Real Estate Investment Trusts

March 13, 2024

7993 / How are the assets and income of a REIT classified if the REIT owns interests in a partnership?

<div class="Section1"> A REIT may own interests in a partnership and participate in that partnership as a partner much in the same way as any other taxpayer-entity. For purposes of the asset and income tests applicable to REITs, the REIT will be deemed to own its proportionate share of each of the underlying partnership assets. The characterization given to any partnership asset for partnership purposes is controlling in determining the character of the asset for purposes of applying the REIT asset tests (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7990">7990</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7992">7992</a>).<a href="#_ftn1" name="_ftnref1">1</a> Under the regulations, the REIT’s proportionate interest in a partnership is determined based upon its capital interest in the partnership. The IRS has found that, because a partner’s capital account typically reflects its net investment in the partnership, a REIT’s capital interest in a partnership is determined by dividing the REIT’s capital account balance by the sum of all of the partners’ capital account balances.<a href="#_ftn2" name="_ftnref2">2</a> For purposes of the income tests applicable to REITs, any income realized when a REIT-partner sells its interest in the partnership will be attributable to real property to the extent that the underlying assets of the partnership constitute real property.<a href="#_ftn3" name="_ftnref3">3</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. § 1.856-3(g). <a href="#_ftnref2" name="_ftn2">2</a>. See Let. Rul. 200310014. <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. § 1.856-3(g). </div></div>

March 13, 2024

7999 / What is a taxable REIT subsidiary (TRS)?

<div class="Section1"> A taxable REIT subsidiary (TRS) is a corporation in which the REIT owns interests, whether directly or indirectly, if both the REIT and the corporation agree to elect that the corporation will be treated as a TRS.<a href="#_ftn1" name="_ftnref1">1</a> A corporation will automatically become a TRS if another TRS owns either (a) securities representing 35 percent or more of the voting power of the corporation or (b) securities representing 35 percent or more of the total value of the corporation.<a href="#_ftn2" name="_ftnref2">2</a> Corporations that own or manage lodging or health care facilities cannot qualify as a TRS.<a href="#_ftn3" name="_ftnref3">3</a>Other than this limitation, a TRS is permitted to provide many of the services that a REIT might otherwise be restricted from providing because of the asset and income tests required to maintain REIT qualification. For example, a REIT that owned residential apartment buildings was permitted to use a TRS in order to provide housekeeping services to its tenants without risking disqualification. The services provided by the TRS did not cause the rental income received by the REIT to fail to qualify as income derived from real property even though the REIT itself would have been unable to provide the housekeeping services in question.<a href="#_ftn4" name="_ftnref4">4</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 856(l)(1). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 856(l)(2). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 856(l)(3). <a href="#_ftnref4" name="_ftn4">4</a>. Rev. Rul. 2002-38, 20026 IRB 4. </div></div>

March 13, 2024

7998 / What are the differences between publicly traded REITs, public unlisted REITs and private REITs?

<div class="Section1"> REITs, like any other corporate entity, can be listed or unlisted, publicly traded or private. Both publicly traded listed REITs and public unlisted REITs are required to file reports with the SEC, though, as the name suggests, only the shares of publicly traded listed REITs are actually traded on public stock exchanges. A publicly traded listed REIT may choose to list its shares on any national stock exchange, though most are listed on the NYSE.<a href="#_ftn1" name="_ftnref1">1</a> Both publicly traded listed and public unlisted REITs are subject to traditional corporate governance rules, including rules regarding the independence of directors. A publicly traded listed REIT must abide by the rules prescribed by the stock exchange on which it chooses to list shares, while public unlisted REITs are subject to the rules adopted by the North American Securities Administrators Association (NASAA), as well as any applicable state laws. Private REITs are not subject to any external corporate governance rules. Some smaller investors may find investing in publicly traded listed REITs more beneficial than investments in unlisted or private REITs. Because both public unlisted REITs and private REITs are not available for purchase on a stock exchange, their shares are typically much less liquid than those of a publicly traded REIT. Shares in REITs that are not publicly listed are typically subject to redemption rules that are set by the individual REIT, and often cannot be redeemed at the will of the investor. Further, information about the value of a publicly traded REIT’s shares is widely available, so smaller investors can make knowledgeable investment decisions based on historical performance and the investments underlying the individual REIT. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. See SEC Investor Bulletin: Real Estate Investment Trusts (REITs), available at http://www.sec.gov/investor/alerts/reits.pdf (last accessed July 19, 2023). </div></div>

March 13, 2024

7977 / How is a shareholder (or beneficiary) in a real estate investment trust taxed?

<div class="Section1"> A real estate investment trust (REIT) invests principally in real estate and mortgages. Shareholders (or holders of beneficial interests) in real estate investment trusts are taxed like shareholders in regular corporations ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7501">7501</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7540">7540</a>) unless the REIT distributes at least 90 percent of its real estate investment trust taxable income.<a href="#_ftn1" name="_ftnref1">1</a> If the required distribution is made, the taxation is similar to that of mutual fund shareholders. Ordinary income dividends. Under JGTRRA 2003, qualified dividend income is treated like net capital gain for most purposes (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="702">702</a>) and is, therefore, eligible for the 20 percent/15 percent/0 percent tax rates instead of the higher ordinary income tax rates. ATRA made these tax rates permanent for tax years beginning after 2012. Because REITs generally do not pay corporate income taxes, most ordinary income dividends paid by REITs do not constitute qualified dividend income, and, consequently, are not eligible for the 20 percent/15 percent/0 percent rates.<a href="#_ftn2" name="_ftnref2">2</a> However, a small portion of dividends paid by REITs may constitute qualified dividend income—for example, if the: (1) dividend is attributable to dividends received by the REIT from non-REIT corporations, such as taxable REIT subsidiaries; or (2) income was subject to tax by the REIT at the corporate level, such as built-in gains, or when a REIT distributes less than 100 percent of its taxable income. REITs that pass through dividend income to their shareholders must meet the holding period test (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="702">702</a>) in order for the dividend-paying stocks that they pay out to be reported as qualified dividends on Form 1099-DIV. Investors must also meet the holding period test relative to the shares they hold directly, from which they received the qualified dividends that were reported to them.<a href="#_ftn3" name="_ftnref3">3</a> Unless designated by the REIT as qualified dividend income, all distributions are ordinary income dividends.<a href="#_ftn4" name="_ftnref4">4</a> Ordinary income dividends are included in the shareholder’s (or beneficiary’s) income for the taxable year in which they are received. Shareholders do not include a share of a REIT’s investment expenses in income, nor with the shareholder’s miscellaneous itemized deductions, as is the case with certain other pass-through entities. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="733">733</a>. Capital gain dividends. Capital gain dividends are designated as such by the REIT in a written notice to the shareholder (beneficiary).<a href="#_ftn5" name="_ftnref5">5</a> The shareholder (beneficiary) reports capital gain dividends as long-term capital gain in the year received, regardless of how long the shareholder has owned an interest in the REIT.<a href="#_ftn6" name="_ftnref6">6</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="702">702</a> for the treatment of capital gains and losses, including the lower rates under JGTRRA 2003 (20 percent/15 percent/0 percent) for long-term capital gains incurred on or after May 6, 2003—now made permanent by ATRA—and the availability of the election to include net capital gain in investment income. If the total amount designated as a capital gain dividend for the taxable year exceeds the net capital gain for the year, the portion of each distribution that will be a capital gain dividend will be only that proportion of the amount so designated that such excess of the net long-term capital gain over the net short-term capital loss bears to the total amount designated as a capital gain dividend. For example, a REIT making its return on the calendar year basis advised its shareholders by written notice mailed December 30 that $200,000 of a distribution of $500,000 made December 15 constituted a capital gain dividend, amounting to $2 per share. It was later discovered that an error had been made in determining the net capital gain of the taxable year, which turned out to be $100,000 instead of $200,000. In such case, each shareholder would have received a capital gain dividend of $1 per share instead of $2 per share.<a href="#_ftn7" name="_ftnref7">7</a> Generally, ordinary income dividends and capital gain dividends declared for the prior REIT tax year are included in income by the shareholder in the year they are received.<a href="#_ftn8" name="_ftnref8">8</a> However, any dividend declared by a REIT in October, November, or December of any calendar year and payable to shareholders on a specified date in such a month is treated as received by the shareholder on December 31 of that calendar year so long as the dividend is actually paid during January of the following calendar year.<a href="#_ftn9" name="_ftnref9">9</a> A REIT may declare but retain a capital gain dividend. If it does so, the REIT must notify its shareholders of the amount of the undistributed dividend and, prior to 2018, pay federal income tax on the undistributed amount at the corporate alternative capital gains rate, which was 35 percent.<a href="#_ftn10" name="_ftnref10">10</a> The corporate AMT was eliminated for tax years beginning after 2017. A shareholder who is notified of an undistributed capital gain dividend is required to include the dividend in computing his or her long-term capital gains for the taxable year that includes the last day of the REIT’s taxable year. However, the shareholder is credited or allowed a refund for the share of the tax paid by the REIT on the undistributed amount; thus, on the shareholder’s income tax return he or she is treated as though the shareholder made an advance payment of tax equal to 21 percent (the rate was reduced from 35 percent to 21 percent for tax years beginning after 2017) of the amount of the undistributed dividend reported.<a href="#_ftn11" name="_ftnref11">11</a> The adjusted basis of a shareholder’s shares in a REIT is increased by the difference between the amount of the undistributed capital gain dividend and the tax deemed paid by the shareholder in respect of such shares.<a href="#_ftn12" name="_ftnref12">12</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 857(a). <a href="#_ftnref2" name="_ftn2">2</a>. See IRC § 857(c); see also National Association of Real Estate Investment Trusts, Policy Bulletin, (58003). <a href="#_ftnref3" name="_ftn3">3</a>. IRS News Release IR0042 (2-19004). <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. § 1.857-6(a). <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 857(b)(3)(B). <a href="#_ftnref6" name="_ftn6">6</a>. IRC § 857(b)(3)(A); Treas. Reg. § 1.857-6(b). <a href="#_ftnref7" name="_ftn7">7</a>. Treas. Reg. 1.857-6(e)(1)(i). <a href="#_ftnref8" name="_ftn8">8</a>. IRC § 858(b); Treas. Reg. § 1.858-1(c). <a href="#_ftnref9" name="_ftn9">9</a>. IRC § 857(b)(9). <a href="#_ftnref10" name="_ftn10">10</a>. IRC § 857(b)(3)(A), prior to amendment by Pub. Law No. 115-97. See IRC § 1201(a), prior to repeal. <a href="#_ftnref11" name="_ftn11">11</a>. IRC § 857(b)(3)(C). <a href="#_ftnref12" name="_ftn12">12</a>. IRC § 857(b)(3)(C)(iii). </div></div>

March 13, 2024

7978 / How are REIT stock dividends taxed?

<div class="Section1"> In a private letter ruling, the IRS concluded that shareholders who received all or part of a REIT’s special stock dividend would be treated as having received a distribution to which IRC Section 301 applies through the application of IRC Section 305(b)(1). The amount of the stock distribution would be equal to the value of the stock on the valuation date rather than on the date of the distribution. The special dividend qualifies for the dividends paid deduction under IRC Sections 561, 562 and 857 provided the REIT has sufficient earnings and profits.<a href="#_ftn1" name="_ftnref1">1</a> The Service determined in a private letter ruling that a distribution of earnings and profits from a newly established REIT (arising from earnings and profits accumulated during the pre-REIT years), in which shareholders could elect to receive cash, stock, or a combination of both, should be treated as a distribution of property to which IRC Section 301 applies.<a href="#_ftn2" name="_ftnref2">2</a> Temporary Guidance Regarding Certain Stock Distributions after 2009 and before 2013. Recognizing the difficulty faced by publicly traded REITs and mutual funds in preserving liquidity in a capital-constrained environment,<a href="#_ftn3" name="_ftnref3">3</a> the Service issued a revenue procedure providing temporary guidance concerning the tax treatment of REIT and mutual fund distributions when shareholders had the ability to elect to receive either cash or stock.<a href="#_ftn4" name="_ftnref4">4</a> (The guidance formalized the conclusion reached by the Service in several earlier private letter rulings.)<a href="#_ftn5" name="_ftnref5">5</a> The Service stated that it will treat a distribution of stock by either a publicly traded REIT or mutual fund as a distribution of property to which IRC Section 301 applies by reason of IRC Section 305(b). The amount of the stock distribution was considered to equal the amount of the money that could have been received instead if: (1) the distribution was made by the corporation to its shareholders with respect to its stock; (2) stock of the corporation was publicly traded on an established securities market in the United States; (3) the distribution was declared on or before December 31, 2012, with respect to a taxable year ending on or before December 31, 2011, whether declared and distributed prior to the close of the taxable year, or whether declared and distributed pursuant to provisions of IRC Sections 855, 852(b)(7), 868, 857(b)(9), or 860; (4) pursuant to such declaration, each shareholder could elect to receive his or her entire entitlement under the declaration in either money or stock of the distributing corporation of equivalent value subject to a limitation on the amount of money to be distributed in the aggregate to all shareholders (the “cash limitation”), provided that: (a) such cash limitation was not less than 10 percent of the aggregate declared distribution, and (b) if too many shareholders elected to receive money, each shareholder electing to receive money would receive a pro rata amount of money corresponding to his respective entitlement under the declaration, but in no event would any shareholder electing to receive money receive less than 10 percent of his entire entitlement under the declaration in money; (5) The calculation of the number of shares to be received by any shareholder would be determined, over a period of up to two weeks ending as close as practicable to the payment date, based upon a formula utilizing market prices that was designed to equate in value the number of shares to be received with the amount of money that could be received instead. For purposes of applying item (4), the value of the shares to be distributed was required to be determined by using the formula described in the preceding sentence; and (6) With respect to any shareholder participating in a dividend reinvestment plan (“DRIP”), the DRIP applied only to the extent that, in the absence of the DRIP, the shareholder would have received the distribution in money under item (4).<a href="#_ftn6" name="_ftnref6">6</a> Revenue Procedure 2010-12 is effective with respect to distributions declared on or after January 1, 2008 and before January 1, 2013. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. Let. Rul. 200122001. <a href="#_ftnref2" name="_ftn2">2</a>. Let. Rul. 200348020. <a href="#_ftnref3" name="_ftn3">3</a>. See National Association of Real Estate Investment Trusts (NAREIT), Letter to Eric Solomon, Assistant Secretary of Tax Policy, Department of the Treasury, October 31, 2008, at: http://www.reit.com. <a href="#_ftnref4" name="_ftn4">4</a>. Rev. Proc. 2009-15, 2009-4 IRB 356. <a href="#_ftnref5" name="_ftn5">5</a>. Let. Ruls. 200832009, 200817031, 200618009, 200615024, 200406031, and 200348020. <a href="#_ftnref6" name="_ftn6">6</a>. Rev. Proc. 2010-12, 2010-1 CB 302, amplifying and superseding Rev. Proc. 2009-15, 2009-1 CB 356, amplifying and superseding Rev. Proc. 2008-68, 2008-52 IRB 1373. </div></div>