[Congressional Record Volume 145, Number 70 (Friday, May 14, 1999)]
[Senate]
[Pages S5377-S5381]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. MACK (for himself, Mr. Graham, Mr. Hatch, Mr. Conrad, Mr. 
        Nickles, Mr. Kerrey, Mr. Gramm, Mr. Bryan, Mr. Chafee, Mr. 
        Baucus, Mr. Murkowski, Mr. Breaux, Mr. Jeffords, Mr. Robb, Mr. 
        Coverdell, Mr. Rockefeller, Mr. Helms, Mr. Torricelli, and Mrs. 
        Hutchison):
  S. 1057. A bill to amend the Internal Revenue Code of 1986 to 
simplify certain provisions applicable to real estate investment 
trusts; to the Committee on Finance.


         real estate investment trust modernization act of 1999

  Mr. MACK. Mr. President, today Senator Bob Graham and I, along with 
17 of our colleagues, are introducing legislation to modernize the tax 
rules that apply to real estate investment trusts (``REITs'').
  This legislation is designed to remove barriers in the tax laws that 
impose unnecessary administrative burdens and make it more difficult 
for REITs to compete in an evolving marketplace. Our bill is similar to 
a proposal included in the President's Fiscal Year 2000 budget that 
permits REITs to establish a new type of subsidiary called a ``taxable 
REIT subsidiary'' (``TRS''). As with the President's proposal, the 
legislation we introduce today would permit REITs to establish a TRS to 
provide non-customary services to their tenants and to provide services 
to third parties. In return for these new rules, the TRS would be 
subject to a number of rules designed to prevent any income from being 
shifted out of the taxable subsidiary to the REIT.
  Congress created REITs in 1960 to enable small investors to invest in 
real estate. The REIT provisions were modeled after the rules that 
applied to mutual funds. If a number of requirements are met, a 
corporation electing to be a REIT may deduct all dividends paid to its 
shareholders. One of the major requirements for REIT status is that 
REITs must distribute virtually all of their taxable income to their 
shareholders. Thus, unlike other C corporations that tend to retain 
most of their earnings, the income tax burden for REITs is shifted to 
the shareholder level. Unlike partnerships, REITs cannot pass losses 
through to their investors.
  REITs are subject to a number of rules to ensure their primary focus 
is real estate activities. For example, at least 75% of a REIT's assets 
must be comprised of rental real estate, mortgages, cash items and 
government securities. A REIT also must satisfy two income tests. 
First, at least 75% of a REIT's annual gross income must consist of 
real property rents, mortgage interest, gain from the sale of a real 
estate asset and certain other real estate-related sources. Second, at 
least 95% of a REIT's annual gross income must be derived from the 
income items from the above 75% test plus other ``passive income'' 
sources such as dividends and any type of interest. In addition, a REIT 
cannot own more than 10% of the voting securities of a non-REIT 
corporation, and the securities of a single non-REIT corporation cannot 
be worth more than 5% of the REIT's assets.
  Although REITs were created in 1960, they did not really become a 
significant part of the real estate marketplace until the 1990s--partly 
because the original legislation did not permit REITs to manage their 
own property. The Tax Reform Act of 1986 changed this, by permitting 
REITs to manage their own properties through the provision of 
``customary services'' to tenants.
  The market capitalization of REITs grew from about $13 billion at the 
end of 1991 to over $140 billion today. The taxes generated from REITs 
similarly have increased, with dividends from public REITs increasing 
from about $1 billion in 1991 to more than $8 billion today. While 
REITs remain a small portion of the entire real estate sector--in the 
range of 10% nationally--they account for as much as half of some 
sectors that require immense amounts of capital, such as shopping 
centers. While the REIT industry has come a long way in recent years, 
it continues to fulfill its original mission: permitting small 
investors access to attractive real estate investments. Almost 90% of 
REIT shareholders are individuals either investing directly or through 
mutual funds.
  Although REITs have seen remarkable growth in the 1990s, their 
ability to meet new competitive pressures in the real estate sector is 
in question as a result of tax law limitations on their activities. 
These rules limit the ability of REITs to provide full services to 
their tenants and to third parties. In general, REITs may only provide 
services to their tenants which the IRS has determined to be 
``customary'' in the business, meaning services already provided by the 
typical real estate company in the market. REITs may only provide real 
estate-related services to third parties through preferred stock 
subsidiaries which they can own but not control. REITs are thus 
prohibited from offering leading edge, full service options to their 
tenants and limited in the use of their expertise to serve third 
parties. This presents competitive problems for REITs as the real 
estate marketplace has evolved and property owners have sought to 
provide a range of services to their tenants and other customers.
  As a result, REITs increasingly have been unable to compete with 
privately-held partnerships and other more exclusive forms of 
ownership. Today, the rules prevent REITs from offering the same types 
of customer services as their competitors, even as such services are 
becoming more central to marketing efforts. Examples abound: (1) 
offering concierge services to office and apartment tenants to pick up 
tickets or dry cleaning, to walk pets, etc.; (2) offering a branded 
credit card at shopping malls, with rebates to be used as store credits 
at stores in the mall; (3) high speed Internet hook-ups, including 
enhanced telecommunications services (e.g., creating and maintaining a 
website) offered by a landlord's partner; (4) partnering with an office 
supply provider to offer reduced prices on office supplies; and (5) 
pick-up and delivery services at self-storage rentals.
  Without greater flexibility to provide competitive services to 
tenants and other customers, REITs will become less and less 
competitive with others in the real estate marketplace. REITs will have 
to wait for services to be deemed ``customary.'' As a practical matter, 
that means a REIT must wait until the IRS concludes that almost 
everybody else has been providing the service. If a REIT is forced to 
lag the market, it can be neither competitive nor provide its investors 
with a satisfactory return on their investment. Certainly, this is not 
consistent with what Congress intended when it created REITs, and when 
it modified the REIT rules over the years. In keeping with the 
Congressional mandate to provide a sensible and effective way for the 
average investor to benefit from ownership of income-producing real 
estate, REITs should be able to provide a range of services through 
taxable subsidiaries.
  The Administration's proposed Fiscal Year 2000 Budget acknowledges 
this problem. The Administration proposes modernizing REIT rules to 
permit REITs, on a limited basis, to use taxable subsidiaries to 
provide the services necessary to compete in the evolving real estate 
marketplace. The Administration proposal is a good start, but I believe 
additional refinements would further promote competitiveness. The 
legislation that we are introducing today builds upon the 
Administration proposal. Our bill addresses the

[[Page S5378]]

appropriate needs of the REIT industry and its investors in a manner 
consistent with the underlying rationale for REITs and the requirements 
of the highly competitive, evolving real estate marketplace.
  This legislation would give greater flexibility to REITs by 
permitting them to establish ``taxable REIT subsidiaries'' (``TRSs'') 
that could provide non-customary services to tenants and services to 
third parties. The 5% and 10% asset tests would not apply to the TRS. 
REITs would continue to be subject to the 75% asset tests so the value 
of their TRS, together with the value of other non-real estate assets, 
could not exceed 25% of the total value of a REIT's assets. In 
addition, the REIT would have to continue to satisfy the 95% and 75% 
income tests, with dividends or interest from a TRS to a REIT counting 
towards the 95% test, but not the 75% test. Accordingly, at least 75% 
of a REIT's gross income would continue to consist of rents, mortgage 
interest, real estate capital gains and the other miscellaneous real 
estate-related items already listed in the Code. The income a TRS would 
receive from both third parties and REIT tenants would be fully subject 
to corporate tax.
  To ensure that a TRS could not inappropriately reduce its corporate 
tax liability by shifting income to the REIT, the bill includes a 
number of stringent rules that limit the relationship between the REIT 
and the TRS. To prevent the TRS from making excessive intra-party 
interest payments to its affiliated REIT, the proposal contains two 
safeguards. One, it would apply the current anti-earnings stripping 
provisions of Code section 163(j) to payments between a REIT and its 
TRS. This would prevent the TRS from deducting intra-party interest 
beyond a modest amount regulated by objective criteria in the Code. 
Two, a 100% excise tax would be imposed on any interest payments by a 
TRS to its affiliated REIT to the extent the interest rate was above a 
commercially-reasonable rate.
  Also, to be certain that a TRS could not reduce its tax obligations 
by deducting rents to its affiliated REIT, our legislation would retain 
the current rules under which any payments to a REIT by a related party 
would not be considered qualified rents for purposes of the REIT gross 
income tests. The only exception would be when a TRS rents less than 
10% of a REIT-owned property and pays rents to the REIT comparable to 
the rents the REIT charges to its unrelated tenants at the same 
property. Under this exception, any rents paid to the REIT that turn 
out to be above comparable rents would be subject to a 100% excise tax.
  Under our bill, a 100% excise tax is also imposed on any rents a REIT 
charges its tenants that are inflated to disguise charges for services 
rendered to the tenant by its affiliated TRS. Limited exceptions would 
be made when: (1) the TRS charges the same amounts for its services to 
both REIT tenants and third parties; (2) rents for comparable space are 
the same regardless of whether the TRS provides a service to the 
tenant; and (3) the TRS recognizes income for its services at least 
equal to 150% of its direct costs of providing the service to an 
affiliated REIT's tenants.
  To discourage a REIT from allocating its expenses to its TRS (which 
would reduce the TRS's corporate tax obligation), the proposal would 
impose a 100% excise tax on any improper cost allocations between a 
REIT and its TRS. The Treasury Department would issue guidance on 
proper ways to allocate such costs.
  Finally, the bill proposes to eliminate the use of preferred stock 
subsidiaries by REITs. These subsidiaries, which have been established 
pursuant to IRS letter rulings since 1988, allow a REIT to provide 
services to third parties. While the asset test rules prevent a REIT 
from owning more than 10% of the voting securities of these 
subsidiaries, they typically own more than 95% of the value of the 
subsidiary. We propose to eliminate these subsidiaries by prohibiting 
REITs from owning more than 10% of the vote or the value in another 
corporation other than a TRS. REITs would be given three years to 
convert, tax-free, their preferred stock subsidiaries to taxable REIT 
subsidiaries.
  In addition, the bill includes some miscellaneous changes to the REIT 
rules that were under consideration when Congress approved a REIT 
simplification package a few years ago. The first provision deals with 
health care property. Under current law, a REIT can conduct a trade or 
business using property acquired through foreclosure for 90 days after 
it acquired such property, if it makes a ``foreclosure property'' 
election. After this period, the REIT can only conduct the trade or 
business through an independent contractor from whom the REIT does not 
derive any income. A health care REIT faces special challenges in using 
these rules when its lease of a nursing home or other health care 
property expires.
  To remedy these challenges and to ensure that care to patients 
remains uninterrupted, the proposal would make two technical changes to 
the REIT foreclosure rules. First, the foreclosure property rules would 
be extended to include leases that terminate (they already apply to 
leases that are breached). Second, for purposes of the foreclosure 
rules, a health care provider would not be disqualified as an 
independent contractor solely because the REIT receives rental income 
from the provider with respect to one or more other properties. For 
this purpose, other rules would be made to ensure that the terms of 
leases of other properties could not be manipulated to circumvent this 
rule.
  Another provision deals with the 95% distribution rule. From 1960 
through 1980, REITs and mutual funds shared a requirement to distribute 
at least 90% of their taxable income. Since 1980, REITs have had to 
distribute 95% of their taxable income. The proposal would restore the 
90% distribution requirement.
  Mr. President, I believe this is a major improvement in the REIT 
rules that preserves the original intent of Congress when it first 
created REITs in 1960, while permitting the industry to adapt to a 
changing marketplace. Most importantly, these REIT modernization rules 
would not expand the activities that can be conducted within the REIT, 
they simply give the REIT greater flexibility to establish fully-
taxable subsidiaries that will enable the REIT to better serve its 
customers.
  This legislation is supported by the American Resort Development 
Association, the International Council of Shopping Centers, the 
National Apartment Association, the National Association of Real Estate 
Investment Trusts, the American Seniors Housing Association, the 
Mortgage Bankers Association of America, the National Association of 
Industrial and Office Properties, the National Association of Realtors, 
the National Multi Housing Council, and the National Realty Committee.
  Mr. President, I ask unanimous consent that the text of the bill be 
printed in the Record.
  There being no objection, the bill was ordered to be printed in the 
Record, as follows:

                                S. 1057

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

     SECTION 1. SHORT TITLE.

       (a) Short Title.--This Act may be cited as the ``Real 
     Estate Investment Trust Modernization Act of 1999''.
       (b) Amendment of 1986 Code.--Except as otherwise expressly 
     provided, whenever in this Act an amendment or repeal is 
     expressed in terms of an amendment to, or repeal of, a 
     section or other provision, the reference shall be considered 
     to be made to a section or other provision of the Internal 
     Revenue Code of 1986.
  TITLE I--TREATMENT OF INCOME AND SERVICES PROVIDED BY TAXABLE REIT 
                              SUBSIDIARIES

     SEC. 101. MODIFICATIONS TO ASSET DIVERSIFICATION TEST.

       Subparagraph (B) of section 856(c)(4) is amended to read as 
     follows:
       ``(B)(i) not more than 25 percent of the value of its total 
     assets is represented by securities (other than those 
     includible under subparagraph (A)), and
       ``(ii) except with respect to a taxable REIT subsidiary and 
     securities includible under subparagraph (A)--
       ``(I) not more than 5 percent of the value of its total 
     assets is represented by securities of any 1 issuer,
       ``(II) the trust does not hold securities possessing more 
     than 10 percent of the total voting power of the outstanding 
     securities of any 1 issuer, and
       ``(III) the trust does not hold securities having a value 
     of more than 10 percent of the total value of the outstanding 
     securities of any 1 issuer.''

[[Page S5379]]

     SEC. 102. TREATMENT OF INCOME AND SERVICES PROVIDED BY 
                   TAXABLE REIT SUBSIDIARIES.

       (a) Income From Taxable REIT Subsidiaries Not Treated as 
     Impermissible Tenant Service Income.--Clause (i) of section 
     856(d)(7)(C) (relating to exceptions to impermissible tenant 
     service income) is amended by inserting ``or through a 
     taxable REIT subsidiary of such trust'' after ``income''.
       (b) Certain Income From Taxable REIT Subsidiaries Not 
     Excluded From Rents From Real Property.--
       (1) In general.--Subsection (d) of section 856 (relating to 
     rents from real property defined) is amended by adding at the 
     end the following new paragraphs:
       ``(8) Special rule for taxable reit subsidiaries.--For 
     purposes of this subsection, amounts paid to a real estate 
     investment trust by a taxable REIT subsidiary of such trust 
     shall not be excluded from rents from real property by reason 
     of paragraph (2)(B) if the requirements of subparagraph (A) 
     or (B) are met.
       ``(A) Limited rental exception.--The requirements of this 
     subparagraph are met with respect to any property if at least 
     90 percent of the leased space of the property is rented to 
     persons other than taxable REIT subsidiaries of such trust 
     and other than persons described in section 856(d)(2)(B). The 
     preceding sentence shall apply only to the extent that the 
     amounts paid to the trust as rents from real property (as 
     defined in paragraph (1) without regard to paragraph (2)(B)) 
     from such property are substantially comparable to such rents 
     made by the other tenants of the trust's property for 
     comparable space.
       ``(B) Exception for certain lodging facilities.--The 
     requirements of this subparagraph are met with respect to an 
     interest in real property which is a qualified lodging 
     facility leased by the trust to a taxable REIT subsidiary of 
     the trust if the property is operated on behalf of such 
     subsidiary by a person who is an eligible independent 
     contractor.
       ``(9) Eligible independent contractor.--For purposes of 
     paragraph (8)(B)--
       ``(A) In general.--The term `eligible independent 
     contractor' means, with respect to any qualified lodging 
     facility, any independent contractor if, at the time such 
     contractor enters into a management agreement or other 
     similar service contract with the taxable REIT subsidiary to 
     operate the facility, such contractor (or any related person) 
     is actively engaged in the trade or business of operating 
     qualified lodging facilities for any person who is not a 
     related person with respect to the real estate investment 
     trust or the taxable REIT subsidiary.
       ``(B) Special rules.--Solely for purposes of this paragraph 
     and paragraph (8)(B), a person shall not fail to be treated 
     as an independent contractor with respect to any qualified 
     lodging facility by reason of any of the following:
       ``(i) The taxable REIT subsidiary bears the expenses for 
     the operation of the facility pursuant to the management 
     agreement or other similar service contract.
       ``(ii) The taxable REIT subsidiary receives the revenues 
     from the operation of such facility, net of expenses for such 
     operation and fees payable to the operator pursuant to such 
     agreement or contract.
       ``(iii) The real estate investment trust receives income 
     from such person with respect to another property that is 
     attributable to a lease of such other property to such person 
     that was in effect as on the later of--

       ``(I) January 1, 1999, or
       ``(II) the earliest date that any taxable REIT subsidiary 
     of such trust entered into a management agreement or other 
     similar service contract with such person with respect to 
     such qualified lodging facility.

       ``(C) Renewals, etc., of existing leases.--For purposes of 
     subparagraph (B)(iii)--
       ``(i) a lease shall be treated as in effect on January 1, 
     1999, without regard to its renewal after such date, so long 
     as such renewal is pursuant to the terms of such lease as in 
     effect on whichever of the dates under subparagraph (B)(iii) 
     is the latest, and
       ``(ii) a lease of a property entered into after whichever 
     of the dates under subparagraph (B)(iii) is the latest shall 
     be treated as in effect on such date if--

       ``(I) on such date, a lease of such property from the trust 
     was in effect, and
       ``(II) under the terms of the new lease, such trust 
     receives a substantially similar or lesser benefit in 
     comparison to the lease referred to in subclause (I).

       ``(D) Qualified lodging facility.--For purposes of this 
     paragraph--
       ``(i) In general.--The term `qualified lodging facility' 
     means any lodging facility unless wagering activities are 
     conducted at or in connection with such facility by any 
     person who is engaged in the business of accepting wagers and 
     who is legally authorized to engage in such business at or in 
     connection with such facility.
       ``(ii) Lodging facility.--The term `lodging facility' means 
     a hotel, motel, or other establishment more than one-half of 
     the dwelling units in which are used on a transient basis.
       ``(iii) Customary amenities and facilities.--The term 
     `lodging facility' includes customary amenities and 
     facilities operated as part of, or associated with, the 
     lodging facility so long as such amenities and facilities are 
     customary for other properties of a comparable size and class 
     owned by other owners unrelated to such real estate 
     investment trust.
       ``(E) Operate includes manage.--References in this 
     paragraph to operating a property shall be treated as 
     including a reference to managing the property.
       ``(F) Related person.--Persons shall be treated as related 
     to each other if such persons are treated as a single 
     employer under subsection (a) or (b) of section 52.''.
       (2) Conforming amendment.--Subparagraph (B) of section 
     856(d)(2) is amended by inserting ``except as provided in 
     paragraph (8),'' after ``(B)''.

     SEC. 103. TAXABLE REIT SUBSIDIARY.

       (a) In General.--Section 856 is amended by adding at the 
     end the following new subsection:
       ``(l) Taxable Reit Subsidiary.--For purposes of this part--
       ``(1) In general.--The term `taxable REIT subsidiary' 
     means, with respect to a real estate investment trust, a 
     corporation (other than a real estate investment trust) if--
       ``(A) such trust directly or indirectly owns stock in such 
     corporation, and
       ``(B) such trust and such corporation jointly elect that 
     such corporation shall be treated as a taxable REIT 
     subsidiary of such trust for purposes of this part.

     Such an election, once made, shall be irrevocable unless both 
     such trust and corporation consent to its revocation. Such 
     election, and any revocation thereof, may be made without the 
     consent of the Secretary.
       ``(2) 35 percent ownership in another taxable reit 
     subsidiary.--The term `taxable REIT subsidiary' includes, 
     with respect to any real estate investment trust, any 
     corporation (other than a real estate investment trust) with 
     respect to which a taxable REIT subsidiary of such trust owns 
     directly or indirectly--
       ``(A) securities possessing more than 35 percent of the 
     total voting power of the outstanding securities of such 
     corporation, or
       ``(B) securities having a value of more than 35 percent of 
     the total value of the outstanding securities of such 
     corporation.
     The preceding sentence shall not apply to a qualified REIT 
     subsidiary (as defined in subsection (i)(2)).
       ``(3) Exceptions.--The term `taxable REIT subsidiary' shall 
     not include--
       ``(A) any corporation which directly or indirectly operates 
     or manages a lodging facility or a health care facility, and
       ``(B) any corporation which directly or indirectly provides 
     to any other person (under a franchise, license, or 
     otherwise) rights to any brand name under which any lodging 
     facility or health care facility is operated.

     Subparagraph (B) shall not apply to rights provided to an 
     eligible independent contractor to operate or manage a 
     lodging facility if such rights are held by such corporation 
     as a franchisee, licensee, or in a similar capacity and such 
     lodging facility is either owned by such corporation or is 
     leased to such corporation from the real estate investment 
     trust.
       ``(4) Definitions.--For purposes of paragraph (3)--
       ``(A) Lodging facility.--The term `lodging facility' has 
     the meaning given to such term by paragraph (9)(D)(ii).
       ``(B) Health care facility.--The term `health care 
     facility' has the meaning given to such term by subsection 
     (e)(6)(D)(ii).''.
       (b) Conforming Amendment.--Paragraph (2) of section 856(i) 
     is amended by adding at the end the following new sentence: 
     ``Such term shall not include a taxable REIT subsidiary.''

     SEC. 104. LIMITATION ON EARNINGS STRIPPING.

       Paragraph (3) of section 163(j) (relating to limitation on 
     deduction for interest on certain indebtedness) is amended by 
     striking ``and'' at the end of subparagraph (A), by striking 
     the period at the end of subparagraph (B) and inserting ``, 
     and'', and by adding at the end the following new 
     subparagraph:
       ``(C) any interest paid or accrued (directly or indirectly) 
     by a taxable REIT subsidiary (as defined in section 856(l)) 
     of a real estate investment trust to such trust.''.

     SEC. 105. 100 PERCENT TAX ON IMPROPERLY ALLOCATED AMOUNTS.

       (a) In General.--Subsection (b) of section 857 (relating to 
     method of taxation of real estate investment trusts and 
     holders of shares or certificates of beneficial interest) is 
     amended by redesignating paragraphs (7) and (8) as paragraphs 
     (8) and (9), respectively, and by inserting after paragraph 
     (6) the following new paragraph:
       ``(7) Income from redetermined rents, redetermined 
     deductions, and excess interest.--
       ``(A) Imposition of tax.--There is hereby imposed for each 
     taxable year of the real estate investment trust a tax equal 
     to 100 percent of redetermined rents, redetermined 
     deductions, and excess interest.
       ``(B) Redetermined rents.--
       ``(i) In general.--The term `redetermined rents' means 
     rents from real property (as defined in subsection 856(d)) 
     the amount of which would (but for subparagraph (E)) be 
     reduced on distribution, apportionment, or allocation under 
     section 482 to clearly reflect income as a result of services 
     furnished or rendered by a taxable REIT subsidiary of the 
     real estate investment trust to a tenant of such trust.
       ``(ii) Exception for certain services.--Clause (i) shall 
     not apply to amounts received directly or indirectly by a 
     real estate investment trust for services described in 
     paragraph (1)(B) or (7)(C)(i) of section 856(d).
       ``(iii) Exception for de minimis amounts.--Clause (i) shall 
     not apply to amounts described in section 856(d)(7)(A) with 
     respect to

[[Page S5380]]

     a property to the extent such amounts do not exceed the one 
     percent threshold described in section 856(d)(7)(B) with 
     respect to such property.
       ``(iv) Exception for comparably priced services.--Clause 
     (i) shall not apply to any service rendered by a taxable REIT 
     subsidiary of a real estate investment trust to a tenant of 
     such trust if--

       ``(I) such subsidiary renders a significant amount of 
     similar services to persons other than such trust and tenants 
     of such trust who are unrelated (within the meaning of 
     section 856(d)(8)(F)) to such subsidiary, trust, and tenants, 
     but
       ``(II) only to the extent the charge for such service so 
     rendered is substantially comparable to the charge for the 
     similar services rendered to persons referred to in subclause 
     (I).

       ``(v) Exception for certain separately charged services.--
     Clause (i) shall not apply to any service rendered by a 
     taxable REIT subsidiary of a real estate investment trust to 
     a tenant of such trust if--

       ``(I) the rents paid to the trust by tenants (leasing at 
     least 25 percent of the net leasable space in the trust's 
     property) who are not receiving such service from such 
     subsidiary are substantially comparable to the rents paid by 
     tenants leasing comparable space who are receiving such 
     service from such subsidiary, and
       ``(II) the charge for such service from such subsidiary is 
     separately stated.

       ``(vi) Exception for certain services based on subsidiary's 
     income from the services.--Clause (i) shall not apply to any 
     service rendered by a taxable REIT subsidiary of a real 
     estate investment trust to a tenant of such trust if the 
     gross income of such subsidiary from such service is not less 
     than 150 percent of such subsidiary's direct cost in 
     furnishing or rendering the service.
       ``(vii) Exceptions granted by secretary.--The Secretary may 
     waive the tax otherwise imposed by subparagraph (A) if the 
     trust establishes to the satisfaction of the Secretary that 
     rents charged to tenants were established on an arms' length 
     basis even though a taxable REIT subsidiary of the trust 
     provided services to such tenants.
       ``(viii) No inference with respect to rents not within 
     exceptions.--In determining whether rents are subject to 
     reduction upon distribution, apportionment, or allocation 
     under section 482 for purposes of subparagraph (B), the fact 
     that rents from real property do not meet the requirements of 
     clauses (ii) through (vii) shall not be taken into account; 
     and such determination, in the case of rents not meeting such 
     requirements, shall be made as if such clauses had not been 
     enacted.
       ``(ix) No inference as to whether redetermined rent is rent 
     from real property.--Rent received by a real estate 
     investment trust shall not fail to qualify as rents from real 
     property under section 856(d) by reason of the fact that all 
     or any portion of such rent is determined to be redetermined 
     rent.
       ``(C) Redetermined deductions.--The term `redetermined 
     deductions' means deductions (other than redetermined rents) 
     of a taxable REIT subsidiary of a real estate investment 
     trust if the amount of such deductions would (but for 
     subparagraph (E)) be increased on distribution, 
     apportionment, or allocation under section 482 to clearly 
     reflect income as between such subsidiary and such trust.
       ``(D) Excess interest.--The term `excess interest' means 
     any deductions for interest payments by a taxable REIT 
     subsidiary of a real estate investment trust to such trust to 
     the extent that the interest payments are in excess of a rate 
     that is commercially reasonable.
       ``(E) Coordination with section 482.--The imposition of tax 
     under subparagraph (A) shall be in lieu of any distribution, 
     apportionment, or allocation under section 482.
       ``(F) Regulatory authority.--The Secretary shall prescribe 
     such regulations as may be necessary or appropriate to carry 
     out the purposes of this paragraph. Until the Secretary 
     prescribes such regulations, real estate investment trusts 
     and their taxable REIT subsidiaries may base their 
     allocations on any reasonable method.''.
       (b) Amount Subject to Tax Not Required To Be Distributed.--
     Subparagraph (E) of section 857(b)(2) (relating to real 
     estate investment trust taxable income) is amended by 
     striking ``paragraph (5)'' and inserting ``paragraphs (5) and 
     (7)''.

     SEC. 106. EFFECTIVE DATE.

       (a) In General.--The amendments made by this title shall 
     apply to taxable years beginning after the date of enactment 
     of this Act.
       (b) Transitional Rules Related to Section 101.--
       (1) Existing arrangements.--
       (A) In general.--Except as otherwise provided in this 
     paragraph, the amendment made by section 101 shall not apply 
     to a real estate investment trust with respect to--
       (i) securities of a corporation held directly or indirectly 
     by such trust on April 28, 1999,
       (ii) securities received by such trust (or a successor) in 
     exchange for, or with respect to, securities described in 
     clause (i) in a transaction in which gain or loss is not 
     recognized, and
       (iii) securities acquired directly or indirectly by such 
     trust as part of a reorganization (as defined in section 
     368(a)(1) of the Internal Revenue Code of 1986) with respect 
     to such trust if such securities are described in clause (i) 
     or (ii) with respect to any other real estate investment 
     trust.
       (B) New trade or business or substantial new assets.--
     Subparagraph (A) shall cease to apply to securities of a 
     corporation as of the first day after April 28, 1999, on 
     which such corporation engages in a substantial new line of 
     business, or acquires any substantial asset, other than--
       (i) pursuant to a binding contract in effect on such date 
     and at all times thereafter before the acquisition of such 
     asset,
       (ii) in a transaction in which gain or loss is not 
     recognized by reason of section 1031 or 1033 of the Internal 
     Revenue Code of 1986, or
       (iii) in a reorganization (as so defined) with another 
     corporation the securities of which are described in 
     paragraph (1)(A) of this subsection.
       (2) Tax-free conversion.--If--
       (A) at the time of an election for a corporation to become 
     a taxable REIT subsidiary, the amendment made by section 101 
     does not apply to such corporation by reason of paragraph 
     (1), and
       (B) such election first takes effect during the 3-year 
     period beginning on the date of the enactment of this Act,

     such election shall be treated as a reorganization qualifying 
     under section 368(a)(1)(A) of such Code.
                      TITLE II--HEALTH CARE REITS

     SEC. 201. HEALTH CARE REITS.

       (a) Special Foreclosure Rule for Health Care Properties.--
     Subsection (e) of section 856 (relating to special rules for 
     foreclosure property) is amended by adding at the end the 
     following new paragraph:
       ``(6) Special rule for qualified health care properties.--
     For purposes of this subsection--
       ``(A) Acquisition at expiration of lease.--The term 
     `foreclosure property' shall include any qualified health 
     care property acquired by a real estate investment trust as 
     the result of the termination of a lease of such property 
     (other than a termination by reason of a default, or the 
     imminence of a default, on the lease).
       ``(B) Grace period.--In the case of a qualified health care 
     property which is foreclosure property solely by reason of 
     subparagraph (A), in lieu of applying paragraphs (2) and 
     (3)--
       ``(i) the qualified health care property shall cease to be 
     foreclosure property as of the close of the second taxable 
     year after the taxable year in which such trust acquired such 
     property, and
       ``(ii) if the real estate investment trust establishes to 
     the satisfaction of the Secretary that an extension of the 
     grace period in clause (i) is necessary to the orderly 
     leasing or liquidation of the trust's interest in such 
     qualified health care property, the Secretary may grant 1 or 
     more extensions of the grace period for such qualified health 
     care property.

     Any such extension shall not extend the grace period beyond 
     the close of the 6th year after the taxable year in which 
     such trust acquired such qualified health care property.
       ``(C) Income from independent contractors.--For purposes of 
     applying paragraph (4)(C) with respect to qualified health 
     care property which is foreclosure property by reason of 
     subparagraph (A) or paragraph (1), income derived or received 
     by the trust from an independent contractor shall be 
     disregarded to the extent such income is attributable to--
       ``(i) any lease of property in effect on the date the real 
     estate investment trust acquired the qualified health care 
     property (without regard to its renewal after such date so 
     long as such renewal is pursuant to the terms of such lease 
     as in effect on such date), or
       ``(ii) any lease of property entered into after such date 
     if--

       ``(I) on such date, a lease of such property from the trust 
     was in effect, and
       ``(II) under the terms of the new lease, such trust 
     receives a substantially similar or lesser benefit in 
     comparison to the lease referred to in subclause (I).

       ``(D) Qualified health care property.--
       ``(i) In general.--The term `qualified health care 
     property' means any real property (including interests 
     therein), and any personal property incident to such real 
     property, which--

       ``(I) is a health care facility, or
       ``(II) is necessary or incidental to the use of a health 
     care facility.

       ``(ii) Health care facility.--For purposes of clause (i), 
     the term `health care facility' means a hospital, nursing 
     facility, assisted living facility, congregate care facility, 
     qualified continuing care facility (as defined in section 
     7872(g)(4)), or other licensed facility which extends medical 
     or nursing or ancillary services to patients and which, 
     immediately before the termination, expiration, default, or 
     breach of the lease of or mortgage secured by such facility, 
     was operated by a provider of such services which was 
     eligible for participation in the medicare program under 
     title XVIII of the Social Security Act with respect to such 
     facility.''
       (b) Effective Date.--The amendment made by this section 
     shall apply to taxable years beginning after the date of 
     enactment of this Act.
     TITLE III--CONFORMITY WITH REGULATED INVESTMENT COMPANY RULES

     SEC. 301. CONFORMITY WITH REGULATED INVESTMENT COMPANY RULES.

       (a) Distribution Requirement.--Clauses (i) and (ii) of 
     section 857(a)(1)(A) (relating to requirements applicable to 
     real estate investment trusts) are each amended by striking

[[Page S5381]]

     ``95 percent (90 percent for taxable years beginning before 
     January 1, 1980)'' and inserting ``90 percent''.
       (b) Imposition of Tax.--Clause (i) of section 857(b)(5)(A) 
     (relating to imposition of tax in case of failure to meet 
     certain requirements) is amended by striking ``95 percent (90 
     percent in the case of taxable years beginning before January 
     1, 1980)'' and inserting ``90 percent''.
       (c) Effective Date.--The amendments made by this section 
     shall apply to taxable years beginning after the date of 
     enactment of this Act.
    TITLE IV--CLARIFICATION OF DEFINITION OF INDEPENDENT CONTRACTOR

     SEC. 401. CLARIFICATION OF DEFINITION OF INDEPENDENT 
                   CONTRACTOR.

       (a) In General.--Paragraph (3) of section 856(d) (relating 
     to independent contractor defined) is amended by adding at 
     the end the following flush sentence:

     ``In the event that any class of stock of either the real 
     estate investment trust or such person is regularly traded on 
     an established securities market, only persons who own, 
     directly or indirectly, more than 5 percent of such class of 
     stock shall be taken into account as owning any of the stock 
     of such class for purposes of applying the 35 percent 
     limitation set forth in subparagraph (B) (but all of the 
     outstanding stock of such class shall be considered 
     outstanding in order to compute the denominator for purpose 
     of determining the applicable percentage of ownership).''
       (b) Effective Date.--The amendment made by this section 
     shall apply to taxable years beginning after the date of the 
     enactment of this Act.
          TITLE V--MODIFICATION OF EARNINGS AND PROFITS RULES

     SEC. 501. MODIFICATION OF EARNINGS AND PROFITS RULES.

       (a) Rules for Determining Whether Regulated Investment 
     Company Has Earnings and Profits From Non-RIC Year.--
     Subsection (c) of section 852 is amended by adding at the end 
     the following new paragraph:
       ``(3) Distributions to meet requirements of subsection 
     (a)(2)(B).--Any distribution which is made in order to comply 
     with the requirements of subsection (a)(2)(B)--
       ``(A) shall be treated for purposes of this subsection and 
     subsection (a)(2)(B) as made from the earliest earnings and 
     profits accumulated in any taxable year to which the 
     provisions of this part did not apply rather than the most 
     recently accumulated earnings and profits, and
       ``(B) to the extent treated under subparagraph (A) as made 
     from accumulated earnings and profits, shall not be treated 
     as a distribution for purposes of subsection (b)(2)(D) and 
     section 855.''.
       (b) Clarification of Application of REIT Spillover Dividend 
     Rules to Distributions To Meet Qualification Requirement.--
     Subparagraph (B) of section 857(d)(3) is amended by inserting 
     before the period ``and section 858''.
       (c) Application of Deficiency Dividend Procedures.--
     Paragraph (1) of section 852(e) is amended by adding at the 
     end the following new sentence: ``If the determination under 
     subparagraph (A) is solely as a result of the failure to meet 
     the requirements of subsection (a)(2), the preceding sentence 
     shall also apply for purposes of applying subsection (a)(2) 
     to the non-RIC year.''
       (d) Effective Date.--The amendments made by this section 
     shall apply to taxable years beginning before, on, or after 
     the date of the enactment of this Act.

  Mr. GRAHAM. Mr. President, I am pleased to join my colleague, Senator 
Mack, in the introduction of the REIT Modernization Act, legislation 
that would modernize the tax rules that apply to real estate investment 
trusts (``REITs'').
  REITs were created in 1960 to give small investors the ability to 
invest in income producing real estate. But it was not until the early 
part of this decade that REITs emerged as a significant factor in real 
estate finance. Their repid growth then contributed in a major way to 
the development of real estate markets. The real estate industry is 
experiencing change today as owners seek to maximize returns by taking 
greater advantage of their employee expertise and tenant base. This 
bill will better enable REITS to expand their services to tenants and 
customers.
  The Administration's Fiscal Year 2000 budget includes a proposal to 
change the rules governing REITs. The legislation that we are 
introducing today is largely based on that proposal. It would permit 
REITs to establish taxable subsidiaries to offer services that a REIT 
cannot offer directly to tenants and third parties. Stringent rules are 
included to ensure that the subsidiary would be fully subject to 
taxation. Current rules designed to ensure that REIT income is 
primarily earned from real estate activities would continue to apply. 
The bill also modifies the tratment of health care facilities to ensure 
that patients' lives are not disrupted in the event of an expired 
lease, and restores the 90% distribution rule that had previously 
applied to REITs.
  REITs play a positive role in the real estate economy that has helped 
to stabilize property values and provide liquidity to the market. As 
long as the basic limitations on REIT activities are preserved, those 
tax rules which impose restraints on REIT activities must be modified. 
In my own state of Florida, REITs have invested more than $13 billion 
in the Florida economy, and are an important source of investment 
capital that has reinvigorated real estate markets.
  I want to thank Senator  Mack  for his leadership on this issue and I 
welcome the bipartisan support this measure has received from members 
of the Senate Finance Committee, along with others, who have joined as 
cosponsors of the bill. I look forward to working with them in the 
months ahead.
  Mr. MOYNIHAN. Mr. President: I commend the efforts of my respected 
colleagues from Florida, Senator Mack and Senator Graham, as they work 
to modernize the tax rules that apply to Real Estate Investment Trusts 
(REITs). I have worked with the REIT industry over the years and have 
seen it grow to be a major contributor to the strength of the real 
estate sector in New York and nationally.
  Congress first authorized REITs in 1960 so that investors of modest 
means could invest in income producing real estate assets. During the 
last four decades, REITs have provided not only real estate ownership 
opportunities for individual investors, but also an important source of 
capital for real estate investment.
  As tax policy makers we have the responsibility to make sure that tax 
laws governing REITs are updated to reflect the realities of a dynamic 
market and to maintain a proper competitive balance between real estate 
owned through the REIT structure and through more traditional corporate 
and partnership structures. But because REITs are pass-through 
entities, we also have a responsibility to ensure that they are not 
used as vehicles for sheltering corporate taxes in a manner 
inconsistent with Congressional intent. In fact, twice in the last 
Congress the Finance Committee crafted legislation, later signed into 
law, to stop inappropriate use of the REIT structure in the case of so-
called ``stapled entities'' and liquidating subsidiaries.
  The Administration has included a proposal in its FY 2000 budget that 
would, among other things, allow REITs to own a taxable REIT 
subsidiary. The legislation introduced by Senators Mack and Graham 
builds on the Administration proposal, and would expand the permissible 
business activities of REITs.
  The approach taken in the proposals advanced by the Administration 
and by Senators Mack and Graham warrant consideration. I have asked my 
staff to review the legislation and work with the authors of the bill. 
It is my hope that Congress can enact REIT modernization legislation 
this year.

                          ____________________