Well real estate investment trust
Real estate investment trusts are entities that are taxed as corporations and that qualify for a tax deduction for dividends paid to shareholders provided that several organizational, investment and operational tests are satisfied on a year-by-year basis. These requirements are intended to ensure that the benefits of Real estate investment trust status are restricted to entities which derive income from passive investment in real estate assets and that distribute substantially all of their net income to investors annually.
History
Historically, a Real estate investment trust was a common law business trust organized to enable a group of investors to participate in an investment in income-producing real estate. Although common law business trusts were used for various business investment activities during the 19th century, by the early 20th century, the form continued to be used primarily for real estate investment. By this time, the generally accepted form for other business activities was the corporation. The common law business trust form continued to be used for investments in real estate, principally for the purpose of avoiding state statutory restrictions on corporate investment in real estate. This was particularly true in Massachusetts, where corporations were prohibited from acquiring and developing real property without a special act of the legislature. Consequently, the term Massachusetts business trust has frequently been used to describe common law business trusts wherever they were organized.
From 1913 to 1935, the tax favoured common law business trusts. These trusts, as distinguished from corporations, were not taxed on trust income currently distributed to the beneficial owners. In 1935, in Morrissey, the Supreme Court held that common law business trusts have so many corporate attributes that they are taxable as corporations.
The Morrissey decision had adverse tax consequences for both Real estate investment trusts and stock and bond investment funds, some of which had used the form of the common law business trust. Within a year of the Morrissey decision, the stock and bond investment funds were successful in obtaining relief by the enactment of the regulated investment company provisions of the internal revenue code. Thereafter, new Real estate investment trusts were no longer organized as common law business trusts. Pooled real estate investments used either the corporate form or the partnership form.
II. Qualification of Real Estate Investment Trusts
Overview
The code provides special tax treatment for entities that qualify and elect to the taxed as Real estate investment trusts. To qualify as a Real estate investment trust, an entity must meet six organizational requirements, three gross income tests and one asset test. In determining compliance with the gross income tests and with the asset test, a trust that is a partner in a partnership will be deemed to own its proportionate share of the income and the assets of the partnership. As a partner in a partnership the Real estate investment trust includes in its taxable income its distributive share of partnership items from the partnership taxable year ending within or with the Real estate investment trusts taxable year. And the character of the items that are included in the Real estate investment trusts distributive share is determined as if those items were realized directly from the source from which they were realized by the partnership or incurred in the same manner as incurred by the partnership. Finally, the trust's accounting period must be the calendar year and for its first year of qualification, it must file with its return an election to be taxed as a Real estate investment trust.
In addition, a Real estate investment trust is subject to certain income taxes on income from foreclosure property, on excessive unqualified income, net income from prohibited transactions .
III. Taxation of Real Estate Investment Trusts
Computing taxable income and excise tax
After it has met the organizational requirements, the asset holding test and the gross income tests for qualification as a Real estate investment trust, to be taxed as a Real estate investment trust and entitled to a deduction for dividends paid to its shareholders, the trust must contribute to its shareholders each year not less than 95 percent of its ordinary net taxable income and 95 percent of its net income from foreclosure property, reduced by the tax payable on such income.
Regular Corporate Tax
A Real estate investment trustwhich distributes not less than 95 percent of its ordinary taxable income pays regular corporate tax on its undistributed Real estate investment trust taxable income . A trust also paid the corporate alternative tax on undistributed long term capital gains, and it could be subject to corporate minimum tax. With a maximum corporate tax rate of 35 percent, the special rate on long term capital gains no longer applies and undistributed capital gains will be taxable as part of the Real estate investment trust taxable income at regular corporate rates . Real estate investment trusts which elect the alternative cost recovery period of 40 years for real estate improvements, with long term capital gains now taxed as ordinary income, should have substantially no exposure to the corporate minimum tax. Therefore, if the trust has no income from prohibited transactions and no unqualified income from foreclosure property, it will pay no corporate taxes if it distributes all of its Real estate investment trust taxable income, including all of its net capital gains.
IV. Taxation of Shareholders of Real Estate Investment Trusts
Dividends
Distributions by Real estate investment trusts that are not designated as capital gain dividends generally are subject to the regular corporate dividend rules and as such they constitute portfolio income which cannot be sheltered by "passive losses". A shareholder treats such distributions as ordinary income to the extent of the trust's current or accumulated earnings and profits. Except with respect to deficiency dividends and consent dividends, distributions in excess of current and accumulated earnings and profits constitute a return of capital until the shareholder has recovered his cost basis and distributions in excess of both earnings and profits and cost basis are treated as gain from the sale of the shares. Deficiency dividends and consent dividends are treated as dividends by the shareholders even if they exceed the Real estate investment trusts earnings and profits.
Other Articles
