As we have discussed in our prior client alerts,1 BDCs and REITs have witnessed a resurgence of late. Below, we provide our observations and a brief comparison of the two investment vehicles.


A BDC is a special investment vehicle designed to facilitate capital formation for small companies. Its regulatory advantages include exemptions from many of the restrictions imposed by the Investment Company Act of 1940 (“1940 Act”). A BDC is defined under the 1940 Act to mean a domestic closed-end company that operates for the purpose of making investments in certain securities and, with limited exceptions, makes available “significant managerial assistance” with respect to the issuers of such securities.

Under the 1940 Act, a BDC generally must have at least 70% of its total assets in the following investments: (i) privately issued securities purchased from issuers that are “eligible portfolio companies”;2 (ii) securities of eligible portfolio companies that are controlled by a BDC and of which an affiliated person of the BDC is a director; (iii) privately issued securities of companies subject to a bankruptcy proceeding, reorganization, insolvency or similar proceeding or otherwise unable to meet its obligations without material assistance; (iv) cash, cash items, government securities, or high quality debt securities maturing in one year or less; and (v) office furniture and equipment, interests in real estate and leasehold improvements and facilities maintained to conduct the business of the BDC.

BDCs typically are organized as limited partnerships and taxed as partnerships in order to obtain pass-through tax treatment. More recently, some BDCs have been organized as corporations and have opted to be treated as RICs for federal income tax purposes thereby avoiding an entity-level tax. A RIC must meet certain income, asset, diversification, and distribution tests to receive preferential tax treatment. For example, at least 90% of its gross income must be derived from certain passive sources (e.g., interest and dividends and gain from stock, securities or foreign currencies), and at the close of each quarter of its tax year its assets must be adequately diversified. To avoid an entity-level tax, RICs generally distribute all or substantially all of their income by the end of each taxable year.

In general, a BDC would file a registration statement on Securities and Exchange Commission (“SEC”) Form N-2. If treated as a partnership for federal income tax purposes, the BDC would file a federal income tax return on IRS Form 1065 and send its investors, annually, Schedules K-1, reporting their shares of partnership income. If, however, the BDC is treated as a RIC for federal income tax purposes, it would file a federal income tax return on IRS Form 1120-RIC and send its investors, annually, IRS Forms 1099, reporting their RIC distributions.


A REIT is an investment vehicle designed to allow investors to pool capital to invest in real estate assets. Its regulatory advantages include an exemption under the 1940 Act, which is available for entities primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on, and interests in, real estate. This exemption generally is available if at least 55% of the REIT’s assets are comprised of qualifying assets and at least 80% of its assets are comprised of qualifying assets and real estate-related assets. For these purposes, qualifying assets generally include mortgage loans and other assets which are the functional equivalent of mortgage loans.

For federal income tax purposes, a REIT is a corporation3 that receives special tax treatment. The special tax treatment is an exemption from federal income tax at the corporate level to the extent the REIT distributes its income annually. A REIT is subject to normal corporate tax on any income that it retains. In order to qualify as a REIT for federal income tax purposes, substantially all of the entity’s assets must be held in real estate related investments. It also must earn, each year, at least 95% of its gross income from passive sources and at least 75% of its gross income from real estate related sources. Real estate mortgages qualify as good REIT investments under the asset test and produce good income for both the 95% and 75% tests. A REIT is subject to a 100% penalty tax on income from sales of “dealer property” (generally, property held as inventory or primarily for sale to customers in the ordinary course of its trade or business, excluding certain foreclosure property), a rule that limits the REIT’s activities. However, a REIT can own a taxable REIT subsidiary (“TRS”), which is subject to a corporate level tax and may engage in activities that would be impermissible for the REIT itself; its investment in TRSs cannot exceed 25% of its total gross assets.

In general, a REIT would file a registration statement on SEC Form S-11. A REIT must file its federal income tax return on IRS Form 1120- REIT and send its investors, annually, IRS Forms 1099.