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My REIT Partner Wants (What?): “But first an intro”

2.3.20 | Industry Insights – REIT Special Edition

Hello there, and welcome to Berdon’s newest blog-ish focused on tax, and other, issues related to situations which may arise when a real estate investor/owner partners with a Real Estate Investment Trust (REIT). As these writings progress over the upcoming months, I will dive into a variety of circumstances which may arise during the life cycle of any such joint venture, and the technical aspects of these unique situations. However, as this is the “kick off special”, a brief introduction would probably be helpful for the uninitiated.

A Real Estate Investment Trust, REIT for short, is a publicly or privately held company that owns real estate equity or real property debt. A REIT structure is intended to eliminate double taxation on distributed income, but with this benefit (along with a few others) comes a plethora of mostly rigid requirements. Provided the REIT meets specific ownership, management, asset, income, and distribution requirements, only the earnings retained by the REIT are taxed,

While the ownership and management of a REIT are primarily an issue for the REIT itself, when partnering with a REIT, the asset, income, and even distribution requirements (both operationally and tax reporting-wise) could pervade your business in unanticipated ways. While most of these pervasions won’t necessarily be intrusive, it’s best to understand a few of the most common, and nuanced issues, that will or may arise when partnering with a REIT.

With regard to the asset requirement, at least 75% of the value of the assets of a REIT must be comprised of real estate, cash, and government securities. Fittingly, other REIT shares are considered real estate assets; however, no more than 25% of a REIT’s assets can be stock in an entity known as a Taxable REIT Subsidiary (TRS). Furthermore, not more than 5% of the assets of a REIT can be stock in any non-real estate corporations, and the REIT may not own more than 10% of the voting securities of any corporation other than another REIT or a TRS. Asset testing is typically done by REITs at the close of every quarter and is based on gross assets determined under GAAP.

The income requirement for REITs first mandates that 95% of the gross income must be derived from dividends, interest, rents, or gains from the sale of certain assets (such as real estate, cash or government securities). Notice that the categories of income just listed are, by their nature, passive. Additionally, 75% of the income of a REIT must be from real property; this bucket includes qualified rents, gain from the sale of real property, mortgage interest and refunds of real property taxes.

Within the asset and income requirements are an abundance of rules determining what actually constitutes “real property” or what is “good/qualified rental income” for REIT qualification purposes. Decades of private letter rulings have helped in clarifying many specific issues, but grey situations still often arise as businesses find new avenues to monetize assets or innovate through technological advancements.

Failure to adhere to the asset or standards, as set out by the Internal Revenue Code, could result in penalties or disqualification as a REIT (which would turn the entity into a corporation, subject to double taxation at its finest). Thus, when you partner with a REIT, it will want to be certain that none of your joint operations put its status in jeopardy. Alas, this reality brings about extra questions, information requests, document provisions, business plan review rights, entities, and possibly more!

With the background information and impetus for this series now concluded, in the next “ish” we’ll move on to more substantive topics. Be on the lookout soon for, My REIT Partner Wants…

  • More K-1 information than my accountant usually provides
  • To read all the leases for the building and approve new ones
  • GAAP valuation data
  • To opt out of bonus/ accelerated depreciation

I hope to have whet your appetite for this series, as I’m really excited to write it.

Questions? Please contact Thea Kruger at 212-699-8865 | tkruger@berdonllp.com or your Berdon LLP tax advisor.