Ups and Downs: A REIT Dilemma

A REIT is like a mutual fund for real estate. It allows investors to buy shares in real estate properties without actually owning them. The REIT is not taxed like regular companies are, which can be an advantage. It brings together owners, property managers, and investors to make money from real estate. This article talks about the important things to consider when joining the public capital markets. REITs are a special type of company that owns real estate and lets people invest in it. To be a REIT, the company has to meet certain rules and tests set by the government. There are different types of REITs, and they usually own and make money from things like office buildings, shopping centers, and apartments. This can be a good investment because it pays out high dividends. A REIT needs to get money from outside sources because it has to distribute most of its earnings. It can do this by selling shares, issuing debt, or getting money from investors. Investors expect to get some of the REIT’s money as distributions, but they also need to understand that the REIT needs money to grow and can get that money from the public markets. When analyzing a REIT’s finances, the terms may be a little different than for other companies, but the basic ideas are the same. For example, instead of looking at net income, we might look at “funds from operations” or “funds available for distribution”. We also use the “net asset value” to see how much the REIT’s assets are worth. This concept is similar to how we value other types of investments. Before investing in a REIT, look at the financial strength and management. Check the balance sheet and cash flows and the experience of the management team. Most REITs are now managed internally by a team of directors or trustees. These people make important decisions about buying and managing properties. Check to see if their decisions have been successful by comparing the acquisition price with the income the property brings in. The tax code has different rules for different types of corporations. “Regular” or “C” corporations are taxed on their income, and then shareholders are taxed on the dividends they receive from the corporation. This means the same money gets taxed twice. But partnerships and S corporations don’t have this double tax – the income is only taxed at the partner or shareholder’s level. However, if a partnership goes public and becomes a publicly traded corporation, it will be taxed like a regular corporation. This can make a big difference in how much money the company and its shareholders end up with. A real estate partnership that needs a lot of money might want to become a publicly held real estate investment trust (REIT) because it can attract money and has tax benefits. The U.S. Congress passed laws in the 1960s to help regular people invest in real estate. But if a partnership becomes a REIT, the partners might have to pay taxes on the increase in value of the property, even if they don’t want to. An UPREIT is a way for investors to pool their money and exchange it for shares in a real estate investment trust (REIT). The REIT then forms a partnership and transfers the public’s cash into it. The partnership also transfers ownership interests to the existing partners who own the real property. This allows the REIT to qualify for tax benefits as a REIT. In simpler terms, it’s a way for people to invest in real estate together and get tax breaks. Essentially, for a real estate investment trust (REIT) to qualify as a REIT, it must follow certain rules about distributing profits to shareholders. In addition to the regular shareholders, the partners in the partnership also get a share of the profits. Even though their share is like a regular shareholder’s, they don’t have voting rights in the company. However, they can convert their partnership interests into shares, which can give them voting rights and the ability to sell the shares for cash. The IRS has rules to prevent people from using partnerships to avoid paying taxes. UPREITs, a specific type of partnership, need to be set up in a way that follows these rules. It’s important for the people setting up UPREITs to make sure they’re following the rules and not trying to cheat the system. The limited partners give their shares in the partnership to a new partnership and get shares in the new partnership in return. This usually doesn’t cause them to owe taxes, but there are some situations where they might have to pay taxes. This can happen if they receive a valuable security and its value is more than what they originally put in. There are some exceptions and rules that might prevent this from happening, but it’s important to be careful. When a partner contributes property with debt to a partnership, it can have tax consequences for the partner. The partner may have to pay taxes on the value of the debt and the property. If a partner gets money from the partnership to pay off the debt, it can also have tax consequences. Sometimes, the partner could also have to pay taxes if they receive property or money from the partnership when they contribute their own property. These rules are important to consider when forming a partnership. An umbrella partnership that is treated as a Publicly Traded Partnership (PTP) under the tax code can cause a Real Estate Investment Trust (REIT) to lose its special tax status. Existing partnerships can make an election to adjust their assets for tax purposes before terminating. An alternative to the UPREIT structure is the DOWNREIT, which allows the partnership to acquire properties without limited partners recognizing gain, unlike a simple REIT. This can be advantageous because there are fewer restrictions under the tax code for the umbrella partnership. An UPREIT is a type of REIT where a new partnership is formed for each acquisition, allowing for tax-deferred exchanges of properties for limited partnership interests with the REIT as the general partner. This structure can be more complicated and costly than a traditional REIT, but it may offer advantages such as fewer conflict of interest issues. The DOWNREIT is similar to the UPREIT, but it is centralized at the REIT level instead of the partnership level. It is designed to allow existing simple REITs to compete with UPREITs for capital. Real Estate Investment Trusts (REITs) must meet specific requirements to avoid taxes. These include income, asset, and distribution tests. There are also securities laws to consider. The IRS has rules for transfers of interests involving REITs. A REIT’s deduction for dividends paid is a set minimum amount. There are complex tax and partnership rules to follow. Brian K. Jordan, a lawyer and CPA, specializes in business and tax law. This column is written by the Real Property, Probate and Trust Law Section. They aim to teach their members about serving the public, improving the legal system, and advancing the study of law.

Source: https://www.floridabar.org/the-florida-bar-journal/ups-and-downs-a-reit-dilemma/