Rev. Rul. 73-425

Advice has been requested whether, for the purposes of qualifying a trust as a real estate investment trust, certain properties, under the situations described below, are "real estate assets" within the meaning of section 856(c)(6)(B) of the Internal Revenue Code of 1954.

An unincorporated trust, otherwise qualifying as a real estate investment trust under section 856 of the Code, plans to invest in obligations secured by mortgages on real property, including total energy systems.

A total energy system is basically a self-contained facility for the production of all the electricity, steam or hot water, and refrigeration needs of associated commercial or industrial buildings, building complexes, shopping centers, apartment complexes, and community developments. The system may be permanently installed within the building, attached to the building, or it may be a separate structure nearby. The principal components consist of electric generators powered by turbines or reciprocating engines, waste heat boilers, heat exchangers, gas-fired boilers, and cooling units. In addition, each facility includes fuel storage tanks, control and sensor equipment, electrical substations, and air handling equipment for heat, hot water, and ventilation. It also includes ducts, piping, conduits, wiring, and other associated parts, machinery and equipment.

The question presented is whether the interest in mortgages acquired by the trust under the following situations qualify as "real estate assets" within the meaning of section 856(c)(6)(B) of the Code.

Situation 1. The trust made a loan for the purpose of constructing a total energy system which is permanently installed in the building which it serves. In return, the trust received an obligation secured by a mortgage covering the total energy system.

Situation 2. The facts are the same as in situation 1 except that the obligation received by the trust is secured by a mortgage covering not only the total energy system, but also the building served by the system. The terms of the mortgage interest in the facilities are the same as the terms of the mortgage interest in the building served by the total energy system.

Situation 3. The facts are the same as in situation 2 except that the total energy system is housed in a separate structure apart from the building which it serves.

Situation 4. A bank advanced permanent mortgage financing covering 80 percent of the cost of construction of a shopping center complex, including the total energy system. The bank received a mortgage covering the entire shopping center project, including the total energy system. The trust purchased an undivided 50 percent interest in the mortgage note held by the bank. The terms of the mortgage interest in the total energy system are the same in every respect as the terms of the mortgage interest in the buildings served by the total energy system.

Section 856(c) of the Code provides, in part, that for a trust to qualify as a real estate investment trust for Federal income tax purposes, a certain percentage of the trust's assets must be represented by specified items including "real estate assets."

Section 856(c)(6)(B) of the Code provides, in part, that the term "real estate assets" means real property (including interests in real property and interests in mortgage on real property).

Section 1.856-3(d) of the Income Tax Regulations provides that 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 of the Code, 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.

Section 1.856-3(d) contemplates that structural components will not be treated as real property unless they are included with land, buildings, or oher inherently permanent structures. Thus, a structural component is not considered real property for this purpose unless the interest held therein is included with an interest held in the building or inherently permanent structure to which the structural component is functionally related.

Accordingly, it is held in the situations described that: (1) the mortgage in situation 1 does not qualify as a real estate asset within the meaning of section 856(c)(6)(B) of the Code since the mortgage is secured only by the total energy system; (2) the mortgage in situations 2 and 3 qualify as real estate assets within the meaning of section 856(c)(6)(B) of the Code; and (3) as to the trust, the undivided 50 percent interest in the mortgage in situation 4 qualifies as a real estate asset within the meaning of section 856(c)(6)(B) of the Code.