Search within this section
Select a section below and enter your search term, or to search all click Income taxes
Favorited Content
8.7 Real estate investment trusts
Publication date: 31 Dec 2022
us Income taxes guide
A real estate investment trust (REIT) is a corporation that meets a series of requirements regarding its income, assets, ownership, and distributions of earnings and elects to be taxed as a REIT. A REIT is generally not subject to tax on income it distributes currently to shareholders, and in practice, most REITs distribute substantially all of their income such that they are effectively nontaxable. If the entity fails to continue to meet the criteria to qualify as a REIT, it will become subject to corporate income taxes and various penalties, and could, in extreme cases, lose its REIT status altogether.
Some traditional C corporations may decide for various business reasons to convert to a REIT. Although some might argue that, in concept, such a conversion is no different than the other changes in tax status from taxable to nontaxable that are described earlier in this chapter, from a technical point of view, there is no blanket nontaxable status for a REIT. A REIT is not required to file an election to effect the change in tax structure; rather, the REIT first reports the conversion to the IRS by filing a specific tax form (1120-REIT) several months after the end of its initial tax year as a REIT. Further, such change does not require approval by the IRS.
The requirements for a REIT conversion to become effective include:
- Setting up the legal entity structure of the REIT,
- Purging accumulated earnings and profits from its operations as a C corporation through a distribution to shareholders (E&P Purge), and
- Filing its initial tax return as a REIT on Form 1120-REIT.
Question TX 8-1
A C corporation plans to convert into a REIT effective January 1, 20X6. When should the C corporation adjust its deferred tax accounts to reflect its new REIT status (i.e., when should it derecognize its existing deferred tax assets and liabilities)?
A C corporation plans to convert into a REIT effective January 1, 20X6. When should the C corporation adjust its deferred tax accounts to reflect its new REIT status (i.e., when should it derecognize its existing deferred tax assets and liabilities)?
PwC response
This fact pattern is not explicitly addressed by ASC 740 or any other literature.
This fact pattern is not explicitly addressed by ASC 740 or any other literature.
In our view, the conversion of a C corporation to a REIT is not a “change in tax status” as described in ASC 740-10-25-33. This is because a REIT is still technically a taxable entity under the Internal Revenue Code. A REIT’s earnings are taxable, although the amount subject to income taxes is reduced by a deduction for the amount of REIT taxable income distributed to shareholders.
Because we do not view the REIT conversion to be a change in tax status, we believe it would be appropriate to reflect the effects of the REIT conversion at the date when the C corporation (1) completed all significant actions necessary to qualify as a REIT and (2) committed to that course of action. This is consistent with the guidance in ASC 740-10-05-9, which addresses situations in which companies have “control” over the outcome of whether certain temporary differences will result in taxable amounts in future years.
The C corporation should account for the conversion to a REIT when it:
- Has committed itself to this course of action in such a way that it would be impossible or practically impossible to not convert to REIT status. Approval by the appropriate parties within the C corporation (e.g., board of directors) and a public announcement of the change might produce this result, provided that this truly constituted a commitment.
- Has obtained financing for the E&P purge (if necessary and considered significant).
- Is “REIT-ready” in all material respects such that the only legal and administrative actions necessary to qualify for REIT status is to file its tax return on Form 1120-REIT (i.e., any remaining steps are considered perfunctory).
At that time, tax assets or liabilities should be adjusted to reflect the change to REIT structure.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
Link copied
