PATH Act modifies REIT prohibited-transaction safe harbors.

• Author: Rose, Travis J.
• Position: Protecting Americans from Tax Hikes Act of 2015, real estate investment trusts

A real estate investment trust (REIT) is subject under Sec. 857(b)(6)(A) to a 100% tax on "net income derived from prohibited transactions," which generally includes net income from the sale or other disposition of property described in Sec. 1221(a)(1)--i.e., property primarily held by the REIT for sale to customers in the ordinary course of a trade of business (so-called dealer property)--and not pursuant to a foreclosure.

Congressional intent behind enactment of Sec. 857(b)(6) was to "prevent a REIT from retaining any profit from ordinary retailing activities such as sales to customers of condominium units or subdivided lots in a development project" (S. Rep't No. 94-938, 94th Cong., 2d Sess. 470 (1976)). However, Congress also believed that "REITS should have a safe harbor within which they can modify the portfolio of their assets without the possibility that a tax would be imposed equal to the entire amount of the appreciation in those assets" (S. Rep't No. 95-1263, 95th Cong., 2d Sess. 178-179 (1978)).

Safe Harbor

Before being amended by the Protecting Americans From Tax Hikes (PATH) Act of 2015 (passed as part of the Consolidated Appropriations Act, 2016, P.L. 114-113), Sec. 857(b)(6)(C) provided a safe harbor under which a prohibited transaction did not include the sale of a real estate asset if the following requirements were met:

1. The REIT has held the property for more than two years;

2. The aggregate expenditures made by the REIT, or any partner of the REIT, within the two-year period preceding the sale of the property that are includible in the basis of the property do not exceed 30% of the property's sales price;

3. (a) No more than seven sales of property have been made by the REIT during the tax year (the seven-sales test), (b) the aggregate adjusted basis of the property sold by the REIT during the tax year does not exceed 10% of the aggregate adjusted basis of all assets held by the REIT as of the beginning of the tax year, or (c) the fair market value (FMV) of the property sold by the REIT during the tax year does not exceed 10% of the total FMV of all assets held by the REIT as of the beginning of the tax year;

4. If the property is land or improvements not acquired through foreclosure or lease termination, the property was held by the REIT for at least two years for the production of rental income; and

5. If the seven-sales test of Sec. 857(b) (6)(C)(iii)(I) (item 3(a) above) is not met, substantially all the marketing and...