February 14, 2012
Obama Budget Includes Three Provisions Helpful to REITs
Yesterday, the Obama Administration released its Fiscal Year 2013 Budget Proposal (the Budget). NAREIT is pleased to highlight below three constructive items in the Budget focused on REITs, two of which relate to current NAREIT legislative and regulatory initiatives. NAREIT is appreciative to see that the Budget seeks to ensure that the REIT approach to real estate investment works effectively in furtherance of assorted national policies.
Repeal of Preferential Dividend Rule for Publicly Offered REITs
The preferential dividend rule has the potential of causing loss of the dividends paid deduction for a REIT's inadvertent error in distributing dividends and in some cases even loss of REIT status. For distributions in taxable years beginning after the date of enactment, the Budget proposes to repeal the preferential dividend rule for "publicly offered" REITs. 1 The "publicly offered" REIT term would mean, as of the distribution date, a REIT that is either publicly traded or:
The REIT was required to file annual and periodic reports with the Securities and Exchange Commission under the Securities Act of 1934;
Not more than one-third of the voting power of the REIT was held by a single person (including any voting power that would be attributed to that person under the rules of I.R.C. section 318); and,
Either the stock with respect to which the distribution was made is the subject of a currently effective offering registration, or such a registration has been effective with respect to that stock within the immediately preceding 10-year period. 2
It also would grant authority for the Treasury Department "to provide for cures of inadvertent violations of the preferential dividend rule" in situations with respect to which it continues in effect.
While the Obama Administration's FY 2012 Budget proposed repealing the preferential dividend rule for publicly traded REITs, the FY 2013 Budget proposal would extend the repeal to all publicly offered REITs, including public, non-listed REITs. The proposal is presumably a response to NAREIT's past discussions with, and submissions to, Treasury officials
in connection with NAREIT's request for a repeal of the rule for all
REITs required to register their securities with the Securities and Exchange Commission (publicly offered REITs), consistent with a similar rule for regulated investment companies enacted in 2010.
Conversion of Energy Efficient Commercial Buildings Deduction to a Credit, Including Rules to Encourage Use by REITs
The Budget proposes, for property placed in service during calendar year 2013, to "replace the existing deduction for energy efficient commercial building property expenditures with a tax credit and also allow taxpayers to take an alternative credit for placing in service more energy efficient properties. 3 The Budget states that "special rules would be provided that would allow the credit to benefit a … REIT or its shareholders." This proposal also was included in the Obama Administration's FY 2012 Budget as part of its "Better Buildings Initiative." See NAREIT's website for more detail regarding NAREIT's efforts to modify certain energy tax incentives to encourage REITs to invest more in energy efficiency and renewable energy.
Reform of Low Income Housing Tax Credit (LIHTC) Program and Modifications to Make LIHTCs "Beneficial" to REITs
The Budget also proposes a number of reforms to the existing LIHTC program in order to serve households in greater need and to provide incentives for creating mixed-income housing. 4 By way of background, Congress enacted the LIHTC program twenty-five years ago to incentivize investment in affordable rental housing. Qualified developers may receive awards of LIHTCs. Typically through limited partnership interests, developers raise equity capital from investors who utilize the tax credits. Limited partnerships pass through LIHTCs to their limited partners who use the LIHTCs to offset tax liability.
Because REITs are not pass-through entities like partnerships, they are not permitted to pass through LIHTCs to shareholders under current law. In order to increase demand for LIHTCs by REITs, the Administration proposes to make LIHTCs beneficial for REITs.
As stated in the Treasury Department's more detailed explanation:
REITs and RICs are C corporations. That is, unlike trusts, partnerships, and S corporations, they generally do not directly pass through tax items to their owners….
The effectiveness of LIHTCs in increasing the construction and preservation of affordable housing would be enhanced if there were more demand for these credits. For example, during the recent economic crisis, there was a sharp drop in the amount that investors were willing to invest for each dollar of LIHTC acquired. If REIT shareholders could benefit from any LIHTCs that REITs receive, there would be an increase in demand. 5
Specifically, the Budget proposes allowing a REIT that is entitled to LIHTCs to designate as tax exempt some of the dividends that it distributes to shareholders, effective for taxable years ending after date of enactment. 6
The maximum amount of dividends that could be designated as exempt by the REIT would be the quotient of the REIT's LIHTCs for the year, divided by the highest corporate rate. (For example, using the highest corporate tax rate of 35%, and assuming a credit of $35 to the REIT, the REIT would be entitled to designate up to $100 of its distribution as tax-exempt.) Accordingly, the after-tax result for the REIT's shareholders would resemble the result as though the REIT had distributed both a taxable dividend and the LIHTCs as well.
NAREIT is pleased and encouraged that the Budget includes these proposals, and plans to work with the Administration and Congress as they may discuss and develop these proposals further over the coming months.
If you have any comments or questions, please contact NAREIT's Executive Vice President & General Counsel, Tony Edwards, at firstname.lastname@example.org.