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IRS working group to review process for qualifying for REIT status

The IRS designates certain companies as qualifying for real estate investment trust status (REIT). REITs are essentially mutual funds that invest in commercial real estate, wherein individual investors earn a share of the income produced by this real estate without having to buy actual pieces of commercial property. Created in the 1960s, REITs were intended to allow middle-income Americans the chance to invest in income-producing commercial property. REIT status is beneficial because it allows entities with such status to avoid paying corporate taxes.

Recently, concerns have arisen regarding the number of companies that have been granted REIT status. Some argue that many REITs obtain favorable tax status while operating primarily as conventional businesses. One concern leading to the creation of the IRS working group is the fact that REITs are also increasingly engaging in cost-sharing agreements with corporate affiliates both in the United States and abroad that do pay corporate taxes. Certain agreements between REITs and their tax-paying affiliates have been employed as tax avoidance measures.

In order to determine if a company is entitled to REIT status, the IRS has created a working group to more accurately define what a REIT company should look like. Currently, there are several requirements a business entity must meet in order to qualify:

  • The company must have 75 percent of its assets in real estate.
  • The company must obtain 75 percent of its income from rents, sales of real estate or interests on mortgages.
  • The company must also be subject to taxation.
  • The company must pay at least 90 percent of its taxes from shares of dividends each year.

REITS must also operate as other businesses do with regard to regulatory and financial reporting and comply with any rules and regulations of public exchanges such as the NYSE or NASDAQ. Currently, more than 160 REIT companies are on the major stock exchanges.

The current status of the taxation of REITs is a controversial matter that can easily affect a company's bottom line. For example, the storage company Iron Mountain recently received a "tentatively adverse" ruling from the IRS regarding whether its racking storage units qualified as a REIT. Its shares subsequently dropped by 15 percent. It is unclear what conclusions the IRS working group will reach regarding the requirements to qualify as a REIT. Many experts believe that it would be best if the IRS was not the sole arbiter in the determination of what entities are entitled to REIT status, and contend that Congress should tackle this issue by enacting further legislation to govern the granting of REIT status. It remains to be seen whether Congress will act on the matter.

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