REIT's and Senior Housing Now More Compatible
By: Multifamily Real Estate Industry Team
Prior to the enactment last month of the Housing Assistance Tax Act of 2008 (the "Act") (for a detailed explanation of the Act, you can go to the following link , a real estate investment trust (a "REIT") could not in a tax-efficient manner derive the economic benefit of operating or managing a "health care facility," a term that includes a nursing home, assisted living facility, congregate care facility or a qualified continuing care facility. Instead, most REIT's that owned senior housing facilities with a health care component triple net leased those facilities to a third-party lessee and operator who would not only provide health care services to the senior residents, but would have to bear the rental risks associated with such a facility. Even a "taxable REIT subsidiary" (a "TRS") of a REIT was prohibited prior to the Act from directly operating or managing a health care facility such as a nursing home or an assisted living facility. For an illustration of how a TRS could own, but not operate, such a "health care facility," you should look at the following link.
By way of background, a REIT must derive at least 95 percent of its gross income from passive sources and at least 75 percent of its gross income from real estate sources. While rents generally qualify as income under both of those tests, rents may be disqualified under those tests if they entail provision of non-customary services to tenants, such as health care services. Several years ago, Congress allowed the provision of certain non-customary services through a TRS, resulting in the incurrence of a corporate level tax on income derived from such services.
Unfortunately, Congress in its infinite wisdom decided that a corporation that operates or manages a health care facility or a hotel or other lodging facility cannot qualify as a TRS. Significantly, however, Congress also decided that a TRS could provide rights to an "eligible independent contractor" to operate and manage a lodging facility if such rights were held by the corporation as a franchisee, licensee or in any similar capacity and the lodging facility was either owned by the TRS or leased to the TRS by the REIT. Moreover, under its arrangement with the "eligible independent contractor," the TRS could bear the expenses for operation of the lodging facility and could receive the revenues from the operation of the facility, net of expenses of operation and management fees payable to the independent contractor. In other words, for a number years, a TRS has been able to derive the economic benefit of operating a hotel or lodging facility, so long as that facility is actually managed by an independent third-party contractor. Such a TRS can reduce its corporate tax liability by paying deductible rent to its parent REIT that actually owns the hotel or lodging facility. Prior to the Act, a comparable arrangement was not possible for a health care facility.
Under the Act, a REIT can now own a senior housing facility, such as a nursing home or an assisted living facility, that provides health care services, and lease that facility to a TRS. The TRS, in turn, can derive the economic benefit from, and assume the rental risks associated with, such a facility so long as it is operated by an independent third-party contractor that is otherwise engaged in the business of operating those types of facilities. Because the rent payable by the TRS to the REIT is deductible by the TRS and is qualifying rental income to the REIT on which the REIT need not pay tax if it distributes the income to its shareholders, the Act creates a potentially tax-efficient structure for a REIT to own and indirectly operate senior housing facilities that provide health care services. Because real estate private equity funds with tax-exempt investors often employ REIT's to block "unrelated business taxable income," it will be interesting to see whether this change in the law correspondingly changes the investor profile for senior housing.
(This entry posted by Howard Solodky, a member of Womble Carlyle's Tax Practice Group)
By way of background, a REIT must derive at least 95 percent of its gross income from passive sources and at least 75 percent of its gross income from real estate sources. While rents generally qualify as income under both of those tests, rents may be disqualified under those tests if they entail provision of non-customary services to tenants, such as health care services. Several years ago, Congress allowed the provision of certain non-customary services through a TRS, resulting in the incurrence of a corporate level tax on income derived from such services.
Unfortunately, Congress in its infinite wisdom decided that a corporation that operates or manages a health care facility or a hotel or other lodging facility cannot qualify as a TRS. Significantly, however, Congress also decided that a TRS could provide rights to an "eligible independent contractor" to operate and manage a lodging facility if such rights were held by the corporation as a franchisee, licensee or in any similar capacity and the lodging facility was either owned by the TRS or leased to the TRS by the REIT. Moreover, under its arrangement with the "eligible independent contractor," the TRS could bear the expenses for operation of the lodging facility and could receive the revenues from the operation of the facility, net of expenses of operation and management fees payable to the independent contractor. In other words, for a number years, a TRS has been able to derive the economic benefit of operating a hotel or lodging facility, so long as that facility is actually managed by an independent third-party contractor. Such a TRS can reduce its corporate tax liability by paying deductible rent to its parent REIT that actually owns the hotel or lodging facility. Prior to the Act, a comparable arrangement was not possible for a health care facility.
Under the Act, a REIT can now own a senior housing facility, such as a nursing home or an assisted living facility, that provides health care services, and lease that facility to a TRS. The TRS, in turn, can derive the economic benefit from, and assume the rental risks associated with, such a facility so long as it is operated by an independent third-party contractor that is otherwise engaged in the business of operating those types of facilities. Because the rent payable by the TRS to the REIT is deductible by the TRS and is qualifying rental income to the REIT on which the REIT need not pay tax if it distributes the income to its shareholders, the Act creates a potentially tax-efficient structure for a REIT to own and indirectly operate senior housing facilities that provide health care services. Because real estate private equity funds with tax-exempt investors often employ REIT's to block "unrelated business taxable income," it will be interesting to see whether this change in the law correspondingly changes the investor profile for senior housing.
(This entry posted by Howard Solodky, a member of Womble Carlyle's Tax Practice Group)
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