Back to Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts (REITs)

  • 7975. What is a real estate investment trust (REIT)?

    • A real estate investment trust (REIT) is a corporate entity that owns, operates, acquires, develops and manages real estate.The investment objective of most REITs is to produce current income through rents or interest on mortgage lending.

      REITs are required to distribute at least 90 percent of their annual earnings to shareholders.Thus, REITs are popular with investors seeking higher levels of current income and real estate as part of their portfolios.While current yields tend to be higher than those of stocks and investment grade bonds, the total return of REIT shares can fluctuate substantially because of their sensitivity to the real estate market.REIT market values and distributable cash flow will both be affected by fluctuations in the real estate market, and REITs tend to run in and out of favor as the real estate market experiences booms and declines.

      REITs are often compared to mutual funds because they allow smaller investors to pool capital to invest in larger and more diversified real estate portfolios than might otherwise be available. Both REITs and mutual funds are pass-through vehicles, as income earned is passed through for taxation at the investor level, bypassing taxation at the corporate level.

      REITs must meet a detailed set of qualification tests in order to qualify for the favorable tax treatment afforded by the IRC.For a discussion of the tax treatment of a REIT, see Q 7983 (entity taxation) and Q 7977 and Q 7980 (shareholder taxation).For the qualification requirements applicable to REITs, see Q .

  • 7976. How is income earned by a REIT taxed?

    • An important aspect of REITs is their pass-through income tax treatment. Like partnerships, REITs are not taxed at the entity level, but at the shareholder level. Thus, annual taxable income is allocated pro-rata to all shareholders, and these amounts are included in the shareholders’ individual returns and will be taxed at their level.

      The amount of income determined at the entity level and passed through to REIT shareholders is usually less than the actual cash distributions received for the same year. In most instances this is due to the fact that taxable income is reduced by depreciation, a deductible expense that does not reduce distributable cash flow. Since REIT distributions differ from REIT income allocations, and the information reported to shareholders on a Form 1099, this can cause confusion that, in some cases, may cause investors to avoid investing in REITs.See Q 7977 and Q 7980 for a discussion of how REIT shareholders are taxed.

      Planning Point: Shareholders use Form 1120-REIT (U.S. Income Tax Return for Real Estate Investment Trusts) to report the income, gains, losses, deductions, credits and to figure the income tax liability of real estate investment trusts.

  • 7977. How is a shareholder (or beneficiary) in a real estate investment trust taxed?

    • A real estate investment trust (REIT) invests principally in real estate and mortgages. Shareholders (or holders of beneficial interests) in real estate investment trusts are taxed like shareholders in regular corporations (Q 7501 to Q 7540) unless the REIT distributes at least 90 percent of its real estate investment trust taxable income.1 If the required distribution is made, the taxation is similar to that of mutual fund shareholders.

      Ordinary income dividends. Under JGTRRA 2003, qualified dividend income is treated like net capital gain for most purposes (see Q 700) and is, therefore, eligible for the 20 percent/15 percent/0 percent tax rates instead of the higher ordinary income tax rates. ATRA made these tax rates permanent for tax years beginning after 2012. Because REITs generally do not pay corporate income taxes, most ordinary income dividends paid by REITs do not constitute qualified dividend income, and, consequently, are not eligible for the 20 percent/15 percent/0 percent rates.2 However, a small portion of dividends paid by REITs may constitute qualified dividend income—for example, if the: (1) dividend is attributable to dividends received by the REIT from non-REIT corporations, such as taxable REIT subsidiaries; or (2) income was subject to tax by the REIT at the corporate level, such as built-in gains, or when a REIT distributes less than 100 percent of its taxable income. percent

      REITs that pass through dividend income to their shareholders must meet the holding period test (see Q 700) in order for the dividend-paying stocks that they pay out to be reported as qualified dividends on Form 1099-DIV. Investors must also meet the holding period test relative to the shares they hold directly, from which they received the qualified dividends that were reported to them.3

      Unless designated by the REIT as qualified dividend income, all distributions are ordinary income dividends.4 Ordinary income dividends are included in the shareholder’s (or beneficiary’s) income for the taxable year in which they are received. Shareholders do not include a share of a REIT’s investment expenses in income, nor with the shareholder’s miscellaneous itemized deductions, as is the case with certain other pass-through entities. See Q 731.

      Capital gain dividends. Capital gain dividends are designated as such by the REIT in a written notice to the shareholder (beneficiary).5 The shareholder (beneficiary) reports capital gain dividends as long-term capital gain in the year received, regardless of how long the shareholder has owned an interest in the REIT.6 See Q 700 for the treatment of capital gains and losses, including the lower rates under JGTRRA 2003 (20 percent/15 percent/0 percent) for long-term capital gains incurred on or after May 6, 2003—now made permanent by ATRA—and the availability of the election to include net capital gain in investment income.

      If the total amount designated as a capital gain dividend for the taxable year exceeds the net capital gain for the year, the portion of each distribution that will be a capital gain dividend will be only that proportion of the amount so designated that such excess of the net long-term capital gain over the net short-term capital loss bears to the total amount designated as a capital gain dividend. For example, a REIT making its return on the calendar year basis advised its shareholders by written notice mailed December 30 that $200,000 of a distribution of $500,000 made December 15 constituted a capital gain dividend, amounting to $2 per share. It was later discovered that an error had been made in determining the net capital gain of the taxable year, which turned out to be $100,000 instead of $200,000. In such case, each shareholder would have received a capital gain dividend of $1 per share instead of $2 per share.7

      Generally, ordinary income dividends and capital gain dividends declared for the prior REIT tax year are included in income by the shareholder in the year they are received.8 However, any dividend declared by a REIT in October, November, or December of any calendar year and payable to shareholders on a specified date in such a month is treated as received by the shareholder on December 31 of that calendar year so long as the dividend is actually paid during January of the following calendar year.9

      A REIT may declare but retain a capital gain dividend. If it does so, the REIT must notify its shareholders of the amount of the undistributed dividend and pay federal income tax on the undistributed amount at the corporate alternative capital gains rate, which is currently 35 percent.10

      A shareholder who is notified of an undistributed capital gain dividend is required to include the dividend in computing his or her long-term capital gains for the taxable year that includes the last day of the REIT’s taxable year. However, the shareholder is credited or allowed a refund for the share of the tax paid by the REIT on the undistributed amount; thus, on the shareholder’s income tax return he or she is treated as though the shareholder made an advance payment of tax equal to 35 percent of the amount of the undistributed dividend reported.11 The adjusted basis of a shareholder’s shares in a REIT is increased by the difference between the amount of the undistributed capital gain dividend and the tax deemed paid by the shareholder in respect of such shares.12


      1 .IRC Sec. 857(a).

      2 .See IRC Sec. 857(c); see also National Association of Real Estate Investment Trusts, Policy Bulletin, (5-28-2003).

      3 .IRS News Release IR-2004-22 (2-19-2004).

      4 .Treas. Reg. §1.857-6(a).

      5 .IRC Sec. 857(b)(3)(B).

      6 .IRC Sec. 857(b)(3)(A); Treas. Reg. §1.857-6(b).

      7 .Treas. Reg. 1.857-6(e)(1)(i).

      8 .IRC Sec. 858(b); Treas. Reg. §1.858-1(c).

      9 .IRC Sec. 857(b)(9).

      10 .IRC Sec. 857(b)(3)(A). See IRC Sec. 1201(a).

      11 .IRC Sec. 857(b)(3)(D).

      12 .IRC Sec. 857(b)(3)(D)(iii).

  • 7978. How are REIT stock dividends taxed?

    • In a private letter ruling, the IRS concluded that shareholders who received all or part of a REIT’s special stock dividend would be treated as having received a distribution to which IRC Section 301 applies through the application of IRC Section 305(b)(1). The amount of the stock distribution would be equal to the value of the stock on the valuation date rather than on the date of the distribution. The special dividend qualifies for the dividends paid deduction under IRC Sections 561, 562 and 857 provided the REIT has sufficient earnings and profits.1

      The Service determined in a private letter ruling that a distribution of earnings and profits from a newly established REIT (arising from earnings and profits accumulated during the pre-REIT years), in which shareholders could elect to receive cash, stock, or a combination of both, should be treated as a distribution of property to which IRC Section 301 applies.2

      Temporary Guidance Regarding Certain Stock Distributions after 2009 and before 2013. Recognizing the difficulty faced by publicly traded REITs and mutual funds in preserving liquidity in a capital-constrained environment,3 the Service issued a revenue procedure providing temporary guidance concerning the tax treatment of REIT and mutual fund distributions when shareholders had the ability to elect to receive either cash or stock.4(The guidance formalized the conclusion reached by the Service in several earlier private letter rulings.)5 The Service stated that it will treat a distribution of stock by either a publicly traded REIT or mutual fund as a distribution of property to which IRC Section 301 applies by reason of IRC Section 305(b). The amount of the stock distribution was considered to equal the amount of the money that could have been received instead if:

      (1)the distribution was made by the corporation to its shareholders with respect to its stock;

      (2)stock of the corporation was publicly traded on an established securities market in the United States;

      (3)the distribution was declared on or before December 31, 2012, with respect to a taxable year ending on or before December 31, 2011, whether declared and distributed prior to the close of the taxable year, or whether declared and distributed pursuant to provisions of IRC Sections 855, 852(b)(7), 868, 857(b)(9), or 860;

      (4)pursuant to such declaration, each shareholder could elect to receive his or her entire entitlement under the declaration in either money or stock of the distributing corporation of equivalent value subject to a limitation on the amount of money to be distributed in the aggregate to all shareholders (the “cash limitation”), provided that:

      (a)such cash limitation was not less than 10 percent of the aggregate declared distribution, and

      (b)if too many shareholders elected to receive money, each shareholder electing to receive money would receive a pro rata amount of money corresponding to his respective entitlement under the declaration, but in no event would any shareholder electing to receive money receive less than 10 percent of his entire entitlement under the declaration in money;

      (5)The calculation of the number of shares to be received by any shareholder would be determined, over a period of up to two weeks ending as close as practicable to the payment date, based upon a formula utilizing market prices that was designed to equate in value the number of shares to be received with the amount of money that could be received instead. For purposes of applying item (4), the value of the shares to be distributed was required to be determined by using the formula described in the preceding sentence; and

      (6)With respect to any shareholder participating in a dividend reinvestment plan (“DRIP”), the DRIP applied only to the extent that, in the absence of the DRIP, the shareholder would have received the distribution in money under item (4).6

      Revenue Procedure 2010-12 is effective with respect to distributions declared on or after January 1, 2008 and before January 1, 2013.


      1 .Let. Rul. 200122001.

      2 .Let. Rul. 200348020.

      3 .See National Association of Real Estate Investment Trusts (NAREIT), Letter to Eric Solomon, Assistant Secretary of Tax Policy, Department of the Treasury, October 31, 2008, at: http://www.reit.com.

      4 .Rev. Proc. 2009-15, 2009-4 IRB 356.

      5 .Let. Ruls. 200832009, 200817031, 200618009, 200615024, 200406031, and 200348020.

      6 .Rev. Proc. 2010-12, 2010-1 CB 302, amplifying and superseding Rev. Proc. 2009-15, 2009-1 CB 356, amplifying and superseding Rev. Proc. 2008-68, 2008-52 IRB 1373.

  • 7979. Do REIT dividends give rise to tax preference items for purposes of the alternative minimum tax?

    • REIT dividends ordinarily do not create tax preferences. However, real estate investment trusts do pass through, and each shareholder must report a proportionate share of the REIT’s own tax preference items.1

      For an explanation of the alternative minimum tax, see Q 775.


      1 .IRC Sec. 59(d).

  • 7980. How is a REIT shareholder taxed when the shareholder sells, exchanges, or redeems shares?

    • When a shareholder (or owner of a beneficial interest) sells, exchanges, or redeems shares, the shareholder will generally have a capital gain or loss. The capital gain or loss will be short-term if the shares were held for one year or less; it will be long-term if the shares were held for more than one year. See Q 697 and Q 700 for the treatment of capital gains and losses, including the lower rates for capital gains incurred on or after May 6, 2003—now permanent under ATRA for tax years beginning after 2012. However, if a loss is realized on the sale of shares held less than six months, such loss must be treated as long-term loss to the extent of any capital gains dividend received on those shares during such period. (This six-month period is tolled during any time that the shareholder’s risk of loss with respect to the shares is reduced through certain option contracts, short sales, or offsetting positions in substantially similar property.) A limited exception will, however, be provided by regulation for sales pursuant to a periodic liquidation plan.1

      The gain or loss is the difference between the shareholder’s adjusted tax basis in the shares and the amount realized from the sale, exchange, or redemption (which includes money plus the fair market value of any property received. See Q 690.)2

      If a shareholder’s shares in the REIT were acquired on the same day and for the same price, the shareholder will have little difficulty in establishing the tax basis and holding period of the shares sold, exchanged, or redeemed. However, if the shares were acquired at different times or prices, the process is more difficult; unless the shareholder can “adequately identify” the lot from which the shares being sold or exchanged originated, the shareholder must treat the sale or exchange as disposing of the shares from the earliest acquired lots (i.e., by a first-in, first-out (FIFO) method). If the earliest lot purchased or acquired is held in a stock certificate that represents multiple lots of stock, and the taxpayer does not adequately identify the lot from which the stock is sold or transferred, the stock sold or transferred is charged against the earliest lot included in the certificate.3 In connection with reporting sales of securities to the IRS, brokers will be obligated to provide the customer’s basis in, and holding period for, shares sold, and brokers must use the principles just described to determine which shares were sold (i.e., FIFO if the shares cannot be adequately identified).4 The “average basis” methods discussed in Q 7949 for mutual fund shares are not available to REIT shareholders. For an explanation of how shares may be “adequately identified,” see Q 698.

      See Q 7615 and Q 7616 for the income tax consequences upon the disposition of a position that is held as part of a conversion transaction.


      1 .IRC Sec. 857(b)(7).

      2 .IRC Sec. 1001.

      3 .Treas. Reg. §1.1012-1(c).

      4 .IRC Sec. 6045(g).

  • 7981. What types of REITs are commonly formed?

    • REITs can be broken down into three basic classes: equity, mortgage and hybrid.

      An equity REIT will actually acquire and take ownership of real property. Most equity REITs buy and hold properties for their net rental income. Others seek profits through appreciation in property values. These often try to add value through increasing occupancy levels or by making physical improvements to the property. Equity REITs can be sub-classified by the type of real estate in which they invest. For example, investments may be confined to (or predominantly focused on) office buildings, apartments, shopping centers, warehouses, or medical care facilities, etc. Some equity REITs may diversify their holdings among several different types of real estate.

      Mortgage REITs do not actually own real estate, but rather, they hold mortgages on income-producing commercial properties. Mortgage REITs generally provide a higher current yield than equity REITS, but they lack the opportunity for capital appreciation through increases in property values. Instead, their market valuations will be affected by fluctuations in the prevailing market interest rates.

      Hybrid REITs are simply REITs that invest in both direct property ownership and in mortgages.

  • 7982. What rules exist to restrict the ability of REITs to actively conduct a trade or business?

    • Originally, REITs were developed to serve as passive vehicles through which investors could invest in real estate assets.The IRS has recognized that Congress intended to restrict pass-through treatment of a REIT’s income to the passive income earned by the REIT through its real estate investments, rather than through the active conduct of a business.1

      However, in the intervening years, the IRC has been amended to permit a REIT to participate more actively in the conduct of its real estate business activities.In 2001, the IRS found that a REIT was permitted to engage in the active conduct of the trade or business of producing rental income from real estate property that qualified as such under IRC Section 856(d).2This has significantly expanded a REIT’s ability to engage in the management and operation of the real estate assets from which it derives income.

      Even though a REIT’s ability to actively produce rental income has been expanded, there are still many activities related to the production of rental income in which a REIT is not permitted to directly engage.As a result, many REITs use independent contractors and taxable REIT subsidiaries (see Q 7999) in order to provide the necessary services.For example, a REIT is permitted to own an apartment building and derive its income from the rents received through that investment.In order to generate this rental income, however, the tenants will require certain basic services, such as landscaping of the premises, elevator maintenance, trash collection, etc.The REIT itself can engage independent contractors to perform these services without jeopardizing the status of rental income as income derived from real property.Taxable REIT subsidiaries are treated in the same manner as independent contractors under the regulations.3

      See Q 7991 for a discussion of the types of property that qualify as real estate assets for REIT purposes.


      1 .Rev. Rul. 73-236, 1973-1 CB 183 (finding that a REIT did not impermissibly engage in the active conduct of a trade or business because its property was managed and operated by independent contractors, rather than direct employees of the REIT itself).

      2 .Rev. Rul. 2001-29, 2001-26 IRB 1348.

      3 .Treas. Reg. §1.856-4(b).

  • 7983. What are the general requirements that must be met in order for a REIT to qualify for pass-through tax treatment?

    • As the name suggests, a real estate investment trust (REIT) is required to invest primarily in assets that are closely connected to real estate.Permissible investments include ownership interests in real property, interest derived from loans where the underlying asset is real property and investments in other REITs.1

      Importantly, a REIT is required to distribute 90 percent of its annual earnings to shareholders.A company that meets the requirements described below will qualify as a REIT, and therefore be allowed to deduct from its corporate taxable income all of the dividends that it pays out to its shareholders.Because of this special tax treatment, most REITs pay out 100 percent of their taxable income (rather than simply meeting the 90 percent requirement) to shareholders and, therefore, owe no tax at the corporate level.

      In addition to paying out at least 90 percent of its taxable income in the form of shareholder dividends, a REIT must meet several tests relating to its management, assets, income and diversification.Specifically, a REIT must:

      be an entity that would be taxable as a domestic corporation “but for” its REIT status;

      be managed by a board of directors or trustees;

      have shares that are fully transferable;

      have a minimum of 100 shareholders after its first year as a REIT;2

      have no more than 50 percent of its shares held by five or fewer individuals during the last half of any taxable year;3

      at the close of each quarter, have investments comprising at least 75 percent of its total assets that consist of real estate, cash (including receivables) and government securities.4See Q to Q 7985;

      derive at least 75 percent of its gross income from real estate related sources (real estate related sources include gain on the sale of real property (other than a nonqualified publicly offered REIT debt instrument), gain from the sale of, or dividends derived from, interests in other REITs, rents derived from real property and interest on mortgages financing real property).5See Q 7988 and Q 7989;

      derive at least 95 percent of its gross income from a combination of real estate related sources and dividends or interest (from any source);6 and

      have no more than 25 percent of its assets consist of non-government securities, stock in taxable REIT subsidiaries or nonqualified publicly offered REIT debt instruments (Q 7992).7


      1 .See IRC Sec. 856(c).

      2 .IRC Sec. 856(a).

      3 .IRC Secs. 856(a)(6), (h), 542(a)(2).

      4 .IRC Sec. 856(c)(4)(A).

      5 .IRC Sec. 856(c)(3).

      6 .IRC Sec. 856(c)(2).

      7 .IRC Sec. 856(c)(4)(B).

  • 7984. What is the 90 percent distribution requirement applicable to REITs?

    • In order to qualify for REIT tax treatment, a REIT is required to distribute 90 percent of its income each tax year.1 The calculation of the amount actually distributed is made by taking the sum of (a) 90 percent of the REIT taxable income (REITTI), determined without regard to the deduction for dividends paid and excluding capital gains and (b) 90 percent of the excess of net income from foreclosure property over the tax imposed on such income. Any excess noncash income is then subtracted.2

      Dividends paid within the tax year are taken into account in determining whether the distribution requirement is met, but there are two exceptions to this rule. First, if a REIT declares a dividend in October, November or December of one tax year, those dividends will be deemed to have been paid to the shareholders as of December 31 of that tax year, even if the REIT doesn’t actually pay them until January of the following year.3

      Second, if a REIT declares a dividend before its tax return is due (including extensions) and actually pays the dividend within the twelve-month period following the close of its tax year (and not later than the date of the first regular dividend payment made after the declaration), then the REIT can elect to treat the dividend (or a portion thereof) as though it was paid in the prior tax year.4 The REIT must make the election in the tax return it files for the taxable year and it is irrevocable once made.5 If the REIT elects this treatment, the shareholder is not required to include the dividend in income until the year in which it is actually paid.6

      Failure to Satisfy 90 Percent Distribution Requirement

      In order to qualify for REIT tax treatment, a REIT is required to distribute 90 percent of its income each tax year.7 Issuance of a preferential dividend can cause the REIT to fail to satisfy this distribution requirement, thus jeopardizing qualification for REIT status. The IRS has found that a REIT’s proposal to issue two classes of common stock would result in the creation of a preferential dividend because one class would pay a special dividend designed to shift investment advisory fees. The existence of the preferential dividend operated to disallow the dividends paid deduction, which could have caused the REIT to fail to meet its 90 percent distribution requirement,8 thus failing to qualify as a REIT.

      The IRS rejected the taxpayer’s arguments that (1) no preferential dividend would be created because the two classes of stock qualified as separate classes and (2) each shareholder owning shares of the same class would receive the same amount of dividends as every other shareholder in that class. While the IRS found this might have been permitted if the special dividend was designed to reduce administrative costs, it was not permissible to reallocate investment advisory fees among shareholders with otherwise identical shareholder rights.

      Further, the IRS found that the establishment of two classes was designed to ensure that only shareholders who made investments in the REIT exceeding certain thresholds were eligible to obtain the shares paying the special dividend, creating what the IRS termed a “tiered investment advisory fee structure” while all other shareholder rights were identical. As a result, the two types of shares were not appropriately characterized as separate classes so that a preferential dividend was created.9


      1 .IRC Sec. 857(a).

      2 .IRC Sec. 857(a)(1).

      3 .IRC Sec. 857(b)(9).

      4 .IRC Sec. 858(a).

      5 .Treas. Reg. §1.858-1(b).

      6 .IRC Sec. 858(b),

      7 .IRC Sec. 857(a).

      8 .IRC Sec. 857(a)(1).

      9 .Let. Rul. 201444022.

  • 7985. What is a deficiency dividend? How can a REIT use deficiency dividends to avoid disqualification based on the 90 percent distribution requirement?

    • A deficiency dividend is a dividend paid by a REIT in a later year with respect to an earlier tax year. Deficiency dividends are typically used when it is determined that an adjustment to a REIT’s taxable income for a prior year, and thus to the corresponding amount required to be distributed to shareholders, was required.Any deficiency dividends are required to be paid within ninety days after it is determined that the adjustment was necessary.1

      Determination of whether an adjustment is necessary may be made by a formal court order or may be made by the REIT itself in a statement attached to an amended or supplemental tax return.2As shown in the following example, the REIT can eliminate its tax liability by distributing the entire amount of the adjustment as a deficiency dividend, but cannot eliminate liability for any interest or penalties that result from the adjustment.3

      Example: For 2019, a REIT reports real estate investment trust taxable income (REITTI) of $100, a dividends paid deduction of $100 and thus incurs no tax liability at the corporate level. In 2021, the Tax Court issues a determination that the REIT’s RETTI for 2019 was actually $120.The REIT pays a $20 dividend and files a claim for a dividend deficiency deduction within the required period, and is allowed that deduction for 2019.The REIT therefore has no undistributed REITTI for 2018 and meets its dividend distribution requirement.However, the REIT is still considered to have underreported by $20 and the time for paying its 2019 taxes (including extensions) has expired.The REIT is liable for interest on the $20 under IRC Section 6601 despite the fact that it was granted the dividend deficiency deduction.4

      The REIT shareholder is taxed on the deficiency dividend in the year that the shareholder actually receives the dividend payment (even though the deficiency dividend will, by definition, relate to an earlier tax year).5


      1 .IRC Sec. 860(f).

      2 .IRC Sec. 860(e).

      3 .Treas. Reg. §1.860-3.

      4 .See Treas. Reg. §1.860-3, Ex. 1.

      5 .IRC Sec. 858(b).

  • 7986. What asset tests apply in determining whether a trust qualifies as a REIT?

    • A REIT must satisfy several asset-based tests in order to qualify for pass-through tax treatment as a REIT.The following asset-based tests are applied at the close of each quarter of the taxable year of a REIT’s existence:

      1.The 75 Percent Test: At least 75 percent of a REIT’s assets must consist of cash, cash items (including receivables), real estate assets and government securities.1

      2.The 25 Percent Test: No more than 25 percent of a REIT’s assets may consist of securities (other than securities permitted under the 75 percent test).2

      3.The Taxable REIT Subsidiary Test: No more than 25 percent of the total value of a REIT’s assets may consist of securities of one or more taxable REIT subsidiary.3

      4.The Nonqualified Publicly Offered REIT Debt Test: No more than 25 percent of the total value of a REIT’s assets may consist of nonqualified publicly offered REIT debt instruments.4

      Further, except with respect to a taxable REIT subsidiary and includible government securities, (1) not more than 5 percent of the value of the REIT’s total assets may be represented by securities of any one issuer, (2) the REIT may not hold securities possessing more than 10 percent of the total voting power of the outstanding securities of any one issuer, and the REIT may not hold securities having a value of more than 10 percent of the total value of the outstanding securities of any one issuer.5

      The purpose of these asset-based tests is to ensure that REITs continue to concentrate their investments in the real estate assets for which they were created.See Q 7990 to Q 7992 for a detailed discussion of the types of assets that qualify as permissible REIT assets for purposes of the 75 percent asset test.See Q 7999 for information on taxable REIT subsidiaries.


      1 .IRC Sec. 856(c)(4)(A), Treas. Reg. §1.856-2.

      2 .IRC Sec. 856(c)(4)(B)(i).

      3 .IRC Sec. 856(c)(4)(B)(ii).

      4 .IRC Sec. 856(c)(4)(B)(iii).

      5 .IRC Sec. 856(c)(4)(B)(iv).

  • 7987. What is the definition of “land” that is used in determining whether an asset qualifies as a real estate asset for purposes of the REIT asset tests?

    • In order to qualify as a REIT, at least 75 percent of the REIT’s assets must consist of certain defined assets, including real estate assets (see Q 7986). “Land” is a type of real property asset that qualifies as a real estate asset for this purpose.1 The IRS has recently clarified what types of property constitute “land” in the context of REITs.

      Land includes any water or air space that is adjacent to the physical land itself, and also includes any natural products (such as crops growing on the land) and deposits that remain physically attached to the land. However, once a product is severed from the land (such as when crops are harvested or minerals are extracted) it no longer qualifies as land and is no longer treated as a real estate asset.2

      The new IRS proposed regulations clarify that if crops, minerals or other products that were previously physically attached to the land are stored upon the land after they are severed, such storage does not serve to recharacterize the stored property as “land” for REIT asset testing purposes.


      1 .IRC Sec. 856(c).

      2 .Treas. Reg. §1.856-10(c).

  • 7988. When is an asset considered to be an “inherently permanent structure” so that it qualifies as a real estate asset? Are there any safe harbor provisions?

    • Buildings and other “inherently permanent structures” qualify as real estate assets for purposes of the REIT asset tests (see Q 7991). Proposed regulations addressing the definition of “inherently permanent structure” were finalized in 2016. Generally, an inherently permanent structure is a building or other structure that is reasonably expected to last indefinitely based on all of the surrounding facts and circumstances. However, the final regulations provide that if the asset serves an active function (such as a piece of machinery or equipment) it is not a building or other inherently permanent structure.1 Inherently permanent structures are those that serve a passive function, as described in the regulations as a function that is designed to contain, support, shelter, cover, or protect—rather than an active function, such as one that is designed to manufacture, create, produce, convert or transport.

      The regulations provide a safe harbor listing of the types of assets that will qualify as buildings or other inherently permanent structures without the need for a facts and circumstances analysis. “Buildings” are defined to include houses, apartments, hotels, factory and office buildings, warehouses, barns, enclosed garages, enclosed transportation stations and terminals, and stores, among others.2

      The safe harbor for “inherently permanent structures” includes the following specifically enumerated structures:

      (1)microwave transmission, cell, broadcast and electrical towers,

      (2)telephone poles,

      (3)parking facilities,

      (4)bridges and tunnels,

      (5)roadbeds,

      (6)railroad tracks,

      (7)transmission lines,

      (8)pipelines,

      (9)fences,

      (10) in-ground swimming pools,

      (11) offshore drilling platforms,

      (12 ) storage structures such as silos and oil and gas storage tanks,

      (13) stationary wharves and docks,

      (14 outdoor advertising displays for which an election has been properly made under IRC Section 1033(g)(3).3

      If a structure is not specifically enumerated within the safe harbor provision of the regulations, a facts and circumstances analysis is necessary to determine whether it qualifies as a building or inherently permanent structure for purposes of meeting the REIT asset tests. Q 7991 outlines the analysis that is undertaken if the asset does not qualify for the safe harbor protection.


      1 .Treas. Reg. §1.856-10(d)(2).

      2 .Treas. Reg. §1.856-10(d)(2)(ii)(B).

      3 .Treas. Reg. §1.856-10(2)(iii)(B).

  • 7989. What is a structural component? When will a structural component qualify as a real estate asset for purposes of the REIT asset tests?

    • Structural components of inherently permanent structures also qualify as real estate assets for purposes of the REIT asset tests.1 Structural components are, generally, those assets that are integrated into an inherently permanent structure and serve the inherently permanent structure in its passive function. The proposed regulations provide a safe harbor listing of structural components that qualify as real estate assets as follows:

      (1)wiring,

      (2)plumbing systems,

      (3)central heating and air conditioning systems,

      (4)elevators or escalators,

      (5)walls, floors and ceilings,

      (6)permanent coverings of walls, floors and ceilings,

      (7)windows and doors,

      (8)insulation,

      (9)chimneys,

      (10)fire suppression systems (such as sprinkler systems and fire alarms),

      (11)fire escapes,

      (12)central refrigeration systems,

      (13)integrated security systems, and

      (14)humidity control systems.2

      An asset that is not listed in the safe harbor regulation may still qualify as a structural component that is a real estate asset based on a facts and circumstances analysis that considers several factors, including the following specifically enumerated factors:

      (1)The manner, time, and expense of installing and removing the asset;

      (2)Whether the asset is designed to be moved;

      (3)The damage that removal of the asset would cause to the item itself or to the inherently permanent structure of which it is a part;

      (4)Whether the asset serves a utility-like function with respect to the inherently permanent structure;

      (5)Whether the asset serves the inherently permanent structure in its passive function;

      (6)Whether the asset produces income from consideration for the use or occupancy of space in or upon the inherently permanent structure;

      (7)Whether the asset is installed during construction of the inherently permanent structure; and

      (8)Whether the asset will remain if the tenant vacates the premises.3


      1 .Treas. Reg. §1.856-10(a).

      2 .Treas. Reg. §1.856-10(d)(3)(iiii).

      3 .Prop. Treas. Reg. §1.856-10(d)(3)(iii).

  • 7990. When will an asset be characterized as “cash items, receivables or government securities” for purposes of the REIT 75 percent asset test?

    • In order to qualify as a REIT, at least 75 percent of a REIT’s assets must consist of cash, cash items (including receivables), real estate assets and government securities at the end of each quarter of a REIT’s tax year.1

      For purposes of the 75 percent asset test, the IRS has found that money market fund shares are considered “cash items,” rather than securities, because they have the essential characteristics of cash items—namely, a high degree of liquidity and relative safety of principal.2Certificates of deposit also qualify as cash items because, based on the IRS’ reasoning, the certificates held by REITs are issued in large denominations, mature within one year and are readily tradable on a secondary market.3 Their short-term nature, coupled with an active secondary market, renders these investments sufficiently liquid and low-risk so as to qualify as cash items.

      The term “receivables” has been interpreted to include only receivables that arise in the REIT’s ordinary course of business (rather than receivables that are purchased from another person).4

      “Government securities” include only securities issued by the federal government—state and local securities do not qualify.5The IRS has issued guidance providing that securities issued by the Federal Housing Administration,6 Federal National Mortgage Administration7 and United States Postal Service,8 among others, qualify as government securities.

      For a discussion of what constitutes a real estate asset for purposes of the 75 percent asset test, see Q 7991 and Q 7992.


      1 .IRC Sec. 856(c)(4)(A), Treas. Reg. §1.856-2.

      2 .Rev. Rul. 2012-17, 2012-25 IRB 1018.

      3 .Rev. Rul. 77-199, 1977-1 CB 195.

      4 .Treas. Reg. §1.856-2.

      5 .15 USC 80(a)-2(a)(16).

      6 .Rev. Rul. 64-85, 1964-1 C.B. 230.

      7 .Rev. Rul. 64-85, above, GCM 39626, Rev. Rul. 92-89, 1992-2 C.B. 154.

      8 .Rev. Rul. 71-537, 1971-2 C.B. 262, GCM 34648.

  • 7991. When will an asset be characterized as a real estate asset for purposes of the REIT 75 percent asset test?

    • In order to qualify as a REIT, at least 75 percent of a REIT’s assets must consist of cash, cash items (including receivables), real estate assets and government securities at the end of each quarter of a REIT’s tax year.1

      “Real estate assets” include real property (and interests therein), interests in other REITs (as long as the REIT issuing the interest was properly qualified as a REIT), and mortgage interests in real property.For a discussion of mortgage interests in real property, see Q 7992.

      Congress acknowledged that a REIT that receives new equity capital may have a difficult time quickly finding satisfactory investments that meet the asset-based tests.Because of this, the term “real estate assets” has been defined in the statute to include property attributable to temporary investment in new capital (even if not otherwise a real estate asset) if the property is stock or a debt instrument. This treatment of temporary investments is permitted for only a one year period.2“New capital” for this purpose means an amount the REIT receives either (1) in exchange for stock (or certificates of beneficial interest) in the REIT or (2) in a public offering of debt instruments issued by the REIT which have maturities of at least five years.3

      Real property includes not only the actual land investment, but also any improvements (including buildings) that are made upon that land.4“Interests in real property” include (whether with regard to the actual land or the improvements on the land):

      ownership interests,

      co-ownership interests,

      leasehold interests,

      options to acquire the property, and

      options to lease the property.5

      The definition of real property interests also encompasses timeshare interests (interests that grant the REIT the right to use real property only for a specified portion of each year) and stock in cooperative housing corporations.Mineral, oil and gas royalty interests are specifically excluded from the statutory definition of “interests in real property.”6

      The IRS has applied a “permanence” standard in determining whether improvements upon real property are considered real property for purposes of the REIT asset tests.In one private letter ruling, the IRS found that manufactured homes are “inherently permanent structures” based on examination of the property in light of the following questions:

      1.Is the property capable of being moved, and has it in fact been moved?

      2.Is the property designed to remain permanently in place?

      3.Are there circumstances that tend to show the intended length of affixation to the underlying real property?

      4.How substantial and time-consuming is the job of moving the property?

      5.How much damage will the property sustain if it is moved?

      6.What is the manner of affixation of the property to the land?7

      Inherently permanent structures, which qualify as real property, must serve a passive function. Final regulations released in August 2016 have clarified that assets (such as machinery and equipment) that serve both active and passive functions do not qualify as real property for REIT purposes.8

      The IRS has also ruled privately that so-called “real estate intangibles” can constitute real estate assets to the extent that the value of the intangibles is inextricably linked to the underlying real estate.9In that ruling, a REIT purchased several well-known hotels, the value of which was significantly increased by the goodwill associated with the brand name.The increase in value associated with this goodwill was characterized as “real estate intangibles” for GAAP purposes.The IRS found that the value of the brand names was created by the underlying real estate assets that made the hotels unique—meaning that the names themselves would have no value but for the quality of the physical real estate to which they were attached.As such, these real estate intangibles were treated as real estate assets for purposes of the REIT asset tests. The final regulations provide that intangible assets do not qualify as real property when they are related to services and are separable from the real property itself, but clarify that an intangible asset may be a partial interest in real property and a partial interest that does not qualify as real property.10

      For a discussion of the definitions of cash items, receivables and government securities for purposes of the 75 percent asset test, see Q 7990.Classification of assets owned through a REIT’s interest in a partnership is discussed in Q 7993.


      1 .IRC Sec. 856(c)(4)(A), Treas. Reg. 1.856-2.

      2 .IRC Sec. 856(c)(6)(D)(ii). See also Let. Rul. 9342021.

      3 .IRC Sec. 856(c)(6)(D)(ii).

      4 .Treas. Reg. §1.856-3(d).

      5 .Treas. Reg. §1.856-3(c).

      6 .Treas. Reg. §1.856-3(c).

      7 .Let. Rul. 8931039.

      8 .T.D. 9784; Treas. Reg. §1.856-10.

      9 .Let. Rul. 200813009.

      10 .T.D. 9784.

  • 7992. When will a loan qualify as a real estate asset?

    • In order to qualify as a REIT, at least 75 percent of a REIT’s assets must consist of cash, cash items (including receivables), real estate assets and government securities at the end of each quarter of a REIT’s tax year.1Interests derived from mortgage loans typically qualify as real estate assets because the mortgage interest is really an interest in the underlying real property that secures the loan.

      If a mortgage loan covers both interests in real property and other non-real estate assets, the regulations require that the interest income on the loan must be apportioned between the two types of property.If the loan value of the property equals or exceeds the amount of the loan, all of the interest can be attributed to real property.If the amount of the loan is greater than the loan value of the property, the interest income apportioned to the real property portion is determined by multiplying the interest income by a fraction, the numerator of which is the loan value of the real property and the dominator of which is the amount of the loan.2

      The loan value of the real property is equal to the fair market value of the property on the date the loan is made.3

      The IRS has set forth a safe harbor in Revenue Procedure 2003-65 that allows a REIT to make a loan to a partnership or other disregarded entity where the loan is secured by interests in the entity that owns the real property, rather than directly by the real property, and still count the loan as a real estate asset.4In order to qualify for the safe harbor, the loan transaction must satisfy all of the following criteria:

      The borrower must be a partner in a partnership or sole member of another type of disregarded entity for tax purposes (e.g., the entity cannot have elected to be taxed as a corporation).

      The loan must be nonrecourse.

      The REIT must be granted a first priority security interest in the pledged property (meaning that the REIT’s interest must be superior to that of all other creditors).

      The terms of the transaction must provide that if the borrower defaults, the REIT will replace the borrower as partner in the partnership or sole member of the disregarded entity.

      The borrower must own real property and the terms of the transaction must provide that if the real property is subsequently sold, the loan will immediately become due and payable.

      The value of the real property owned by the borrower must constitute 85 percent or more of the total value of the entity’s assets at each testing date.

      The loan value of the real property owned by the borrower must equal or exceed the amount of the loan made by the REIT (the loan value of the property is reduced by any encumbrances on the real property and any other liabilities of the borrower).

      The interest on the loan must only constitute compensation for the use of money and the determination of interest cannot depend upon the income or profits of any person.


      1 .IRC Sec. 856(c)(4)(A), Treas. Reg. § 1.856-2.

      2 .Treas. Reg. §1.856-5(c)(1).

      3 .Treas. Reg. §1.856-5(c)(2).

      4 .Rev. Proc. 2003-65, 2003-32 IRB 336.

  • 7993. How are the assets and income of a REIT classified if the REIT owns interests in a partnership?

    • A REIT may own interests in a partnership and participate in that partnership as a partner much in the same way as any other taxpayer-entity.For purposes of the asset and income tests applicable to REITs, the REIT will be deemed to own its proportionate share of each of the underlying partnership assets.The characterization given to any partnership asset for partnership purposes is controlling in determining the character of the asset for purposes of applying the REIT asset tests (see Q 7990 to Q 7992).1

      Under the regulations, the REIT’s proportionate interest in a partnership is determined based upon its capital interest in the partnership.The IRS has found that, because a partner’s capital account typically reflects its net investment in the partnership, a REIT’s capital interest in a partnership is determined by dividing the REIT’s capital account balance by the sum of all of the partners’ capital account balances.2

      For purposes of the income tests applicable to REITs, any income realized when a REIT-partner sells its interest in the partnership will be attributable to real property to the extent that the underlying assets of the partnership constitute real property.3


      1 .Treas. Reg. §1.856-3(g).

      2 .See Let. Rul. 200310014.

      3 .Treas. Reg. §1.856-3(g).

  • 7994. What diversification requirements apply in determining whether a trust qualifies as a REIT?

    • In addition to meeting the asset-based tests described in Q 7986, a REIT must satisfy several diversification testswith respect to its assets in order to qualify for pass-through tax treatment as a REIT.The following diversification tests are applied at the close of each quarter of each taxable year of a REIT’s existence:

      1.No more than five percent of the value of a REIT’s total assets may consist of securities of any one issuer (except with respect to taxable REIT subsidiaries (TRS) and securities permitted under the 75 percent test).

      2.A REIT may not hold securities that represent more than ten percent of the voting power of the outstanding securities of any one issuer.

      3.A REIT may not hold securities that represent more than ten percent of the total value of the outstanding securities of any one issuer.1

      The IRC recognizes that the value of securities may fluctuate between quarters.As such, Section 856 provides that if a REIT meets the diversification requirements at the close of any given quarter, it will not fail to meet the requirements in the subsequent quarter unless the failure is due to the acquisition of securities or property and is wholly or partially the result of that acquisition.If a REIT fails to meet the diversification tests at the close of a quarter as a result of an acquisition of securities made during that quarter, it has a thirty day period in which to correct the discrepancy.If the discrepancy is corrected within that thirty day period, the REIT will be treated as having satisfied the diversification test for the quarter.2


      1 .IRC Sec. 856(c)(4)(B)(iii).

      2 .IRC Sec. 856(c)(4).

  • 7995. What are the income-related qualification requirements that a REIT must satisfy?

    • In order to ensure that REITs continue to further the legislative intent that their income should primarily be derived passively from real estate activities, a REIT must satisfy both of the following income tests in order to qualify as a REIT:1

      75 Percent Income Test: At least 75 percent of the REIT’s gross income each tax year must be derived from rents, mortgage interest, gain from the sale of real property, dividends received from other qualified REITs and certain other income derived from real estate sources.

      The 95 Percent Income Test: At least 95 percent of the REIT’s gross income must be derived from (a) items that qualify for the 75 percent income test and (b) income from interest, dividends, gain from the sale of stocks or other securities and certain mineral royalty income.

      Unlike in the case of the asset-based qualification tests, the income-related qualification tests must only be satisfied at the close of each tax year (rather than on a quarterly basis).


      1 .IRC Sec. 856(c)(2) and (c)(3).

  • 7996. What is gross income of a REIT for purposes of the income qualification tests?

    • Gross income, for purposes of the REIT income qualification tests, is determined in the same manner as for any other entity under IRC Section 61.1Therefore, losses from the sale of stock, securities, real property, etc. do not impact the REIT’s gross income.However, the gross income from a REIT does not include amounts realized in a prohibited transaction, which, for REIT purposes, generally means income from the sale of property that has been held primarily for sale to customers in the ordinary course of business.2

      However, the IRC now excepts certain types of sales from the prohibited transaction rules applicable to REITs, so that the term “prohibited transaction” does not include a sale of property which is a real estate asset if:

      (i) the REIT has held the property for not less than two years,

      (ii) aggregate expenditures made by the REIT, or any REIT partner, during the two-year period preceding the date of sale which are includible in the basis of the property do not exceed 30 percent of the net selling price of the property;

      (iii) (I) during the taxable year the REIT does not make more than seven sales of property (other than sales of foreclosure property or sales to which Section 1033 applies), or (II) the aggregate adjusted bases (as determined for purposes of computing earnings and profits) of property (other than sales of foreclosure property or sales to which Section 1033 applies sold during the taxable year does not exceed 10 percent of the aggregate bases (as so determined) of all of the assets of the REIT as of the beginning of the taxable year, or (III) the fair market value of property (other than sales of foreclosure property or sales to which Section 1033 applies) sold during the year does not exceed 10 percent of the fair market value of all of the assets of the REIT as of the beginning of the taxable year, or (IV) the REIT satisfies the requirements of (II), above, applied by substituting “20 percent” for “10 percent” and the three-year average adjusted bases percentage for the taxable year does not exceed 10 percent, or (V) the REIT satisfies the requirements of (III), above, applied by substituting “20 percent” for “10 percent” and the three-year average fair market value percentage for the taxable year does not exceed 10 percent; or

      (iv) in the case of property that consists of land or improvements, but that is not acquired through foreclosure (or deed in lieu of foreclosure), or lease termination, the REIT has held the property for not less than two years for production of rental income.3

      Income earned by qualified REIT subsidiaries that are wholly-owned by the REIT must be included in the REIT’s gross income.4

      A REIT that owns interests in a partnership is also required to include in its gross income the share of partnership income that corresponds to its proportionate ownership share of the partnership’s assets.See Q 7993 for more information on the treatment of partnership interests in the REIT context.


      1 .Treas. Reg. §1.856-2(c)(1).

      2 .IRC Secs. 857(b)(2), 857(b)(6), 1221(a)(1).

      3 .IRC Sec. 857(b)(6)(C).

      4 .IRC Sec. 856(i).

      5 .See, for example, Let. Rul. 9428018.

  • 7997. What is the penalty if a REIT fails to satisfy the income tests?

    • If a REIT fails to meet either of the two income tests for any given tax year, and the failure is due to reasonable cause (rather than willful neglect),1 the REIT will continue to qualify as a REIT for that year, but will be subject to an excise tax equal to 100 percent of the unqualified income.The tax is calculated by dividing 95 percent or 75 percent of the total gross income of the REIT (depending upon which test is failed) by the amount of REIT income that would qualify for the particular test.2

      Once the REIT has determined that it has failed one or both of the income tests for the year, it is required to file a schedule describing each item of its gross income that would qualify for the failed test (or tests) in order to avoid disqualification.3

      If the failure is due to willful neglect, the REIT will be disqualified and will be taxed as a regular corporation the tax year, and for four years following the year of disqualification.4


      1 .IRC Sec. 856(c)(6).

      2 .IRC Sec. 857(b)(5).

      3 .IRC Sec. 856(c)(6)(A).

      4 .IRC Sec. 856(g)

  • 7998. What are the differences between publicly traded REITs, public unlisted REITs and private REITs?

    • REITs, like any other corporate entity, can be listed or unlisted, publicly traded or private.Both publicly traded listed REITs and public unlisted REITs are required to file reports with the SEC, though, as the name suggests, only the shares of publicly traded listed REITs are actually traded on public stock exchanges.A publicly traded listed REIT may choose to list its shares on any national stock exchange, though most are listed on the NYSE.1

      Both publicly traded listed and public unlisted REITs are subject to traditional corporate governance rules, including rules regarding the independence of directors.A publicly traded listed REIT must abide by the rules prescribed by the stock exchange on which it chooses to list shares, while public unlisted REITs are subject to the rules adopted by the North American Securities Administrators Association (NASAA), as well as any applicable state laws.Private REITs are not subject to any external corporate governance rules.

      Some smaller investors may find investing in publicly traded listed REITs more beneficial than investments in unlisted or private REITs.Because both public unlisted REITs and private REITs are not available for purchase on a stock exchange, their shares are typically much less liquid than those of a publicly traded REIT.Shares in REITs that are not publicly listed are typically subject to redemption rules that are set by the individual REIT, and often cannot be redeemed at the will of the investor.

      Further, information about the value of a publicly traded REIT’s shares is widely available, so smaller investors can make knowledgeable investment decisions based on historical performance and the investments underlying the individual REIT.


      1 .See SEC Investor Bulletin: Real Estate Investment Trusts (REITs), available at http://www.sec.gov/investor/alerts/reits.pdf (last accessed May 12, 2020).

  • 7999. What is a taxable REIT subsidiary (TRS)?

    • A taxable REIT subsidiary (TRS) is a corporation in which the REIT owns interests, whether directly or indirectly, if both the REIT and the corporation agree to elect that the corporation will be treated as a TRS.1A corporation will automatically become a TRS if another TRS owns either (a) securities representing 35 percent or more of the voting power of the corporation or (b) securities representing 35 percent or more of the total value of the corporation.2

      Corporations that own or manage lodging or health care facilities cannot qualify as a TRS.3Other than this limitation, a TRS is permitted to provide many of the services that a REIT might otherwise be restricted from providing because of the asset and income tests required to maintain REIT qualification.

      For example, a REIT that owned residential apartment buildings was permitted to use a TRS in order to provide housekeeping services to its tenants without risking disqualification.The services provided by the TRS did not cause the rental income received by the REIT to fail to qualify as income derived from real property even though the REIT itself would have been unable to provide the housekeeping services in question.4


      1 .IRC Sec. 856(l)(1).

      2 .IRC Sec. 856(l)(2).

      3 .IRC Sec. 856(l)(3).

      4 .Rev. Rul. 2002-38, 2002-26 IRB 4.

  • 8000. What is a qualified REIT subsidiary?

    • A qualified REIT subsidiary is a corporation in which the REIT owns 100 percent of the interests—e.g., it is a wholly owned subsidiary of a REIT.A qualified REIT subsidiary is not treated as an entity separate from the parent-REIT, so that all of the income and assets of the subsidiary are considered along with the REIT’s for purposes of the REIT income and asset tests.1

      A subsidiary that has elected to be treated as a taxable REIT subsidiary (see Q 7999) cannot qualify as a qualified REIT subsidiary.2

      If a qualified REIT subsidiary ceases to be 100 percent wholly-owned by the parent-REIT, its status as a qualified REIT subsidiary is terminated and it is treated as a new corporation that acquired all of its assets from the parent-REIT in exchange for its stock.3


      1 .IRC Sec. 856(i)(1).

      2 .IRC Sec. 856(i)(2).

      3 .IRC Sec. 856(i)(3).

  • 8001. Does the Foreign Investment in Real Property Tax Act (FIRPTA) impose any special rules upon foreign individuals who invest in U.S. REITs?

    • Yes. In general, the Foreign Investment in Real Property Tax Act (FIRPTA) imposes a 15 percent tax (10 percent prior to 2016) upon gains or losses stemming from the disposition of a foreign investor’s holdings in any United States real property interest.1 However, special rules apply in the case of REIT distributions of “United States real property interests” involving foreign individuals or corporations. If such a REIT distribution to a nonresident alien or foreign corporation is treated as a gain from the sale or exchange of U.S. real property, the REIT must deduct and withhold a 35 percent tax on the amount distributed.2

      The amount subject to this 35 percent tax is the foreign individual’s proportionate share of the amount of any distribution that is designated by the REIT to be a capital gain distribution.3

      See Q 8002 for a discussion of the exceptions to the general treatment of foreign investments in REITs that can allow foreign individuals and corporations to avoid the 35 percent FIRPTA tax.


      1 .IRC Sec. 1445(a).

      2 .IRC Sec. 1445(e)(6).

      3 .Treas. Reg. §1.1445-8(c)(2)(ii).

  • 8002. Are there any exceptions to the 35 percent tax that is imposed upon certain REIT distributions to foreign individuals under FIRPTA?

    • Yes. While the Foreign Investment in Real Property Tax Act (FIRPTA) imposes a 35 percent tax upon certain REIT distributions to foreign individuals and corporations (see Q 8001), this withholding requirement applies only to gains and losses resulting from a sale or exchange of a United States real property interest. Several exclusions apply to this general rule.

      First, a foreign investor may avoid the 35 percent FIRPTA tax if investing in certain publicly-traded REITs. If the shares of the REIT are regularly traded in a U.S. securities market, a distribution to a foreign individual will not be treated as gain recognized from the sale or exchange of a United States real property interest if the foreign individual (or foreign corporation) does not own more than 10 percent of the REIT shares (5 percent prior to 2016) at any time during the one-year period ending on the date of the distribution.1

      Further, if the REIT qualifies as a domestically controlled qualified investment entity, distributions to foreign individuals or corporations will not be subject to the 35 percent tax because the IRC defines the term “United States real property interest” to exclude interests in a domestically controlled qualified investment entity.2 A domestically controlled qualified investment entity includes a REIT (whether publicly or non-publicly held) in which foreign individuals and corporations own less than 50 percent of the value at all times during the shortest of the following periods:

      (1)The period beginning June 19, 1980 and ending on the date of the distribution;

      (2)The five-year period ending on the date of the distribution; or

      (3)The period that the REIT has been in existence.3

      These rules effectively allow a foreign individual or corporation to avoid the 35 percent tax imposed upon REIT distributions under FIRPTA if the foreign ownership is limited to 5 percent of a publicly-traded REIT or less than 50 percent of any other REIT.


      1 .IRC Sec. 897(h)(1).

      2 .IRC Sec. 897(h)(2).

      3 .IRC Sec. 897(h)(4).