REIT 101 “a practical view of a complex topic”
MARKS PANETH LLPNovember 9, 2015
Michael W. Hurwitz, CPA, MSTC: 646.499.0634O: 212.201.2230
REIT 101 - Agenda• Choice of Business Entity - warm up• Historical Background / Overview of REITs• REIT Structures and Subsidiaries• Operating in a REIT Compliant Manner• Federal & State Tax Considerations• Other: Tax Teasers and Planning• Happy hour - refreshments
Choice of Business Entity C-Corporation S-Corporation Sole Proprietor Partnership and Limited Liability Company RIC and REMIC Real Estate Investment Trust (REIT) Other (Insurance Co. / Government Agency)
Types of Businesses Operating as REITs
Office Industrial Data centers Student housing Manufactured homes Malls / shopping
centers
Health care facilities Self-storage Hotels Cell towers Timber Financing / Mortgage
Historical Background REIT Legislation Enacted in 1960 – federal law
that authorized REITs; described as mutual funds for real estate
Tax Reform Act of 1986 – REITs are allowed to provide customary management services without independent contractor
REIT Modernization Act 1999 – creation of Taxable REIT Subsidiaries (TRS) to provide competitive services to REIT tenants
American Jobs Creation Act of 2004 – REIT savings provisions
Private Letter Rulings
Overview In order for a company to qualify to be a
REIT, it must comply with certain provisions within the Internal Revenue Code
Entitled to dividends paid deduction – benefit! Taxable income in excess of dividends paid
deduction is subject to corporate tax Let’s take a quick look at the current draft
copy of the Federal Form 1120 -REIT
REIT Structures Stand alone / special purpose blocker REITs UPREITs DOWN REITs Pair-Shared or Stapled REITs Use of Operating Partnership Use of TRSs & QRSs
Note: can be public or private!
Common REIT Structure - UPREIT
Real Estate Assets
REIT
OperatingPartnership
Fund
Real Estate Assets
LP’s and Sponsors (Conversion Rights)
Outside Investors
TRSs
Management Company
Property Management
Company
REIT Subsidiaries Taxable REIT Subsidiary (TRS) a corporate
subsidiary of the REIT that can provide the competitive services that tenants desire beyond the “usual and customary” services - (ability to generate “bad income” and convert it to “good income “ -dividends) does not have to be 100% owned by REIT
Qualified REIT Subsidiary (QRS) wholly-owned subsidiary ignored for federal income tax purposes; as such the assets, liabilities, income and deductions are deemed to be those of the REIT’s (100% owned)
Operating in a REIT Compliant Manner
Organizational Tests Quarterly Asset Tests Annual Income Tests Yearly Distribution Tests Record Keeping Requirements
“professional services rendered in connection with educating and ensuring company operates in a REIT-Compliant
manner”
Failure to Satisfy RequirementsIf a REIT fails to comply with or satisfy
certain REIT qualification provisions, the REIT may be required to pay a $50,000
penalty for each failure “due to reasonable cause and not willful neglect” - - other
penalties can be imposed for negligence, substantial underestimation of tax, reportable
transactions, and fraud.
Organizational Tests Organized as a corporation, trust or association Formed in one of the 50 states or District of Columbia Managed / governed by one or more trustees or directors Transferable shares or certificates Must be owned by 100 or more persons (waived 1st year) Not be closely held (the “5/50% Test” - attribution rules) Mailing of Demand Letters ( just the mailing of…) Affirmative election to be taxed as a REIT Not be a financial institution or insurance company
Quarterly Asset Tests 75% Test: 75% of the value of the REIT’s assets must
consist of real estate assets; including mortgages on real property (cash, cash items, receivables and/or Government securities)
25% Test: Not more than 25% of the value of the REIT’s total assets may consist of securities of one or more Taxable REIT Subsidiaries (TRS)
10% Test: A REIT cannot own more than 10% of the outstanding securities (vote or value) of any single issuer (other than those qualifying for the 75% and the securities of a TRS)
5% Test: Not more than 5% of the value of a REIT’s total assets may consist of securities of any single issuer (other than those qualifying for the 75% and the securities of a TRS)
Straight Debt ExceptionDebt securities that are owned by a REIT and qualify
for the straight debt safe harbor / exception are not subject to the 10% value test. Straight debt means a written unconditional promise to pay on demand (or
on a specific date) a sum certain in money if:1. The interest rate and payments are not contingent on
profits, the borrower’s discretion or similar factors2. The debt in not convertible (directly or indirectly)
into REIT stock
Annually Income Tests 75% Test: Generally, at least 75% of the REIT’s annual
gross income must be derived from real-estate related income, more specifically: “rents from real property”, qualifying interest on mortgage debt, gain from the sale of non-dealer real property or mortgages dividends on or disposition of shares in other REITs, property tax refunds, income and gain from foreclosure property, qualifying points or fees and / or qualified temporary investment income
95% Test: No more than 5% of the REIT’s annual gross income can be derived from items other than those which satisfy the 75% test mentioned above and other passive forms of income such as dividends, interest and / or gains from the sale of securities
“5% bad income bucket”
Rents from Real PropertyRent generally will not qualify as rents
from real property if:1) The rent is based on the income or profits of
any person2) The REIT owns, directly or indirectly, 10%
or more of the tenant or3) The REIT itself furnishes services other than
ordinary and customary property management services (use TRS or independent contractor for providing impermissible tenant services)
Impermissible Tenant Service Income
Any amount received or accrued by the REIT for rendering services to the tenants of such property or managing or operating the
property. There are three exceptions that provide ways in which a REIT can directly or indirectly render services to its tenants with
out causing the income to constitute impermissible tenant service income:
1. use of independent contractor2. use of TRS 3. unrelated business taxable income exception
Independent Contractor (IK)1. IK can not own directly or indirectly > 35% of REIT2. If IK is a corporation, > 35% shareholder cannot
own > 35% of REIT shares3. Relationship between REIT and IK must be arm’s-
length; common employees and/or officers will be scrutinized-transfer pricing / re-determined amounts
4. IK must be adequately compensated for its services5. IK must not be an employee of the REIT6. The REIT must not receive income of any type
(interest, dividends, rent and other) from the IK
Prohibited Transactions A prohibited transaction is the sale or other disposition
of property, other than foreclosure property, held primarily for the sale to customers in the ordinary course of business; 100% tax on aggregate of all gains
Safe Harbor: 1) REIT held property for not less than two years and 2) aggregate expenditures includible in basis does not exceed 30% of selling price and 3) either not more than seven sales or aggregated FMV of property sold does not exceed the aggregate of 10% of the FMV of all of the assets of the REIT at beginning of the year
Foreclosed Property Rules If a REIT acquires property through a foreclosure,
deed in lieu of foreclosure, or upon eviction of a tenant in default, a REIT may be able to engage in certain nonqualified activities with respect to the property without jeopardizing its REIT status or incurring the prohibited transaction tax (100%) by making a “foreclosure property” irrevocable election
Three year grace period to orderly liquidate the REIT’s interest in such property (extensions granted)
Yearly Distribution Tests In general, a REIT must distribute annually to its
shareholders dividends equal to at least 90% of its REIT taxable income (determined without regard to the deduction for dividends paid and by excluding any net capital gain - Note - A REIT can retain its capital gains but, must pay tax on any retained gains; the tax it pays on such gains will then be passed through as a credit to its shareholders
Must designate composition of distribution within 30 days of year end on form 1099-DIV or with its annual report – ordinary dividend, capital gain, unrecaptured section 1250, return of capital and / or 15% ordinary dividends from C Corporations
Federal Considerations Partnership issues – 704, 707, 731 & 752 Calculation of earnings and profits (E&P) Thinly capitalized TRS – 163j interest expense
limitation / disallowance Conversion to REIT status – holding period to
avoid C-level taxes A REIT may engage in a tax-free (spin off)
reorganization pursuant to 355
State Considerations Withholding taxes - nonresident partners of OP Recognition of Limited Liability Companies Capital stock, franchise taxes and other fees Business Trust REIT vs. Corporate REIT Unitary vs. separate filing requirements State apportionment factors New State Legislation State Audits
Tax Teasers New proposed repair regulations and related 3115s Debt financed distributions – interest tracing rules Long-term incentive plans using profits interests Deferred exchanges - 1031 Exchange (recycle capital) Allocation waterfalls, promoted interests Unrelated Business Income Tax (UBIT) Transfer pricing - arm’s length Investor types FAS 109 FIN 48 Other
Strategic Planning Considerations
Any final thoughts?Additional comments?
Take a ways?Questions?
Michael W. Hurwitz, CPA, MST
C: 646.499.0634
O: 212.201.2230
Recommended
