CO2 allowances and REITs

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Publication February 20, 2018

CO2 allowances that forestry companies receive for preserving trees are not “real property” for REIT purposes, the IRS said.

The IRS revoked a private letter ruling that said the opposite. It made the announcement in December in Private Letter Ruling 201751011. The revoked ruling is PLR 201123003.

The latest IRS action means that paper and timber companies organized as real estate investment trusts, or REITs, should not own such allowances directly. They should be held in a separate taxable REIT subsidiary.

A REIT is a corporation or trust whose units are publicly traded, but that is not subject to income taxes to the extent it distributes its income each year to its shareholders.

REITs must be careful to maintain the right asset and income mix. At least 75% of assets must be real estate, cash and government securities. At least 75% of annual income must be from real property, and at least 95% of income must be from real property plus dividends and interest.

The ruling dealt with a CO2 emissions trading program in a foreign country.

Trees capture carbon dioxide and later, when the trees are cut down, the CO2 is released.

Participation in the emissions trading program is mandatory for owners of older forests, but voluntary for owners of newer forests. Anyone participating receives one unit, or allowance, for each metric ton of CO2 captured by his trees. The units can be freely sold in the market. If the trees are later cut down, then the owner must turn in the number of units corresponding to the CO2 released. If he does not have enough, he must buy them on the open market. If the forest is sold, the units transfer with it.

The program operates in a way that discourages forestry companies from cutting down trees.

The IRS reached a number of complicated conclusions about the tax consequences of the program to forest owners in the latest ruling on the subject.

First, the units themselves are not real property, the IRS said. Thus, holding them directly in a REIT makes it harder to maintain REIT status.

Second, the market value must be reported as income upon receipt. The IRS said the units are the equivalent of a payment for selling the government an easement over the forest. It is as if the owner sold an easement and the units are compensation.

However, since the units themselves are not real property, the income from any later sale of them is not income from real property.


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