tax for this office. He was also a Partner with Draper, Hall in Indianapolis, Indiana which provided services to a related group of Partners owning Indiana healthcare facilities. Timothy Hall earned his B.S. in Accounting with High Distinction from Indiana University in Bloomington, Indiana in 1980. He is a Certified Public Accountant in the State of Illinois and a graduate from the United States Naval School of Music in Norfolk, Virginia.

KJ- What is a Real Estate Investment Trust (REIT)?

TH- A Real Estate Investment Trust (REIT) is like a mutual fund for real estate. In a mutual fund there are a number of individual investors coming together with small amounts of money but the mutual fund can now buy stock in a number of companies in a meaningful way and diversify the individual’s small dollar investment among several companies. A REIT pools together money from investors to purchase real estate and thus diversify their ownership versus buying one building and having all of the risk in one building, for example. The investor also obtains the benefit of a portfolio of real estate under professional management. Many of the leading REITs are publicly held companies, so an individual can purchase the stock in their ETrade or Schwab account just as they would buy the stock of any other public company traded on the stock exchange.


KJ- It is my understanding that REITs do not pay tax. Why is that?

TH- REITs are different in that there is only one level of tax between the corporation and shareholder, unlike regular corporations where there is an income tax imposed at the corporate level, then again at the shareholder level on the dividends distributed by the corporation. Congress passed REIT legislation in 1960 as a favorable tax vehicle to encourage individual investors to invest in real estate. The REIT is taxed under the provisions of a C corporation, but is allowed a dividends paid deduction against its taxable income unlike other C corporations. In that regard, the tax treatment is similar to partnerships and S Corporations where only the individual partner/shareholder pays the tax. The character of the taxable income also passes out to the individual shareholder, so that capital gains from the sale of real estate by the REIT may be taxed at the more favorable 15% tax rate to the individual.


KJ- What are the tax requirements for a REIT?

TH- A REIT must have one hundred shareholders and must be formed as an entity taxed as a corporation. No more than 50% of the shares can be owned by five or fewer individuals. There are several asset and income tests to be met, but the primary one is that at least 75% of the assets are real estate assets and at least 75% of the gross income is either rents from real property or interest on mortgages on real property. In general, a REIT cannot buy and sell real estate as a dealer in real estate; rather, it must buy the real estate with the intent of leasing it and holding on to it long term. Finally, a REIT must pay dividends of at least 90% of its taxable income.


KJ- It is my understanding that there are a variety of different REITs. Can you tell us about that?

TH- First, there are Equity REITs and Mortgage REITs. The difference between the two is that an Equity REIT owns real estate and collects rents; however, a Mortgage REIT loans money to real estate owners and collects interest on their mortgage loans.
The types of property owned by an Equity REIT include retail, residential, self-storage, health care, office, industrial and lodging. There are even REITs that specialize in subsets of those categories. For example, within retail some REITs own primarily regional malls where others might own neighborhood and community shopping centers. There are usually two or three very large players in each category of REITs. In some cases, a diversified REIT may own several types of properties.


KJ- What is a captive REIT?

TH- By law, a REIT must have one hundred shareholders. However, some REITs are considered captive REITs because most of the ownership is held by one corporate entity or an affiliated group. The other shareholders have a very small ownership percentage as opposed to a public REIT where there is no one individual or corporate entity that owns a significant percentage of the REIT. Captive REITs have been used by corporations in various ways for tax planning purposes through the years.


KJ- What is one of the most unusual REITs you have encountered in terms of the category?

TH- Although they have been around for a while now, there are timber REITs that own timberland. There are also entertainment REITs which own theatres, vineyards, wineries and ski parks.


KJ- What is an UP REIT?

TH- Although Congress first passed REIT legislation in 1960, it wasn’t until 1992 that partnerships were used in conjunction with the public company REIT to address the tax issues where various existing partnerships owning multiple properties came together to form a REIT. Many of the large REITs today are in an UPREIT structure. UPREIT stands for Umbrella Partnership REIT. In the formation of an UPREIT, a public company obtains money from shareholders in an Initial Public Offering (IPO) and contributes it to an Operating Partnership (OP). Then, partners in various partnerships owning multiple properties contribute those properties to the OP for a limited partnership interest. The benefit to the limited partners is that they can diversify their real estate interests on a tax-deferred basis. They also obtain liquidity because they can convert their partnership interest for REIT stock at some point in the future. The cash from the public is used to either pay down some of the debt assumed by the OP with the contribution of properties, or to buy additional real estate properties.


KJ- What REIT’s do you expect the most growth?

TH- With the current economic environment, I believe that the healthcare REITs will be stronger than many other categories in the near future.


Timothy, thank you for taking the time to answer our questions. Your perspective is valuable to the Tax Intelligence Report readers around the world and we genuinely appreciate the time you gave to share your experience.

Kathleen Jennings (KJ)
Editor, The Tax Intelligence Report
Kathleen@etsearch.com


Timothy Hall (TH)
Vice President of Tax
First Industrial Realty Trust - Chicago, Illinois
hall7086@sbcglobal.net