NAREIT's "Talking Points" on Built-in Gains (March 9, 1998)

Current law

With one important exception, a C corporation that elects S corporation, REIT or mutual fund status is subject to a double level tax as if it sold its assets and distributed the proceeds to its shareholders. The exception allows the corporation to make an election under Code section 1374 to defer this double tax on the "built in gain." In exchange, the tax on these gains is recognized if the corporation sells these assets within 10 years after making the section 1374 election.

Administration Proposal

The Administration's proposed budget for Fiscal Year 1999 would not allow any C corporation to use the section 1374 election if it is worth at least $5 million. This proposal, estimated to raise $144 million over five years, would apply to elections for taxable years beginning after January 1, 1999, or to mergers effective after 1998. This proposal is essentially the same as the proposals contained in the Administration's budgets for Fiscal Years 1997 and 1998, but that were not adopted by Congress.

NAREIT Position

NAREIT continues to oppose this proposal.

  • The current 10-year "toll charge" is a sufficient barrier to prevent any tax abuse.


  • The proposal effectively would prevent small investors in REITs from benefiting from large portfolios of properties currently owned by C corporations.


  • Real estate is capital intensive, and therefore the $5 million threshold would mean that section 1374 would be meaningless with respect to REITs.


  • Although the Administration supports this proposal as equating an S corporation or REIT election with converting to a partnership, there are significant differences between a REIT and a partnership. For example, a REIT cannot pass through losses to its investors.