REIT 101 REIT 101 “a practical view of a complex topic”“a practical view of a complex topic”

MARKS PANETH LLPMARKS PANETH LLPNovember 9, 2015November 9, 2015

Michael W. Hurwitz, CPA, MSTMichael W. Hurwitz, CPA, MSTC: 646.499.0634C: 646.499.0634O: 212.201.2230O: 212.201.2230

REIT 101 - AgendaREIT 101 - Agenda• Choice of Business Entity - warm upChoice of Business Entity - warm up• Historical Background / Overview of REITsHistorical Background / Overview of REITs• REIT Structures and SubsidiariesREIT Structures and Subsidiaries• Operating in a REIT Compliant MannerOperating in a REIT Compliant Manner• Federal & State Tax ConsiderationsFederal & State Tax Considerations• Other: Tax Teasers and PlanningOther: Tax Teasers and Planning• Happy hour - refreshmentsHappy hour - refreshments

Choice of Business EntityChoice of Business Entity C-CorporationC-Corporation S-CorporationS-Corporation Sole ProprietorSole Proprietor Partnership and Limited Liability CompanyPartnership and Limited Liability Company RIC and REMICRIC and REMIC Real Estate Investment Trust (REIT)Real Estate Investment Trust (REIT) Other (Insurance Co. / Government Agency)Other (Insurance Co. / Government Agency)

Types of Businesses Operating as Types of Businesses Operating as REITsREITs

OfficeOffice IndustrialIndustrial Data centersData centers Student housingStudent housing Manufactured homesManufactured homes Malls / shopping Malls / shopping

centerscenters

Health care facilitiesHealth care facilities Self-storageSelf-storage HotelsHotels Cell towersCell towers TimberTimber Financing / MortgageFinancing / Mortgage

Historical BackgroundHistorical Background REIT Legislation Enacted in 1960 REIT Legislation Enacted in 1960 – federal law – federal law

that authorized REITs; described as mutual funds for real that authorized REITs; described as mutual funds for real estateestate

Tax Reform Act of 1986 Tax Reform Act of 1986 – REITs are allowed to – REITs are allowed to provide customary management services without independent provide customary management services without independent contractorcontractor

REIT Modernization Act 1999 REIT Modernization Act 1999 – creation of – creation of Taxable REIT Subsidiaries (TRS) to provide competitive Taxable REIT Subsidiaries (TRS) to provide competitive services to REIT tenantsservices to REIT tenants

American Jobs Creation Act of 2004 American Jobs Creation Act of 2004 – REIT – REIT savings provisionssavings provisions

Private Letter Rulings Private Letter Rulings

OverviewOverview In order for a company to qualify to be a In order for a company to qualify to be a

REIT, it must REIT, it must comply with certain provisions comply with certain provisions within the Internal Revenue Codewithin the Internal Revenue Code

Entitled to Entitled to dividends paid deduction dividends paid deduction – benefit!– benefit! Taxable income in excess of dividends paid Taxable income in excess of dividends paid

deduction is deduction is subject to corporate taxsubject to corporate tax Let’s take a quick look at the current draft Let’s take a quick look at the current draft

copy of the Federal Form copy of the Federal Form 1120 -REIT1120 -REIT

REIT StructuresREIT Structures Stand alone / special purpose blocker REITsStand alone / special purpose blocker REITs UPREITs UPREITs DOWN REITsDOWN REITs Pair-Shared or Stapled REITsPair-Shared or Stapled REITs Use of Operating Partnership Use of Operating Partnership Use of TRSs & QRSsUse of TRSs & QRSs

Note: can be public or Note: can be public or privateprivate!!

Common REIT Structure - Common REIT Structure - UPREITUPREIT

Real Estate Assets

REIT

OperatingPartnership

Fund

Real Estate Assets

LP’s and Sponsors (Conversion Rights)

Outside Investors

TRSs

Management Company

Property Management Company

REIT SubsidiariesREIT Subsidiaries Taxable REIT Subsidiary Taxable REIT Subsidiary (TRS) a corporate (TRS) a corporate

subsidiary of the REIT that can provide the subsidiary of the REIT that can provide the competitive services that tenants desire beyond the competitive services that tenants desire beyond the “usual and customary” services - (ability to generate “usual and customary” services - (ability to generate “bad income” and convert it to “good income “ - “bad income” and convert it to “good income “ - dividends) does dividends) does notnot have to be 100% owned by REIT have to be 100% owned by REIT

Qualified REIT Subsidiary Qualified REIT Subsidiary (QRS) wholly-owned (QRS) wholly-owned subsidiary ignored for federal income tax purposes; subsidiary ignored for federal income tax purposes; as such the assets, liabilities, income and deductions as such the assets, liabilities, income and deductions are deemed to be those of the REIT’s (100% owned)are deemed to be those of the REIT’s (100% owned)

Operating in a REIT Compliant Operating in a REIT Compliant MannerManner

Organizational TestsOrganizational Tests Quarterly Asset TestsQuarterly Asset Tests Annual Income TestsAnnual Income Tests Yearly Distribution TestsYearly Distribution Tests Record Keeping RequirementsRecord Keeping Requirements

““professional services rendered in professional services rendered in connection with educating and connection with educating and

ensuring company operates in a ensuring company operates in a REIT-Compliant manner” REIT-Compliant manner”

Failure to Satisfy RequirementsFailure to Satisfy Requirements

If a REIT fails to comply with or satisfy If a REIT fails to comply with or satisfy certain REIT qualification provisions, the certain REIT qualification provisions, the REIT may be required to pay a $50,000 REIT may be required to pay a $50,000

penalty for each failure “penalty for each failure “due to reasonable due to reasonable cause and not willful neglectcause and not willful neglect” - - other ” - - other

penalties can be imposed for negligence, penalties can be imposed for negligence, substantial underestimation of tax, reportable substantial underestimation of tax, reportable

transactions, and fraud.transactions, and fraud.

Organizational TestsOrganizational Tests Organized as a corporation, trust or association Organized as a corporation, trust or association Formed in one of the 50 states or District of ColumbiaFormed in one of the 50 states or District of Columbia Managed / governed by one or more trustees or directorsManaged / governed by one or more trustees or directors Transferable shares or certificatesTransferable shares or certificates Must be owned by 100 or more persons (waived 1Must be owned by 100 or more persons (waived 1stst year) year) Not be closely held (the “5/50% Test” - attribution rules)Not be closely held (the “5/50% Test” - attribution rules) Mailing of Demand Letters ( just the mailing of…)Mailing of Demand Letters ( just the mailing of…) Affirmative election to be taxed as a REITAffirmative election to be taxed as a REIT Not be a financial institution or insurance companyNot be a financial institution or insurance company

Quarterly Asset TestsQuarterly Asset Tests 75% Test75% Test: : 75% of the value of the REIT’s assets must 75% of the value of the REIT’s assets must

consist of real estate assets; including mortgages on real consist of real estate assets; including mortgages on real property (cash, cash items, receivables and/or Government property (cash, cash items, receivables and/or Government securities)securities)

25% Test25% Test: : Not more than 25% of the value of the REIT’s Not more than 25% of the value of the REIT’s total assets may consist of securities of one or more Taxable total assets may consist of securities of one or more Taxable REIT Subsidiaries (TRS)REIT Subsidiaries (TRS)

10% Test10% Test: : A REIT cannot own more than 10% of the A REIT cannot own more than 10% of the outstanding securities (vote or value) of any single issuer outstanding securities (vote or value) of any single issuer (other than those qualifying for the 75% and the securities of a (other than those qualifying for the 75% and the securities of a TRS)TRS)

5% Test5% Test: : Not more than 5% of the value of a REIT’s total Not more than 5% of the value of a REIT’s total assets may consist of securities of any single issuer (other than assets may consist of securities of any single issuer (other than those qualifying for the 75% and the securities of a TRS)those qualifying for the 75% and the securities of a TRS)

Straight Debt ExceptionStraight Debt ExceptionDebt securities that are owned by a REIT and qualify Debt securities that are owned by a REIT and qualify

for the straight debt safe harbor / exception are for the straight debt safe harbor / exception are not not subject to the 10% value testsubject to the 10% value test. Straight debt means a . Straight debt means a written unconditional promise to pay on demand (or written unconditional promise to pay on demand (or

on a specific date) a sum certain in money if:on a specific date) a sum certain in money if:1.1. The interest rate and payments are not contingent on The interest rate and payments are not contingent on

profits, the borrower’s discretion or similar factorsprofits, the borrower’s discretion or similar factors2.2. The debt in not convertible (directly or indirectly) The debt in not convertible (directly or indirectly)

into REIT stockinto REIT stock

Annually Income TestsAnnually Income Tests 75% Test75% Test: Generally, at least 75% of the REIT’s annual gross : Generally, at least 75% of the REIT’s annual gross

income must be derived from real-estate related income, more income must be derived from real-estate related income, more specifically: “specifically: “rents from real propertyrents from real property”, qualifying interest on ”, qualifying interest on mortgage debt, gain from the sale of non-dealer real property or mortgage debt, gain from the sale of non-dealer real property or mortgages dividends on or disposition of shares in other REITs, mortgages dividends on or disposition of shares in other REITs, property tax refunds, income and gain from foreclosure property, property tax refunds, income and gain from foreclosure property, qualifying points or fees and / or qualified temporary investment qualifying points or fees and / or qualified temporary investment incomeincome

95% Test95% Test: : No more than 5% of the REIT’s annual gross income No more than 5% of the REIT’s annual gross income can be derived from items other than those which satisfy the 75% can be derived from items other than those which satisfy the 75% test mentioned above and other passive forms of income such as test mentioned above and other passive forms of income such as dividends, interest and / or gains from the sale of securities dividends, interest and / or gains from the sale of securities

““5% bad income bucket5% bad income bucket””

Rents from Real PropertyRents from Real PropertyRent generally will Rent generally will notnot qualify as rents qualify as rents

from real property if:from real property if:1)1) The rent is based on the income or profits of The rent is based on the income or profits of

any personany person2)2) The REIT owns, directly or indirectly, 10% or The REIT owns, directly or indirectly, 10% or

more of the tenant ormore of the tenant or3)3) The REIT itself furnishes services other than The REIT itself furnishes services other than

ordinary and customary property management ordinary and customary property management services (use TRS or independent contractor services (use TRS or independent contractor for providing impermissible tenant services)for providing impermissible tenant services)

Impermissible Tenant Service Impermissible Tenant Service IncomeIncome

Any amount received or accrued by the REIT for Any amount received or accrued by the REIT for rendering services to the tenants of such property rendering services to the tenants of such property

or managing or operating the property. There or managing or operating the property. There are three exceptions that provide ways in which are three exceptions that provide ways in which a REIT can directly or indirectly render services a REIT can directly or indirectly render services

to its tenants with out causing the income to to its tenants with out causing the income to constitute impermissible tenant service income:constitute impermissible tenant service income:

1.1. use of independent contractoruse of independent contractor2.2. use of TRS use of TRS 3.3. unrelated business taxable income exceptionunrelated business taxable income exception

Independent Contractor (IK)Independent Contractor (IK)1.1. IK can not own directly or indirectly > 35% of REITIK can not own directly or indirectly > 35% of REIT2.2. If IK is a corporation, > 35% shareholder cannot If IK is a corporation, > 35% shareholder cannot

own > 35% of REIT sharesown > 35% of REIT shares3.3. Relationship between REIT and IK must be arm’s-Relationship between REIT and IK must be arm’s-

length; common employees and/or officers will be length; common employees and/or officers will be scrutinized-transfer pricing / re-determined amountsscrutinized-transfer pricing / re-determined amounts

4.4. IK must be adequately compensated for its servicesIK must be adequately compensated for its services5.5. IK must not be an employee of the REITIK must not be an employee of the REIT6.6. The REIT must not receive income of any type The REIT must not receive income of any type

(interest, dividends, rent and other) from the IK(interest, dividends, rent and other) from the IK

Prohibited TransactionsProhibited Transactions A prohibited transaction is the sale or other disposition A prohibited transaction is the sale or other disposition

of property, other than foreclosure property, held of property, other than foreclosure property, held primarily for the sale to customers in the ordinary course primarily for the sale to customers in the ordinary course of business; 100% tax on aggregate of all gainsof business; 100% tax on aggregate of all gains

Safe HarborSafe Harbor: 1) REIT held property for not less than : 1) REIT held property for not less than two years and 2) aggregate expenditures includible in two years and 2) aggregate expenditures includible in basis does not exceed 30% of selling price and 3) either basis does not exceed 30% of selling price and 3) either not more than seven sales or aggregated FMV of not more than seven sales or aggregated FMV of property sold does not exceed the aggregate of 10% of property sold does not exceed the aggregate of 10% of the FMV of all of the assets of the REIT at beginning of the FMV of all of the assets of the REIT at beginning of the yearthe year

Foreclosed Property RulesForeclosed Property Rules If a REIT acquires property through a foreclosure, If a REIT acquires property through a foreclosure,

deed in lieu of foreclosure, or upon eviction of a tenant deed in lieu of foreclosure, or upon eviction of a tenant in default, a REIT may be able to engage in certain in default, a REIT may be able to engage in certain nonqualified activities with respect to the property nonqualified activities with respect to the property without jeopardizing its REIT status or incurring the without jeopardizing its REIT status or incurring the prohibited transaction tax (100%) by making a prohibited transaction tax (100%) by making a “foreclosure property” irrevocable election “foreclosure property” irrevocable election

Three year grace period to orderly liquidate the REIT’s Three year grace period to orderly liquidate the REIT’s interest in such property (extensions granted)interest in such property (extensions granted)

Yearly Distribution TestsYearly Distribution Tests In general, a REIT must distribute annually to its In general, a REIT must distribute annually to its

shareholders dividends equal to at least 90% of its shareholders dividends equal to at least 90% of its REIT taxable income (determined without regard to REIT taxable income (determined without regard to the deduction for dividends paid and by excluding the deduction for dividends paid and by excluding any net capital gain - Note - A REIT can retain its any net capital gain - Note - A REIT can retain its capital gains but, must pay tax on any retained gains; capital gains but, must pay tax on any retained gains; the tax it pays on such gains will then be passed the tax it pays on such gains will then be passed through as a credit to its shareholdersthrough as a credit to its shareholders

Must designate composition of distribution within 30 Must designate composition of distribution within 30 days of year end on form days of year end on form 1099-DIV1099-DIV or with its annual or with its annual report – ordinary dividend, capital gain, unrecaptured report – ordinary dividend, capital gain, unrecaptured section 1250, return of capital and / or 15% ordinary section 1250, return of capital and / or 15% ordinary dividends from C Corporationsdividends from C Corporations

Federal ConsiderationsFederal Considerations Partnership issues – 704, 707, 731 & 752Partnership issues – 704, 707, 731 & 752 Calculation of earnings and profits (E&P)Calculation of earnings and profits (E&P) Thinly capitalized TRS – 163j interest expense Thinly capitalized TRS – 163j interest expense

limitation / disallowancelimitation / disallowance Conversion to REIT status – holding period to Conversion to REIT status – holding period to

avoid C-level taxes avoid C-level taxes A REIT may engage in a tax-free (spin off) A REIT may engage in a tax-free (spin off)

reorganization pursuant to 355reorganization pursuant to 355

State ConsiderationsState Considerations Withholding taxes - nonresident partners of OPWithholding taxes - nonresident partners of OP Recognition of Limited Liability CompaniesRecognition of Limited Liability Companies Capital stock, franchise taxes and other feesCapital stock, franchise taxes and other fees Business Trust REIT vs. Corporate REITBusiness Trust REIT vs. Corporate REIT Unitary vs. separate filing requirementsUnitary vs. separate filing requirements State apportionment factorsState apportionment factors New State LegislationNew State Legislation State AuditsState Audits

Tax TeasersTax Teasers New proposed repair regulations and related 3115sNew proposed repair regulations and related 3115s Debt financed distributions – interest tracing rulesDebt financed distributions – interest tracing rules Long-term incentive plans using profits interests Long-term incentive plans using profits interests Deferred exchanges - 1031 Exchange (recycle capital)Deferred exchanges - 1031 Exchange (recycle capital) Allocation waterfalls, promoted interestsAllocation waterfalls, promoted interests Unrelated Business Income Tax (UBIT)Unrelated Business Income Tax (UBIT) Transfer pricing - arm’s lengthTransfer pricing - arm’s length Investor types Investor types FAS 109 FAS 109 FIN 48FIN 48 OtherOther

Strategic Planning Strategic Planning ConsiderationsConsiderations

Any final thoughts?Any final thoughts?Additional comments?Additional comments?

Take a ways?Take a ways?Questions?Questions?

Michael W. Hurwitz, CPA, MSTMichael W. Hurwitz, CPA, MST

C: 646.499.0634C: 646.499.0634

O: 212.201.2230O: 212.201.2230

mhurwitz@markspaneth.com