The Good, the Bad, and the REIT

A portion of the take from a gambling casino won't hurt the tax-preferred status of a real estate trust, according to the IRS.

Contrary to popular belief, gambling can be good for your taxes. That’s so even if you manage a real estate investment trust that garners a percentage of its rent based on a casino’s winnings, the Internal Revenue recently found.

In terms of tax, a REIT’s income may be considered “bad” under rules governing the trusts contained in Sections 856 of the Internal Revenue Code. An overabundance of such income can cost a REIT its tax-favored status.

Bad REIT earnings tend to run afoul of Section 856, which provides that at least 95% of a REIT’s gross income must be derived from “rents from real property.” It also provides that at least 75% of its gross income must be derived from that source.

Under the code, rents from real property include:
•Rents from interests in real property.
•Charges for services customarily furnished or rendered in connection with the rental of real property.
•Rent attributable to personal property leased under, or in connection with, a lease of real property. That’s only the case, however, if the rent attributable to such personal property for the taxable year does not exceed 15% of the total rent for the taxable year attributable to both the real and personal property leased under, or in connection with, the lease.

In private letter ruling (LTR 201108009) issued February 25, the IRS considered the case of a certain REIT. The REIT owned a certain percentage of the outstanding units of a limited partnership we’ll call LP1. In turn, LP1 has a certain interest in another limited partnership, LP2, which owns and operates a shopping center.

LP2 is negotiating a grounds lease involving a certain amount of acres with a gaming entrepreneur we’ll call Lucre, who wants to build and operate a gambling facility on the property. Under the ground lease, Lucre will pay LP2 the sum of a minimum annual rental payment and a percentage rent.

The percentage rent consists of a certain piece of the annual gross revenues derived from retail sales and a certain portion of the annual gross revenues received from gaming revenues. The gaming revenues include amounts received by Lucre from patrons for video lottery terminal (VLT) gaming, less refunds, complimentary hotel rooms and meals, and amounts returned to patrons through winnings.

Section 856 provides that rents from real property do not exclude amounts ” based on a fixed percentage of “receipts or sales.” Revenue recognized and reported by a casino is generally defined as “the win” from gaming activities, not the amount wagered. The cost of providing promotional allowances is included in costs and expenses.

Thus, determining gross proceeds from the VLTs to include only that part of a wager that is not returned to patrons, exclusive of winnings and promotional allowances paid for by the casino to induce patrons to bet on the VLTs, is consistent with normal business practice in the gaming industry. It’s all to the good for the REIT, the IRS reasoned.

Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.

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