At least 75 percent of a REIT’s gross income must be derived from rents from real property, interest on obligations secured by mortgages on real property, dividends from other REITs, and gain from the sale or other disposition of real property. Rents from real property is defined to include rents; charges for services customarily furnished in connection with rental of real property; and generally rent attributable to personal property which is leased in connection with a lease of real property. impermissible tenant service income is excluded from rents from real property. A taxable REIT subsidiary (TRS) is primarily used to allow the REIT to provide otherwise non-qualifying services. Under IRC Section 856(d)(2)(C), ITSI is excluded from the definition of “rents from real property.” IRC Section 856(d)(7)(A) defines ITSI as any amount received or accrued by a REIT for services furnished or rendered to tenants or for managing or operating the property. ITSI does not include (1) payments for services, management or operation provided through an IK or a TRS or (2) any amount that would be excluded from unrelated business taxable income (UBTI) under IRC Section 512(b)(3) if received by an organization described in IRC Section 511(a)(2) (IRC Section 856(d)(7)(C)).
- While the allure of not paying taxes is attractive, REITs may not be the best vehicle for an individual who directly owns property.
- A taxable REIT subsidiary (“TRS”) is a corporation that is owned directly or indirectly by a REIT and has jointly elected with the REIT to be treated as a TRS for tax purposes.
- ITSI is not considered qualifying income for either the 75 percent or the 95 percent tests.
- Excellent lawyers who also understand your business, anticipate developments in your industry, help you manage your budget and staffing needs, connect you with business opportunities, partner with you on community outreach and giving, and assist in educating your staff are a considerably rarer breed.
Taxpayer, a publicly-held REIT, owns interests through its operating partnership and other subsidiary partnerships in certain Class A office properties (the Properties). Taxpayer intends to make some or all of the following services and amenities available to the Properties’ tenants. REITs offer diversification by investing in many different property types across all parts of the world. A prohibited transaction is a sale or other disposition of property that is held primarily for sale to customers in the ordinary course of a trade or business. There are certain safe harbors to follow in order to avoid a sale being deemed a prohibited transaction.
Impermissible tenant service income
These income tests are based on the gross income, as computed for tax purposes, from the various properties that a REIT owns, including the REIT’s share of income from underlying partnerships (based on its capital ownership). Because IKs will develop, control and maintain the interior signs and software application, any portion of the rents attributable to those services is not ITSI. Accordingly, the IRS ruled that Taxpayer’s provision of the Listed Services will not cause otherwise qualifying amounts received by Taxpayer to be excluded from rents from real property under IRC Section 856(d). A real estate investment trust (“REIT”) considering such an event may have more to think about than just finding the right hors d’oeuvres and dance-worthy band. Whenever a REIT offers a service or amenity to its tenants, the possibility of generating impermissible tenant service income (“ITSI”) must be considered. IRC Section 512(b)(3), in part, excludes rents from real property from the computation of UBTI.
All of the real estate income from the 75 percent test qualifies for the 95 percent test. This can most often be seen in retail properties when a portion of a tenant’s rent is fixed, and the other portion varies based on the net profits of the store that occupies the space. Conversely, the sharing of gross profits between tenants and the REIT is acceptable. Similar rules regarding fixed and variable rate mortgages also apply to interest income for mortgage REITs. For purposes of this limited rental exception, the IRS ruled that the relevant “property” with regard to Taxpayer’s fiber optic cable is the continuously connected fiber optic cable within the geographic boundaries of the applicable Area. With the increasing popularity of REITs and based on the increasingly service-oriented nature of the real estate assets, a TRS can be an effective structuring option to ensure a REIT maintains its REIT status.
Taxable REIT subsidiaries: Q&A primer
The REIT’s ownership (which must be proven by transferable shares or by transferable certificates of beneficial interest) must be held by at least 100 shareholders for at least 335 days of a 365-day calendar year (or equivalent thereof for a short tax year) for the second taxable year and beyond. While REITs differentiate themselves through various characteristics, all REITs must follow the same regulations under federal tax law. Excellent lawyers who also understand your business, anticipate developments in your industry, help you manage your budget and staffing needs, connect you with business opportunities, partner with you on community outreach and giving, and assist in educating your staff are a considerably rarer breed. Stradley Ronon represented Customers Bank, the primary subsidiary of Customers Bancorp, Inc.
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Property managers are typically the best source of market information, as typical and customary services vary not only across regions but across property types. Under Section 856(c)(2), a REIT must derive at least 95% of its gross income from certain categories of income, including rents from real property. Under Section 856(c)(3), a REIT must derive at least 75% of its gross income from certain sources, including rents from real property.
EisnerAmper LLP is a licensed independent CPA firm that provides attest services to its clients, and Eisner Advisory Group LLC and its subsidiary entities provide tax and business consulting services to their clients. Eisner Advisory Group LLC and its subsidiary entities are not licensed CPA firms. Taxpayer engages in occasional marketing activities to enhance its ability to attract new tenants and keep existing tenants, including hosting seasonal holiday parties and social events (Marketing Services). Social events may include a tasting event (for which a local merchant may donate products), a breakfast, a happy hour, an ice cream party, an outing, a bingo night, a raffle, or a pool party. As discussed in our prior article, a REIT can serve as a tax-efficient investment vehicle as long as it abides by strict compliance rules.
Of course, this assumes the corporation is not otherwise disqualified (for reasons previously discussed). The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting or tax advice or opinion provided by Ernst & Young LLP to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader’s specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action https://turbo-tax.org/ is to be contemplated. The reader should contact his or her Ernst & Young LLP or other tax professional prior to taking any action based upon this information. Ernst & Young LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein. While the 100 shareholder test can be easily administered, the 5/50 test requires a significant diversification of ownership that often deters owners that own a majority stake in real estate.
Section 1.512(b)-1(c)(5), payments for the use or occupancy of rooms and other spaces where services are rendered to the occupant, such as in hotels, boarding houses, tourist camps, parking lots, warehouses, storage garages, etc., do not constitute rent from real property. Services are generally considered rendered to an occupant if they are primarily for the occupant’s convenience and are not usually or customarily rendered in connection with renting rooms or other spaces for occupancy only. IRC Section 856(c)(2) requires a REIT to derive at least 95% of its gross income from specified sources of passive income, including rents from real property.
On March 31, 2021, President Biden introduced The American Jobs Plan (the Jobs Plan) which proposes raising the corporate tax rate to 28%. IKs will offer certain services (Third-Party Services) directly to tenants at certain Properties, and tenants will directly compensate the IKs. Specifically, a bicycle attendant will assist tenants with minor repairs and maintenance of their bicycles in the Designated Storage Areas, and IKs at staffed Fitness Centers may offer additional services, such as personal training or massages, for additional fees. Clients receive concierge service because every client is important in a firm our size.
Taxpayer represented that the Listed Services are customarily furnished or arranged by landlords in connection with leasing space in Class A office buildings in the city in which the Properties are located and are not personal services rendered to any particular tenant. A user must pay for a specified minimum volume commitment per month even if it uses less than its entire reserved capacity. For each agreement, the rent for the leased personal property (e.g., pumps, compressors, meters) is 15% or less of the total rent for the real and personal property leased under that agreement. The first question is a two part question that depends on what is considered a customary service and what is considered the geographic region. What might be considered a customary service in Los Angeles might not be considered customary in Chicago.
In its analysis, the IRS first noted that, when determining if impermissible tenant service income exists, only the income that is attributable to a provision of a service is analyzed. Although services may be provided in the Facilities, the IRS explained that the Facilities themselves are not services. Thus, income that is attributable to making the Facilities available to all tenants at no additional cost is not income from the provision of a service and is therefore not impermissible tenant service income. Any services that are provided in or with respect to the Facilities, however, are analyzed as any other service provided to tenants.