[Congressional Record Volume 144, Number 36 (Thursday, March 26, 1998)]
[Senate]
[Pages S2680-S2683]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. ROTH (for himself and Mr. Moynihan):
  S. 1871. A bill to provide that the exception for certain real estate 
investment trusts from the treatment of stapled entities shall apply 
only to existing property, and for other purposes; to the Committee on 
Finance.

[[Page S2681]]

               real estate investment trusts legislation

  Mr. ROTH. Mr. President, Senator Moynihan and I introduce a bill to 
limit the tax benefits of so-called ``stapled'' or ``paired-share'' 
Real Estate Investment Trusts (``stapled REITs''). Identical 
legislation is being introduced in the House of Representatives by 
Congressman Archer.
  In the Deficit Reduction Act of 1984 (``1984 Act''), Congress 
eliminated the tax benefits of the stapled REIT structure out of 
concern that it could effectively result in one level of tax on active 
corporate business income that would otherwise be subject to two levels 
of tax. Congress also believed that allowing a corporate business to be 
stapled to a REIT was inconsistent with the policy that led Congress to 
create REITs.
  As part of the 1984 Act provision, Congress provided grandfather 
relief to the small number of stapled REITs that were already in 
existence. Since 1984, however, almost all the grandfathered stapled 
REITs have been acquired by new owners. Some have entered into new 
lines of businesses, and most of the grandfathered REITs have used the 
stapled structure to engage in large-scale acquisitions of assets. Such 
unlimited relief from a general tax provision by a handful of taxpayers 
raises new questions not only of fairness, but of unfair competition, 
because the stapled REITs are in direct competition with other 
companies that cannot use the benefits of the stapled structure.
  This legislation, which is a refinement of the proposal contained in 
the Clinton Administration's Revenue Proposals for fiscal year 1999, 
takes a moderate and fair approach. The legislation essentially 
subjects to the grandfathered stapled REITs to rules similar to the 
1984 Act, but only to acquisitions of assets (or substantial 
improvements of existing assets) occurring after today. The legislation 
also provides transition relief for future acquisitions that are 
pursuant to a binding written contract, as well as acquisitions that 
already have been announced (or described in a filing with the SEC).
  Mr. President, I ask unanimous consent that additional material be 
printed in the Record.
  There being no objection, the material was ordered to be printed in 
the Record, as follows:

                                S. 1871

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. TERMINATION OF EXCEPTION FOR CERTAIN REAL ESTATE 
                   INVESTMENT TRUSTS FROM THE TREATMENT OF STAPLED 
                   ENTITIES.

       (a) In General.--Notwithstanding paragraph (3) of section 
     136(c) of the Tax Reform Act of 1984 (relating to stapled 
     stock; stapled entities), the REIT gross income provisions 
     shall be applied by treating the activities and gross income 
     of members of the stapled REIT group properly allocable to 
     any nonqualified real property interest held by the exempt 
     REIT or any stapled entity which is a member of such group 
     (or treated under subsection (c) as held by such REIT or 
     stapled entity) as the activities and gross income of the 
     exempt REIT in the same manner as if the exempt REIT and such 
     group were 1 entity.
       (b) Nonqualified Real Property Interest.--For purposes of 
     this section--
       (1) In general.--The term ``nonqualified real property 
     interest'' means, with respect to any exempt REIT, any 
     interest in real property acquired after March 26, 1998, by 
     the exempt REIT or any stapled entity.
       (2) Exception for binding contracts, etc.--Such term shall 
     not include any interest in real property acquired after 
     March 26, 1998, by the exempt REIT or any stapled entity if--
       (A) the acquisition is pursuant to a written agreement 
     which was binding on such date and at all times thereafter on 
     such REIT or stapled entity, or
       (B) the acquisition is described on or before such date in 
     a public announcement or in a filing with the Securities and 
     Exchange Commission.
       (3) Improvements and leases.--
       (A) In general.--Except as otherwise provided in this 
     paragraph, the term ``nonqualified real property interest'' 
     shall not include--
       (i) any improvement to land owned or leased by the exempt 
     REIT or any member of the stapled REIT group, and
       (ii) any repair to, or improvement of, any improvement 
     owned or leased by the exempt REIT or any member of the 
     stapled REIT group,
     if such ownership or leasehold interest is a qualified real 
     property interest.
       (B) Leases.--Such term shall not include any lease of a 
     qualified real property interest.
       (C) Termination where change in use.--
       (i) In general.--Subparagraph (A) shall not apply to any 
     improvement placed in service after December 31, 1999, which 
     is part of a change in the use of the property to which such 
     improvement relates unless the cost of such improvement does 
     not exceed 200 percent of--

       (I) the cost of such property, or
       (II) if such property is substituted basis property (as 
     defined in section 7701(a)(42) of the Internal Revenue Code 
     of 1986), the fair market value of the property at the time 
     of acquisition.

       (ii) Binding contracts.--For purposes of clause (i), an 
     improvement shall be treated as placed in service before 
     January 1, 2000, if such improvement is placed in service 
     before January 1, 2004, pursuant to a binding contract in 
     effect on December 31, 1999, and at all times thereafter.
       (4) Treatment of entities which are not stapled, etc. on 
     march 26, 1998.--Notwithstanding any other provision of this 
     section, all interests in real property held by an exempt 
     REIT or any stapled entity with respect to such REIT (or 
     treated under subsection (c) as held by such REIT or stapled 
     entity) shall be treated as nonqualified real property 
     interests unless--
       (A) such stapled entity was a stapled entity with respect 
     to such REIT as of March 26, 1998, and at all times 
     thereafter, and
       (B) as of March 26, 1998, and at all times thereafter, such 
     REIT was a real estate investment trust.
       (5) Qualified real property interest.--The term ``qualified 
     real property interest'' means any interest in real property 
     other than a nonqualified real property interest.
       (c) Treatment of Property Held by 10-Percent 
     Subsidiaries.--For purposes of this section--
       (1) In general.--Any exempt REIT and any stapled entity 
     shall be treated as holding their proportionate shares of 
     each interest in real property held by any 10-percent 
     subsidiary entity of the exempt REIT or stapled entity, as 
     the case may be.
       (2) Property held by 10-percent subsidiaries treated as 
     nonqualified.--
       (A) In general.--Except as provided in subparagraph (B), 
     any interest in real property held by a 10-percent subsidiary 
     entity of an exempt REIT or stapled entity shall be treated 
     as a nonqualified real property interest.
       (B) Exception for interests in real property held on march 
     26, 1998, etc.--In the case of an entity which was a 10-
     percent subsidiary entity of an exempt REIT or stapled entity 
     on March 26, 1998, and at all times thereafter, an interest 
     in real property held by such subsidiary entity shall be 
     treated as a qualified real property interest if such 
     interest would be so treated if held directly by the exempt 
     REIT or the stapled entity.
       (3) Reduction in qualified real property interests if 
     increase in ownership of subsidiary.--If, after March 26, 
     1998, an exempt REIT or stapled entity increases its 
     ownership interest in a subsidiary entity to which paragraph 
     (2)(B) applies above its ownership interest in such 
     subsidiary entity as of such date, the additional portion of 
     each interest in real property which is treated as held by 
     the exempt REIT or stapled entity by reason of such increased 
     ownership shall be treated as a nonqualified real property 
     interest.
       (4) Special rules for determining ownership.--For purposes 
     of this subsection--
       (A) percentage ownership of an entity shall be determined 
     in accordance with subsection (e)(4),
       (B) interests in the entity which are acquired by the 
     exempt REIT or stapled entity in any acquisition described in 
     an agreement, announcement, or filing described in subsection 
     (b)(2) shall be treated as acquired on March 26, 1998, and
       (C) except as provided in guidance prescribed by the 
     Secretary, any change in proportionate ownership which is 
     attributable solely to fluctuations in the relative fair 
     market values of different classes of stock shall not be 
     taken into account.
       (d) Treatment of Property Secured by Mortgage Held by 
     Exempt REIT or Member of Stapled REIT Group.--
       (1) In general.--In the case of any nonqualified obligation 
     held by an exempt REIT or any member of the stapled REIT 
     group, the REIT gross income provisions shall be applied by 
     treating the exempt REIT as having impermissible tenant 
     service income equal to--
       (A) the interest income from such obligation which is 
     properly allocable to the property described in paragraph 
     (2), and
       (B) the income of any member of the stapled REIT group from 
     services described in paragraph (2) with respect to such 
     property.
     If the income referred to in subparagraph (A) or (B) is of a 
     10-percent subsidiary entity, only the portion of such income 
     which is properly allocable to the exempt REIT's or the 
     stapled entity's interest in the subsidiary entity shall be 
     taken into account.
       (2) Nonqualified obligation.--Except as otherwise provided 
     in this subsection, the term ``nonqualified obligation'' 
     means any obligation secured by a mortgage on an interest in 
     real property if the income of any member of the stapled REIT 
     group for services furnished with respect to such property 
     would be impermissible tenant service income were such 
     property held by the exempt REIT and such services furnished 
     by the exempt REIT.
       (3) Exception for certain market rate obligations.--Such 
     term shall not include any obligation--

[[Page S2682]]

       (A) payments under which would be treated as interest if 
     received by a REIT, and
       (B) the rate of interest on which does not exceed an arm's 
     length rate.
       (4) Exception for existing obligations.--Such term shall 
     not include any obligation--
       (A) which is secured on March 26, 1998, by an interest in 
     real property, and
       (B) which is held on such date by the exempt REIT or any 
     entity which is a member of the stapled REIT group on such 
     date and at all times thereafter,
     but only so long as such obligation is secured by such 
     interest. The preceding sentence shall not cease to apply by 
     reason of the refinancing of the obligation if (immediately 
     after the refinancing) the principal amount of the obligation 
     resulting from the refinancing does not exceed the principal 
     amount of the refinanced obligation (immediately before the 
     refinancing).
       (5) Treatment of entities which are not stapled, etc. on 
     march 26, 1998.--A rule similar to the rule of subsection 
     (b)(4) shall apply for purposes of this subsection.
       (6) Increase in amount of nonqualified obligations if 
     increase in ownership of subsidiary.--A rule similar to the 
     rule of subsection (c)(3) shall apply for purposes of this 
     subsection.
       (7) Coordination with subsection (a).--This subsection 
     shall not apply to the portion of any interest in real 
     property that the exempt REIT or stapled entity holds or is 
     treated as holding under this section without regard to this 
     subsection.
       (e) Definitions.--For purposes of this section--
       (1) REIT gross income provisions.--The term ``REIT gross 
     income provisions'' means--
       (A) paragraphs (2), (3), and (6) of section 856(c) of the 
     Internal Revenue Code of 1986, and
       (B) section 857(b)(5) of such Code.
       (2) Exempt reit.--The term ``exempt REIT'' means a real 
     estate investment trust to which section 269B of the Internal 
     Revenue Code of 1986 does not apply by reason of paragraph 
     (3) of section 136(c) of the Tax Reform Act of 1984.
       (3) Stapled reit group.--The term ``stapled REIT group'' 
     means, with respect to an exempt REIT, the group consisting 
     of--
       (A) all entities which are stapled entities with respect to 
     the exempt REIT, and
       (B) all entities which are 10-percent subsidiary entities 
     of the exempt REIT or any such stapled entity.
       (4) 10-percent subsidiary entity.--
       (A) In general.--The term ``10-percent subsidiary entity'' 
     means, with respect to any exempt REIT or stapled entity, any 
     entity in which the exempt REIT or stapled entity (as the 
     case may be) directly or indirectly holds at least a 10-
     percent interest.
       (B) Exception for certain c corporation subsidiaries of 
     reits.--A corporation which would, but for this subparagraph, 
     be treated as a 10-percent subsidiary of an exempt REIT shall 
     not be so treated if such corporation is taxable under 
     section 11 of the Internal Revenue Code of 1986.
       (C) 10-percent interest.--The term ``10-percent interest'' 
     means--
       (i) in the case of an interest in a corporation, ownership 
     of 10 percent (by vote or value) of the stock in such 
     corporation,
       (ii) in the case of an interest in a partnership, ownership 
     of 10 percent of the assets or net profits interest in the 
     partnership, and
       (iii) in any other case, ownership of 10 percent of the 
     beneficial interests in the entity.
       (5) Other definitions.--Terms used in this section which 
     are used in section 269B or section 856 of such Code shall 
     have the respective meanings given such terms by such 
     section.
       (f) Guidance.--The Secretary may prescribe such guidance as 
     may be necessary or appropriate to carry out the purposes of 
     this section, including guidance to prevent the avoidance of 
     such purposes and to prevent the double counting of income.
       (g) Effective Date.--This section shall apply to taxable 
     years ending after March 26, 1998.

                         Technical Explanation

       The tax benefits of the stapled real estate investment 
     trust (``REIT'') structure were curtailed for almost all 
     taxpayers by section 269B, which was enacted by the Deficit 
     Reduction Act of 1984 (``1984 Act''). The bill limits the tax 
     benefits of a few stapled REITs that continue to qualify 
     under the 1984 Act's grandfather rule.
       A REIT is an entity that receives most of its income from 
     passive real-estate related investments and that essentially 
     receives pass-through treatment for income that is 
     distributed to shareholders. In general, a REIT must derive 
     its income from passive sources and not engage in any active 
     trade or business. In a stapled REIT structure, both the 
     shares of a REIT and a C corporation may be traded, and in 
     most cases publicly traded, but are subject to a provision 
     that they may not be sold separately. Thus, the REIT and the 
     C corporation have identical ownership at all times.


                                overview

       Under the bill, rules similar to the rules of present law 
     treating a REIT and all stapled entities as a single entity 
     for purposes of determining REIT status (sec. 269B) would 
     apply to real property interests acquired after March 26, 
     1998, by the existing stapled REIT, or by a stapled entity, 
     or a subsidiary or partnership in which a 10-percent or 
     greater interest is owned by the existing stapled REIT or 
     stapled entity (together referred to as the ``REIT group''), 
     unless the real property is grandfathered under the rules 
     discussed below. Different rules would be applied to certain 
     mortgage interests acquired by the REIT group after March 26, 
     1998, where a member of the REIT group performs services with 
     respect to the property secured by the mortgage.


                             general rules

       The bill treats certain activities and gross income of a 
     REIT group with respect to real property interests held by 
     any member of the REIT group (and not grandfathered under the 
     rules described below) as activities and income of the REIT 
     for certain purposes. This treatment would apply for purposes 
     of certain provisions of the REIT rules that depend on the 
     REIT's gross income, including the requirement that 95 
     percent of a REIT's gross income be from passive sources (the 
     ``95-percent test'') and the requirement that 75 percent of a 
     REIT's gross income be from real estate sources (the ``75-
     percent test''). Thus, for example, where a stapled entity 
     earns gross income from operating a non-grandfathered real 
     property held by a member of the REIT group, such gross 
     income would be treated as income of the REIT, with the 
     result that either the 75-percent or 95-percent test might 
     not be met and REIT status might be lost.
       If a REIT or stapled entity owns, directly or indirectly, a 
     10-percent-or-greater interest in a subsidiary or partnership 
     that holds a real property interest, the above rules would 
     apply with respect to a proportionate part of the 
     subsidiary's or partnership's property, activities and gross 
     income. Thus, any real property acquired by such a subsidiary 
     or partnership that is not grandfathered under the rules 
     described below would be treated as held by the REIT in the 
     same proportion as the ownership interest in the entity. The 
     same proportion of the subsidiary's or partnership's gross 
     income from any real property interest (other than a 
     grandfathered property) held by it or another member of the 
     REIT group would be treated as income of the REIT. Similar 
     rules attributing the proportionate part of the 
     subsidiary's or partnership's real estate interests and 
     gross income would apply when a REIT or stapled entity 
     acquires a 10-percent-or-greater interest (or in the case 
     of a previously-owned entity, acquires an additional 
     interest) after March 26, 1998, with exceptions for 
     interests acquired pursuant to agreements or announcements 
     described below.


                        grandfathered properties

       Under the bill, there is an exception to the treatment of 
     activities and gross income of a stapled entity as activities 
     and gross income of the REIT for certain grandfathered 
     properties. Grandfathered properties generally are those 
     properties that had been acquired by a member of the REIT 
     group on or before March 26, 1998. In addition, grandfathered 
     properties include properties acquired by a member of the 
     REIT group after March 26, 1998, pursuant to a written 
     agreement which was binding on March 26, 1998, and all times 
     thereafter. Grandfathered properties also include certain 
     properties, the acquisition of which were described in a 
     public announcement or in a filing with the Securities and 
     Exchange Commission on or before March 26, 1998.
       In general, a property does not lose its status as a 
     grandfathered property by reason of a repair to, an 
     improvement of, or a lease of, a grandfathered property. On 
     the other hand, a property loses its status as a 
     grandfathered property under the bill to the extent that a 
     non-qualified expansion is made to an otherwise grandfathered 
     property. A non-qualified expansion is either (1) an 
     expansion beyond the boundaries of the land of the otherwise 
     grandfathered property or (2) an improvement of an otherwise 
     grandfathered property placed in service after December 31, 
     1999, which changes the use of the property and whose cost is 
     greater than 200 percent of (a) the undepreciated cost of the 
     property (prior to the improvement) or (b) in the case of 
     property acquired where there is a substituted basis, the 
     fair market value of the property on the date that the 
     property was acquired by the stapled entity or the REIT. A 
     non-qualified expansion could occur, for example, if a member 
     of the REIT group were to construct a building after December 
     31, 1999, on previously undeveloped raw land that had been 
     acquired on or before March 26, 1998. There is an exception 
     for improvements placed in service before January 1, 2004, 
     pursuant to a binding contract in effect on December 31, 
     1999, and at all times thereafter.
       If a stapled REIT is not stapled as of March 26, 1998, or 
     if it fails to qualify as a REIT as of such date or any time 
     thereafter, no properties of any member of the REIT group 
     would be treated as grandfathered properties, and thus the 
     general provisions of the bill described above would apply to 
     all properties held by the group.


                             mortgage rules

       Special rules would apply where a member of the REIT group 
     holds a mortgage (that is not an existing obligation under 
     the rules described below) that is secured by an interest in 
     real property, where a member of the REIT group engages in 
     certain activities with respect to that property. The 
     activities that would have this effect under the bill are 
     activities that would result in a type of income that is not 
     treated as counting toward the 75-percent and 95-percent 
     tests if they are performed by the REIT. In such cases, all 
     interest on the mortgage and all gross income received by a 
     member of the REIT

[[Page S2683]]

     group from the activity would be treated as income of the 
     REIT that does not count toward the 75-percent or 95-percent 
     tests, with the result that REIT status might be lost. In the 
     case of a 10-percent partnership or subsidiary, a 
     proportionate part of the entity's mortgages, interest and 
     gross income from activities would be subject to the above 
     rules.
       An exception to the above rules would be provided for 
     mortgages the interest on which does not exceed an arm's-
     length rate and which would be treated as interest for 
     purposes of the REIT rules (e.g., the 75-percent and 95-
     percent tests, above). An exception also would be available 
     for certain mortgages that are held on March 26, 1998, by an 
     entity that is a member of the REIT group. The exception for 
     existing mortgages would cease to apply if the mortgage is 
     refinanced and the principal amount is increased in such 
     refinancing.


                              other rules

       For a corporate subsidiary owned by a stapled entity, the 
     10-percent ownership test would be met if a stapled entity 
     owns, directly or indirectly, 10 percent or more of the 
     corporation's stock, by either vote or value. (The bill would 
     not apply to stapled REIT's ownership of a corporate 
     subsidiary, although a stapled REIT would be subject to the 
     normal restrictions on a REIT's ownership of stock in a 
     corporation.) For interests in partnerships and other pass-
     through entities, the ownership test would be met if either 
     the REIT or a stapled entity owns, directly or indirectly, a 
     10-percent or greater interest.
       The Secretary of the Treasury would be given authority to 
     prescribe such guidance as may be necessary or appropriate to 
     carry out the purposes of the provision, including guidance 
     to prevent the double counting of income and to prevent 
     transactions that would avoid the purposes of the provision.
                                 ______