Nareit Summary of Real Estate Provisions in H.R. 2488 as Passed by the House of Representatives


(July 22, 1999)







On July 22, the House of Representatives approved H.R. 2488, the Financial Freedom Act of 1999, which would provide $792 billion in tax relief. H.R. 2488 contains several items affecting real estate, including all of H.R. 1616 (the REIT Modernization Act of 1999), a limit on closely held REITs, and a reduction of the real estate depreciation recapture rate. H.R. 2488 will go to conference after the Senate passes the Taxpayer Refund Act of 1999, expected late in the week of July 26.

REIT Modernization Act of 1999

Taxable REIT Subsidiaries. As described in greater detail in the Government Relations section of, the centerpiece of H.R. 1616 is a change that would allow a REIT to own up to 100% of the stock of a taxable REIT subsidiary ("TRS") that could provide a limited amount of services to a REIT's tenants and others. H.R. 1616 would change current law by allowing a REIT to have voting control of subsidiaries that provide services to third parties, and to provide "non-customary" services to the REIT's tenants through a TRS without disqualifying the rents the REIT receives from those tenants.

H.R. 2488 adopts the TRS provisions of H.R. 1616, with two exceptions. First, H.R. 2488 would not apply the new 10% vote or value test to certain debt securities. Under H.R. 2488 (and under H.R. 1616), a REIT could not own more than 10% of the vote or value of an issuer's securities, as defined under the Investment Company Act of 1940, with the exception of a TRS. The 1940 Act's definition of securities is broad and could well apply to debt securities. H.R. 2488 recognizes this possible overreach by excepting from the 10% vote or value test "safe harbor debt," which is non-contingent, non-convertible debt issued by a REIT that is actively engaged in the business of lending money, so long as the REIT owns no other securities of the issuer. A further exception would be made for a REIT's loan to a partnership in which the REIT owns at least 20% of its profits.

Second, the effective dates have been changed. The TRS provisions of H.R. 1616 would have applied to taxable years beginning after December 31, 1999. H.R. 2488 would apply instead to taxable years beginning after December 31, 2000. This change in effective date reduces the revenue cost of the TRS provisions for the 10-year period that the tax writers must forecast under the budget rules. Further, the effective date of the "grandfather rule" (under which the 10% vote or value test would not apply to securities held by a REIT) would be deferred from April 28, 1999 (the date H.R. 1616 was introduced) to July 12, 1999.

Other RMA Changes. Again effective for taxable years beginning after 2000, H.R. 2488 would (1) restore the 90% distribution requirement; (2) liberalize the foreclosure property rules for health care facilities; and (3) codify current practice in determining whether a publicly traded entity qualifies as an independent contractor. Effective for distributions made after 2000, H.R. 2488 would remove some traps for the unwary with respect to two computational rules relating to a REIT's requirement to distribute non-REIT earnings and profits.

Closely Held REITs

H.R. 2488 adopts the Administration's proposal to prohibit any entity from owning 50% or more of the vote or value of a REIT's stock. However, H.R. 2488 makes three important exceptions, all supported by Nareit.

First, as with the current "five or fewer" and 100 person ownership tests, the closely held test would not apply to a REIT's first taxable year in order to allow a REIT some time in which to comply with these complex rules.

Second, the new 50% test would not apply to "incubator REITs." To qualify for the exception, the entity must satisfy a number of requirements, e.g. having only one class of stock and owning less than half of its real estate assets as mortgages. The incubation period would last for the second and third taxable years of the REIT, and it could be extended for up to two more taxable years. However, if the incubator REIT did not engage in a "going public" transaction after this extended period, the tax benefits of being a REIT during this period would be reversed retroactively.

Third, the closely held REIT test would not apply to REITs or pension plans that own 50% or more of a REIT's stock. H.R. 2488 would apply this new closely held test to a partnership or other pass-through entity, other than a partnership (like most UPREITs and DownREITs) in which a REIT owns at least 50% of its capital and profits interests. Consistent with our past position, Nareit will continue to seek to narrow any closely held REIT rule to apply only to C corporations owning more than 50% of a REIT's stock.

The closely held REIT rules would apply to taxable years ending after July 12, 1999, except for REITs in existence on that date that have "significant business assets or activities as of such date."

At Risk Rules

H.R. 2488 would modify the rules relating to qualified nonrecourse financing to except from the at risk rules qualified publicly traded debt. The proposal would benefit limited partners in an UPREIT or DownREIT in which the Operating Partnership issues public debt.

Under the proposal, the financing could not be borrowed from a person that is a related person with respect to the taxpayer. Qualified publicly traded debt would generally mean any debt instrument that is readily tradable on an established securities market. However, qualified publicly traded debt would not include any debt instrument, the yield to maturity on which equals or exceeds the applicable Federal rate of interest for the calendar month in which it is issued, plus 5 percentage points. The proposal would be effective for debt instruments issued after December 31, 1999.

Individual Capital Gains Tax Rate

H.R. 2488 would lower the maximum capital gains tax rate for assets sold by individuals, on or after July 1, 1999, from 20% to 15%, with the "recapture" rate of real estate depreciation lowered from 25% to 20%.

Reduction of Corporate Capital Gain Rate

Under H.R. 2488, the corporate capital gain rate would decrease from 35% under current law to 30% for taxable years beginning in 2005 and thereafter.

Repeal of Corporate Alternative Minimum Tax

H.R. 2488 would repeal the corporate AMT for taxable years beginning after 2008.

Exclusion of Dividend Income

H.R. 2488 would provide individual taxpayers an exclusion from income of interest and dividends (other than capital gain dividends from mutual funds and REITs, and certain other dividends) received in a taxable year. The maximum exclusion from income would be $50 of combined interest and dividends ($100 for married couples filing a joint return) for taxable years beginning in 2001 or 2002, increasing to $100/$200 for taxable years beginning in 2003 or 2004, and finally rising to $200/$400 for any taxable year beginning after 2004.

Tenant Improvements

H.R. 2488 does not include the Tenant Improvement legislation (H.R. 844) Nareit and other real estate organizations support.