1. U.S. Real Estate Investment Trusts: REIT
Presented by:
Kate Fishers, CPA
Chastang, Ferrell, Sims & Eiserman, LLC

2. REIT REIT – Requirements: Organizational Operational REIT Taxation
REIT Shareholder Taxation

3. To qualify as a REIT, any entity must:
Be organized as a corporation, trust, or an association
Be managed by one or more trustees or directors
Have transferable shares or certificates
Be taxable as a domestic corporation “but for the REIT regulations”
Not be financial institution or insurance company
Be owned by 100 or more persons
Not be closely held
Make an election to be taxed as a REIT

4. Ongoing requirements to remain in REIT status:
Quarterly assets tests
Annual income tests

5. REIT Must be organized: Corporation Trust Association
Foreign corporations, trusts or associations do not
qualify:
Even if qualifying under other sections of the code.
Requirement: Both a corporation and domestic.
Domestic: Organized under the U.S. Law.

6. Management of REITs Must be professionally managed
One or more trustees or directors
Must not be required to seek shareholder ratification for their business decisions
Rights and powers of trustees must satisfy the “centralization of management” test
Exclusive authority

7. Management of REITs
Congress intended that REIT’s income should be “passive” in nature and not derived from the active operation of business.
The Code requires the trustees to delegate certain management of the REIT’s rental properties to an independent contractor.
The independent contractor’s employees rather that the REIT’s employees provide certain services furnished to REIT tenants.

8. Independent contractors
35% - Private REIT
5% - public REIT
Contractors do not own directly/indirectly 35% of REIT
REIT shareholder owning 35% or more of REIT cannot own more than 35% of independent contractor

9. A trustee CAN:
Establish rental terms
Choose tenants
Enter into and renew leases
Deal with taxes, interest, and insurance
Make capital expenditures
Make decisions as to repairs of trust property

10. Transferability of shares/certificates
Trust documents can include stock transfer restrictions if provisions prevent:
Violation of “closely held” prohibition
Disqualifying as a domestically controlled REIT

11. Must have at least 100 shareholders
Each at least purchase $10 worth of shares

12. Closely held provision
An entity will not qualify as a REIT if is closely held
If during the last half of the taxable year more than 50% of the value of its outstanding stock is owned directly or indirectly by five or fewer individuals

13. Election to be Taxed as a REIT
Must make an Election
Election, once made, continues until revoked or terminated by the entity’s failure to qualify as a REIT for a taxable year
Cannot re-elect REIT until the fifth year after initial revocation

14. Accounting period for a REIT
Must be the calendar year!

15. REIT Qualification
Congress intended that REITs be holders of real estate assets in a “portfolio type” manner.
While the original REIT provisions have been relaxed to allow REITs to become integrated real estate operating companies, the REIT qualifications tests still provide for significant operational constrains.

16. Assets tests
A REIT must satisfy six interacting assets tests at the close of each quarter of the taxable year:
At least 75% of the value of its total assets must consist of real estate assets, cash and cash items (operating A/R), and government securities
Not more than 25 % of the values of its total assets may consist of securities, other than those includible under the 75% test
Not more than 20% of the value of its total assets may consist of securities of one or more “taxable REIT subsidiaries”

17. Assets tests
Not more than 5% of the value of its total assets may consist of securities of anyone issuer, except with respect to a taxable REIT subsidiary and those securities includible under the 75% test
Not more than 10% of the outstanding total voting power of the outstanding securities of anyone issuer may be held, except with respect to a taxable REIT subsidiary and those securities includible under the 75% test

18. Assets tests
Not more than 10% of the outstanding total value of the outstanding securities of any one issuer may be held, except with respect to a taxable REIT subsidiary and those securities includible under the 75% test.

19. Assets tests
Failure to meet tests could disqualify REIT unless due to:
Reasonable cause not willful neglect
Correct failure within certain time frame
Pay penalties

20. Income Tests Applied on annual basis – evaluating gross income
75% gross income test
95% gross income test
75% must be derived from:
Rents from real property
Interest on obligations secured by mortgages on real property
Abatements and real property tax refunds
Income gain derived from foreclosure property

21. Income Tests
95% of a REIT’s gross income must be from the following sources:
Sources mentioned under the 75% test
Dividends
Interest and
Gain from the sale or other disposition of stocks or securities

22. Failure of the income tests
If a REIT fails one or two of the income tests in any year, it may be disqualified from the REIT status. The REIT may still qualify for REIT status provided that the failure to meet income tests was due to reasonable cause and not willful neglect.
If it fails the tests, it is subject to a penalty tax.

23. Operations of a REIT Minimum distribution requirements
90% of the REITs taxable income
Can deduct the dividends paid

24. Distributions and cash flows
Taxable income is less than cash flow
Depreciation
Amortization
If distributions are greater than minimum distribution
The distribution could provide the shareholder with a return on capital (non-taxable) distribution

25. Taxable income is greater than cash flow
Non-cash income (phantom income)
Subtracted from amount that would otherwise be distributable (not all non-cash income can be adjusted)
Distribution of its stock may qualify for dividend paid deduction and is treated as a distribution of property

26. “Subsequent year dividend procedure”
Dividends actually paid during the taxable year are
taken into account
Dividends declared
October
November
December
But paid in
January the following tax year
Will be deemed paid by the REIT and received by
shareholders on December 31 of that year.

27. Dividend declared prior to October and paid following January will NOT qualify
A shareholder includes the amount in income only in the year the dividends are received.
4% excise tax on certain undistributed income -
4% x (“required distribution”- distributed amount).
Purpose :
Prevent REITS from making excessive use of the subsequent year dividend procedure to defer recognition of income by REIT shareholders

28. Tax of the REIT and its shareholders
REIT’s taxable income
Similar to other domestic corporations
Except: A REIT is entitled to a dividend paid deduction
A REIT is potentially subject to entity level tax if all
REIT taxable income is not distributed

29. Special capital gain rules
The net capital gain is not included in the REIT TI from which the 90% minimum distribution requirement is calculated
Not include in the deduction for dividends paid for purposes of determining if the REIT satisfies the 90% distribution requirement.
A REIT is subject to Corporate tax on any recognized capital gain unless it is distributed as capital gain divided that same year

30. Calculation of minimum dividend distribution
REIT’s taxable income before dividend paid deduction:
Net Capital gains $20
Other net income
Total taxable REIT income $120
before divided paid deduction

31. Calculation of minimum dividend distribution
Basis for calculation minimum distribution:
REIT Taxable $120
Less net capital gain <20> Basis for calculation 90% $100
minimum distribution
90% <90>
Retained income
Capital gain
Potential taxable income
at REIT level

32. Calculation of minimum dividend distribution
Must distribute $90 ordinary dividend
May distribute $20 capital gain dividends
May distribute $10 addition ordinary dividends

33. If taxed and retained at REIT level, the shareholder must include their proportionate share of undistributed long term capital gains will be deemed to have paid REIT level taxes on that reportable/taxable gain (impact on a basis of shareholder stock)
Undistributed capital gains lose its long term capital gain character

34. Shareholders REIT distribution of ordinary income
Taxed in same manner as other corporate distributions
Net capital gain distributions taxed at long-term capital gains rates (15%)

35. Qualified dividends
15% reduced rate for certain individual shareholders – applies to: Dividends paid by a corporation that is subject to tax at the corporate level
REIT distributions will therefore generally not qualify for the reduced capital gains rate

36. Taxation of REIT shareholders
Dividends treated as ordinary dividends to extent of current or accumulated earnings and profits (E&P)
Dividends in excess of E&P are non-taxable return of capital to extent of the shareholders basis in the shares
Any dividends in excess of basis is treated as taxable gain from the sale of shareholders shares

37. Foreign Shareholder - Taxation
Complex withholding requirements when distributing to foreign shareholders
Taxed as ordinary dividend or capital gains dividend
Ordinary dividends:
30% (or lesser treaty rate)

38. Foreign Shareholder - Taxation
Treaty considerations:
- No 15% unless one the following three conditions is met:
- Shareholder owns not more than 10% or
- REIT publicly traded and shareholder owns not more than 5% or
- REIT is “diversified’’ and shareholder owns not more than 10%

39. Foreign Shareholder - Taxation
Why treaty restrictions?
Example:
Individual resident in Denmark holds U.S. real property:
- 30% tax gross receipts
- Or net at graduated rates
Placing real estate in a REIT:
Real estate income dividend income (5/15%)
(Significantly reducing the U.S. tax)

40. Foreign Shareholder - Taxation
Capital gain distributions:
FIRPTA (Foreign Investment Real Property Tax Act)
Treated as gain realized from the taxable sale or exchange of USRPI taxed as effectively connected income – graduated rates
Capital gains distributions:
- Subject to a withholding rate of 35% (or 15% to the extent provided for in regulations)

41. Foreign Shareholder - Taxation
Capital gain distributions subject to U.S. Tax
October 22, 2004
Capital gain distributions made by a REIT to a foreign owner is not treated as income effectively connected with a U.S. trade or business

42. Result Treated a as REIT dividend that is not a capital
gain distributions if
REIT publicly traded
Foreign investor owns less than 5% of the stock on date of distribution

43. Foreign Shareholder – Sale of REIT shares
Domestically controlled REIT:
50% or less of value of the REIT’s outstanding stock is held, directly or indirectly, by the foreign persons
If domestically controlled, its stock is excluded from the definition of U.S. real property interest and sale of stocks by foreign shareholders generally escape U.S. tax
If considered foreign controlled, it most likely will be considered a U.S. Real Property Holding Company (if 50% or more of the value of its assets is U.S. real estate)
Sale of stock subject to U.S. taxation

44. Kate Fishers, CPA k-fishers@cfsecpa.com
CHASTANG, FERELL, SIMS & EISERMAN,L.L.C. Certified Public Accountants & Consultants
Kate Fishers, CPA
1400 W. Fairbanks Ave. Suite 102 Winter Park, Florida Tel.: *Fax:
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