7997 / What is the penalty if a REIT fails to satisfy the income tests?

If a REIT fails to meet either of the two income tests for any given tax year, and the failure is due to reasonable cause (rather than willful neglect),¹ the REIT will continue to qualify as a REIT for that year, but will be subject to an excise tax equal to 100 percent of the unqualified income. The tax is calculated by dividing 95 percent or 75 percent of the total gross income of the REIT (depending upon which test is failed) by the amount of REIT income that would qualify for the particular test.²

Once the REIT has determined that it has failed one or both of the income tests for the year, it is required to file a schedule describing each item of its gross income that would qualify for the failed test (or tests) in order to avoid disqualification.³

If the failure is due to willful neglect, the REIT will be disqualified and will be taxed as a regular corporation the tax year, and for four years following the year of disqualification.⁴

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1. IRC § 856(c)(6).