IRS Issues PLR Clarifying Hedge Treatment for mREIT Gross Income Tests

Even though IRS Private Letter Rulings, or PLRs, only apply to the requesting taxpayer and cannot be cited as precedent, these rulings remain a key source of guidance for Real Estate Investment Trusts (REITs).

One such noteworthy ruling is PLR 202601013, which the IRS released on January 2, 2026. The PLR ruled that income from hedges and counteracting hedges is excluded from gross income for purposes of both the 75% and 95% gross income tests, provided neither the hedges nor the counteracting hedges will exceed notional principal amounts (“over-hedging”).

In plain terms, the ruling gives public and private REITs, particularly mortgage REITs (mREITs), more certainty. They can likely manage financial risk without being concerned that normal risk-management activity will accidentally jeopardize their REIT status.

Overview of the Transaction

An mREIT, which we’ll refer to as the taxpayer, primarily holds long-term, fixed-rate mortgage assets. To finance these assets, the taxpayer uses short-term sale-repurchase agreements (REPOs) that bear variable interest rates tied to the Secured Overnight Financing Rate (SOFR). The duration mismatch between the long-term mortgage assets and the short-term REPOs creates an interest rate risk for the taxpayer.

The taxpayer uses the following two methods to mitigate its risks:

1. Hedges: Interest rate swaps (swap hedges) and options for swaps (swaption hedges) where the taxpayer pays a fixed rate and receives a qualified floating rate.
2. Counteracting Hedges: Notional principal contracts or swaptions entered into to offset existing hedges when a full termination of the original hedge is commercially impractical due to high breakage costs.

IRS Analysis and Relevant Code Sections

This PLR issued rulings regarding the treatment of income from these transactions under the REIT gross income tests (the 95% test under IRC Section 856(c)(2) and the 75% test under Sec. 856(c)(3)):

• Treatment of Hedges: Income from hedges is excluded from gross income for purposes of both the 75% and 95% gross income tests pursuant to Sec. 856(c)(5)(G). This applies because the hedges manage interest rate risk on debt incurred to acquire real estate assets and are properly identified under Sec. 1221(a)(7).
• Treatment of Counteracting Hedges: Income from counteracting hedges is also excluded from gross income for the purpose of the 75% and 95% tests. This ruling is made pursuant to Sec. 856(c)(5)(J)(i), which allows the secretary to determine certain income items do not constitute gross income to carry out the purposes of the REIT tax provisions.

How This PLR Impacts Public and Private mREITs

This ruling is relevant to mREITs, whether publicly traded or privately held, that frequently manage the spread between fixed-rate mortgage yields and variable-rate borrowing costs. While the scope is limited to specific facts and representations provided by the taxpayer in this particular PLR, REITs with similar hedging structures should carefully evaluate their own identification procedures, hedging policies and the notional limits to ensure alignment with IRS expectations.

Contact Asha Shettigar, Pargat Singh or a member of your service team to discuss this topic further.

In this blog Cohen & Co is not rendering legal, accounting, investment, tax or other professional advice. Rather, the information contained in this blog is for general informational purposes only. Any decisions or actions based on the general information contained in this blog should be made or taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.