REIT's could face Obama tax hike.

by--Bloomberg news--Investment News
Lobbyists already seeking to deflect tax code change; potential S-corp fallout

Lobbyists for the largest real estate investment trusts in the U.S. are working to shield the industry from paying corporate taxes if President Barack Obama and Congress agree to a tax code rewrite.

The industry, which includes Simon Property Group Inc. and Equity Residential, is guarding against a potential proposal from the Obama administration that would impose new taxes on partnerships and similar companies with more than $50 million in gross receipts that are currently exempt from corporate income tax. The National Association of Real Estate Investment Trusts has spent $1.1 million this year lobbying Congress on issues that include a tax overhaul, while the Real Estate Roundtable has spent $1.5 million.

REITs, which are companies that own, operate and sometimes finance real estate projects, reported a total equity market capitalization of $461 billion as of July 31, according to the National Association of Real Estate Investment Trusts. The administration would be overlooking a significant revenue source that could be used to offset lower corporate rates if it ignores these firms in shifting tax-status rules, said Henrietta Treyz, a vice president at Height Analytics, a Washington research firm.

“If you carve out REITs, how much money is Treasury really raising?” she told Bloomberg Government. “If you carve out this revenue-raising proposal, what are you left with?”

Obama is expected to propose revisions to the U.S. tax code as early as September. Sandra Salstrom, a spokeswoman for the U.S. Treasury Department, declined to comment yesterday on what might be included in the plan, including whether it would affect REITs. 

Paying Individual Rates
One of the main questions about Obama's tax proposal and those being developed in Congress involves the treatment of so-called pass-through companies. These are firms structured as partnerships or S corporations that accounted for almost one-third of all income reported on individual returns in 2009, according to the Tax Policy Center, a Washington-based nonpartisan research organization. The profits pass through to individual tax returns, allowing owners to avoid paying the corporate income tax, regardless of the firm's size.

Though REITs and pass-through entities don't have to pay most corporate taxes, they are structured in ways that impose different requirements on their owners. 


Covering Forgone Revenue
Treyz estimates that it will cost the Treasury $125 billion per percentage point over 10 years to lower the corporate tax rate from its current 35 percent maximum. Pass-through entities are a place to look for money to help cover the forgone revenue.

“This is all about the concept of broadening the base,” she said. “That doesn't just mean people making less than $8,000 a year paying taxes now. That means getting more companies to pay into the corporate tax.”

Tony Edwards, the senior vice president and general counsel of the National Association of Real Estate Investment Trusts, said his industry has some fundamental differences from pass- through entities. While pass-throughs may retain some income, REITs are required by law to distribute at least 90 percent of their taxable income to shareholders each year. Any remaining income is taxed at the corporate rate, so most REITs return 100 percent of taxable income to shareholders.
That creates market pressure, he said.

“Since REITs must distribute virtually all of their taxable income, they need to periodically go back to the market to raise more capital,” Edwards said. “If they have not been good stewards on behalf of their shareholders, it becomes difficult to raise more money.” 

Ordinary Income
Though REITs don't pay a corporate tax, their shareholders can't take advantage of the 15 percent tax rate for dividends that Congress passed in 2003. REIT dividends are treated as ordinary income.

“REIT dividends are already disadvantaged versus C corporations with respect to taxes,” said Jim Sullivan, the managing director of REIT research at Greenstreet Advisors, a research firm in Newport Beach, California.

Sullivan said the REIT industry's current tax structure is central to its business model.

“It's extremely important in the sense that the REIT industry was built upon a promise that in return for no corporate income tax, REITs would have to give out most of their income to their owners,” he said. “It's easy to see how changes would hurt them.”

Edwards said Congress and the administration should revise the tax treatment of REITs only if they also shift the tax status of mutual funds, where income is also exempt from tax. 

Mutual Fund Comparison
“Congress has patterned REITs on mutual funds, so any imposition of a corporate level tax on mutual funds would raise a similar tax policy issue with respect to REITs,” he said.

Martin A. Sullivan, a former Treasury Department tax economist, said political disagreements over broader questions associated with tax policy will likely protect REITs from being required to pay corporate taxes.

“First, there's the general problem of raising any taxes that we've seen,” said Sullivan, who is now a contributing editor at Tax Analysts, a nonprofit organization in Falls Church, Virginia. “Then there's the more specific but equally thorny problem of raising taxes on pass-throughs, which will be nuclear. And then you'd get to REITs.”