Real Estate Investment Trusts

<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 />

<div class="Section1">In order to ensure that REITs continue to further the legislative intent that their income should primarily be derived passively from real estate activities, a REIT must satisfy both of the following income tests in order to qualify as a REIT:<a href="#_ftn1" name="_ftnref1">¹</a><br /> <ul><br /> <li><em>75 Percent Income Test</em>: At least 75 percent of the REIT&rsquo;s gross income each tax year must be derived from rents, mortgage interest, gain from the sale of real property, dividends received from other qualified REITs and certain other income derived from real estate sources.</li><br /> <li><em>The 95 Percent Income Test</em>: At least 95 percent of the REIT&rsquo;s gross income must be derived from (a) items that qualify for the 75 percent income test and (b) income from interest, dividends, gain from the sale of stocks or other securities and certain mineral royalty income.</li><br /> </ul><br /> Unlike in the case of the asset-based qualification tests, the income-related qualification tests must only be satisfied at the close of each tax year (rather than on a quarterly basis).<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)(2) and (c)(3).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> 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><br /> <br /> 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.<br /> <br /> 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><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(l)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 856(l)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 856(l)(3).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. Rev. Rul. 2002-38, 20026 IRB 4.<br /> <br /> </div></div><br />