Rev. Rul. 74-471

Advice has been requested (1) whether a trust will continue to qualify as a real estate investment trust under section 856 of the Internal Revenue Code of 1954 where the trustees of the trust delegate authority to a corporation to act as the trust's adviser under an advisory agreement and the shareholders of the trust have the right to terminate such advisory agreement and (2) whether, in such a case, the corporation's function as adviser to the trust will disqualify it as an independent contractor for purposes of section 856.

An unincorporated trust, otherwise qualifying as a real estate investment trust under section 856 of the Code, has a management agreement with a corporation under which the corporation, as an independent contractor, manages certain properties owned by the trust and is paid reasonable fees for its management services. The trust subsequently entered into an advisory agreement with the same corporation, under which the corporation, subject to the supervision of the trustees and as an agent and fiduciary of the trust, serves as the trust's investment adviser in connection with the investments of the trust and administers its day-to-day investment operations. In addition, the corporation will perform any other administrative functions necessary in the trust management that are agreed upon by the corporation and the trustees. The advisory agreement also provides for the compensation of the corporation for its advisory services.

The term of the advisory agreement is one year from its effective date. However, it may be extended from year to year by the affirmative vote of a majority of the trustees who are not shareholders, officers, directors, or employees of the corporation. The agreement may be terminated by the trust upon 60 days' notice either by a vote of the majority of trustees who are not shareholders, officers, directors, or employees of the corporation or by a vote of the holders of a majority of the outstanding shares of the trust.

The advisory agreement also provides that the services to be performed by the corporation under such agreement will be exclusive of the services to be performed by the corporation under the management agreement, and nothing in the agreement will relate in any way to the services performed by the corporation under the management agreement.

Section 856(a)(1) of the Code provides, in part, that the term real estate investment trust means an unincorporated trust or an unincorporated association which is managed by one or more trustees.

Section 1.856-1(d)(1) of the Income Tax Regulations provides, in part, that the term "trustee" means a person who has such rights and powers as will meet the requirement of "centralization of management" under section 301.7701-2(c) of the Procedure and Administration Regulations and that the trustee must have continuing exclusive authority over the management of the trust.

Rev. Rul. 72-254, 1972-1 C.B. 207, concludes that trustees have powers similar to those possessed by directors of a corporation and, since the board of directors of a corporation generally has the power to delegate discretionary authority to an agent, the trustees of a real estate investment trust possess the same power. Thus, the trust in that Revenue Ruling met the "centralization of management" and "continuing exclusive authority" requirements of section 1.856-1(d)(1) and section 301.7701-2(c) of the regulations. Accordingly, that Revenue Ruling holds that the trustees in delegating authority to the advisory company did not, in that case, violate the requirement of section 856(a)(1) of the Code that a real estate investment trust must be managed by one or more trustees.

Rev. Rul. 70-569, 1970-2 C.B. 147, holds, in part, that the right granted shareholders of a real estate investment trust to approve an increase in the trust's adviser's compensation does not violate the requirement of section 856(a)(1) of the Code that a real estate investment trust must be managed by one or more trustees.

In the instant case, only the trustees who are not shareholders, officers, directors, or employees of the corporation that is adviser to the trust may renew the advisory agreement, and the corporation is subject to the supervision of the trustees. The shareholders of the trust do not have the right to pass on the agreement or on any provision thereof but may at any time vote to terminate the agreement. Thus, the right of the shareholders of the trust to terminate the advisory agreement is similar to the right given the shareholders in Rev. Rul. 70-569 to approve an increase in the trust adviser's compensation.

The second question is whether the corporation's function as adviser to the trust will affect its status as an independent contractor. Under section 856(d)(3) of the Code "rents from real property" do not include amounts received with respect to real property managed for the trust by one other than an "independent contractor" from whom the trust itself does not derive or receive any income.

An independent contractor may not be an agent of or subject to control by the trust. See section 1.856-4(b)(3)(i)(b) of the regulations. The corporation as adviser is an agent subject to control by the trust and is also a trust fiduciary bound by the fiduciary duty of loyalty. Rosenfeld v. Black, 445 F. 2d 1337 (2nd Cir. 1971). The corporation's fiduciary position as adviser is inconsistent and in conflict with its purported status as an independent contractor dealing with the trust as an independent third party. Accordingly, it cannot be the independent contractor that Congress required in order "to draw a sharp line between passive investments and the active operation of business. . . ." H.R. Rep. No. 2020, 86th Cong., 2d Sess. (1960), 1960-2 C.B. 819, 821.

Consequently, in the instant case, it is held that neither the trustees' delegation of authority to the corporation to act as the trust's adviser under the advisory agreement nor the right of the shareholders of the trust to terminate the advisory agreement violates the requirement of section 856(a)(1) of the Code that a real estate investment trust be managed by one or more trustees.

It is further held that, for purposes of section 856 of the Code, the corporation's status as investment adviser and fiduciary to the trust under the advisory agreement disqualifies it as an independent contractor under the management agreement, and thus, rents received by the trust from the real properties managed by the corporation do not qualify as "rents from real property."