Top Tax Tips for REITs

By Steven Bandolik and Mark Van Deusen

In Deloitte’s 2018 Real Estate & Construction Outlook, we offer ideas intended to help REITs accelerate growth, such as revisiting corporate governance and communications, optimizing property portfolios, and strategizing listing status.

The new tax law will have far-reaching consequences and creates new planning considerations for the real estate industry. Several areas in particular offer potentially significant opportunities for investors.

Deduction Limits

The new tax law imposes a new limitation on business interest deductions. Generally, net business interest expense will be limited to 30 percent of adjusted taxable income.

That said, the limitation does not apply to an electing real property trade or business (RPTOB), a category which encompasses development/redevelopment, construction/reconstruction, acquisition, conversion, operations, management, leasing and brokerage. However, an electing RPTOB is subject to slightly longer depreciation periods on certain assets.

Sale-Leasebacks

The new tax law could give these transactions a boost in popularity. Many operating businesses that own real property are not classified as an RPTOB (e.g., a manufacturer that owns its corporate headquarters). As a result, the interest deductions attributable to the real property held by an operating business will be subject to the new limit.

But suppose an operating business and an electing RPTOB engage in a sale-leaseback transaction. In that case, the deduction limits do not apply to the rent paid by the operating business. Nor would the RPTOB be subject to the interest limitation on its debt financing.

Moreover, the reduction of the corporation tax rate from 35 percent to 21 percent should make sale-leaseback transactions more attractive for C corporations.

Publicly traded REITs organized in an UPREIT structure may be particularly attractive counterparties for a variation of the sale-leaseback transaction, the contribution-leaseback. An owner of real property can generally contribute real property to the operating partnership of a publicly traded REIT in exchange for operating partnership units—economically equivalent to REIT stock—on a tax-deferred basis.  Thus, an owner of real property can engage in a contribution-leaseback transaction, recognize no gain on the contribution, and fully deduct the rent paid on the leaseback portion of the transaction.

Passthrough Provisions

The new tax law also allows qualifying non-corporate taxpayers a 20 percent passthrough deduction on  REIT dividends. That provision reduces the new 37 percent maximum individual rate to 29.6 percent.

The 20 percent deduction also applies to income from certain proprietorships and partnerships, but that income is subject to limitations that do not apply to REITs.

And because REITs are not subject to those limitations, investors—especially those that hold foreign assets or raw land—may want to investigate the option of owning property through a private REIT in order to benefit fully from the 20 percent deduction.

We’ve only scratched the surface of this vastly complex legislation, and there is much more regarding tax planning, for 2018 and beyond, that industry executives should be thinking about. Other important considerations include expanded provisions related to carried interest, like-kind exchanges, and non-corporate business losses.

Steven Bandolik

Steven Bandolik is a managing director with Deloitte Services LP and a senior leader in Deloitte¹s real estate and construction practice. A 30-year industry veteran, he provides advisory services in capital markets (debt and equity), corporate finance, mergers and acquisitions, investments, strategy, restructuring and reorganization, and asset recovery.

Mark Van Deusen

Mark Van Deusen is a principal with Deloitte Tax LLP ’s Washington National Tax practice and focuses on tax issues faced by REITs and other real estate investors. Van Deusen has 20 years of experience advising REITs and other real estate investors.

You’ll find more on this topic in the March 2018 issue of CPE.