As a result of these rules, a ReIT can be created as a trust, partnership, limited liability company, or corporation.
Can LLC invest in REIT?
Mortgage REITs aren’t common in the hard money lending market. Nothing prevents a private money mortgage fund from acting as a REIT. It’s just not done very often. This is mostly due to the fact that the principal benefit of a REIT, the absence of entity-level taxation, can be attained by creating a fund as a limited partnership (“LP”) or a limited liability company (“LLC”). REITs have always had one or two potential advantages over LPs and LLCs, but funds that potentially profit from these advantages have rarely, if ever, been compelled to comply with the additional rules and limits required to qualify as a REIT.
Even in the private lending market, the handling of REIT income under the recently adopted Tax Cuts and Jobs Act (“TCJA”) is generating renewed interest in REITS. This is because, while the TCJA promised a 20% tax deduction for income earned from all pass-through entities, private mortgage fund managers are discovering that REIT investors are in a much better position to take advantage of these deductions than investors in funds organized as limited partnerships or limited liability companies. As a result, some investors are wondering if their fund(s) can and should be REITs. Of course, the answer will differ from fund to fund, but if the topic is asked, a fundamental understanding of REITs and their requirements is a good place to start the discussion.
What is a REIT?
The first and most apparent question is: what precisely is a REIT? A true REIT is an entity that meets very specific qualifications and elects to be taxed as a REIT under the Internal Revenue Code (). The term is often used broadly or as a shorthand to refer to any type of real estate investment entity; however, a true REIT is an entity that meets very specific qualifications and elects to be taxed as a REIT under the Internal Revenue Code () “IRC (“Internet Relay Chat”).
The abbreviation R.E.I.T. stands for “A REIT, or real estate investment trust, does not have to be structured as a trust. In truth, many REITs are organized as corporations, but nothing prevents a REIT from being organized as a partnership or a limited liability company. REITs are also not obligated to confine their investments to real estate ownership interests. They have to be their own “real estate-related assets,” but this term encompasses more than just direct real estate ownership interests. Most importantly for private lenders, loans secured by real estate have always been included in this definition, as have REITs that invest in real estate secured loans (i.e., REITs that invest in REITs that invest in REITs that invest in REITs that invest in REITs that invest in REITs that invest in REITs that invest in “In the financial markets, mortgage REITs (“mortgage REITs”) are both permitted and widely used.
A REIT is classified as a C-corporation for tax purposes, regardless of the kind of legal entity used, and pays tax on income made at the entity level. Nonetheless, because a REIT is allowed to deduct the amount of any dividends it pays to its shareholders when calculating its taxable income, it is considered a sort of “pass-through organization” like partnerships, LLCs, and S-corporations (referred to above as “Non-REIT Pass-Through Entities”). It can virtually remove the business level tax payable on income made and given to its shareholders as dividends by doing so (via tax deductions).
REITS, on the other hand, differ significantly from Non-REIT Pass-Through Entities. REIT deductions simulate a pass-through effect by eliminating (or considerably decreasing) the REIT’s entity level tax liability, but they do not pass-through the character of that income. Rather, regardless of the nature of income received at the REIT level, income distributed by a REIT is corporate dividend income. 1 Several of the possible benefits of operating as a REIT are based on the capacity to deliver dividend income to investors regardless of the type of income received by the REIT, as detailed below.
Potential REIT Benefits
The “pass-through” taxation effect noted above is the primary benefit of establishing a REIT. REIT status allows real estate or loan funds that must (or have compelling reasons to) operate as corporations rather than Non-REIT Pass-Through Entities to do so without incurring double taxes. To enable the sale of their shares on national stock markets, public firms often prefer to be constituted as C-corporations rather than Non-REIT Pass-Through Entities. Real estate investment trusts (REITs) allow public real estate enterprises to operate as C-corporations while avoiding considerable entity-level taxation.
The key reason a private mortgage fund may consider operating as a REIT prior to the TCJA was the impact of leverage on tax-exempt investors. Many private mortgage fund managers are aware that using leverage can result in “unrelated business taxable income,” or “UBTI,” which is taxable to otherwise tax-exempt investors like pension and profit-sharing plans, as well as IRAs. Unlike real pass-through income, REIT dividends are not recognized as UBTI regardless of whether or not leverage is used at the corporate level. As a result, funds looking to use leverage or generate a considerable amount of UBTI benefit from REIT classification if a significant portion of their capital comes from tax-exempt investors.
Foreign investors benefit from the capacity to receive REIT dividends, and REITs are an excellent alternative for funds that raise a large portion of their capital from outside the United States. Many private money mortgage funds have not previously considered facilitating foreign investment, but this is changing as the industry and individual funds grow and seek and receive capital from a greater range of sources.
As previously stated, the TCJA provides an extra benefit to REITs. The TCJA revised IRC Section 199A to offer a 20% income tax deduction for “qualifying business income” or “QBI” received from pass-through organizations, including both REITs and Non-REIT Pass-Through Entities. It was signed into law by President Trump in December 2017. Unfortunately, Section 199A, as amended, limits the amount of QBI a Non-REIT Pass-Through Entity can distribute to its owners based on the amount of W-2 wages earned and the value of the entity’s “qualified property.” Applying these restrictions and estimating the amount of QBI generated by a company is difficult, and the results will differ from fund to fund. However, for the vast majority of private mortgage funds, only a small portion of their income will qualify as QBI, and each investor’s 20% deduction on their share of that QBI will be minimal.
The above-mentioned W-2 wage and qualified property requirements do not apply to REIT distributions. Rather, Section 199A regards REIT income as a distinct sort of income that is deemed QBI regardless of the REIT’s W-2 salaries or asset holdings. While 100% of a REIT’s income is deemed QBI under Section 199A, investors’ ability to take a full 20% deduction on that income may be limited by restrictions and “phase-out” provisions that apply to individual taxpayers. Nonetheless, the option to classify all of a REIT’s income as QBI, as well as the possibility of granting investors a full share of the 20% deduction, appears to be a significant new benefit that can be acquired by operating as a REIT. However, whether or not a private fund should choose to become a REIT is largely determined by the fund’s capacity to meet the REIT’s standards and limits.
REIT Requirements & Restrictions
An investment entity must meet certain requirements established in the IRC with respect to its income, assets, distributions, and structure in order to qualify as a REIT. The following is a quick rundown of these needs and limitations.
REITs must meet two income requirements: (1) “real estate related” revenue must account for at least 75% of yearly gross income, and (2) “passive” income must account for 95% of annual gross income. Sources of income that are deemed acceptable “Real estate related interest” (including interest on obligations secured by real property), rents from real property, real property gains, dividends and gains from other REITs, income from foreclosure properties, and income from temporary (non-real estate) investments are all examples of “real estate related” and “passive” for these purposes.
The following asset tests apply to REITs: (1) a REIT’s total assets must be worth at least 75 percent of its total value; (2) a REIT’s total assets must be worth at least 75 percent of its total value; (3) a REIT’s total assets must be worth at least 75 percent of its total “sed of “real estate assets” (including real estate secured loans), cash, and government securities; (2) securities other than government securities can account for no more than 25% of a REIT’s total assets; (3) securities of a single issuer can account for no more than 5% of a REIT’s total assets, except for investments in other REITs and certain REIT subsidiaries; and (4) a REIT can own no more than 10% of the total sed of “real estate assets” (including real estate secured
A REIT is required to distribute at least 90% of its taxable income to its shareholders each year. The taxable income of a REIT is calculated in the same way as the income of a regular C-corporation for this purpose, but without the advantage of the REIT’s dividend deduction. If a REIT distributes less than 100% of its REIT taxable income (including the 10% the REIT is entitled to keep), the undistributed portion must be taxed at standard corporate tax rates. The amount given must not be preferential unless the REIT is publicly offered (meaning, every stockholder of the class of stock to which a distribution is made must be treated the same as every other stockholder of that class, and no class of stock can be treated other than according to its dividend rights as a class).
A REIT must have 100 or more shareholders, and no more than 50% of the value of the REIT’s outstanding stock can be owned by five or fewer people. However, neither of these shareholder criteria applies until after the first taxable year in which a REIT election is taken, allowing the shares to be purchased by the required number of owners.
A REIT is also subject to the following corporate restrictions: (1) REIT shares must be transferable; however, securities law restrictions, restrictions on transferability of stock issued to employees, and restrictions imposed by stockholder level agreements should not result in a violation of this requirement; (2) a REIT must be managed by trustees or directors and structured accordingly; and (3) a REIT must be taxable as a US corporation (i.e., foreign corporations cannot be REITs).
To REIT or not to REIT
Looking at the REIT requirements above, it’s likely that some of them aren’t a problem for private fund managers, while others are “non-starters.” The income and asset tests should not be a problem for typical mortgage funds that invest purely in mortgage loans, and are likely currently being met. However, for many funds, distributing 90% of a fund’s income is just not a possibility.
These constraints may also raise some concerns about the net benefits of a REIT election. Will the corporation tax on undisbursed REIT income, for example, undermine the benefits of the TCJA’s 20 percent deduction for investors? Will the costs of reorganization to meet REIT standards be justified?
However, it should be evident that the structural and business concerns that must be evaluated in conjunction with the decision to operate as a REIT are substantial. Finally, the decision of whether to REIT or not to REIT must be decided only after the genuine net benefits of gaining REIT status have been assessed and weighed against the time, expenses, and effort required.
Endnotes
1 This is a simplified explanation, and REITs can use many strategies to “pass-through” capital gain income to their investors; however, a discussion of these methods is outside the scope of this article.
Does a REIT have to be a corporation?
The Ministry of Finance declared in June 2006 that REITs would be introduced in 2007. The legal specifics appear to be based on British REIT regulations.
A law governing REITs was passed on June 1, 2007, with retroactive effect from January 1, 2007.
- REITs must be formed as corporations, either as “REIT-AG” or “REIT-Aktiengesellschaft.”
- The REIT must pay at least 90% of its taxable income to its stockholders in the form of dividends.
- The corporation is tax-exempt, but the dividends must be paid by the stockholders as individual income taxes.
- Residential properties developed before January 1, 2007 are not eligible for investment.
The German public real estate sector is worth 0.21 percent of the entire worldwide REIT market cap. The EPRA index, which is controlled by the European Public Real Estate Association, includes three of the four G-REITS (EPRA).
Is a REIT a registered investment company?
To be classified as a regulated investment firm, a corporation must meet certain criteria.
- Exist as a corporation or other entity that would normally be subject to corporate taxes.
- Register with the Securities and Exchange Commission as an investment business (SEC).
- Elect to be treated as a RIC under the Investment Company Act of 1940 if its income source and asset diversification meet certain criteria.
In addition, capital gains, interest, or dividends produced on investments must account for at least 90% of a RIC’s income. An RIC must also distribute a minimum of 90% of its net investment income to its shareholders in the form of interest, dividends, or capital gains. If the RIC does not disperse this portion of its earnings, the IRS may levy an excise tax.
Finally, at least 50% of a business’s total assets must be in the form of cash, cash equivalents, or securities to qualify as a regulated investment company. Unless the investments are government securities or the securities of other RICs, no more than 25% of the company’s total assets may be invested in securities of a single issuer.
Can a REIT be a disregarded entity?
A REIT may invest in overseas real estate through a foreign limited liability company that checks the box to be a disregarded entity (DE) in order to ensure instant flow-through of foreign income to the REIT and meet the REIT income and asset requirements.
Can an LLC own another LLC?
In terms of ownership, an LLC is permitted to be a member of another LLC. “Members” are the LLC’s proprietors. Who can become a member of an LLC is not restricted by law. Individuals or commercial entities such as companies or other LLCs can thus be members of an LLC. It’s also conceivable to incorporate a single-member LLC with another LLC as its sole owner.
How are REITs taxed?
Dividend payments are assigned to ordinary income, capital gains, and return of capital for tax reasons for REITs, each of which may be taxed at a different rate. Early in the year, all public firms, including REITs, must furnish shareholders with information indicating how the prior year’s dividends should be allocated for tax purposes. The Industry Data section contains a historical record of the allocation of REIT distributions between regular income, return of capital, and capital gains.
The majority of REIT dividends are taxed as ordinary income up to a maximum rate of 37% (returning to 39.6% in 2026), plus a 3.8 percent surtax on investment income. Through December 31, 2025, taxpayers can deduct 20% of their combined qualifying business income, which includes Qualified REIT Dividends. When the 20% deduction is taken into account, the highest effective tax rate on Qualified REIT Dividends is normally 29.6%.
REIT dividends, on the other hand, will be taxed at a lower rate in the following situations:
- When a REIT makes a capital gains distribution (tax rate of up to 20% plus a 3.8 percent surtax) or a return of capital dividend (tax rate of up to 20% plus a 3.8 percent surtax);
- When a REIT distributes dividends received from a taxable REIT subsidiary or other corporation (20% maximum tax rate plus 3.8 percent surtax); and when a REIT distributes dividends received from a taxable REIT subsidiary or other corporation (20% maximum tax rate plus 3.8 percent surtax); and when a REIT distributes dividends received from
- When allowed, a REIT pays corporation taxes and keeps the profits (20 percent maximum tax rate, plus the 3.8 percent surtax).
Furthermore, the maximum capital gains rate of 20% (plus the 3.8 percent surtax) applies to the sale of REIT stock in general.
The withholding tax rate on REIT ordinary dividends paid to non-US investors is depicted in this graph.
Are REITs considered real estate?
REITs, or real estate investment trusts, are businesses that own or finance income-producing real estate in a variety of markets. To qualify as REITs, these real estate businesses must meet a variety of criteria. The majority of REITs are traded on major stock markets and provide a variety of incentives to investors.
Can anyone set up a REIT?
Who is eligible to apply? A company or the principal company of a group can apply to be a REIT if it: has an existing property rental business with at least three properties, none of which represents more than 40% of the total value of the properties involved; and has an existing property rental business with at least three properties, none of which represents more than 40% of the total value of the properties involved. For tax reasons, he or she is a UK resident.
Can REITs invest in government securities?
Companies that operate as real estate investment trusts (REITs) must concentrate their operations in one or more sectors of the real estate industry. If a government-issued bond is tied to real estate, it is eligible to be held by a REIT.
Are all ETFs RICS?
Yes, in a nutshell. Under the Investment Company Act of 1940, most ETFs (Exchange Traded Funds) are registered as investment firms with the Securities and Exchange Commission (SEC). As a result, they are classified as RICs (Registered Investment Companies) for legal and tax purposes, exactly like regular open-end mutual funds.
Almost all ETFs fall within this category.
Commodity-based ETFs and exchange-traded notes, on the other hand, are subject to distinct rules (or ETNs, which are sometimes confused with ETFs, but are very different in nature).
If you possess an ETF (not an ETN or a commodity-ETF, though), you can safely use the designation RIC for purposes of identifying dividends for foreign tax credit reasons when entering data into TurboTax (and for completing Form 1116, the foreign tax credit form).
