Who can’t buy REITs?
Tower Companies Might be Disqualified as REITs
Within the few last years, many companies have reorganized as investment trusts (REITs) for federal income tax purposes. American Tower Corporation began operating as a REIT at the start of 2012 and Crown Castle followed suit in January 2014.
Nevertheless, the Boston Globe recently reported, “A Republican leader in the home of Representatives wants to block the rush to form REITs. Using the surge in real estate trusts costing the U. S. federal government billions in lost tax payments, Representative Dave Camp of The state of michigan, who chairs the House Ways and Means Committee, has drafted an enormous tax reform bill that would reverse past IRS rulings as well as outlaw many REIT conversions. ”
Unfortunately, this legislation would limit the kinds of assets that would qualify as real estate and some legal specialists suggested that mobile phone towers would be disqualified. “The REIT rules were not meant to facilitate erosion of the corporate tax base, ” the Methods Committee said in a document accompanying a draft of the actual tax proposal.
This may be one of the reasons the major structure corporations are buying up ground leases to secure their position in the housing market. It’s not clear whether this proposed legislation would force non-traditional trusts to revert to being corporations because their property would no longer qualify as property. But the language in the Ways and Means proposal indicates those companies would lose their tax-free REIT status.
If we’re disqualified as a REIT, we will be subject to tax like a regular corporation and face substantial tax liability.
Qualification as a REIT involves the use of highly technical and complex U. S. federal income tax code provisions that only a limited number of judicial or administrative interpretations can be found. Accordingly, there can be no assurances that we will have the ability to remain qualified as a REIT for U. S. federal tax purposes. Even a technical or inadvertent mistake could jeopardize the REIT status.
Furthermore, Congress or the IRS might change tax laws or regulations and also the courts might issue new rulings, in each case potentially having retroactive effect that may make it more difficult or impossible for us to qualify like a REIT in a particular tax year. If we fail to qualify like a REIT in any tax year, then:
• we would be taxed like a regular domestic corporation, which, among other things, means that we would struggle to deduct distributions to our stockholders in computing taxable income and we’d be subject to U. S. federal income tax on the taxable income at regular corporate rates;
• any resulting tax liability might be substantial, would reduce the amount of cash available for distribution to the stockholders and could force us to liquidate assets at inconvenient times, causing lower income or higher losses than would result if these assets weren’t liquidated; and
• unless we were entitled to relief below applicable statutory provisions, we would be disqualified from treatment like a REIT for the subsequent four taxable years following the year where we lost our qualification and, thus, our cash available for distribution to our stockholders would be reduced for each one of the years during which we did not qualify as a REIT.
Even though we remain qualified as a REIT, we might face other tax liabilities that reduce our income. Further, we might be subject to federal, state and nearby taxes on our income and property. Any of these taxes would decrease cash readily available for distribution to our stockholders.
Summary Of REIT Simplification Provisions
INVESTMENT TRUST SIMPLIFICATION ACT OF 1997 (“REITSA”)
Summary Of REIT Simplification Provisions Within the Taxpayer Relief Act (August 1997)
The tax provisions in the Real Estate Investment Trust Simplification Act (‘REITSA’) passed included in the budget package fall within three broad categories. All provisions work for taxable years beginning after August 5, 1997.
Traps For that Unwary. First, prior law disqualified a REIT that satisfied all required ownership tests but didn’t follow certain administrative details relating to shareholder demand letters. REITSA replaces the potential disqualification having a reporting penalty imposed on a REIT’s failure to follow INTERNAL REVENUE SERVICE notification rules. Also, a REIT that sends out shareholder letters and doesn’t know of a violation of the ‘five or fewer’ ownership test has become deemed to satisfy this test.
Second, REITSA creates a de minimis exception to prior law to ensure that a REIT’s rental income is not disqualified if it works nominal, although impermissible, services for a tenant. For example, a condo REIT can now offer tennis lessons to its tenants without having ‘tainting’ the underlying rents.
Third, REITSA corrects a technical “glitch” by which stock ownership attribution may occur between unrelated partners. The prior constructive ownership rule might have resulted in: (1) certain rents received by a REIT not qualifying for that REIT income tests; or (2) certain parties not really being qualified as independent contractors.
Mutual Fund Conformity. First, earlier law taxed a REIT that retained capital gains, and imposed another level of the tax on the REIT shareholders when later they received the administrative centre gain distribution. REITSA mirrors the corresponding mutual fund rules governing taxation of retained capital gains by passing via a credit to shareholders for capital gains taxes paid at the organization level.
Second, REITSA repeals the 30% gross income test (in conformity using the repeal of the analogous ‘short-short’ test for mutual funds). The actual 100% excise tax on prohibited transactions (i. e., sales that the REIT is a dealer) is not materially transformed.
Other Simplification Measures. First, REITSA makes a technical change to what sort of REIT computes its earnings & profits (“E&P”). Because 1986, a REIT must distribute all pre-REIT earnings and earnings within its first REIT taxable year or lose its REIT standing. However, if a REIT has unexpected year-end earnings, the normal ordering rules governing E&P distributions created a considerable risk that a new REIT (or a REIT into which a C corporation merges inside a tax-free reorganization) may fail to distribute all of it’s pre-REIT E&P, notwithstanding its good faith efforts to comply using the distribution requirement. REITSA corrects the ordering rules for accumulated E&P distributions to create it easier for a new REIT (or a REIT into which a C corporation merges) to adhere to the distribution requirement.
Second, REITSA simplifies the administration of the actual REIT foreclosure property rules by: (a) extending the timeframe for the foreclosure election from 2 to 3 years; and (b) coordinating the foreclosure property independent contractor rule using the primary independent contractor rule for REITs.
Third, REITSA updates the present REIT hedging rule to include income from all hedges associated with REIT liabilities.
Fourth, REITSA extends an exception to the current 95% distribution rule to incorporate other forms of phantom income, e. g., income from the actual discharge of indebtedness.
Fifth, REITSA corrects a problem in the wording of Congress’ past liberalization from the safe harbor from the 100% excise tax on prohibited dealings, i. e., sales of property in the ordinary course associated with business. The provision does not count as a dealer sale property that’s involuntarily converted.
Sixth, REITSA creates a safe harbor to the shared appreciation mortgage (“SAM”) rules that doesn’t penalize a REIT lender for the borrower’s bankruptcy. The provision also clarifies that SAMs may be based on appreciation in value in addition to gain.
Last, REITSA codifies an IRS ruling position by allowing a REIT to utilize a wholly-owned subsidiary to hold property even if the subsidiary previously have been owned by a non-REIT.