FAQ Real Estate Investment Trust Morrison Foerster | 20 the foregoing rules. The REIT requirements expressly respect the good faith value determinations of the directors or trustees of a REIT. A REIT generally will not fail the asset tests solely as a result of fluctuations in the values of its assets (and not attributable to the acquisition of any additional asset). What ability does a REIT have to cure an asset test violation? Upon a failure of any of the asset tests (other than de minimis failures of the 5% or 10% securities ownership restrictions, described below), REIT status will not terminate, provided: (i) the REIT files with the IRS a schedule describing the assets resulting in such failure; (ii) the failure was due to reasonable cause; (iii) the failure is corrected within 6 months of discovery; and (iv) the REIT pays a penalty of $50,000 or, if greater, the highest corporate tax rate generally multiplied by the net income generated by the assets causing the failure. ▪ De minimis failure of 5% or 10% securities ownership restriction – Additionally, upon a failure of the 5% or 10% securities ownership restrictions, REIT status will not terminate if: (i) the failure is due to ownership of assets valued at the lesser of (a) 1% of the REIT’s total assets or (b) $10,000,000; and (ii) the failure is cured within 6 months. What are the REIT income test requirements? For each taxable year, a REIT must satisfy the following two gross income tests. A REIT that is a partner in a partnership generally will be treated as earning a proportionate share of each item of partnership gross income, based on its capital interest in the partnership. ▪ 75% Income Test – A REIT must derive at least 75% of its annual gross income (excluding income from prohibited transactions, discussed below) from “rents from real property,” qualifying interest on mortgages (and amounts paid for entering into agreements to make such loans or to purchase or lease real property or mortgages), gains from the sale of real property or mortgages not held as a “dealer,” dividends and gain with respect to other REIT stocks not held as a “dealer,” income attributable to stock or debt instruments from the investment, for up to one year, of capital received from (i) the issuance of stock (other than pursuant to a DRIP) or (ii) publicly offered debt with maturities of at least 5 years, and certain other real estate-related items. ▪ 95% Income Test – At least 95% of the REIT’s annual gross income (excluding income from prohibited transactions, discussed below) must consist of items qualifying under the 75% test, plus dividends, non-mortgage interest income and gains from sales of stock or securities not held as a “dealer.” What are the consequences of a REIT failing one or more of the REIT qualification requirements? Generally, if a REIT fails any of the above requirements for qualification as a REIT, and no exception applies, its REIT status will terminate for the taxable year of the failure, and the REIT (and certain successor entities) may not re-elect REIT status until the fifth taxable year after which REIT status was lost or revoked (unless the loss of REIT status was not due to willful neglect or fraud). However, an entity’s REIT status will not terminate if any such failure is due to reasonable cause and the REIT pays the applicable penalty for such failure ($50,000 for failures of requirements other than the asset and income tests and formulaic penalties for failures of the asset and income tests). A failure of either the 75% or 95% gross income tests will not result in termination of REIT status, provided (i) the failure was due to reasonable cause; and (ii) the REIT files with the IRS a schedule describing each item of its gross income qualifying under those tests. Additionally, the REIT will be required to pay a penalty equal to the amount by which it failed the relevant test or tests, multiplied by a fraction that is intended to reflect the REIT’s overall profitability. What are the requirements to qualify as “rents from real property”? Subject to the exceptions below, amounts generally will qualify as “rents from real property” if they are attributable to the use of, or the right to use, real property of the REIT, and personal property leased in connection with real property, provided not more than 15% of the rent under any lease for any year is attributable to personal property.
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