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Sen. Elizabeth Warren (D-Mass.) is the latest member of Congress to call for the Internal Revenue Service (IRS) to pay more attention to taxation around real estate investment trusts (REITs). Officials are closely examining how some in the health care and hospitality sectors behave regarding owning properties.
REITs don't pay corporate income tax if they meet certain requirements. Instead, they pass most of their income directly to shareholders, avoiding the “double taxation” other corporations face. To maintain this tax-exempt status, a REIT must follow certain rules, including distributing at least 90% of its taxable income to shareholders as dividends. A REIT must also have 75% of its assets in real estate, cash, or government securities and derive at least 75% of its gross income from real estate-related activities, such as rent, mortgage interest, or property sales.
Concerns over REIT taxation began this summer with a July letter from Senator Ron Wyden (D-OR) to the IRS. The IRS responded in August with a letter clarifying and restating REIT rules. It pointed out that one exception to rules about related party rents exists for qualified lodging facilities. REITs are allowed to own qualified lodging facilities or qualified health care properties, but they cannot directly operate them. Instead, REITs use a taxable REIT subsidiary (TRS).
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The REIT Investment Diversification and Empowerment Act of 2007 created the TRS structure. It allowed health care and hospitality businesses to be structured as REITs. Before that, many REITs were restricted from operating health care and senior housing facilities because they had to generate most of their income from passive sources, such as rent, rather than active business operations.
The IRS letter clarified that the TRS must contract an eligible independent contractor to operate and manage the qualified lodging facility. It cannot directly or indirectly operate or manage a lodging facility or it risks losing its special tax status. The IRS stated that it is aware that some REITs have been having the TRS lease the qualified lodging facility from the REIT and indirectly operate it, warning that REITs using this approach could lose their tax status for five years.
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Senator Warren responded to that letter with her own letter to the IRS. She stated that while REITs are intended to be passive income opportunities for smaller-scale investors, some may violate the rules. She specifically called out Medical Properties Trust (NYSE:MPW) as raising questions about whether it has met IRS requirements.
In the letter, she said: "As the IRS continues to identify massive corporations and businesses that may be violating tax law, I urge you to increase enforcement scrutiny of REITs, especially large health and hospitality REITs that may be illegally claiming significant tax breaks while meddling in the operations of their tenants."
Bisnow contacted the National Association of Real Estate Investment Trusts (Nareit), which said in a statement that there are no signs that REITs have violated any tax laws. The IRS has named no specific REITs concerning any potential violations.
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This article Senator Elizabeth Warren Joins The Call For REIT Crackdowns: What's Behind The Controversy? originally appeared on Benzinga.com