Recently, the U.S. Congress made several changes to the qualification rules for real estate investment trusts (REITs) that will be effective for taxable years beginning after December 31, 2000. Specifically, the Ticket to Work and Work Incentives Improvement Act of 1999 (Public Law 106-170, December 17, 1999) changed the federal treatment of REITs by allowing a REIT to own shares of a "taxable REIT subsidiary," a type of asset that REITs generally cannot hold under current law. P.L. 106-170, §§ 542 - 543, amending IRC § 856(d) and adding to § 856 new subsection (l). The Act added a new requirement that a REIT cannot own more than 10% of the total voting power or total value of the outstanding securities of any one issuer. P.L. 106-170, § 541 amending IRC § 856(c)(4). However, this new test does not apply to taxable REIT subsidiaries or certain other securities. Id. In addition, the Act decreased the amount of taxable income a REIT is required to distribute from 95% to 90%, and made several other changes that affect the organization and operation of REITs. P.L. 106-170, § 556 amending IRC § 857(a)(1); see generally P.L. 106-170, §§ 541 - 571.
As discussed below, it is not clear how this federal tax law change affects the treatment of corporate trust REITs for Massachusetts tax purposes. (1) However, it appears that the federal tax law change, if not adopted by Massachusetts, would have a disruptive effect on the Massachusetts taxation of corporate trust REITs and their shareholders. This Technical Information Release announces that, pending legislation clarifying the Massachusetts law governing the taxation of corporate trust REITs and their shareholders, the Department will treat a corporate trust as a REIT for Massachusetts purposes, provided that the corporate trust qualifies as a REIT for federal income tax purposes. (2)
II. Federal Law
Under § 856 of the Internal Revenue Code (Code) a corporation or corporate trust may elect to be a REIT if it satisfies certain organizational requirements. In addition, a REIT must satisfy all the initial and continuing requirements at IRC §§ 856 through 859 concerning the character of its assets and income, the payment of dividends, and the maintenance of records. Effective for tax years beginning after December 31, 2000, Congress made substantial changes to REIT qualification requirements, including the following:
Taxable REIT Subsidiaries For tax years beginning after 2000, IRC § 856 has been amended to allow REITs to own up to 100% of the shares in a "taxable REIT subsidiary," provided the total value of all taxable REIT subsidiary securities does not exceed 20% of the total value of a REIT's assets. IRC § 856(d)(7)(C)(i). A taxable REIT subsidiary, as defined at new IRC § 856(l), can conduct activities that the parent REIT cannot (such as providing services to REIT tenants) without disqualifying the rents received by the REIT. Taxable REIT subsidiaries are taxed as C corporations, and the Act includes a set of complex rules to ensure that a taxable REIT subsidiary is subject to an appropriate level of corporate taxation.
REIT Asset Test For tax years beginning after 2000, the REIT securities diversification test will prohibit the ownership of more than 10% of the voting power or more than 10% of the value of the securities of any one issuer, unless the issuer is a taxable REIT subsidiary, a "grandfathered" entity, or comes within certain other exceptions. IRC § 856(c)(4)(B).
Distribution Test For tax years beginning after 2000, the Act decreases the amount of taxable income a REIT is required to distribute from 95% to 90%. IRC § 857(a)(1)(A)(i) and (ii).
III. Massachusetts Treatment of REITs Organized as Corporate Trusts
For Massachusetts personal income tax purposes, REIT status confers an important benefit on a corporate trust. A corporate trust that is a REIT is not subject to income tax at the entity level. (3) The new federal law has raised the issue whether a REIT organized as a corporate trust will lose this tax benefit if it takes advantage of the new federal eligibility rules. The crux of the problem is whether references to § 856 of the Code in the Massachusetts personal income tax statue include (1) all REITs which qualify for federal income tax purposes, or (2) only those REITs which would qualify under the Code as amended and in effect on January 1, 1998.
The personal income tax statute governs taxation of REITs organized as corporate trusts. For personal income tax purposes, references to the Code are, unless the context indicates otherwise, to the Code as amended and in effect on January 1, 1998. G.L. c. 62, § 1(c). A REIT organized as a corporate trust is exempt from the Massachusetts personal income tax at the entity level, provided it qualifies under § 856 of the Code as defined in chapter 62. G.L. c. 62, § 8(b)(i). A literal reading of the statute may require that REITs organized as corporate trusts must continue to comply with REIT requirements in effect as of January 1, 1998, in order to continue to qualify for an exemption from Massachusetts taxation under G.L. c. 62, § 8(b)(i). Thus, under this literal interpretation, corporate trusts could not take advantage of the new federal rules if they wish to retain their status as REITs for Massachusetts purposes. In contrast, this issue is not raised with respect to REITs organized as corporations on account of the automatic Code update provisions of Chapter 63, i.e., references to the Code in Chapter 63 are to the "federal Internal Revenue Code, as amended and in effect for the taxable year."
The above interpretations notwithstanding, it could be argued that the Massachusetts personal income tax provides for an automatic Code update with respect to REIT qualification. This argument is based on the theory that the context in which the term REIT is used indicates that a departure from the 1998 Code definitions may be allowed. Therefore, the term REIT may be construed as referring to a corporate trust's federal tax status as in effect for the current taxable year. This Technical Information Release is not intended to resolve these conflicting interpretations.
In order to provide the Legislature the opportunity to consider the appropriate Massachusetts tax treatment of REITs that are corporate trusts and their shareholders, pending further notification, the Department of Revenue will treat a corporate trust as a REIT for Massachusetts purposes, provided that the corporate trust qualifies as a REIT for federal income tax purposes under the Code as amended and in effect for the taxable year. At the shareholder level, a distribution from a REIT qualified for federal income tax purposes will be treated as a distribution from a REIT for Massachusetts tax purposes.
In addition, the Department will take a similar position with respect to any changes in the federal definition of regulated investment companies (RICs) under IRC § 851 and real estate mortgage investment conduits (REMICs) under IRC § 860D, as those terms are used in G.L. c. 62, § 8(b) and G.L. c. 62, § 2(a)(2)(A), (I), and (J). Specifically, pending further notification, the Department will treat any entity that qualifies as a RIC or REMIC for federal income tax purposes under the Code as amended and in effect for the taxable year as a RIC or REMIC for Massachusetts personal income tax purposes. Distributions from such entities will be treated as distributions from RICs or REMICs as the case may be.
Any change in the position announced by this Technical Information Release will have prospective effect only.
Frederick A. Laskey
Commissioner of Revenue
January 16, 2001
1 A corporate trust is any partnership, association or trust, the beneficial interest of which is represented by transferable shares. G.L. c. 62, § 1(j). For Massachusetts income tax purposes, a Massachusetts business trust is a corporate trust.
2 See Technical Information Release 97-14 which made a similar announcement with respect to regulated investment companies (RICs), real estate investment trusts (REITs), and Real Estate Mortgage Investment Conduits (REMICs) after federal law changes were made in 1997 to the taxation of RICs.
3 But see Technical Information Release 00-6 which notifies taxpayers that certain corporate trusts, including REITs, come within the definition of "financial institution" and are subject to the financial institution excise at G.L. c. 63, §§ 1, 2 and 2A. If a corporate trust is a REIT and a financial institution for purposes of chapter 63, it must file Form 63 FI.