Mutual Funds Uni Trusts Reits

<div class="Section1"><br /> <p>Under the passive loss rules, aggregate losses from "passive" activities (see <a href="javascript:void(0)" class="accordion-cross-reference" id="8011">Q 8011</a>) may generally be deducted in a year only to the extent they do not exceed aggregate income from passive activities in that year; credits from passive activities may be taken against tax liability allocated only to passive activities.<a href="#_ftn1" name="_ftnref1">¹</a> (Aggregation is not permitted in the case of certain publicly traded partnerships. See below.) The rules generally apply to losses incurred in tax years beginning after 1986. The rules are intended to prevent losses from passive activities from offsetting salaries, interest, dividends, and income from "active" businesses. They apply to individuals, estates, trusts, closely held C corporations, and personal service corporations.</p><br /> <p>An <em>individual</em> can also deduct a limited amount of losses (and the deduction-equivalent of credits) arising from certain rental real estate activities against nonpassive income. See <a href="javascript:void(0)" class="accordion-cross-reference" id="8021">Q 8021</a>. A <em>closely held C corporation</em> (other than a personal service corporation) can deduct its passive activity losses against its net active income (other than its investment, or "portfolio," income) and its passive credits can be applied against its tax liability attributable to its net active income.<a href="#_ftn2" name="_ftnref2">²</a> Generally, a corporation is "closely" held if five or fewer individuals own more than 50 percent of the value of the stock.<a href="#_ftn3" name="_ftnref3">³</a> (For these purposes, certain organizations—including a qualified retirement plan under IRC Section 401(a) and a trust providing for the payment of supplemental unemployment compensation benefits under IRC Section 501(c)(17)—are considered an "individual.")<a href="#_ftn4" name="_ftnref4">⁴</a> A personal service corporation is a corporation the principal activity of which is the performance of personal services and the services of which are substantially performed by employee-owners.<a href="#_ftn5" name="_ftnref5">⁵</a></p><br /> <p>An exception to the passive loss restrictions is applied to certain casualty losses resulting from unusual events such as fire, storm, shipwreck, and earthquake. Losses from such casualties are generally not subject to the passive loss rules.<a href="#_ftn6" name="_ftnref6">⁶</a> Likewise, passive activity income does not include reimbursements for such losses if (1) the reimbursement is includable in gross income under Treasury Regulation Section 1.165-1(d)(2)(iii) as an amount the taxpayer had deducted in a prior taxable year, and (2) the deduction for the loss was not a passive activity deduction. In other words, both the losses and the reimbursement should be taken into account in the calculation of the partnership's gross income, not its passive activity gross income.<a href="#_ftn7" name="_ftnref7">⁷</a> The exception does not apply to losses that occur regularly in the conduct of the activity, such as theft losses from shoplifting in a retail store, or accident losses sustained in the operation of a rental car business.<a href="#_ftn8" name="_ftnref8">⁸</a></p><br /> <p>Special restrictions apply to <em>publicly traded partnerships</em> under the passive loss rules. The rules are applied separately to items attributable to a publicly traded partnership; thus, income, losses, and credits attributable to the partnership may not be aggregated with other income, losses, and credits of the taxpayer/partner for purposes of the passive loss rules.<a href="#_ftn9" name="_ftnref9">⁹</a> Net passive loss from a publicly traded partnership will be treated as passive, while net passive income from a publicly traded partnership is to be treated as investment income. See <a href="javascript:void(0)" class="accordion-cross-reference" id="8040">Q 8040</a>.<a href="#_ftn10" name="_ftnref10">¹⁰</a> Generally, net passive loss from a publicly traded partnership is carried forward until the partner has additional passive income from the partnership or the partner disposes of the partnership interest. See <a href="javascript:void(0)" class="accordion-cross-reference" id="8019">Q 8019</a>.Also, the $25,000 rental real estate exemption (see <a href="https://prod-taxfacts-alm.content.pugpig.com/faqs_page/limitation-on-loss-deductions/pugpig_index.html#faq-8021">Q 8021</a>) is available with respect to a publicly traded partnership only in connection with the low-income housing credit (see <a href="javascript:void(0)" class="accordion-cross-reference" id="7808">Q 7808</a>) and the rehabilitation investment credit. See <a href="https://prod-taxfacts-alm.content.pugpig.com/faqs_page/real-estate/pugpig_index.html#faq-7808">Q 7808</a>.Furthermore, a taxpayer will not be treated as having disposed of the taxpayer's entire interest in an activity of a publicly-traded partnership until disposition of the entire interest in the partnership. A publicly traded partnership is a partnership that is traded on an established securities market or is readily tradable on a secondary market (or the substantial equivalent thereof).<a href="#_ftn11" name="_ftnref11">¹¹</a> It would seem that if a publicly traded partnership is taxed as a closely held C corporation or any personal service corporation (see ), the partnership is not a taxpayer subject to the passive loss rules.<a href="#_ftn12" name="_ftnref12">¹²</a></p><br /> <p>Losses and credits disallowed under the passive loss rules may be carried over to offset passive income and the tax attributable to it in later years. See <a href="javascript:void(0)" class="accordion-cross-reference" id="8019">Q 8019</a>. Suspended losses and credits of an activity may also offset the income and tax of that activity when the activity ceases to be passive or there is a change in status of a closely held corporation or personal service corporation. See <a href="javascript:void(0)" class="accordion-cross-reference" id="8020">Q 8020</a>.As to losses allowed upon disposition of an interest in a passive activity, see <a href="https://prod-taxfacts-alm.content.pugpig.com/faqs_page/limitation-on-loss-deductions/pugpig_index.html#faq-8019">Q 8019</a>.</p><br /> <p>The passive loss rules apply to passive losses incurred in tax years beginning after 1986. They do not apply to any loss or credit carried over from a year beginning before 1987.<a href="#_ftn13" name="_ftnref13">¹³</a> A taxpayer may elect to treat investment interest (see <a href="javascript:void(0)" class="accordion-cross-reference" id="8040">Q 8040</a>) as a passive activity deduction if the interest was carried over from a year prior to 1987 and is attributable to property used in a passive activity after 1986.<a href="#_ftn14" name="_ftnref14">¹⁴</a> However, the interest deduction is not treated as being from a pre-enactment interest in a passive activity.<a href="#_ftn15" name="_ftnref15">¹⁵</a> This election had to be made by filing an amended return on or before the later of (1) the due date (taking into account any extensions of time to file obtained by the taxpayer) for filing the income tax return of the taxpayer for the taxpayer's first taxable year beginning after December 31, 1987, or (2) August 15, 1989.<a href="#_ftn16" name="_ftnref16">¹⁶</a></p><br /> </div><br /> <div class="refs"><br /> <hr align="left" size="1" width="33%"><br /> <p><a href="#_ftnref1" name="_ftn1">1</a>. IRC § 469.</p><br /> <p><a href="#_ftnref2" name="_ftn2">2</a>. IRC § 469(e)(2).</p><br /> <p><a href="#_ftnref3" name="_ftn3">3</a>. IRC § 469(j)(1).</p><br /> <p><a href="#_ftnref4" name="_ftn4">4</a>. IRC § 542(a)(2).</p><br /> <p><a href="#_ftnref5" name="_ftn5">5</a>. IRC § 469(j)(2).</p><br /> <p><a href="#_ftnref6" name="_ftn6">6</a>. Temp. Treas. Reg. § 1.469T(d)(2), Treas. Reg. § 1.469(d)(2)(xi).</p><br /> <p><a href="#_ftnref7" name="_ftn7">7</a>. Temp. Treas. Reg. § 1.469T(c)(7), Treas. Reg. § 1.469(c)(7)(vi).</p><br /> <p><a href="#_ftnref8" name="_ftn8">8</a>. TD 8290, 1990-1 CB 109.</p><br /> <p><a href="#_ftnref9" name="_ftn9">9</a>. IRC § 469(k)(1).</p><br /> <p><a href="#_ftnref10" name="_ftn10">10</a>. Notice 88-75, 1988 CB 386.</p><br /> <p><a href="#_ftnref11" name="_ftn11">11</a>. IRC § 469(k).</p><br /> <p><a href="#_ftnref12" name="_ftn12">12</a>. See IRC § 469(a).</p><br /> <p><a href="#_ftnref13" name="_ftn13">13</a>. TRA '86 § 501(c)(2).</p><br /> <p><a href="#_ftnref14" name="_ftn14">14</a>. TAMRA '88 § 1005(c)(11).</p><br /> <p><a href="#_ftnref15" name="_ftn15">15</a>. Notice 89-36, 1989-1 CB 677.</p><br /> <p><a href="#_ftnref16" name="_ftn16">16</a>. TAMRA '88 § 1005(c)(11; Notice 89-36, 1989-1 CB 6771.</p><br /> </div>

<div class="Section1"><br /> <p>The "at risk" rules apply to each of the following activities when engaged in by an individual (including partners and S corporation shareholders) as a trade or business or for the production of income:</p><br /> <p>…holding, producing, or distributing motion picture films or video tapes;</p><br /> <p>…farming (including raising, shearing, feeding, caring for, training, or management of animals);</p><br /> <p>…leasing of depreciable personal property (and certain other "IRC Section 1245" property, which includes both real and personal property and certain other tangible property that is being, or has been depreciated or amortized<a href="#_ftn1" name="_ftnref1">¹</a>);</p><br /> <p>…exploring for, or exploiting, oil and gas reserves (see <a class="accordion-cross-reference" href="https://www.thinkadvisor.com/tax-facts/2024/03/13/7857-how-do-individuals-invest-in-oil-and-natural-gas/">Q 7857</a> to <a class="accordion-cross-reference" href="https://www.thinkadvisor.com/tax-facts/2024/03/13/7887-what-items-of-tax-preference-for-purposes-of-the-alternative-minimum-tax-are-unique-to-an-oil-and-gas-program/">Q 7887</a>);</p><br /> <p>…exploring, or exploiting, geothermal deposits;</p><br /> <p>…holding real property (see <a class="accordion-cross-reference" href="https://www.thinkadvisor.com/tax-facts/2024/03/13/7792-does-the-at-risk-limitation-on-losses-apply-to-an-investor-in-real-estate-if-so-what-effect-will-it-have/">Q 7792</a> for effective date and transitional relief rules);</p><br /> <p>…all other activities engaged in by a taxpayer in carrying on a trade or business or for the production of income.<a href="#_ftn2" name="_ftnref2">²</a></p><br /> <p>Apparently, if a publicly traded partnership is taxed as a corporation (see ), the partnership is not subject to the at risk rules unless it is closely-held (generally, more than 50 percent control by five or fewer individuals).<a href="#_ftn3" name="_ftnref3">³</a> For these purposes, a qualified retirement plan described in IRC Section 401(a) as well as a plan providing for the payment of unemployment compensation benefits under IRC Section 501(c)(17) are considered individuals.<a href="#_ftn4" name="_ftnref4">⁴</a></p><br /> </div><br /> <div class="refs"><br /> <hr align="left" size="1" width="33%"><br /> <p><a href="#_ftnref1" name="_ftn1">1</a>. IRS Publication 925, Passive Activity and At-Risk Rules.</p><br /> <p><a href="#_ftnref2" name="_ftn2">2</a>. IRC §§ 465(c), 464(e).</p><br /> <p><a href="#_ftnref3" name="_ftn3">3</a>. See IRC § 465(a).</p><br /> <p><a href="#_ftnref4" name="_ftn4">4</a>. IRC § 542(a)(2).</p><br /> </div>

<div class="Section1">Yes. In general, the Foreign Investment in Real Property&nbsp;Tax Act (FIRPTA) imposes a 15 percent tax (10 percent prior to 2016) upon gains or losses stemming from the disposition of a foreign investor&rsquo;s holdings in any United States real property interest.<a href="#_ftn1" name="_ftnref1">¹</a> However, special rules apply in the case of REIT distributions of &ldquo;United States real property interests&rdquo; involving foreign individuals or corporations. If such a REIT distribution to a nonresident alien or foreign corporation is treated as a gain from the sale or exchange of U.S. real property, the REIT must deduct and withhold an amount equal to the highest corporate tax rate (currently 21 percent) on the amount distributed.<a href="#_ftn2" name="_ftnref2">²</a><div class="Section1"><br /> <br /> The amount subject to this tax is the foreign individual&rsquo;s proportionate share of the amount of any distribution that is designated by the REIT to be a capital gain distribution.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8002">8002</a> for a discussion of the exceptions to the general treatment of foreign investments in REITs that can allow foreign individuals and corporations to avoid the FIRPTA tax.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect;&nbsp;1445(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect;&nbsp;1445(e)(6).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; Treas. Reg. &sect;&nbsp;1.1445-8(c)(2)(ii).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Yes. While the Foreign Investment in Real Property Tax Act (FIRPTA) imposes a 21 percent tax upon certain REIT distributions to foreign individuals and corporations (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8001">8001</a>), this withholding requirement applies only to gains and losses resulting from a sale or exchange of a United States real property interest. Several exclusions apply to this general rule.<br /> <br /> First, a foreign investor may avoid the 21 percent FIRPTA tax if investing in certain publicly-traded REITs. If the shares of the REIT are regularly traded in a U.S. securities market, a distribution to a foreign individual will not be treated as gain recognized from the sale or exchange of a United States real property interest if the foreign individual (or foreign corporation) does not own more than 10 percent of the REIT shares (5 percent prior to 2016) at any time during the one-year period ending on the date of the distribution.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> Further, if the REIT qualifies as a domestically controlled qualified investment entity, distributions to foreign individuals or corporations will not be subject to the tax because the IRC defines the term &ldquo;United States real property interest&rdquo; to exclude interests in a domestically controlled qualified investment entity.<a href="#_ftn2" name="_ftnref2">²</a> A domestically controlled qualified investment entity includes a REIT (whether publicly or non-publicly held) in which foreign individuals and corporations own less than 50 percent of the value at all times during the shortest of the following periods:<br /> <p style="padding-left: 40px">(1) The period beginning June 19, 1980 and ending on the date of the distribution;</p><br /> <p style="padding-left: 40px">(2) The five-year period ending on the date of the distribution; or</p><br /> <p style="padding-left: 40px">(3) The period that the REIT has been in existence.<a href="#_ftn3" name="_ftnref3">³</a></p><br /> These rules effectively allow a foreign individual or corporation to avoid the tax imposed upon REIT distributions under FIRPTA if the foreign ownership is limited to 5 percent of a publicly-traded REIT or less than 50 percent of any other REIT.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 897(h)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 897(h)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 897(h)(4).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> In addition to meeting the asset-based tests described in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7986">7986</a>, a REIT must satisfy several diversification tests with respect to its assets in order to qualify for pass-through tax treatment as a REIT. The following diversification tests are applied at the close of each quarter of each taxable year of a REIT&rsquo;s existence:<br /> <ol><br /> <li>No more than five percent of the value of a REIT&rsquo;s total assets may consist of securities of any one issuer (except with respect to taxable REIT subsidiaries (TRS) and securities permitted under the 75 percent test).</li><br /> <li>A REIT may not hold securities that represent more than 10 percent of the voting power of the outstanding securities of any one issuer.</li><br /> <li>A REIT may not hold securities that represent more than 10 percent of the total value of the outstanding securities of any one issuer.<a href="#_ftn1" name="_ftnref1">¹</a></li><br /> </ol><br /> The IRC recognizes that the value of securities may fluctuate between quarters. As such, Section 856 provides that if a REIT meets the diversification requirements at the close of any given quarter, it will not fail to meet the requirements in the subsequent quarter unless the failure is due to the acquisition of securities or property and is wholly or partially the result of that acquisition. If a REIT fails to meet the diversification tests at the close of a quarter as a result of an acquisition of securities made during that quarter, it has a 30-day period in which to correct the discrepancy. If the discrepancy is corrected within that 30-day period, the REIT will be treated as having satisfied the diversification test for the quarter.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 856(c)(4)(B)(iii).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 856(c)(4).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> 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><br /> <br /> 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.<br /> <br /> 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.<br /> <br /> Further, information about the value of a publicly traded REIT&rsquo;s shares is widely available, so smaller investors can make knowledgeable investment decisions based on historical performance and the investments underlying the individual REIT.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <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).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> 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.<a href="#_ftn1" name="_ftnref1">¹</a> Therefore, losses from the sale of stock, securities, real property, etc. do not impact the REIT&rsquo;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.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> However, the IRC now excepts certain types of sales from the prohibited transaction rules applicable to REITs, so that the term &ldquo;prohibited transaction&rdquo; does not include a sale of property which is a real estate asset if:<br /> <p style="padding-left: 40px">(i) the REIT has held the property for not less than two years;</p><br /> <p style="padding-left: 40px">(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;</p><br /> <p style="padding-left: 40px">(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 &ldquo;20 percent&rdquo; for &ldquo;10 percent&rdquo; 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 &ldquo;20 percent&rdquo; for &ldquo;10 percent&rdquo; and the three-year average fair market value percentage for the taxable year does not exceed 10 percent; or</p><br /> <p style="padding-left: 40px">(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.<a href="#_ftn3" name="_ftnref3">³</a></p><br /> Income earned by qualified REIT subsidiaries that are wholly-owned by the REIT must be included in the REIT&rsquo;s gross income.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> 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&rsquo;s assets.<a href="#_ftn5" name="_ftnref5">⁵</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7993">7993</a> for more information on the treatment of partnership interests in the REIT context.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. &sect; 1.856(c)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect;&sect; 857(b)(2), 857(b)(6), 1221(a)(1).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 857(b)(6)(C).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC &sect; 856(i).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. See, for example, Let. Rul. 9428018.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> A qualified REIT subsidiary is a corporation in which the REIT owns 100 percent of the interests&mdash;e.g., it is a wholly owned subsidiary of a REIT. A qualified REIT subsidiary is not treated as an entity separate from the parent-REIT, so that all of the income and assets of the subsidiary are considered along with the REIT&rsquo;s for purposes of the REIT income and asset tests.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> A subsidiary that has elected to be treated as a taxable REIT subsidiary (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7999">7999</a>) cannot qualify as a qualified REIT subsidiary.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> If a qualified REIT subsidiary ceases to be 100 percent wholly-owned by the parent-REIT, its status as a qualified REIT subsidiary is terminated and it is treated as a new corporation that acquired all of its assets from the parent-REIT in exchange for its stock.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 856(i)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 856(i)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 856(i)(3).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> 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><br /> <br /> Under the regulations, the REIT&rsquo;s proportionate interest in a partnership is determined based upon its capital interest in the partnership. The IRS has found that, because a partner&rsquo;s capital account typically reflects its net investment in the partnership, a REIT&rsquo;s capital interest in a partnership is determined by dividing the REIT&rsquo;s capital account balance by the sum of all of the partners&rsquo; capital account balances.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> 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><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. &sect; 1.856-3(g).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. See Let. Rul. 200310014.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. &sect; 1.856-3(g).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> 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),<a href="#_ftn1" name="_ftnref1">¹</a> 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.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> 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.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> 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.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 856(c)(6).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 857(b)(5).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 856(c)(6)(A).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC &sect; 856(g).<br /> <br /> </div></div><br />