A recently issued Revenue Procedure (Rev. Proc. 2018-48) establishes that certain income, including “global intangible low-taxed income” (“GILTI”), received by a real estate investment trust (“REIT”) through its foreign subsidiaries will be qualifying income for the 95% gross income test applicable to REITs (the “95% Gross Income Test”), and that certain related foreign currency gain will be excluded for purposes of the 95% Gross Income Test. The Revenue Procedure is effective for taxable years beginning after September 13, 2018; however, a REIT may elect for it to apply to any prior taxable year(s). The changes set forth in the Revenue Procedure significantly benefit REITs with non-U.S. real estate assets. Specifically, prior to the issuance of the Revenue Procedure, such REITs could find it difficult to satisfy the 95% Gross Income Test without a private letter ruling, in particular because of GILTI inclusions.
Qualifying Income and Exclusions from the 95% Gross Income Test
Under Section 856(c)(2) of the Internal Revenue Code of 1986, as amended (the “Code”), a REIT must annually satisfy the 95% Gross Income Test by deriving at least 95% of its gross income from certain enumerated sources, including rents from real property, dividends, interest and gain from the sale or other disposition of stock, securities, and real property. Under Section 856(c)(5)(J) of the Code, the Secretary of the Treasury is authorized to determine whether any other item of income or gain is gross income for purposes of the 95% Gross Income Test and, if so, whether it is qualifying income for the purposes of such test.
Previously, the treatment of certain foreign income inclusions for purposes of the 95% Gross Income Test was unclear. A REIT may own interests in certain foreign subsidiaries, including subsidiaries that may be “controlled foreign corporations” (“CFCs”) or “passive foreign investment companies” for U.S. federal income tax purposes, and may be required to include in gross income certain types of income or earnings of such subsidiaries, without regard to whether the REIT has received any cash distributions from the subsidiaries. Additionally, under the Tax Cuts and Jobs Act (P.L. 115-97), each U.S. shareholder of a CFC is subject to tax on its share of the CFC’s GILTI. GILTI, generally, is the U.S. shareholder’s pro rata share of income accrued within CFCs in excess of 10% of the CFCs’ tangible overseas investment, reduced by certain interest expense incurred by the CFCs. A U.S. corporation, including a REIT, is required to include GILTI in its income in a manner generally similar to inclusions of Subpart F income. In June 2018, Nareit urged the Internal Revenue Service (“IRS”) to issue guidance clarifying that GILTI amounts are qualifying for the 95% Gross Income Test.
The Revenue Procedure provides that amounts required to be included in income under Sections 951(a)(1) (except by reason of Section 965), 951A(a), 1291(a), 1293(a)(1) and 1296(a) of the Code are qualifying income for purposes of the 95% Gross Income Test. Such income includes Subpart F income, GILTI, and “passive foreign investment company income” received by the REIT. In addition, the Revenue Procedure excludes from gross income for purposes of the 95% Gross Income Test amounts required to be taken into account by a REIT under Section 986(c) of the Code as foreign currency gain with respect to distributions of previously taxed earnings and profits.
More Favorable Treatment than Recent Private Letter Rulings
The Revenue Procedure is more generous than recent private letter rulings on this topic, as some recent private letter rulings have imposed activity restrictions on the underlying foreign subsidiary (e.g., requiring that income earned be passive in nature). Under the Revenue Procedure, REITs with foreign subsidiaries will not need to submit themselves to the private letter ruling process to receive guidance on the foreign income inclusions.
Additionally, the new rules can apply electively to any prior taxable years for which the REIT is required to account for such income or foreign currency gain. This allows all REITs to receive the favorable new treatment for prior years.
The IRS issued the Revenue Procedure the same day it released proposed GILTI regulations.