REITs and taxable REIT subsidiaries potentially subject to PHC tax treatment.

• Author: Temkin, Charles
• Position: Real estate investment trusts, personal holding companies

This item discusses a potential issue that some real estate investment trusts (REITs), particularly private ones, may face due to the overlapping of the rules that govern REITs and personal holding companies (PHCs). Both the REIT and the PHC provisions set forth ownership and income requirements that must be met for an entity to be considered a REIT or a PHC. Because REITs generally look to the PHC ownership tests, it has typically been assumed that, if an entity is not considered closely held for REIT purposes, it is not closely held for PHC purposes either. However, recent analysis has shown that a REIT can be subject to the PHC tax as well as to other rules affecting PHCs. Indeed, page 1 of Form 1120-REIT, U.S. Income Tax Return for Real Estate Investment Trusts, requires a REIT to indicate whether it is a PHC. A REIT must enter any PHC tax it owes on Schedule J, Tax Computation, of the Form 1120-REIT. The reason a nonclosely held REIT can be a closely held PHC is that Sec. 856(h)(1)(B) eliminates the PHC partnership attribution rule for the determination of REIT closely held status, but this attribution rule remains intact for purposes of Pile determinations, and there is no other provision that prevents the PHC rules from applying to REITs or their taxable REIT subsidiaries (TRSs). If a REIT or a TRS meets the PHC ownership requirements, then it is necessary both to monitor its income and to monitor and regulate its distributions so as to become comfortable either that the entity does not fall within the PHC income requirement or, if it does, that it will not have any undistributed PHC income that would give rise to a tax.

Situations in Which a REIT or TRS Meets the PHC Ownership Rules

Under the PHC partnership attribution rule, each partner is deemed to own everything each of its partners owns (Sec. 544(a)(2)). Furthermore, while the PHC rules for reattribution prevent the double application of the partnership attribution rule, they permit the application of that rule in combination with other attribution rules, such as entity-to-owner attribution (Sec. 544(a)(5)). These attribution rules make it surprisingly easy to meet the PHC closely held test (i.e., more than 50% in value held by five or fewer individuals).

The reach of these rules can be illustrated in examples that are reasonably common. Perhaps the most obvious is when a REIT is owned primarily by a partnership. This structure is used extensively in the private equity context...