The Reit-an Investment Alternative
| Publication year | 1985 |
| Pages | 1780 |
| Citation | Vol. 14 No. 9 Pg. 1780 |
1985, October, Pg. 1780. The REIT-An Investment Alternative
The 1985 Tax Reform Proposals ("Proposals") are causing many taxpayers to reevaluate their investment strategies. The Proposals encourage investments for the economic benefits they offer rather than for tax-motivated reasons.(fn1)
Traditionally, real estate has been a popular investment. However, certain provisions of the Proposals may cause investors to abandon real estate partnerships in favor of real estate investment trusts ("REITs"). The Proposals include suggestions to limit a limited partner's interest deduction to $5,000 plus that partner's net investment income,(fn2) and to extend the "at risk" rules to real estate.(fn3) Other factors contributing to the current interest in REITs are the well-publicized Internal Revenue Service ("IRS") disallowance of the anticipated tax benefits of numerous real estate tax shelter partnerships; the non-liquid aspect of limited partnership investments; and the failure of many limited partnerships to generate positive cash flows during their early years.
Since the 1985 Proposals discourage investments made solely for tax reasons, clients increasingly should be concerned with the economic return on their investments. A REIT may be a viable investment alternative. This article provides a basic overview of the REIT for the attorney who represents such clients.
A REIT is defined by § 856 of the Internal Revenue Code of 1954, as amended ("Code"). It must be a corporation, trust or association which, but for Code §§ 856 through 860, would be taxable as a domestic corporation and must be managed by one or more trustees or directors. REIT ownership interests must be evidenced by transferable shares or by transferable certificates of beneficial interest. Also, the REIT must have at least 100 beneficial owners for 335 days of a twelve-month taxable year or for a proportionate part of a taxable year of less than twelve months. A financial institution or an insurance company may not be a REIT nor can a personal holding company under Code § 542 qualify as a REIT.
An entity can only be a REIT if it makes an election to do so when filing its tax return or if it made the election for a previous taxable year and that election has not been terminated or revoked.(fn4) If it has been terminated or revoked, a new election may not be made until the fifth year following the year of revocation or termination.(fn5)
At least 95 percent of a REIT's gross income must be passive income derived from specific sources. These sources are: (1) dividends; (2) interest; (3) rents from real property; (4) gain from sales or dispositions of stock, securities and real property which is not property held for sale in the ordinary course of business ["inventory property"]; (5) abatements and refunds of taxes on real property, (6) income and gain derived from foreclosure property; (7) amounts received as consideration for making loans secured by mortgages on real property or on interests in real property or for purchasing or leasing real property; and (8) gain from the sale of a real estate asset which is not a prohibited transaction.(fn6) A few of these items deserve highlighting because the Code defines them so precisely.
1. Rents from real property: Code § 856(d)(1) defines "rents from real property" as rent from interests in real property, charges for services customarily furnished in connection with the rental of real property and rent attributable to personal property leased in connection with the real property if the rent allocable to the personal property is less than 15 percent of the...
To continue reading
Request your trial