The following generally summarizes some of the
basic tax law requirements applicable to REITs.
These rules are complex, and the following is only a general summary.
In order to qualify as a REIT, an entity must meet
a number of organizational, operational, distribution, and
compliance requirements. If the REIT satisfies
these requirements, it will be entitled to deduct any dividends paid
from its taxable income. A REIT that distributes
100% of its taxable income therefore will have no federal income tax
liability. Although state tax laws relating to REITs
vary, most states with an income-based tax regime follow the federal
law and permit a REIT a "dividends paid deduction."
1. Organizational
A REIT must be formed in one of the 50
states or District of Columbia as an entity taxable for federal
purposes as a corporation. It must be governed by directors or
trustees, and its shares must be transferable. Beginning with its
second taxable year, a REIT must meet two ownership tests: it must
have at least 100 different shareholders (the "100 Shareholder Test"),
and 5 or fewer individuals cannot own more than 50% of the value of
the REIT's stock during the last half of its taxable year (the "5/50
Test"). These ownership requirements generally mean that the REIT
structure is not a good choice for a closely held family business. A
number of "look through" rules currently apply when determining
whether the REIT meets the 5/50 Test.
In an attempt to ensure compliance with these tests, most REITs
include percentage ownership limitations in their organizational
documents. For example, many REITs do not permit any one shareholder
to own more than at most 9.9% of a REIT's stock without a waiver by
the REIT's board of directors. Because of the need to have 100
shareholders and the complexity of both of these tests, general
legal, and tax and securities law advice are strongly recommended
prior to beginning the process of forming a REIT.
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2. Operational
The REIT must satisfy two annual income
tests and a number of quarterly asset tests that are designed to
ensure that the majority of the REIT's income and assets are derived
from real estate sources.
Annually, at least 75% of the REIT's gross income must be from real
estate-related income such as rents from real property and interest
on obligations secured by mortgages on real property. Additionally,
95% of the REIT's gross income must be from the above-listed sources,
but can also include other passive forms of income such as dividends
and interest from non-real estate sources (like bank deposit
interest). As a result of these rules, no more than 5% of a REIT's
income can be from nonqualifying sources, such as from service fees
or a non-real estate business. A REIT can own up to 100% of the
stock of a "taxable REIT subsidiary" ("TRS"), a corporation with
which a REIT makes a joint election that can earn such income.
Quarterly, at least 75% of a REIT's assets must consist of real
estate assets such as real property or loans secured by real
property. Although a REIT can own up to 100% of a TRS, a REIT cannot
own, directly or indirectly, more than 10% of the voting securities
of any corporation other than another REIT, TRS or qualified REIT
subsidiary ("QRS"), a wholly-owned subsidiary of the REIT whose
assets and income are considered owned by the REIT for tax purposes.
Nor can a REIT own stock in a corporation (other than a REIT, TRS or
QRS) the value of whose stock comprises more than 5% of a REIT's
assets. Finally, the value of the stock of all of a REIT's TRSs
cannot comprise more than 20% of the value of the REIT's assets.
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3. Distribution
In order to qualify as a REIT, generally,
the REIT must distribute at least 90% of the sum of its taxable
income. To the extent that the REIT retains income, it must pay tax
on such income just like any other corporation.
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4. Compliance
In order to qualify as a REIT, a company
must make a REIT election. The REIT election is made by filing an
income tax return on Form 1120-REIT. Because this form is not due
until, at the earliest, March 15th following the end of the REIT's
last tax year, the REIT does not make its election until after the
end of its first year (or part-year) as a REIT. Nevertheless, if it
desires to qualify as a REIT for that year, it must meet the various
REIT tests during that year (with the exception of the 100
Shareholder Test and the 5/50 Test, both of which must be met
beginning with the REIT's second taxable year.) Additionally, the
REIT annually must mail letters to its shareholders of record
requesting details of beneficial ownership of shares. Significant
monetary penalties will apply to a REIT that fails to mail these
letters on a timely basis.
For more information concerning the legal requirements applicable to
REITs, please consider purchasing NAREIT's publication,
"Laws Affecting REITs"
or West Group's publication "Real
Estate Investment Trusts Handbook."
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5. Examples of Law Firms
with REIT expertise:
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6. Examples of Accounting
Firms with REIT expertise:
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7. Examples of Investment
Banking Firms with REIT expertise
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Disclaimer
Please note that the discussion set forth
above is for informational purposes only and is not intended to
constitute legal or tax advice. Because the formation and operation
of a REIT involves many complex legal, securities, tax and
accounting rules, we strongly advise you to seek professional advice
from competent attorneys, accountants, and other advisors prior to
beginning the process of forming a REIT. Since we are not providing
legal advice through this Web site, you should not rely upon any
information contained herein for any purpose without seeking legal
and/or tax and accounting advice from a duly licensed attorney or
tax practitioner. |
