[Congressional Record Volume 149, Number 117 (Friday, August 1, 2003)]
[Senate]
[Pages S10917-S10918]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

       By Mr. HATCH (for himself, Mr. Breaux, Mr. Smith, Mr. Lott, and 
        Ms. Snowe):
  S. 1568. 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.
  Mr. HATCH. Mr. President, along with my good friends and colleagues, 
Senators Breaux, Smith, Lott, and Snowe, I rise today to introduce the 
Real Estate Investment Trust Improvement Act of 2003. This legislation 
would update the tax rules governing real estate investment trusts, 
commonly referred to as REITs, by making a number of minor but 
important changes to remove uncertainties in the law and improve their 
investment climate. Identical legislation has been introduced in the 
House of Representatives.
  REITs are publicly traded real estate companies that pass through 
their earnings to individual shareholders. Congress originally created 
REITs in 1960 to enable small investors to make investments in large-
scale, income producing real estate. By doing so, Congress made 
commercial real estate more accessible, more liquid, more transparent, 
and more attuned to investor interests. REITs have evolved to own 
properties across the country, including office buildings, apartments, 
shopping centers, and warehouses. As a result, these entities play a 
key role in helping our economy move forward by promoting investment 
and creating jobs.
  The Internal Revenue Code includes detailed rules governing the 
operations of REITs, the types of income they can earn, and the assets 
they hold. Congress last amended these provisions in 1999. The REIT 
Improvement Act is the product of almost two years of discussions with 
the staffs of the Treasury Department and the Joint Committee on 
Taxation on how to find solutions to several thorny problem areas where 
the rules are in need of clarification or modification.
  The REIT Improvement Act includes three titles: Title I--REIT 
Corrections; Title II--FIRPTA Corrections; and Title III--REIT Savings.
  Title I includes several corrections to the REIT tax rules to remove 
some uncertainties and provide corrections largely arising from 
enactment of the REIT Modernization Act in 1999. Although these 
provisions have very little effect on revenue to the Treasury, they are 
of considerable importance to REITs because they remove uncertainties 
that interfere with the efficient operation of their businesses.
  Because publicly-held REITs have to report quarterly to the 
Securities and Exchange Commission that they are in compliance with the 
specialized income and asset tests applicable to REITs, the uncertain 
application of these tax rules creates greater difficulties in REIT 
business operators than unclear tax rules generally do for other 
corporations.

  The most important, time-sensitive provision in this title deals with 
what is called the ``straight debt'' rule. This rule, which was adopted 
in the REIT Modernization Act of 1999, prohibits REITs from owning more 
than 10 percent of the value of any other entity's securities. Although 
this rule was intended to prevent REITs from owning more than 10 
percent of the equity of another corporation, as drafted the rules 
potentially apply to many situations when individuals and businesses 
owe some sort of debt, ``security'' defined broadly, to a REIT.
  There are many situations in which REITs make non-abusive, ordinary 
loans in the course of business for which they could face loss of REIT 
status because the loans do not qualify as

[[Page S10918]]

``straight debt.'' The most common context for this situation is in the 
REIT's relationship with its tenants. For example, the REIT might lend 
the tenant money for leasehold improvements. In some circumstances such 
a loan could represent more than 10 percent of the tenant's total debt 
obligations. In such a case, although the amount owed could be small, 
it could lead to REIT disqualification. The bill we are introducing 
today would exempt from the 10 percent rule certain categories of loans 
that are non-abusive and present little or no opportunity for the REIT 
to participate in the profits of the issuer's business. This includes 
any loan from a REIT to an individual or to a government, and any debt 
arising from a real property rent arrangement.
  Other provisions in this title clarify the related party rent rules 
that limit the amount of space a taxable subsidiary may lease from its 
parent REIT, update the hedging definitions in the REIT rules, remove a 
safe harbor protection for a taxable subsidiary providing customary 
services to a REIT's tenants, and restore a formula for imposing a tax 
on REITs that fail to meet the 95 percent gross income test.
  Finally, the bill would modify a safe harbor to the prohibited 
transaction rule that imposes a 100 percent tax on the income REITs 
earn from sales of ``dealer property.'' Currently, the safe harbor is 
limited to sales of property held for the production of rental income 
that meet a series of tests. The change proposed in this title would 
extend the safe harbor to other REIT property, not just that held for 
the production of rental income.
  Title II of the bill would modify the Foreign Investment in Real 
Property Tax Act (``FIRPTA'') to remove barriers to foreign investment 
in REITs. Today, there is very little foreign investment in REITs. We 
understand that U.S. money managers routinely receive assignments to 
place foreign investment capital in the United States under which they 
have complete discretion to invest in any U.S. stocks except REITs. The 
reason they are expressly told to avoid REITs is that under FIRPTA, 
foreign investors that receive REIT capital gains distributions are 
treated as doing business in the United States.
  Title II would modify the FIRPTA rules so that a publicly traded 
REIT's payment of capital gains dividends to a foreign portfolio 
investor would no longer cause the REIT investor to be considered doing 
business in the United States. The effect of this would be to threat 
investments in REITs like investment in other corporations, and the 
provision would parallel current law governing a portfolio investor's 
sale of REIT stock.

  Title III of our bill, REIT Savings, would modify a number so-called 
``death trap'' provisions in the REIT tax rules that result in the 
disqualification of the REIT if various rules are not met. The loss of 
REIT status would be a catastrophic occurrence that the management of a 
REIT tries to avoid at all costs, so much so that they expend 
significant resources to put in place compliance measures to avoid such 
a result. A better, simpler alternative would be to build in some 
flexibility to the REIT tax rules and impose monetary penalties, in 
lieu of REIT disqualification, for the failure to meet these strict 
rules that lead to REIT disqualification.
  For example, under current law, a REIT is disqualified if more than 5 
percent of its assets are comprised of the securities of any entity, or 
if it owns more than 10 percent of the voting power or value of any 
entity. In lieu of disqualification of the REIT status for violations 
of these rules, our bill would first give REITs an opportunity to 
comply with the asset tests with respect to any violation that does not 
exceed 1 percent of their total assets. Assets in excess of the 1 
percent de minimis amount would be subject to a tax of the greater of 
$50,000 or the highest corporate tax rate multiplied by the net income 
from the assets if the violation was justified by reasonable cause.
  Under current law, a REIT is disqualified if it does not meet certain 
other tests relating to its organizational structure, the distribution 
of its income, its annual elections to the IRS, the transferability of 
its shares, and other requirements. In lieu of this disqualification, 
Title III would change the law, assess a monetary penalty of $50,000 
for each reasonable cause failure to satisfy these rules. This is a 
much more reasonable solution.
  These changes are similar to ``intermediate sanctions'' legislation 
that Congress approved a few years ago dealing with nonprofit 
organizations. That legislation imposed monetary penalties on nonprofit 
organizations for violation of certain tax rules in lieu of a 
devastating loss of the organizations' tax-exempt status. Those 
changes, like the ones we are proposing today, recognize that it is far 
more likely that an entity will be sanctioned under a penalty regime 
than under draconian rules that entirely disqualify the organization.
  The REIT Improvement Act would provide reasonable and much needed 
reforms to the rules governing a key component of our economy. We urge 
our colleagues to join with us in sponsoring this legislation and 
supporting its inclusion in tax legislation heading for passage this 
year.
  Mr. BREAUX. Mr. President, I am pleased to join my colleague, Senator 
Hatch in the introduction of the REIT Improvement Act of 2003. Through 
this legislation we hope to remove a number of uncertainties in the tax 
laws that hinder the management of REITs, and to improve the investment 
climate for REITs, particularly with respect to their ability to 
attract foreign capital.
  Real estate investment trusts (``REITs'') were created by Congress in 
1960 as a means of enabling small investors to invest in real estate 
through professionally managed companies. While REITs remained a very 
small sector of the real estate industry for many years--primarily as 
mortgage owning companies--with the enactment of tax reform in 1986, 
and the collapse of the real estate markets in the late 1980s--the REIT 
structure rapidly grew in the 1990s as an attractive means of owning 
real estate. Unlike the traditional form of real estate ownership, 
REITs are publicly traded corporations that go to the public capital 
markets to raise capital for their operations. Today, REITs are 
corporations or business trusts that combine the capital of many 
investors to own, operate or finance income-producing real estate, such 
as apartments, storage facilities, hotels, shopping centers, offices, 
and warehouses.
  Because REITs are publicly traded corporations that must show results 
to the financial markets, the REIT structure injects better market 
discipline into the real estate sector. This minimizes the wild 
valuation swings that have characterized the real estate sector in the 
past. It also limits the exposure of federally insured depository 
institutions that have been traditional lenders to private real estate 
companies.
  The legislation that we are introducing today, the REIT Improvement 
Act of 2003 (RIA), has three objectives. Number one, to make a number 
of minor corrections in the REIT tax rules, including most importantly 
fixing an unintended problem arising from the REIT Modernization Act of 
1999 that now causes a company to lose its REIT status by holding 
ordinary debt, e.g., a loan to a small tenant to finance tenant 
improvements.
  Number two, to eliminate a major barrier to foreign investment in 
publicly traded REITs that now treats portfolio investors as doing 
business in the U.S. merely because they receive REIT capital gains 
distributions. The change would parallel the existing Tax Code rule for 
a foreigner's sale of a publicly traded REIT's stock.
  Number three, to replace the penalty for reasonable cause violations 
of REIT tests from a loss of REIT status to a monetary penalty. This is 
similar to a test that was enacted as part of the REIT Simplification 
Act of 1977, as well as ``intermediate sanction'' legislation Congress 
passed a few years ago for tax-exempt organizations.
  Twenty-nine members of the Ways and Means Committee are cosponsoring 
identical legislation in the House of Representatives, H.R. 1890. I 
expect we will eventually have similar support for this legislation in 
the Senate Finance Committee. I invite may colleagues to join us as 
cosponsors of this legislation in the weeks ahead.
                                 ______