PwC Partner Highlights State Tax Issues Impacting REITs

Sam Melehani, partner at PwC, joined REIT.com for a video interview during REITWise 2015: NAREIT’s Law, Accounting and Finance Conference held in Phoenix.

Melehani commented on two recent developments at the state level regarding the taxation of REITs. First, he noted that proposed legislation in Hawaii to abolish the dividends paid deduction for REITs has been deferred, pending further study.  “Hopefully they’ll decide that there’s a lot more benefit to the REIT than that they get a dividends paid deduction,” he said.

A second noteworthy development, according to Melehani, is the movement toward combined reporting.  He explained that a combined return taxes the family of related entities, rather than the REIT itself. In some cases, this could result in REITs paying taxes at the state level, he said.

Melehani also pointed to potential “traps” that REITs should be aware of at the state level. One such “trap” regards the type of entity used to purchase real estate. In some states, he said, using limited liability companies (LLCs) to purchase property could shield companies from benefits accruing to REITs under state law. REITs could also run up hefty fees if they use LLCs to purchase property, he said.

Meanwhile, an ongoing issue at the state level is the treatment of so-called captive REITs, or REITs specifically formed to take advantage of state law. Melehani noted that state rules to deny benefits to REITs that were formed for this purpose “cast a really wide net.” States are now trying to relax those rules, he said, but he noted that they have already impacted private REITs and “baby REITs” formed for the purposes of a joint venture.

Melehani also said he is paying close attention to a case in California, 926 North Ardmore Avenue v. County of Los Angeles, which deals with transfer tax. The California Court of Appeals decision, if left intact, would change California from a documentary transfer tax state to a controlling interest transfer tax state, Melehani said. The California Supreme Court has accepted the case and a decision is expected this summer.

In the meantime, Melehani stressed that REITs also need to pay attention to tax challenges at the local level. Many cities are imposing local business taxes, he said, and the process is becoming increasingly sophisticated. Melehani added that it is likely to take some time before local authorities become better educated about REITs and start to apply the rules correctly.