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Limitations on Liquidating REITs

Archer, Roth Introduce Bill to End Abusive REIT Transactions:
Limitations on Liquidating REITs

Background

As discussed at the Government Relations Committee meeting on May 6, over the past few months the Treasury Department and the Administration had become aware of transactions in which a corporation eliminated taxes on certain items of income by sponsoring a private REIT or mutual fund. At the GRC meeting, we reported that it appeared that policy-makers had decided to address this structure legislatively rather than through administrative action. Last week, proposed legislation was introduced to end the tax benefits derived from these transactions.

Targeted Transactions

The transactions addressed by the proposed legislation typically involved a non-REIT corporation setting up a private REIT or mutual fund (sometimes for state tax planning purposes) in which it owned 80% or more of the equity. After some 'seasoning," the non-REIT corporation would plan to liquidate the REIT. For the next three years, the recipient corporation would not pay tax on the REIT's distributions, which continued to be eligible for the dividends paid deduction. The net effect was that the corporation and the REIT did not pay taxes on the REIT's earnings (typically, mortgage interest) during the liquidation period.

Proposed legislation

On May 22, Senators Roth (R-DE) and Moynihan (D-NY) and Representative Archer (R-TX) introduced legislation (H.R. 3947 and S. 2122) that would end the tax benefits arising from the transactions described above. The proposed legislation would raise over $8 billion over five years, and we expect that it likely will be included in a tax bill this year.

The proposed legislation introduced by the senior members of the tax-writing committees, and supported by the Treasury Department, would require all owners of a liquidating REIT to recognize the liquidating REIT's dividends as income, effective for distributions made after May 21, 1998. (Note that a REIT that receives liquidating dividends from another REIT could reduce its corporate tax liability by distributing the dividends to its own shareholders.) H.R. 3947 and S. 2122 would not otherwise change the treatment of REIT distributions. For example, the liquidating REIT would continue to not recognize gain on any distribution.

NAREIT fully supports this legislation and is pleased that its sponsors, acknowledging the importance of REITs, specifically designed rules to end the abuse raised by the transactions while not negatively affecting the REIT industry. The sponsors of the legislation stated: "RICs and REITs are important investment vehicles, particularly for small investors.....This legislation will not affect the intended beneficiaries of the RIC and REIT rules."

We will keep you advised of further developments with respect to this legislation, as well as the 1999 Fiscal Year budget. Questions should be directed to the Government Relations Department at 800-3NAREIT.