IRS Partially Revokes Penn Gaming’s Casino REIT Ruling

By Stuart E. Leblang, Michael J. Kliegman, and Amy S. Elliott

In a private letter ruling (PLR) released in redacted form February 4, 2022 (but issued to the impacted taxpayer on November 4, 2021), ¹ the Internal Revenue Service (IRS) disclosed that it had reversed part of a PLR it issued back in 2013.  The 2013 PLR contained 50 separate rulings.  The IRS has now decided to revoke part of one of those rulings as it is “not in accord with the current views” of the agency. ² Specifically, the IRS determined that a portion of the lease payments described in the original ruling should not constitute qualifying rents from real property under the real estate investment trust (REIT) tax rules.

More details follow below, but in general, we do not think the revocation reflects a change in IRS policy, but more likely, the correction of what was an oversight in the original PLR.  Further, as best we can glean from public documents, we do not think that the problematic lease provision was widespread either among casino REITs or REITs across other industries but merely reflected an aberration.

Although the partial revocation is notable (such revocations are generally few and far between), we suspect its impact will most likely be limited to the requesting taxpayer (casino operator Penn National Gaming, Inc. (NASDAQ:  PENN) (Penn Gaming)) and its related REIT (Gaming and Leisure Properties, Inc. (NASDAQ:  GLPI) (GLPI)). ³ At the same time, the ruling provides generous limitations on retroactivity, effectively allowing the companies to avoid the impact of the revocation for as long as the subject leases remain in effect and largely unmodified.

Articles in the tax press on the development circulated widely with headlines such as “REITs Checking Their Leases in Wake of Ruling Revocation” ⁴ and “Is GLPI's REIT Status in Peril?”—the latter of which ended with the sobering prediction that REITs that drafted their lease provisions in a similar fashion (and that inherently do not have the benefit of the transition relief afford to GLPI) “might be in imminent danger of losing their coveted REIT status.” ⁵ We would be surprised if there were many other REITs with similar provisions in their leases, and we therefore think such dire warnings were mere speculation. ⁶ 

The Aberrational Lease Terms

A key requirement (there are many) for a corporation to qualify as a REIT is that at least 75 percent of its gross income must qualify as “rents from real property.”⁷  Regulations provide that rent payments that are determined by reference to income or profits generally do not qualify as rents from real property (details are fleshed out as to what this means). ⁸ The problematic lease payments in the 2013 PLR were calculated based off of the lessee’s “Adjusted Revenue” (defined in the lease generally as gaming revenues plus retail sales minus expenses other than interest, tax, depreciation, amortization and rent).⁹ While the regulations permit lease payments calculated based on underlying receipts or sales to qualify as rents from real property, those calculated based net of expenses cannot.¹⁰

So why did the IRS sign off on the problematic portion of the ruling in 2013? It is possible that it had not realized a portion of the lease payments were not tied to gross revenues but amounts after subtracting for expenses.  “Adjusted Revenue” does not appear to be a defined term in the 2013 PLR as redacted and released to the public—only “Net Revenues,” which does not take into account the reduction for expenses.

The original PLR¹¹(released Sept. 13, 2013, but issued September 28, 2012) involved casino operator Penn Gaming and the to-be-formed GLPI REIT.¹²The PLR was viewed as groundbreaking because it resulted in the first casino REIT utilizing the so-called OpCo-PropCo structure (where Penn Gaming was the OpCo and GLPI was the PropCo) created by way of a tax-free Internal Revenue Code (IRC) Section 355 spin-off.

Most of the 50 rulings in the original PLR had to do with the spin-off separation and distribution.  The spin-off then enabled OpCo to enter into a lease with PropCo (effectively allowing the rental income stream to avoid being subject to corporate tax—at least to the extent that it qualified as good REIT income).  “Rents from real property” is a type of good REIT income, and that is what the partially revoked ruling involved (it was in the “Other Rulings” section of the PLR).

According to the new ruling and a review of GLPI’s securities filings, the lease in question (the “Master Lease”) generally provided that the rent amount would be comprised of two parts:  the “Base Rent” and the “Percentage Rent.” However, both the “Base Rent” and the “Percentage Rent” are subject to adjustments, some of which take into account “Adjusted Revenue” (which the IRS has now flagged as problematic).  These adjustments are called the “Escalation and the Other Adjustments.”

The partial revocation of the ruling means that while the unadjusted “Percentage Rent” payments would still be treated as good REIT income (rents from real property), any modifications to rent amounts made pursuant to the “Escalation and the Other Adjustments” provisions will result in payments that will not constitute rents from real property—at least on a going forward basis and subject to the transition and grandfather rules below.

Limited Impact

If this partially revoked ruling means that the some portion of the rent paid by Penn Gaming to GLPI is no longer qualifying, then it could theoretically threaten GLPI’s REIT status.  However, we do not think this is a likely outcome.

To start, the IRS granted extremely generous relief to GLPI, providing that the agency will not apply the partial revocation of the ruling on a retroactive basis, but only prospectively and only unless and until an impacted lease is amended or modified in a very particular way.  This greatly limits the negative impact to GLPI.

Note that while the ruling at issue in the 2013 PLR only applied to one particular lease—the “Master Lease” presumably between Penn Gaming and GLPI—the 2022 PLR that provided for the ruling’s partial revocation contains transition rules that extend relief not just to the “Master Lease” but also to several other leases (together, the “Subject Leases”) presumably between Penn Gaming, GLPI and each of their affiliates.  The transition relief/grandfathering described above applies to all of the Subject Leases entered into before the IRS decided that it was going to reconsider the ruling (at which time the IRS gave authorized representatives of Penn Gaming and GLPI a heads up about its change in thinking prior to issuing the new ruling).

But since GLPI spun off from Penn Gaming, it has acquired gaming assets from other casinos and has entered into OpCo/PropCo leases with other operators including Caesars Entertainment, Inc. (NASDAQ:  CZR) (Caesars), Boyd Gaming Corporation (NYSE:  BYD) and Bally’s Corporation (NYSE:  BALY)—taxpayers not identified in the 2022 ruling.  It may be the case that some of those leases had similarly problematic terms, which may explain why, for example, on June 14, 2020, GLPI amended its master lease with Caesars to, among other things, “remove the variable rent component in its entirety” and “provide fixed escalation percentages.”¹³ Because GLPI’s leases with operators not affiliated with Penn Gaming would not seem to benefit from the relief provided for in the 2022 ruling, we expect that GLPI has since modified its non-Penn Gaming leases to eliminate or revise the definition of “Adjusted Revenue.”

We have scoured the public filings of REITs to see if we can find any indication that similar lease terms exist in the market to no avail.  REIT tax practitioners to whom we have spoken think that the problematic lease terms highlighted by the partial revocation are uncommon.  What is common is for leases involving REITs to contain provisions clearly stating that the parties intend for the rent and other amounts paid by the tenant pursuant to the lease to qualify as rents from real property within the meaning of Section 856(d).  If any amounts fail to qualify as such, leases generally state that the parties agree to cooperate to amend the lease to remedy the failure.¹⁴ 

Context for Ruling Revocations

As previously mentioned, ruling revocations are uncommon.  Of the approximately 285 PLRs dated (not numbered) in 2021 and released to-date, there were only about three ruling modifications (one of which was the partial revocation REIT ruling).

Pursuant to IRC Section 7805(b) and regulations thereunder, a ruling may be revoked by the IRS.  Revenue Procedure 2022-1 ¹⁵ describes procedures for revoking private letter rulings.  Among other things, the revenue procedure states that a ruling “found to be in error or not in accord with the current views of the [IRS] may be revoked or modified.” The revocation may be retroactive to all open years, but the revocation will ordinarily not be retroactive where all relevant facts were disclosed, the taxpayer relied on the PLR in good faith and there was not a change in law requiring the revocation.

What of any other REITs that may have similar provisions in their lease agreements? As noted above, we think this provision was more aberrational, but may not be unique.  Other REITs without PLRs approving such a provision are technically exposed to the IRS disqualifying REIT status for open years.  We think this is generally unlikely, if only because—while certainly not lax in trying to ensure full compliance with the REIT rules—the IRS is not generally in the business of disqualifying publicly traded REITs that may inadvertently fall short of REIT asset or income tests (in fact, the IRS generally offers relief to REITs that may have failed such tests by reason of a mere foot-fault and not willful neglect).

^{[1] LTR 202205001}

^{[2] The IRS may have flagged the error in connection with a regulatory project to clarify the definition of good REIT income. In 2016, Treasury and the IRS released final REIT regulations addressing which assets are qualifying for purposes of the REIT asset tests. In connection, the IRS partially revoked at least one PLR (see LTR 201123003, which was modified by LTR 201751011).}

^{[3] Penn Gaming disclosed that it received a PLR from the IRS dated Sept. 28, 2012, and the facts match.}

^{[4] Chandra Wallace, REITs Checking Their Leases in Wake of Ruling Revocation, Tax Notes, Feb. 14, 2022 (subscription required).}

^{[5] Robert Willens, Is GLPI's REIT Status in Peril?, 38 Tax Mgmt. Real. Est. J. No. 2 (Feb. 16, 2022).}

^{[6] As a reminder, PLRs may not be relied upon as precedent by any taxpayer other than the one to whom it was issued. Nevertheless, it is common for the tax bar to take comfort from PLRs issued to other taxpayers as they navigate how the tax rules would apply to similar transactions.}

^{[7] IRC §856(c)(3).}

^{[8] Treas. Reg. §1.856-4(b)(3).}

^{[9] For the Master Lease, dated as of November 1, 2013, among GLP Capital, L.P. and Penn Tenant, LLC, see:  https://www.sec.gov/Archives/edgar/data/1575965/000110465913082396/a13-23794_2ex10d1.htm; In that lease, Adjusted Revenue is generally defined as:  “. . . Net Revenue (i) minus expenses other than Specified Expenses and (ii) plus Specified Proceeds, if any; provided, however, that for purposes of calculating Adjusted Revenue, Net Revenue shall not include Gaming Revenues, Retail Sales or Promotional Allowances of any subtenants of Tenant or any deemed payments under subleases of this Master Lease, licenses or other access rights from Tenant to its operating subsidiaries . . .” And Specified Expenses is generally defined as:  “. . . (i) Rent incurred for the same Test Period, and (ii) the (1) income tax expense, (2) consolidated interest expense, (3) depreciation and amortization expense, (4) any nonrecurring, unusual, or extraordinary items of income, cost or expense . . . (5) any non-cash items of expense . . . (6) any Pre-Opening Expenses, (7) transaction costs for the spin-off of GLP, the entry into this Master Lease, the negotiation and consummation of the financing transactions in connection therewith and the other transactions contemplated in connection with the foregoing consummated on or before the date hereof, (8) non-cash valuation adjustments, (9) any expenses related to the repurchase of stock options, and (10) expenses related to the grant of stock options, restricted stock, or other equivalent or similar instruments . . .”}

^{[10] Note, however, that GLPI regularly discloses that it does “not anticipate receiving rent that is based in whole or in part on the income or profits of any person (except by reason of being based on a fixed percentage or percentages of gross receipts or sales consistent with the rules described above).” (GLPI’s Form 10-K filed Feb. 24, 2022:  https://www.sec.gov/ix?doc=/Archives/edgar/data/1575965/000157596522000005/glpi-20211231.htm).}

^{[11] LTR 201337007}

^{[12] Penn Gaming disclosed that it received a PLR from the IRS dated Sept. 28, 2012 and the facts match.}

^{[13] GLPI, Form 10-K, filed Feb. 19, 2021
(https://www.sec.gov/ix?doc=/Archives/edgar/data/1575965/000157596521000008/glpi-20201231.htm).}

^{[14] See, for example, https://www.sec.gov/Archives/edgar/data/0000911147/000091114719000065/cnty-20191211xex10_1.htm}

^{[15] The IRS issues a revenue procedure at the beginning of each year laying out procedures for requesting and issuing PLRs. The revocation guidelines are set forth in Section 11 of that revenue procedure. See also relevant provisions in the Internal Revenue Manual, IRM 32.3.2.3.5.2 (07-09-2014).}