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REIT Distribution Requirements– What Happens if Requirements Are Not Met

A REIT must distribute at least 90% of taxable income in order to meet REIT testing requirements.

It will pay tax on the remaining 10% of that income at a rate of 21%. A REIT is special because it can deduct dividends paid on its federal tax return to the extent it has earnings and profits. Most REITs overdistribute so they generally don’t pay any tax. But, what if a REIT is strapped for cash and can’t make that distribution requirement or fails to adequately plan and realizes after December 31st it didn’t make enough distributions?

A REIT can declare dividends in October, November or December to be paid in January of the following year and claim the dividends paid deduction on the tax return for the year declared. The shareholders of record would report the income as if paid by December 31st and the REIT would be considered to have paid the dividend by December 31st.

Example
A REIT declares a dividend in November 2019, but doesn’t pay it until January 2020. The REIT claims the dividends paid deduction on the 2019 tax return and the shareholders pick up the income on their 2019 tax returns.

A REIT can pay a dividend after the close of the taxable year as long as it declares the dividend before it files its tax return for that taxable year, including the time of extension granted, and it distributes the dividend within the 12-month period following the close of the taxable year. The dividend must also be paid before any distributions are paid for the following (current) tax year. Shareholders report the dividends in the year received.

Example
A REIT completes its 2019 4th quarter REIT testing in February 2020 and realizes it is short on the 90% test. The REIT can then declare a dividend by September 15th, 2020 (assuming the REIT filed a federal extension) and pay it by December 31, 2020 (12 months following the close of the 2019 tax year) assuming it pays the distribution before any 2020 distributions are made. The shareholders pick up the dividend income in the year received (2020), but the REIT can report the dividend for the dividends paid deduction on the 2019 tax return.

For more information on this topic, please contact a member of the Real Estate Services Group.

A REIT can also make consent dividends as a last resort. Shareholders have to “consent” to picking up the dividend income on their tax returns as taxable income and the REIT would take the dividends paid deduction even though no cash changes hands. A dividend is only a consent dividend if it otherwise would have been included in the shareholders’ income if actually paid. The REIT shareholders would increase their basis in the stock for the amount of the consent dividend on which they each paid tax. This is generally not favorable to investors since they would report income, but not actually receive any cash. The upside is it helps a REIT meet the 90% test as a last resort and offset income with the dividends paid deduction. A form must be signed by the shareholders and be filed with the REIT’s tax return. The shareholders must report the consent dividend in income in the same year the REIT claims the consent dividend for the dividends paid deduction.

Example
For the 2019 tax year, a REIT makes a consent dividend. Shareholders do not actually receive any cash, but sign Form 972, which is filed with the REIT’s tax return. The shareholders must report the dividend income in 2019 since the REIT is claiming the dividend for the dividends paid deduction.

Since REITs have a multitude of requirements to meet, diligence and planning is best done before the close of the current taxable year to avoid any last minute issues. Thankfully, there are a few options available for a REIT to use if it later realizes it needs to make additional distributions.

Author: Ashley Kettler, CPA | akettler@withum.com

Real Estate Services

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