Real Estate Investment Trust Simplification Act of 1997 ("REITSA")

Floor Statement By Senator Orrin G. Hatch On REITSA
[VOL. 143 Cong. Rec. S5611 (Daily Ed., June 12, 1997)]

Mr. HATCH. Mr. President on behalf of myself and Senators Baucus, Mack, and D'Amato, I rise today to introduce the Real Estate Investment Trust Tax Simplification Act of 1997. This legislation would simplify and reform the tax law concerning Real Estate Investment Trusts [REITs]. Similar legislation has been introduced in the House by Representative E. Clay Shaw, Jr. along with many of our House colleagues.

REITs were designed to allow small investors to invest in large real estate projects that they otherwise could not afford, including apartment buildings, office buildings, shopping centers, malls, warehouses, etc. Real Estate Investment Trusts have become a very popular form of investment as indicated by the fact that the market capitalization in the whole industry has risen from $9 billion in 1991 to over $100 billion today.

Mr. President, if a REIT properly follows all of the rules, it is not normally taxed at the entity level, but passes through most items of income to the shareholders to report on their own individual tax returns. However, there are many minefields for the unwary that can inadvertently penalize investors and even the general public in some circumstances. This bill is designed to alleviate these complexities and uncertainties.

Let me share with my colleagues an example of the difficulties facing small investors. Under the current rules, in order to gain the benefits of REIT taxation, the investment has to be passive in nature. Hence, the normal procedure is for the REIT to buy the underlying property and lease it out to tenants. However, the REIT must be careful not to provide directly to the tenants any services that are not customary in the real estate business. If this rule is violated, severe consequences can follow. For example, under a literal interpretation of the law, if a REIT that operates a retail mall provides wheelchairs to the customers of the retail tenants, or even assists the tenant in moving into its space, the entity's very status as a REIT could be placed in jeopardy. This is ridiculous and needs to be changed.

Furthermore, current law imposes a tax on a REIT that retains capital gains and imposes a second level of tax on the REIT shareholders when they later receive the capital gain distribution. We need to make the changes necessary to help unsuspecting investors to avoid double taxation. This bill would adopt the corresponding mutual fund rules governing taxation of retained capital gains by passing through a credit to shareholders capital gains taxes paid at the corporate level. The bill would also conform a REIT's 95-percent annual distribution requirement to a mutual fund's 90-percent requirement.

Mr. President, this bill also relaxes some of the current law's onerous penalties for failing to perform some recordkeeping requirements. Currently, a REIT could lose its favored tax status simply by failing to send out or receive back shareholder demand letters for the purpose of verifying the fact that no five or fewer parties own controlling interest in the REIT. So, even though the REIT in fact meets this test, Mr. President, simply by failing to have on file sufficient shareholder letters substantiating this fact, all of the REIT shareholders could face the extremely harsh penalty of REIT disqualification and double taxation.

Rather than penalizing the REIT so severely for this oversight, Mr. President, this bill would impose a $25,000 penalty for failing to comply with this requirement, if the failure is inadvertent in nature. The penalty would rise to $50,000 in the case of willful noncompliance. I believe my colleagues would agree that this approach makes much more sense than the current rules. It serves as an adequate incentive to keep the appropriate records without causing the unsuspecting, innocent investors severe and unnecessary tax penalties.

Mr. President, this bill also addresses other problems that are detailed in the summary of the bill that I ask unanimous consent to be included in the RECORD after my remarks.

I do not believe this bill is controversial. And, according to the Joint Committee on Taxation, it will have a negligible effect on revenues. It is also important to note that this bill is endorsed by the National Association of Real Estate Investment Trusts, which represents a high percentage of the REIT industry. Whenever we can do things to simplify the Tax Code without causing substantial revenue loss or negative policy consequences we should do it.

Mr. President, this is an opportunity for us to do just that in the area of real estate investment trusts. I urge my colleagues on both sides of the aisle to join me in reforming and simplifying the tax law regarding this very difficult and complex area of the law.

Mr. President, I ask unanimous consent that the text of the bill and a detailed summary of its provisions be printed in the RECORD.