A taxable REIT subsidiary (“TRS”) is a corporation that is owned directly or indirectly by a REIT and has decided to be regarded as a TRS for tax purposes in conjunction with the REIT. A TRS is liable to standard corporate income tax, which is currently a flat rate of 21% because to the Tax Cuts and Jobs Act (TCJA). President Biden released The American Jobs Plan (the Jobs Plan) on March 31, 2021, which proposes hiking the corporate tax rate to 28%.
To give some context, the TRS was created by the Tax Relief Extension Act of 1999 to give REITs more flexibility. Because a REIT’s income must come mostly from passive real estate investments, the TRS was developed to do tasks that the REIT couldn’t handle on its own without risking its REIT status. These corporations are now routinely imbedded in REIT structures, some two decades after the TRS was first introduced.
Why might a TRS be a desirable, or necessary, addition to an existing REIT structure?
A REIT can be a tax-efficient investment vehicle if it follows tight compliance regulations, as we described in a previous post. A TRS may be required by a REIT in specific circumstances in order to acquire a desired investment or perform particular tenant services without violating the REIT’s constraints.
A REIT may use a TRS to hold assets that it is unable or unwilling to hold on its own. For example, if a REIT wants to buy a portfolio of properties but a few of them aren’t a good long-term fit, a TRS can buy those assets with the intention of selling them without risking being subject to the REIT prohibited transaction tax (see prior article). It’s vital to note that securities of one or more TRS cannot account for more than 20% of a REIT’s total assets.
REITs can incorporate a TRS to handle prohibited tenant service income in addition to holding certain assets. Rents from real property include basic rents for use of real property, charges for services normally given in connection with rental real property, and rent attributable to personal property for the REIT’s annual income test (subject to applicable limitations). Utilities, laundry, security services, garbage service, sprinkler/fire safety, common area cleaning, and application fees are just a few examples of typical and usual services. Receipts for services that are not ordinary and customary are considered impermissible tenant service revenue. Non-customary services may include maid service, valet parking, child care centers, personal training, food service operations or catering, and car wash/detailing, depending on the applicable market and asset class. While a REIT is normally barred from providing these services, a TRS is generally permitted to do so and pay tax on any net revenue. Nonetheless, service-related costs paid by a REIT tenant to the TRS must be at arm’s length, or the REIT could face a penalty tax of 100%. Redetermined rents, redetermined deductions, excess interest, and redetermined TRS service income are all subject to a tax of 100% for REITs. To help limit penalty tax exposure, a REIT can use multiple safe harbor rules.
Benefits of a TRS when acquiring hotel or health care assets?
A REIT is often barred from directly operating a hotel or health care facility due to the inherent level of services supplied and the operating nature of the asset. The conventional workaround entails the REIT (or a subsidiary) leasing the property to the TRS (or a subsidiary), which then operates the property indirectly and pays tax on the net revenue generated after deducting the lease and other REIT expenses. It’s worth noting that a TRS can’t run a hotel or a health-care institution without losing their TRS accreditation. To avoid this negative outcome (which would almost certainly result in the REIT failing its security tests), the hotel and health-care facilities should be managed as follows:
- A TRS cannot lease a health care or lodging facility unless the TRS hires an eligible independent contractor (EIK) to manage the property. An EIK must not only meet the normal requirements for an independent contractor (IK), but also be in the business of managing unrelated health care or hotel properties. While it is obvious that managing a single unconnected property would be insufficient, there is no “black line” for the number of properties required. There may be little cause for concern for big, diverse operators, but certain instances involving a small number of unconnected assets may necessitate a thorough examination of the relevant facts and circumstances.
- Because there is a risk of tax arbitrage between the nontaxable REIT and its taxable TRS, due diligence should be performed to ensure that these intercompany lease arrangements are on an arm’s length basis. In the worst-case situation, the REIT could face a 100 percent tax, as mentioned above, if the terms are not considered arms-length. Given the potential for such a severe repercussion, a best practice normally entails the REIT retaining a transfer pricing specialist to assess the economics of the intercompany lease conditions to ensure they are comparable to other comparable third-party arrangements. The findings of such an investigation are usually documented in a transfer pricing research report, which supports the rent structure outlined in the lease. RSM has dedicated transfer pricing experts who are familiar with the intricacies of hotel and health-care leasing agreements. The transfer pricing issues outlined above are not restricted to intercompany leasing arrangements and can apply to a variety of REIT-TRS intercompany payments.
What does a taxable REIT subsidiary do?
A taxable REIT subsidiary (TRS) is a corporation owned by a REIT that elects to pay corporate income tax at the ordinary rate. TRSs give REITs the ability to keep up to 20% of their total assets in businesses that wouldn’t be allowed under the REIT structure otherwise. In other words, REITs can group similar assets or operations into a single corporate entity and pay tax only on the TRS component.
What is a qualified REIT subsidiary?
(2) A subsidiary of a qualified REIT For the purposes of this subsection, a “qualifying REIT subsidiary” is any corporation in which the real estate investment trust owns 100 percent of the stock. A taxable REIT subsidiary is not included in this definition.
Is a qualified REIT subsidiary a disregarded entity?
Three types of entities may be disregarded as entities separate from their owners under the Internal Revenue Code and its regulations: qualified REIT subsidiaries (within the meaning of section 856(i)(2)), qualified subchapter S subsidiaries (within the meaning of section 1361(b)(3)(B)), and single owner eligible entities.
How are REITs taxed in a taxable account?
REITs are already tax-advantaged investments because their profits are shielded from corporate income taxes. Because REITs are considered pass-through corporations, they must disperse the majority of their profits to shareholders.
The majority of your REIT dividends will be classified as regular income if you hold them in a conventional (taxable) brokerage account. However, it’s likely that some of your REIT dividends will fall under the IRS’s definition of qualified dividends, and that some of them would be treated as a non-taxable return of capital.
Ordinary income REIT dividends meet the requirements for the new Qualified Business Income deduction. This permits you to deduct up to 20% of your REIT payouts from your taxable income.
Holding REITs in tax-advantaged retirement accounts, such as regular or Roth IRAs, SIMPLE IRAs, SEP-IRAs, or other tax-deferred or after-tax retirement accounts, is the greatest option to avoid paying taxes on them.
You can save hundreds or thousands of dollars on your investment taxes if you follow these guidelines.
Can a REIT be a LLC?
Any entity that would otherwise be classified as a domestic corporation for federal income tax purposes but for the ReIT election may be eligible for ReIT treatment. As a result of these rules, a ReIT can be created as a trust, partnership, limited liability company, or corporation.
How are REIT dividends 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.
What tax form do REITs file?
To record a REIT’s income, gains, losses, deductions, credits, certain penalties, and calculate its income tax liability, use Form 1120-REIT, United States Income Tax Return for Real Estate Investment Trusts.
Can a REIT own another REIT?
To ensure that the majority of a REIT’s income and assets come from real estate sources, it must pass two yearly income tests and a number of quarterly asset tests.
Real estate-related income, such as rentals from real property and interest on obligations secured by mortgages on real property, must account for at least 75% of the REIT’s annual gross income. An additional 20% of the REIT’s gross revenue must come from the above-mentioned sources or from non-real estate sources such as dividends and interest (like bank deposit interest). Non-qualifying sources of revenue, such as service fees or a non-real estate business, cannot account for more than 5% of a REIT’s income.
At least 75 percent of a REIT’s assets must be real estate assets, such as real property or loans secured by real property, on a quarterly basis. A REIT cannot own more than 10% of the voting securities of any corporation other than another REIT, a taxable REIT subsidiary (TRS), or a qualified REIT subsidiary, directly or indirectly (QRS). A REIT cannot own stock in a corporation (other than a REIT, TRS, or QRS) in which the stock’s worth exceeds 5% of the REIT’s assets. Finally, the stock of all of a REIT’s TRSs cannot account for more than 20% of the value of the REIT’s assets.
Does a DRE need an EIN?
The DRE will need an employer identification number (EIN), which will require a responsible party to have a Social Security number (SSN), an international taxpayer identity number (ITIN), or an EIN, according to the existing regulations.
