FAQ Real Estate Investment Trust Morrison Foerster | 21 Payments received from hotel guests and residents of healthcare or nursing/long-term care facilities will generally not qualify as “rents from real property,” since the portion of the payments attributable to services provided are so significant relative to the portion for the mere use of space (see “How can a REIT earn qualifying ‘rents from real property’ from hotels or healthcare facilities?” below). What types of rents do not qualify as “rents from real property”? Subject to certain limited exceptions, the following do not qualify as “rents from real property”: ▪ Rents from personal property leased with real property, if the personal property exceeds 15% of the total rent; ▪ Rents based, in whole or in part, on the income or profits derived by any person from the property, e.g., a percentage of the net (as opposed to gross) income of a tenant; ▪ Rents from any person in which the REIT owns, actually or constructively, a 10% interest; and ▪ Rents from any property if the REIT provides services to the tenants, other than (i) services not rendered primarily for the benefit of or those customarily provided in connection with the leasing of space for occupancy only (such as heat, lighting, common area maintenance, etc.), which services may be provided directly by the REIT; (ii) services provided through an “independent contractor” from whom the REIT does not derive or receive any income (provided separately charges are imposed on the tenant for non-customary services); or (iii) services provided through a TRS (regardless of whether separate charges are imposed). What is a Taxable REIT Subsidiary? A taxable REIT subsidiary (“TRS”) is a corporation that is owned directly or indirectly by a REIT and has jointly elected with the REIT to be treated as a TRS for tax purposes. A TRS is subject to regular corporate income tax. The primary function of a TRS is to engage in activities and/or earn income or gain that could not be earned by the REIT itself without resulting in negative tax consequences to the REIT or even potential REIT disqualification. Any transactions between a REIT and its TRS must be on arms-length terms, and a TRS must be adequately compensated for any services it provides for the REIT or its tenants. Some examples of how a TRS may be utilized include: ▪ The lease by a REIT of lodging or healthcare properties to its TRS (as described below), which, if operated by or on behalf of the REIT itself, would generate non-qualifying REIT income; ▪ The provision by a TRS of certain impermissible services to tenants of the REIT, which, if provided directly by the REIT, could result in the disqualification of some or all of the rental income earned by the REIT from such tenants; ▪ The holding and sale by a TRS of property that, in the hands of the REIT, could be characterized as “dealer property,” the gain on which would be subject to a 100% prohibited transactions tax; and ▪ Earning certain mortgage servicing fees that would be non-qualifying income in the hands of the REIT. How can a REIT earn qualifying “rents from real property” from hotels or healthcare facilities? A REIT can lease to its TRS a “qualified lodging facility” or a “qualified healthcare property.”5 The rents earned by the REIT can be qualifying rents from real property even though the REIT owns in excess of 10% of the TRS. However, all of the other exclusions to “rents from real property” will apply to these TRS leases (including the exclusion of rents based on net income and rents attributable to personal property that exceed 15% of total rents). 5 A “qualified lodging facility” generally includes a hotel or motel or other establishment if (i) more than one-half of the dwelling units are used on a transient basis and (ii) wagering activities generally are not conducted. A “qualified healthcare property” generally includes a hospital, nursing facility, assisted living facility, congregate care facility, qualified continuing care facility (as defined in Section 7872(g)(4) of the Code),\ or other licensed facility that extends medical or nursing or ancillary services to patients.
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