Real estate investment trusts (REITs) have become increasingly popular due to their tax advantages and investment opportunities. However, starting a private REIT can be a complex process that requires careful consideration of organizational and operational requirements. In this article, we will delve into the key steps and considerations involved in starting a private REIT.
REIT Structure and Organizational Requirements
According to the National Association of Real Estate Investment Trusts (Nareit), REITs can be formed in all 50 states and the District of Columbia. To qualify as a REIT, certain organizational and operational requirements must be met. These include:
- Having a board of directors or board of trustees.
- Ensuring transferability of shares.
- Maintaining a minimum of 100 shareholders by the second year, known as the 100 shareholder test.
- Ensuring that the REIT is not closely held, meaning that five or fewer people cannot hold more than 50 percent of the shares, as per the 5/50 test.
Navigating the intricacies of REIT ownership provisions can be challenging, and seeking advice from tax and securities law experts is crucial to ensure compliance with organizational charters.
Operations Requirements for REITs
To maintain REIT status, entities must meet certain annual income tests. These tests include:
- A minimum of 75 percent of the REIT's gross income must be derived from real estate, such as leases on real property assets or mortgage interest.
- Additionally, 20 percent of the REIT's gross income must come from dividends, interest generated from REIT funds held by financial institutions, or other qualified sources.
- Not more than 5 percent of the REIT's income can be derived from fees or services unrelated to real estate.
Furthermore, a quarterly requirement stipulates that at least 75 percent of the REIT's assets must be directly linked to real estate, such as real property or real estate-backed loans.
REIT Compliance Requirements
Companies or entities seeking REIT status must file a Form 1120-REIT on their tax return. Additionally, the REIT must mail a shareholder demand letter annually to comply with the 5/50 and 100 shareholder ownership tests. Failure to fulfill this requirement may result in an IRS fine of up to $50,000.
The Benefits and Considerations of Private REITs
Private REITs offer certain advantages compared to publicly traded REITs. As they are not publicly traded securities, they are exempt from SEC regulations and disclosure requirements. Consequently, private REITs are usually externally managed and offered exclusively to institutional and accredited investors, making their shares highly illiquid.
Starting a private REIT involves complying with numerous rules and regulations. Real estate investors considering this avenue should engage the services of accounting, legal, and investment banking firms experienced in REIT formation to ensure compliance with stipulations.
In conclusion, starting a private REIT can be a fruitful venture for real estate investors, offering tax advantages and investment opportunities. However, it is crucial to navigate the complex organizational and operational requirements while adhering to compliance obligations. By seeking expert guidance, investors can embark on their private REIT journey with confidence.
Sources:
- REIT Industry Monthly Data, September 2021, Nariet
- Waivers of Ownership Limitation Provisions in REIT Charters, Goodwin Proctor LLP
- Deadline For REIT Shareholder Demand Letters, Ernst & Young LLP
This material is for general information and educational purposes only. It should not be used as a primary basis for investment decisions or construed as tailored advice. Seeking the guidance of qualified professionals for individual situations is recommended.