December 01, 2017 | By Keith Martin in Washington, DC

A solar incentive payment from a utility counts as good income for a real estate investment trust.

A REIT asked the IRS about such a payment. The REIT will share in the incentive payment as a partner in a partnership that owns a shopping center. The partnership plans to buy or lease a solar rooftop system to put on the roof.

The local municipal utility will make a one-time lump-sum payment to the partnership as a reward for installing solar. The amount of the payment is tied to the installed cost of the system or else calculated under a formula based on the expected output. If the output formula is used, then the payment amount is also affected by whether the partnership will keep the renewable energy credits to which it will be entitled for generating renewable energy or transfer them to the municipal utility. If it transfers them, then the incentive payment will be higher, but part of it will be considered purchase price for the future RECs.

REITs are corporations or trusts that do not have to pay income taxes on their earnings to the extent the earnings are distributed each year to shareholders. However, they must be careful to ensure their assets are largely real estate and their income is largely passive income from the use of real estate.

There is both a 95% and a 75% income test. At least 95% of the REIT’s gross income each year must come from dividends, interest, rents from real property, or gain from the sale of stock, securities and real property. At least 75% of gross income must come from rents from real property, interest on mortgages secured by real property or gain from sales of real property.

The REIT asked the IRS for a ruling that the base incentive payment — the amount it would receive if it kept the RECs — is good income. The IRS said yes.

The IRS said that even though solar incentive payments are not listed in its regulations as good income for the 95% and 75% income tests, the legislative history behind the REIT provisions in the US tax code indicates that the purpose of the gross income tests is to ensure that the REIT receives largely of passive income rather than income from the active conduct of a business. Treating the incentive payments as good income would “not interfere with or impede the objectives” of Congress in setting up the two gross income tests, the IRS said.

It made the statement in a private letter ruling made public in late October. The ruling is Private Letter Ruling 201742013.

REITs must also show that at least 75% of their assets are real property or interests in real property. Examples of such assets are land, site leases, buildings and mortgages secured by real property.

Solar advocates were disappointed with regulations the IRS issued in 2016 that said rooftop solar panels are normally considered equipment rather than real property. The IRS said the only circumstances where a solar rooftop system would qualify as a “structural component” of the building on which it sits is if it performs a utility-like function for the building, such as providing electricity to tenants. The electricity must be part of what the tenants receive for their rent for use of the space, the REIT must own or have the same legal interest in the solar equipment and the building, and the solar equipment must be expected to remain permanently in place.

The REIT in this latest case told the IRS the solar system qualifies as a good asset for the asset test. It did not ask for a ruling on that issue. (For a discussion about what solar equipment the IRS considers a good asset, see “Solar REITs” in the October 2016 NewsWire.)