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NAREIT Analysis of REIT Provisions in the Senate

(August 2, 1999)

Introduction

On July 30, the Senate approved S. 1429, the Taxpayer Refund Act of 1999, which would reduce taxes by $792 billion over 10 years. During the week of August 2, it will go to conference to be reconciled with the H.R. 2488, the Financial Freedom Act of 1999, as passed by the House of Representatives on July 22. President Clinton has stated that he would veto either bill.

REIT Modernization Act

Fortunately, S. 1429 adopts the same provisions from the REIT Modernization Act of 1999 ("RMA") that have been incorporated in H.R. 2488. As described in detail in the National Policy Bulletin dated July 13, H.R. 2488 adopts the taxable REIT subsidiary (with some beneficial technical changes), 90% distribution test, health care REIT, and other provisions of the RMA except that the provisions would apply a year later (taxable years beginning after 2000). S. 1429 contains the same provisions.

Closely Held REITs

S. 1429 also adopts the same restrictions on closely held REITs (i.e., a REIT 50% or more owned by one person) as H.R. 2488, including an almost identical exception for incubator REITs. In addition, the Senate bill would not apply the closely held REIT test to a company that had filed with the SEC on July 14,1999. Further, S. 1429 would raise some revenue by modifying the estimated tax rules for closely held REITs, effective beginning with estimated payments due on September 15, 1999.

S. 1429 would require any person owning at least 10% of the vote or value of a closely held REIT to accelerate the recognition of year-end dividends attributable to such REIT for purposes of such person's estimated tax payments. It would define a closely held REIT for estimated tax purposes as one in which at least 50% of the vote or value is owned by five or fewer persons. It appears that the estimated tax proposal would apply to owners of REITs that are grandfathered from the proposed new ownership rules on closely held REITs.

Personal Property Rule

The Senate adopted an amendment as part of the "Managers Amendment" offered by Chairman Roth that would change the measurement of the REIT 15% personal property rule from adjusted tax basis to fair market value. This rule would particularly benefit apartment and hotel REITs, and would be effective for taxable years beginning after December 31, 1999.

Related Party Rule

The Senate also adopted on the Floor a change in how a REIT should determine rents from a related party. Under current law, amounts are not considered "real property rents" if a REIT receives them from a person in which the REIT owns 10% or more of its voting stock or the number of shares (regardless of value). S. 1429 would change the rule to a 10% vote or value test, effective for taxable years beginning after December 31, 1999, except for amounts paid pursuant to binding contracts in effect on that date.

Third Party Subsidiary Transition Rule

The Senate also clarified that the "grandfather" rule for existing third party subsidiaries (under which a REIT could continue to own more than 10% of the value of a non-REIT C corporation) would apply only if the REIT does not increase its equity or debt investment in the subsidiaries after July 12, 1999, other than through certain binding contracts and reorganizations.

Other Real Estate Related Provision

Unlike H.R. 2488, S. 1429 would not reduce capital gains rates (other than excluding the first $1,000 of individual capital gains), alter the "at risk" rules, repeal the corporate alternative minimum tax, or exclude from income any dividend or interest income. However, unlike H.R. 2488 S. 1429 would depreciate over 15 years (compared to 39 years under current law) tenant improvements placed into service after 2002.