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Forming a Real Estate Investment Trust

The following generally summarizes some of the basic tax law requirements applicable to REITs. These rules are complex, and the following is only a general summary. In order to qualify as a REIT, an entity must meet a number of organizational, operational, distribution, and compliance requirements. If the REIT satisfies these requirements, it will be entitled to deduct any dividends paid from its taxable income. A REIT that distributes 100 percent of its taxable income therefore will have no federal income tax liability. Although state tax laws relating to REITs vary, most states with an income-based tax regime follow the federal law and permit a REIT a "dividends paid deduction."

1. Organizational
2. Operational
3. Distribution
4. Compliance
5. Examples of Law Firms with REIT expertise
6. Examples of Accounting Firms with REIT expertise
7. Examples of Investment Banking Firms with REIT expertise
8. Other

1. Organizational

A REIT must be formed in one of the 50 states or District of Columbia as an entity taxable for federal purposes as a corporation. It must be governed by directors or trustees, and its shares must be transferable. Beginning with its second taxable year, a REIT must meet two ownership tests: it must have at least 100 different shareholders (the "100 Shareholder Test"), and 5 or fewer individuals cannot own more than 50% of the value of the REIT's stock during the last half of its taxable year (the "5/50 Test"). These ownership requirements generally mean that the REIT structure is not a good choice for a closely held family business. A number of "look through" rules currently apply when determining whether the REIT meets the 5/50 Test.

In an attempt to ensure compliance with these tests, most REITs include percentage ownership limitations in their organizational documents. For example, many REITs do not permit any one shareholder to own more than at most 9.9% of a REIT's stock without a waiver by the REIT's board of directors. Because of the need to have 100 shareholders and the complexity of both of these tests, general legal, and tax and securities law advice are strongly recommended prior to beginning the process of forming a REIT.

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2. Operational

The REIT must satisfy two annual income tests and a number of quarterly asset tests that are designed to ensure that the majority of the REIT's income and assets are derived from real estate sources.

Annually, at least 75% of the REIT's gross income must be from real estate-related income such as rents from real property and interest on obligations secured by mortgages on real property. Additionally, 95% of the REIT's gross income must be from the above-listed sources, but can also include other passive forms of income such as dividends and interest from non-real estate sources (like bank deposit interest). As a result of these rules, no more than 5% of a REIT's income can be from nonqualifying sources, such as from service fees or a non-real estate business. A REIT can own up to 100% of the stock of a "taxable REIT subsidiary" ("TRS"), a corporation with which a REIT makes a joint election that can earn such income.

Quarterly, at least 75% of a REIT's assets must consist of real estate assets such as real property or loans secured by real property. Although a REIT can own up to 100% of a TRS, a REIT cannot own, directly or indirectly, more than 10% of the voting securities of any corporation other than another REIT, TRS or qualified REIT subsidiary ("QRS"), a wholly-owned subsidiary of the REIT whose assets and income are considered owned by the REIT for tax purposes. Nor can a REIT own stock in a corporation (other than a REIT, TRS or QRS) the value of whose stock comprises more than 5% of a REIT's assets. Finally, the value of the stock of all of a REIT's TRSs cannot comprise more than 25% of the value of the REIT's assets.

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3. Distribution

In order to qualify as a REIT, generally, the REIT must distribute at least 90% of the sum of its taxable income. To the extent that the REIT retains income, it must pay tax on such income just like any other corporation.

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4. Compliance

In order to qualify as a REIT, a company must make a REIT election. The REIT election is made by filing an income tax return on Form 1120-REIT. Because this form is not due until, at the earliest, March 15th following the end of the REIT's last tax year, the REIT does not make its election until after the end of its first year (or part-year) as a REIT. Nevertheless, if it desires to qualify as a REIT for that year, it must meet the various REIT tests during that year (with the exception of the 100 Shareholder Test and the 5/50 Test, both of which must be met beginning with the REIT's second taxable year.) Additionally, the REIT annually must mail letters to its shareholders of record requesting details of beneficial ownership of shares. Significant monetary penalties will apply to a REIT that fails to mail these letters on a timely basis.

For more information concerning the legal requirements applicable to REITs, please consider purchasing West Group's publication "Real Estate Investment Trusts Handbook."

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5. Examples of Law Firms with REIT expertise:

Alston & Bird LLP
Rosemarie Thurston
rosemarie.thurston@alston.com

Goodwin Procter LLP
Gilbert G. Menna
gmenna@goodwinprocter.com

Greenberg Traurig, LLP
Judith D. Fryer
fryerj@gtlaw.com

Hogan Lovells
David W. Bonser
david.bonser@hoganlovells.com

Locke Lord LLP
Bryan L. Goolsby
bgoolsby@lockelord.com

Morrison and Foerster
David Slotkin
dlotkin@mofo.com

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6. Examples of Accounting Firms with REIT expertise:

Deloitte LLP
Robert T. O'Brien
robrien@deloitte.com

Ernst & Young LLP
Robert W. Lehman
robert.lehman@ey.com

Grant Thornton LLP
Gregory E. Ross
Greg.ross@us.gt.com

KPMG LLP
Andrew Corsini
acorsini@kpmg.com

PricewaterhouseCoopers LLP
Thomas Wilkin
tom.wilkin@us.pwc.com

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7. Examples of Investment Banking Firms with REIT expertise

Bank of America Merrill Lynch
Jeffrey D. Horowitz
jeff.horowitz@baml.com

Barclays Capital
Scott Schaevitz
scott.schaevitz@barclays.com

BMO Capital Markets
Mark Decker Jr.
mark.deckerjr@bmo.com

Citi Global Markets Inc.
Paul J. Ingrassia
paul.j.ingrassia@citi.com

Credit Suisse
Andrew Richard
andy.richard@credit-suisse.com

Eastdil Secured
David Lazarus
dlazarus@eastdilsecured.com

Goldman Sachs & Co.
Michael Graziano
mike.graziano@gs.com

Greenhill & Company, LLC
Richard J. Lieb
rlieb@greenhill.com

J.P. Morgan
Jonathan Gerber
jonathan.gerber@jpmorgan.com

Morgan Stanley
Guy Metcalfe
guy.metcalfe@morganstanley.com

Raymond James
Vivek Seth
vick.seth@raymondjames.com

RBC Capital Markets
John C. Brady
john.brady@rbccm.com

Stifel Nicolaus Weisel
Chad Gorsuch
cmgorsuch@stifel.com

U.S. Bank
John E. Besse
John.besse@usbank.com

UBS Investment Bank
Peter E. Baccile
peter.baccile@ubs.comTOP


 

8. Other

Chatham Financial 
Michael Bontrager
mbontrager@chathamfinancial.com

Green Street Advisors
Mike Kirby
mkirby@greenstreetadvisors.com

Real Foundations
David W. Stanford
david.stanford@realfoundations.net

Willis
Joe Downey
joe.downey@willis.comTOP


Disclaimer

Please note that the discussion set forth above is for informational purposes only and is not intended to constitute legal or tax advice. Because the formation and operation of a REIT involves many complex legal, securities, tax and accounting rules, we strongly advise you to seek professional advice from competent attorneys, accountants, and other advisors prior to beginning the process of forming a REIT. Since we are not providing legal advice through this Web site, you should not rely upon any information contained herein for any purpose without seeking legal and/or tax and accounting advice from a duly licensed attorney or tax practitioner.