Proposed IRS Regulations Would Qualify PV Modules as Real Property under REIT Rules in Certain Circumstances

by Wilson Sonsini Goodrich & Rosati

On May 9, 2014, the Internal Revenue Service (IRS) issued proposed regulations that clarify the definition of real property for purposes of the real estate investment trust (REIT) provisions of the Internal Revenue Code.

In order to qualify as a REIT, Section 856 of the code requires that at least 75 percent of the value of the REIT's total assets consist of real estate, cash and cash items, and government securities. For purposes of this rule, real estate includes "land or improvements thereon, such as buildings or other inherently permanent structures."

These proposed regulations were issued in order to address certain types of assets that had not been covered by prior guidance. One such asset is a "solar energy site," consisting of land, photovoltaic modules (PV modules), mounts, and exit wire. As described in further detail below—and with an important exception—the proposed regulations provide that PV modules are generally not real property for purposes of the REIT rules. As such, unless the PV modules are part of a solar energy site mounted on land adjacent to a commercial building and thus an inherently permanent structure, a taxpayer intending to qualify as a REIT will not be permitted to include the value of such PV modules (but may be permitted to include the value of land, mounts, and the exit wire).

Specifically, with respect to these solar energy sites, the proposed regulations include two examples that illustrate whether components of a solar energy site qualify as inherently permanent structures and, therefore, real property.

The first of these examples generally provides that each component of the solar energy site is a distinct asset that must be separately tested to determine whether it qualifies as an inherently permanent structure. With respect to each component, according to the proposed regulations: (i) the solar energy site land is real property; (ii) given that the PV modules perform an active function of converting solar photons into electricity and are items of machinery or equipment, they are not inherently permanent structures; (iii) given that the mounts are designed and constructed to remain permanently in place and that they have a passive function of supporting the PV modules, the mounts are inherently permanent structures; and (iv) given that the exit wire is buried underground and designed to remain permanently in place, it is an inherently permanent structure.

The second example relating to solar energy sites in the proposed regulations addresses the situation where a REIT owns both an office building and an adjacent solar energy site. This example generally provides that, if a solar energy site is mounted on land adjacent to an office building and the solar energy site is leased to the building's tenant, the solar energy site is considered a structural component of the office building. Factors provided for in the example that showed that the solar energy site is a structural component are that the solar energy site: (i) would be expensive and time consuming to install and remove; (ii) is designed specifically for the office building; (iii) would not cause damage to the building if removed (but would damage the mounts); (iv) serves a utility-like function for the office building; (v) produces income from consideration for the use of space within the office building; (vi) will remain in place when the tenant vacates; and (vii) is owned by the REIT. According to the proposed regulations, the solar energy site still would qualify as real property if solar shingles were used on the office building.

While this example may be somewhat fact specific, if these regulations are finalized as proposed, it makes it clear that certain solar facilities (including the PV modules) fit within the definition of real property for purposes of the REIT rules under certain circumstances.

Importantly, these proposed regulations do not address whether income derived from a solar energy site will satisfy the income test of the REIT rules, and by highlighting the fact that income from the PV module is "active," these proposed regulations may foreclose the possibility of counting income derived from the PV modules as REIT-qualifying income if the regulations are finalized as proposed.

These proposed regulations are intended to be effective for calendar quarters beginning after they are published as final regulations. The Internal Revenue Service has requested comments on the proposed regulations by August 12, 2014, and will hold public hearings on September 18, 2014.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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