IRS Reduces Built-in Gains Tax Period for REITs to Five Years

New law ahead road signBy:  Amanda Wilson

One of the key benefits of a real estate investment trust (“REIT”) is that it is effectively a pass through entity for income tax purposes.  While a REIT pays tax on its taxable income, it also receives a dividends paid deduction on dividend distributions to its shareholders.  Since a REIT has to distribute at least 90% of its taxable income ever year, this dividends paid deduction effectively wipes out the REIT’s taxable income, avoiding an entity level tax.

To avoid corporations electing REIT status and then selling their assets under this preferential tax regime, the REIT rules require a REIT to pay a built-in gains tax on any gains that were built-in at the time of the REIT election if the REIT disposes of that property within a specified recognition period.  The built-in gains tax rules for REITs are found in Treasury Regulation Section 1.337(d)-7, which applies the S corporation built-in gains tax rules of Section 1374.

The Protecting Americans Against Tax Hikes Act of 2015 (“PATH Act”) amended Section 1374 to reduce the built-in gain recognition period for S corporations from 10 years to 5 years.  Practitioners expected the IRS to modify Treasury Regulation Section 1.337(d)-7 similarly.  However, the IRS instead issued proposed and temporary regulations in the summer of 2016 that kept the built-in gains tax recognition period for REITs at 10 years.

I am happy to share that today, the IRS backed away from this position, and issued final regulations providing that the recognition period for REITs is the same period provided for under Section 1374.  As a result, the recognition period for REITs has been officially reduced from 10 years to 5 years.   This change will go into effect February 17, 2017, but taxpayers may affirmatively apply this new recognition period for any transactions that occurred on or after August 8, 2106

The PATH Act Brings Important REIT Changes

New law ahead road signBY:  Amanda Wilson

The recently enacted PATH Act included several important changes to the REIT tax rules.  A full discussion of these changes can be found here.



REITs Targeted In Extenders Bill

Capitol buildingBy:   Amanda Wilson

Earlier this year, I discussed the IRS’s recent no rule policy on spin-offs, and how that would likely have a chilling impact on spin-offs, particularly the common practice of businesses spinning off their real estate in a REIT (discussed here).  My prediction is coming true as this week Yahoo announced that it was cancelling its Alibaba spin-off since it could not get an IRS private letter ruling that the spin-off would be tax-free.

Well, REITs are being further targeted.  Yesterday, a two-year tax extenders bill was introduced in the House.  This was not a surprise.  The surprise was that the bill includes two provisions that will have major impacts on REITs.  First, the bill provides that a spin-off of a REIT will only be tax free if, immediately after the distribution, both the distributing and controlled corporations were REITs (the IRS no rule policy had a similar provision).  So a REIT can divide and spin-off its assets, but existing C corporations would no longer be able to spin-off their real estate in a REIT.  If enacted, this provision would currently apply to deals in progress.  In other words, any spin-offs currently in the planning stage wouldnot be grandfathered in and would be killed by this bill.

The bill also introduces a new rule that targets fixed percentage rent and interest income received from a related party.  If a REIT receives such rent or income from a single C corporation tenant and it exceeds 25% of the combined rent and interest income received by the REIT, the new bill would provide that this income no longer qualifies as rents from real property and interest (i.e., is no longer good REIT income).

Stay tuned to see what happens!


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