REIT L if the 
site is needed for a higher public purpose. REIT L leases space on 
the tower to various cell service providers. Each cell service 
provider installs its equipment on a designated space on REIT L's 
cell tower. The permit does not produce, or contribute to the 
production of, any income other than REIT L's receipt of payments 
from the cell service providers in consideration for their being 
allowed to use space on the tower. The permit is in the nature of a 
leasehold that allows REIT L to place a cell tower in a specific 
location on government land. Therefore, the permit is an interest in 
real property.
    Example 13.  License to operate a business. REIT M owns a 
building and receives a license from State to operate a casino in 
the building. The license applies only to REIT M's building and 
cannot be transferred to another location. REIT M's building is an 
inherently permanent structure under paragraph (d)(2)(i) of this 
section and, therefore, is real property. However, REIT M's license 
to operate a casino is not a right for the use, enjoyment, or 
occupation of REIT M's building but is rather a license to engage in 
the business of operating a casino in the building. Therefore, the 
casino license is not real property.
    (h) Effective/applicability date. The rules of this section apply 
for taxable years beginning after August 31, 2016. For purposes of 
applying the first sentence of the flush language of section 856(c)(4) 
to a quarter in a taxable year that begins after August 31, 2016, the 
rules of this section apply in determining whether the taxpayer met the 
requirements of section 856(c)(4) at the close of prior quarters. 
Taxpayers may rely on this section for quarters that end before the 
applicability date.

    Approved: August 8, 2016.
John Dalrymple,
Deputy Commissioner for Services and Enforcement.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2016-20987 Filed 8-30-16; 8:45 am]
 BILLING CODE 4830-01-P