7996 / What is gross income of a REIT for purposes of the income qualification tests?

Gross income, for purposes of the REIT income qualification tests, is determined in the same manner as for any other entity under IRC Section 61.¹ Therefore, losses from the sale of stock, securities, real property, etc. do not impact the REIT’s gross income. However, the gross income from a REIT does not include amounts realized in a prohibited transaction, which, for REIT purposes, generally means income from the sale of property that has been held primarily for sale to customers in the ordinary course of business.²

However, the IRC now excepts certain types of sales from the prohibited transaction rules applicable to REITs, so that the term “prohibited transaction” does not include a sale of property which is a real estate asset if:

(i) the REIT has held the property for not less than two years;

(ii) aggregate expenditures made by the REIT, or any REIT partner, during the two-year period preceding the date of sale which are includible in the basis of the property do not exceed 30 percent of the net selling price of the property;

(iii) (I) during the taxable year the REIT does not make more than seven sales of property (other than sales of foreclosure property or sales to which Section 1033 applies), or (II) the aggregate adjusted bases (as determined for purposes of computing earnings and profits) of property (other than sales of foreclosure property or sales to which Section 1033 applies) sold during the taxable year does not exceed 10 percent of the aggregate bases (as so determined) of all of the assets of the REIT as of the beginning of the taxable year, or (III) the fair market value of property (other than sales of foreclosure property or sales to which Section 1033 applies) sold during the year does not exceed 10 percent of the fair market value of all of the assets of the REIT as of the beginning of the taxable year, or (IV) the REIT satisfies the requirements of (II), above, applied by substituting “20 percent” for “10 percent” and the three-year average adjusted bases percentage for the taxable year does not exceed 10 percent, or (V) the REIT satisfies the requirements of (III), above, applied by substituting “20 percent” for “10 percent” and the three-year average fair market value percentage for the taxable year does not exceed 10 percent; or

(iv) in the case of property that consists of land or improvements, but that is not acquired through foreclosure (or deed in lieu of foreclosure), or lease termination, the REIT has held the property for not less than two years for production of rental income.³

Income earned by qualified REIT subsidiaries that are wholly-owned by the REIT must be included in the REIT’s gross income.⁴

A REIT that owns interests in a partnership is also required to include in its gross income the share of partnership income that corresponds to its proportionate ownership share of the partnership’s assets.⁵ See Q 7993 for more information on the treatment of partnership interests in the REIT context.