Updated August 11, 2022
A real estate investment trust (REIT) is an organization that is taxable as a corporation that invests principally in real estate and mortgages and elects special tax treatment. A REIT, in contrast to other corporations, may deduct dividends it distributes to its shareholders allowing it to serve as a conduit. However, a REIT election is available only if the corporation satisfies certain requirements in the Internal Revenue Code. These requirements include provisions on the REIT’s organization, structure, distributions, and perhaps most importantly, its sources of income.
To qualify as a REIT, the corporation’s income must be primarily derived from passive real estate investments. If more than the statutorily mandated amount of the REIT’s income is derived from unallowed sources, the corporation fails the test and is no longer allowed the conduit treatment.
Notably, one such allowed source is gross income from rental of real property, including amounts received for services customarily furnished in connection with the rental of real property, whether or not separate charges are made for those services (IRC §856(d)(1)(B)). While this seems to limit the scope of services a REIT can offer to those only customarily furnished in connection with the rental of real property, if additional services are provided through a taxable REIT subsidiary (TRS), the REIT can pass the income test.
A REIT is not treated as providing services or management when the services are provided by a TRS. A TRS is a corporation in which the REIT owns stock (either directly or indirectly) and which elects, with the REIT, to be treated as a TRS. This rule applies even if no separate charge is imposed on tenants for the services of the TRS. Thus, a TRS may provide services other than customary services to tenants of the REIT's property without disqualifying the amounts received by the REIT from treatment as rents from real property.
Example #1: A REIT (R) that owns an apartment building uses a taxable REIT subsidiary (T) to provide non-customary housekeeping services to tenants of R's building. T does not impose a separate charge on the tenants for the services. However, R pays T a fee for the services. The housekeeping services are treated as provided by T and do not disqualify the rents received by R from being treated as real property rents.
Example #2: A REIT that has previously provided telecommunications services through an independent contractor because it was not certain whether the services are customary services may provide these services through its TRS.
Besides providing services to tenants of the REIT’s property, a TRS may also provide services, including management and operating services, to third parties that are unrelated to the REIT.
Example #3: Where a TRS entered into a partnership with an unrelated corporation that qualified as an independent contractor and the partnership provided non-customary services to tenants of the REIT's properties, the services did not disqualify the rents received by the REIT from being treated as real property rents.
These examples highlight only a few of the many possibilities available to ensure your company can provide a breadth of services and still enjoy the benefits of REIT taxation.
If you have a corporation that is currently treated as a REIT, or if you are considering purchasing real estate and are interested in the benefits that a REIT can provide, contact our experts.
