INSIGHT: Floating Docks Found to Be ‘Real Estate Assets’

The IRS recently concluded in a private letter ruling that floating docks are real property for the purpose of qualifying as “real estate assets” held by a real estate investment trust.

The taxpayer, an indirect owner of interests in a company that held the floating docks, intended to be taxed as a REIT. The company, a partnership for federal tax purposes, owned and leased, or leased and subleased, properties located on inland lakes or on coasts.

The properties’ boat slips were bound by floating docks. The floating docks were affixed to the lake bed or sea bottom using either pilings or winches and cables. The floating docks provided a conduit or route for tenants to access their boat slips. The floating docks served no active function. The floating docks weighed hundreds of thousands to millions of pounds, and could not be towed on the water.

The floating docks affixed to pilings were “designed to remain in place indefinitely.” The company had never moved a floating dock. Removing a floating dock from its pilings would require total deconstruction of the floating dock. Under the winch and cable method of affixation, the floating docks were attached to the sea bed by a system of wire rope cables, concrete anchors, and winches. The floating docks affixed using the winch and cable method were also designed to remain in place indefinitely.

The properties also contained dry dock storage facilities, which the taxpayer represented were inherently permanent structures. A taxable REIT subsidiary (TRS) or an independent contractor would move the tenants’ boats into and out of the dry dock storage facilities. One of the properties also contained cabins used by guests for stays of less than one week. The taxpayer intended to have a TRS own the cabins and any areas reserved for cabin guests, and to have the company manage the cabins. The taxpayer represented that the income it received attributable to the cabins would be treated as “non-qualifying” income for purposes of tax code Section 856(c)(2) and (3).

Inherently Permanent Structures

Section 856(c)(4)(A) provides that, at the close of each quarter of its tax year, at least 75% of the value of a REIT’s total assets must be represented by real estate assets, cash, cash items, and government securities. Real estate assets means real property. Real property means land and improvements to land. Improvements to land means inherently permanent structures and their structural components. Inherently permanent structures means any permanently affixed building or other permanently affixed structure. Affixation may be by sheer weight alone.

The regulations provide that a “distinct asset” that “serves an active function,” such as an item of machinery or equipment, is not a building or other inherently permanent structure. The regulations provide a list of distinct assets that may qualify as inherently permanent structures if they are permanently affixed. Stationery wharves and docks (as opposed to floating docks) are included in the listing.

The regulations further provide facts and circumstances that must be considered in determining if a distinct asset that serves a passive function—and is not otherwise listed—is an inherently permanent structure. These factors include:

• the manner in which the distinct asset is affixed to real property,
• whether the distinct asset is designed to remain in place indefinitely,
• the damage that removal would cause, and
• the time and expense required to move the (unlisted) distinct asset.

Because only stationery wharves and docks are included in the list of inherently permanently structures under Treasury Regulations Section 1.856-10(d)(2)(iii)(B), floating docks that do not serve an active function must be analyzed based on all the facts and circumstances to determine if they are inherently permanent structures.

With regard to those floating docks affixed to pilings, the IRS determined they were designed to remain in place indefinitely. Removal would require total deconstruction of the floating docks as well as the destruction of the pilings, and moving a floating dock would be “time-consuming and more expensive than building a new one.” The floating docks, as indicated, served no active function. The agency concluded that the floating docks that were affixed using the piling method constituted inherently permanent structures and, therefore, real property and real estate assets for purposes of Section 856(c)(4). The taxpayer made similar representations with respect to the floating docks affixed to the sea bed by winch and cable technology. These, too, were found to be real estate assets.

Rents From Real Property

The taxpayer represented that its dry dock storage facilities were inherently permanent structures, and that it leased racking structure space in the facilities for a term with a minimum length not specified in the ruling. While the dry dock storage facilities did not allocate to a tenant a specifically identified spot in the racking structure, they did guarantee the tenant a specified amount of storage space in a facility for the dry dock storage of the tenant’s vessel. The service of moving boats into and out of the dry dock storage facilities was “customarily provided” to tenants of similar dry dock storage facilities in the geographic area in which the company operated and was, here, being provided by a TRS of the taxpayer or by an independent contractor from whom the taxpayer derived no income.

The IRS concluded that the amounts received for the use of racking structure space in dry dock storage facilities would not be considered as other than rents from real property (a form of qualifying income for a REIT) by reason of the storage leases’ failure to convey to tenants a right of entry or a right to use specifically enumerated space within the dry dock facilities.”

Lodging Facilities

Section 856(l)(3) provides that the term “taxable REIT subsidiary” or “TRS” shall not include any corporation that directly or indirectly manages a lodging facility. There is no prohibition against a TRS owning such a facility. The term “lodging facility” means a hotel, motel, or other establishment more than half of the dwelling units in which are used “on a transient basis.”

The cabins located at one of the properties were, admittedly, dwelling units used on a transient basis. Together with any areas reserved for cabin guests, they were “an establishment that is a lodging facility.” However, the IRS noted, the (mere) presence of the cabins at the property would not “taint” the other assets located there. The presence of the cabins, the agency ruled, would not cause the assets at the property, other than the cabins and any areas reserved for cabin guests, to be treated as lodging facilities for these purposes.

In short, the IRS reasoned, “the characterization of a separately identifiable item of property that is rented and used independently of the greater property on which the item of property is physically located should not dictate the characterization of the greater property.” Thus, here, the presence of the cabins would not deprive the TRS that owned (but did not manage) them of its status as such a TRS, and because the income derived from the leasing of the cabins was small in comparison to the remainder of the taxpayer’s income, the taxpayer would still be able to satisfy the REIT income tests, which require that a specified percentage of a REIT’s gross income be derived from, respectively, passive sources and real estate sources.

See PLR 201930003, Dec. 19, 2018, released July 26, 2019. (The IRS struggled with this ruling—it was not issued to the taxpayer until more than 13 months following the submission of the ruling request.)

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Robert Willens is president of the tax and consulting firm Robert Willens LLC in New York and an adjunct professor of finance at Columbia University Graduate School of Business.