On July 30, 2008, President Bush signed into law the "Housing and Economic Recovery Act of 2008," which liberalizes some of the tax rules governing real estate investment trusts (REITs) proposed by NAREIT in 2007. Below is a brief summary of certain provisions of the Housing Act.

Amendments Affecting Prohibited Transactions Safe Harbor Holding Period

REITs are generally required to pay a 100% tax on any net income from prohibited transactions (i.e., sales or other taxable dispositions of property, other than foreclosure property, held primarily for sale to customers in the ordinary course of business sometimes referred to as "dealer" property). The Internal Revenue Code contains a safe harbor applicable to REITs which exempt certain sales of property from the 100% prohibited transaction tax. Prior to the Housing Act, to qualify for the safe harbor (i) the REIT must have held the property for at least four years for the production of rental income prior to sale, (ii) the aggregate capital expenditures made by the REIT during the four-year holding period preceding the sale could not exceed 30% of the net selling price of the property, and (iii) during the taxable year, the REIT could not sell (a) more than seven properties or (b) properties with aggregate adjusted basis in excess of 10% of the aggregate basis of all of the REIT's assets as of the beginning of the taxable year. The changes in the Housing Act to the safe harbor requirements are as follows:

  • Both (i) the holding period during which the REIT is required to hold the property and (ii) the period during which the 30% limit on capital expenditures is measured are reduced from four (4) to two (2) years.
  • The 10% limit on asset sales may now be measured by either tax basis or fair market value of the property (at the REITs annual option). The new dealer sales rules apply to sales made after the date of enactment of the Housing Act.

Amendments Affecting the REIT Asset Tests

At the close of each quarter, REITs must satisfy certain tests relating to the nature and diversification of its assets. The Housing Act contains the following changes to the asset tests:

  • Increases the amount (by value) that a REIT may invest in the stock or securities of taxable REIT subsidiaries (TRS) from 20% to 25% of the REIT's total assets.
  • Allows foreign currency to be treated as "cash" for purposes of the REIT asset tests if certain conditions are met, including that the foreign currency be held for use in the normal course of the REIT's activities.

The new asset test rules apply in the REIT's first taxable year beginning after the date of enactment.

Amendments Affecting the Gross Income Tests

To maintain REIT qualification, REITs must satisfy, on an annual basis, various tests relating to the nature of its gross income. In general, REITs must derive (i) 95% of its annual gross income from certain sources such as rent, dividends and interest and (ii) 75% of its annual gross income from investments relating to real estate. The Housing Act contains the following changes to the income tests:

  • Excludes most real estate-related foreign currency gains from the computation of the above income tests.
  • Expands the scope of the hedging exception by providing that certain hedging income that used to be excluded only from the 95% income test is now also excluded from the 75% income test.
  • Provides the Treasury Department with clear authority to determine whether an item of income not expressly provided for in the REIT rules constitutes qualifying income for purposes of one or both of the 95% and 75% income tests or is excluded from income for purposes of one or both of these tests.

The new foreign currency rules apply to income, gains, and deductions recognized after the date of enactment, except the changes to the hedging exception apply to hedging transactions entered into after the date of enactment.

Amendments Affecting Healthcare REITs

The Housing Act extends the "related party rent" exception that permits leases between hotel REITs and their TRS' to qualify as "rents from real property" to also apply to healthcare REITs. Thus, a TRS can rent a healthcare facility from its parent REIT without disqualifying the rents paid to the parent REIT for purposes of the 95% and 75% income tests, so long as the healthcare facility is managed and operated by an independent contractor, not the TRS itself. This long-awaited change allows healthcare REITs to be treated the same as hotel REITs.

The new healthcare property rules apply in the REIT's first taxable year beginning after the date of enactment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.