FAQ Real Estate Investment Trust Morrison Foerster | 7 Are there Investment Company Act considerations in structuring and operating a REIT? In addition to a REIT’s beneficial federal income tax treatment, a REIT has other regulatory advantages. Most REITs can qualify for one or more exemptions or exceptions to avoid regulation as an “investment company” under the Investment Company Act of 1940, as amended and the rules and regulations promulgated thereunder (the “Investment Company Act”). Most equity REITs qualify for an exemption under Section 3(c)(5)(c) of the Investment Company Act, which is available for entities that are primarily engaged in … [the business of] purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. The exemption generally applies if at least 55% of the REIT’s assets are comprised of qualifying assets (generally fee and ground lease interests in real estate and the structures thereon) and at least 80% of its assets are comprised of qualifying assets and real estate-related assets. Alternatively, equity REITs can definitionally not be an “investment company” under Section 3(a)(1)(A) of the Investment Company Act because it does not engage primarily, or hold itself out as being engaged primarily, in the business of investing, reinvesting or trading in securities as such REITs are primarily engaged in non-investment company businesses related to real estate. It meets this definitional exception so long as the total value of the REIT’s total assets (exclusive of U.S. government securities and cash items) are less than 40%. Excluded from the definition of “investment securities” are securities issued by majority-owned subsidiaries that are themselves not “investment companies” and that are not relying on the exemptions from the definition of investment company set forth in Section 3(c) Down REIT PARTNERSHIP Down REIT PARTNERSHIP COMMON STOCK COMMON STOCK Down REIT Units Down REIT Units Down REIT Units Down REIT Units 100% 100% 100% PROPERTY OWNING SUBSIDIARY PROPERTY OWNING SUBSIDIARY PROPERTY OWNING SUBSIDIARY PROPERTY OWNING SUBSIDIARY REIT (GENERAL PARTNER) PROPERTY OWNING SUBSIDIARY LIMITED PARTNER LIMITED PARTNER MANAGEMENT/ INSIDERS STOCKHOLDERS The following diagram shows a typical DownREIT structure:
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