IRS Rules that Developer Can Deduct Payments in Lieu of Taxes (PILOTs)

» Articles » Tax Articles » Article

August 18, 2009

Local governments frequently encourage economic development by acquiring property with public bonds, then leasing the property to real estate developers. Because the local government owns the property, it is exempt from real property taxes. The local government can preserve its tax base by requiring the real estate developer to make payments in lieu of taxes, called PILOTs, to the local government. What has not been clear is whether the federal income tax deduction for real property taxes applies to PILOTs. The analysis used by the IRS in a recent Private Letter Ruling holding that a real estate developer's PILOTs qualified as deductible real property taxes for federal income tax purposes, will provide useful guidance for real estate developers and their tax advisors facing this issue.

In PLR 200926023, dated March 25, 2009, the IRS considered a real estate developer's request for a ruling that the developer could deduct PILOTs to a local government as real property taxes. In this case, the real estate developer entered into a ground lease with the government agency that owned the property and built a condominium building. The lease required the developer to pay the government agency, as the landlord under the lease, an annual PILOT equal to the real estate taxes that would have been paid to the city where the property was located as if the property was not exempt from real estate taxes. Any late payment of the PILOT would bear interest at the same rate the city charged for late payment of taxes. In addition, as condominium units would be sold, PILOT payments would be included as part of each owner's common charges payable to the condominium board, which the board would remit to the landlord.

The IRS ruled that the PILOT qualified as a deductible real property tax because it satisfied a three-prong test set forth in a Revenue Ruling over 38 years old, that is Rev. Rul. 71-49, dated January 1, 1971, which provides that a PILOT will be treated as a real property tax if: 

  1. The payments are measured by and are equal to the amounts imposed by the regular taxing statutes;
  2. The payments are imposed by a specific state statute (even though the vehicle of a lease agreement is used); and
  3. The proceeds are designated for a public purpose rather than for some privilege, service, or regulatory function, or for some other local benefit tending to increase the value of the property upon which the payments are made.

The IRS also ruled that the condominium owners could deduct their respective shares of the PILOT payments included in their common charges.

Continue reading below

FREE Tax Training from Lorman

Lorman has over 37 years of professional training experience.
Join us for a special white paper and level up your Tax knowledge!

Miscellaneous 1099 Issues
Presented by Jennifer A. Driskill CPA, M.B.A.

Learn More

Although only the taxpayer receiving a Private Letter Ruling can rely on it, this IRS ruling provides valuable guidance to real estate developers and their advisors. Based on the reasoning used by the IRS in this ruling, developers should ensure that leases that include PILOTs calculate the PILOT based on the taxes that would be payable if the property was not exempt from real property taxes, that the PILOTs are required by a specific state statute, and that the proceeds from the PILOTs can only be used for public purposes.

Should you wish to discuss this federal tax development in more detail, please contact any one of the following attorneys in the Firm's Tax Department:

Atlanta, Georgia 
Nedom A. Haley  404.221.6505  [email protected] 
Michael M. Smith  404.589.3419  [email protected] 
Michael S. Evans  404.221.6517  [email protected] 

Birmingham, Alabama 
Thomas J. Mahoney Jr.  205.250.8346  [email protected] 
Robert T. Gardner  205.250.8373  [email protected] 
Vincent J. Schilleci  205.244.3827  [email protected] 

New Orleans, Louisiana 
Robert Nuzum  504.566.5209  [email protected] 

Baton Rouge, Louisiana 
Alton E. "Biff" Bayard III  225.381.7019  [email protected] 
Brandon A. Lagarde  225.381.7022  [email protected] 

Jackson, Mississippi 
James K. Dossett Jr.  601.351.2482  [email protected] 
Jon D. Seawright  601.351.8921  [email protected] 
David P. Webb  601.969.4678  [email protected] 

Memphis, Tennessee 
William H.D. Fones Jr.  901.577.2247  [email protected] 
Adam C. Flock  901.579.3125  [email protected] 

East Memphis, Tennessee 
James R. "Josh" Hall Jr.  901.579.3126  [email protected] 
Christopher J. Coats  901.579.3127  [email protected] 

Nashville, Tennessee 
Carolyn W. Schott  615.726.7312  [email protected] 
John B. Burns  615.726.5599  [email protected] 

Chattanooga, Tennessee 
Carl E. Hartley  423.756.2010  [email protected] 
Thomas A. Caldwell  423.209.4104  [email protected] 

Knoxville, Tennessee 
Angelia M. Nystrom  865.971.5170  [email protected] 

Washington, D.C. 
James W. McBride  202.508.3467  [email protected] 
Scott D. Smith  202.508.3430  [email protected] 

More Tax Articles

The material appearing in this web site is for informational purposes only and is not legal advice. Transmission of this information is not intended to create, and receipt does not constitute, an attorney-client relationship. The information provided herein is intended only as general information which may or may not reflect the most current developments. Although these materials may be prepared by professionals, they should not be used as a substitute for professional services. If legal or other professional advice is required, the services of a professional should be sought.

The opinions or viewpoints expressed herein do not necessarily reflect those of Lorman Education Services. All materials and content were prepared by persons and/or entities other than Lorman Education Services, and said other persons and/or entities are solely responsible for their content.

Any links to other web sites are not intended to be referrals or endorsements of these sites. The links provided are maintained by the respective organizations, and they are solely responsible for the content of their own sites.