Income from selling tax credits counted as good income for real estate investment trusts.

Two REITs are developing one or more mixed-use real estate projects on land that was contaminated by hazardous waste. The state where the projects are located offers tax credits that are a percentage of the amount spent on cleaning up the sites. The sites must be in economically distressed areas to qualify.

The tax credits can be sold to a corporation or non-profit entity for cash.

The tax credits in this case will be sold. The REITs will have to report the sales proceeds as income.

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 REITs asked the IRS for a ruling that the income from tax credit sales is good income. The IRS said yes.

The key, the IRS said, is the state tax credit program provides an incentive to redevelop real estate. Thus, the tax credits are an inducement to engage in a permissible activity for a REIT.

The analysis is in two identical private letter rulings made public at the end of January. The rulings are Private Letter Rulings 202005017 and 202005018.