[Congressional Record (Bound Edition), Volume 153 (2007), Part 3]
[Extensions of Remarks]
[Pages 4575-4577]
[From the U.S. Government Publishing Office, www.gpo.gov]




INTRODUCTION OF THE REIT INVESTMENT DIVERSIFICATION AND EMPOWERMENT ACT

                                 ______
                                 

                          HON. JOSEPH CROWLEY

                              of new york

                    in the house of representatives

                       Friday, February 16, 2007

  Mr. CROWLEY. Madam Speaker, along with my good friends and 
colleagues, Representatives Cantor, Pomeroy and Reynolds, I introduce 
the REIT Investment Diversification and Empowerment Act, RIDEA. This 
legislation will continue the tradition of Congress to periodically 
review and amend the tax rules governing REITs to ensure that they are 
able to operate within the competitive norms of the marketplace. In an 
effort to keep REITs competitive, this bill addresses several issues 
tied to REIT investment diversification and empowerment. The 
legislation would make several minor, but important, changes in the 
REIT tax rules to permit REITs on behalf of their shareholders to 
continue to compete with other real estate companies in international 
and domestic markets.
  In 1960, Congress created the REIT rules to allow average investors 
to obtain the benefits of owning large-scale, income producing real 
estate such as shopping malls, apartment communities and office 
buildings. REITs are typically publicly traded companies that pass 
through their earnings to individual shareholders. The vision of 
Congress has come to fruition: The equity market capitalization of 
REITs as of December 31, 2006 was $438 billion--up from only $1.4 
billion at the end of 1971. Investment professionals such as Burton 
Malkiel of Princeton University, Jeremy

[[Page 4576]]

Siegel of the Wharton School at the University of Pennsylvania and 
David Swensen, the manager of the Yale Endowment, have recommended that 
individual investors should maintain a discrete allocation of REITs as 
part of a diversified portfolio to maximize performance while lowering 
investment risk.
  Commercial real estate plays an essential part in the national 
economy, producing about 6 percent of the gross domestic product 
according to the Federal Reserve Board. REITs have grown to be an 
essential component of the real estate marketplace and provided 
investment opportunities for everyone to invest in where we work, live 
and shop. REITs own all types of income producing real estate, from 
community shopping centers to landmarks such as Roosevelt Field on Long 
Island, Tyson's Comer in Virginia, and Queens Plaza, in my home borough 
of Queens, NY.
  REITs are subject to a number of rules to ensure their primary focus 
is commercial real estate activities. At least 75 percent 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 percent 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 percent of a REIT's annual gross income must be derived from 
the income items from the above 75 percent test plus other ``passive 
income'' sources such as dividends and any type of interest.
  For over three decades, the IRS has recognized that real estate 
investments abroad qualify as ``good assets'' and generate ``good 
income'' under the REIT tax rules. With that said, the treatment of 
foreign currency gains directly attributable to overseas real estate 
investment is not altogether clear, but its correct characterization is 
becoming increasingly important as REITs continue investing in the most 
attractive marketplaces for their shareholders. Similarly, as more and 
more countries begin to authorize REIT-like approaches to real estate 
investment, it is important that U.S. tax rules allow U.S. REITs to 
invest in these businesses without negatively affecting their own REIT 
status.
  I do not believe this bill is controversial. The three previous 
changes to the REIT rules made over the past decade have been sponsored 
by many Members on both sides of the aisle, and we expect that RIDEA 
will follow in these bipartisan footsteps. It is also important to note 
that this bill is endorsed by the National Association of Real Estate 
Investment Trusts and the Real Estate Roundtable.
  Madam Speaker, this is an opportunity for us to provide REITs the 
flexibility needed to remain competitive and to make other minor, but 
important, changes to the REIT rules. I urge my colleagues on both 
sides of the aisle to join me in supporting these changes.
  Madam Speaker, I ask unanimous consent that the text of the bill and 
a detailed summary of its provisions be printed in the Record.
  The REIT Investment Diversification and Empowerment Act (``RIDEA'') 
includes five titles: Title I--Foreign Currency and Other Qualified 
Activities, Title II--Taxable REIT Subsidiaries, Title III--Dealer 
Sales, Title IV--Health Care REITs, and Title V--Foreign REITs.
  As the REIT market develops and as REITs continue to expand their 
overseas investments, the issue of the correct characterization of 
foreign currency gains, and other types of non-specified income and 
assets, has become even more important. Title I would in effect codify 
existing law concerning the income derived, and assets held, by REITs 
in connection with their REIT-permissible activities outside of the 
U.S.
  Specifically, Title I would treat as qualified REIT income foreign 
currency gains derived with respect to its business of investing in 
``real estate assets'' outside of the U.S. Today REITs can achieve 
approximately the same results by establishing a ``subsidiary REIT'' in 
each currency zone in which it operates and securing a private letter 
ruling from the IRS. RIDEA would allow a REIT to obtain the same result 
by operating a qualified business unit that satisfies the 75 percent 
income and asset tests.
  Title I also would provide the IRS with authority to determine 
whether certain types of foreign currency gains were qualifying income, 
as well as to provide that certain items of income not specifically 
listed in the REIT gross income provisions should not be taken into 
account in computing a REIT's gross income.
  Under current law, even if a REIT were to earn a substantial amount 
of certain types of income that are not specified in the gross income 
baskets, the REIT could jeopardize its REIT status--even though these 
types of income may be directly attributable to the REIT's business of 
owning and operating commercial real estate. Examples include amounts 
attributable to recoveries in settlement of litigation and ``break up 
fees'' attributable to a failure to consummate a merger. The IRS has 
issued private letter rulings to taxpayers holding that the particular 
type of income should be considered either qualifying income or should 
be ignored for purposes of the REIT rules.
  Under this provision, I would expect that the IRS would conclude, for 
example, that dividend-like items of income such as Subpart F income 
and income produced by holding stock of a passive foreign investment 
company either are considered qualified income for purposes of the REIT 
income tests are not taken into account for purposes of these tests.
  Furthermore, Title I would conform the current REIT hedging rule to 
also apply to foreign currency gains, apply those rules for purposes of 
both REIT gross income tests and would make conforming changes to other 
REIT provisions reflecting foreign currency gains.
  Title II would increase the limit on taxable REIT subsidiaries, TRS, 
securities from 20 percent to 25 percent, as originally contemplated in 
the REIT Modernization Act of 1999. The rationale for a 25 percent 
limit on TRSs remains the same today. The dividing line for testing a 
concentration on commercial real estate in the REIT rules has long been 
set at 25 percent, and even the mutual fund rule uses a 25 percent 
test. It is not too often that an industry requests Congress to 
increase the amount of income it can earn to a double level of 
taxation.
  Title III updates the rules that require a REIT to be a long-term 
investor in real estate. A REIT is subject to a 100 percent tax on net 
income from sales of property in the ordinary course of business--
``prohibited transactions'' or ``dealer sales''. In 1976, Congress 
recognized the need for a bright line safe harbor for determining 
whether a REIT's property sale constituted a prohibited transaction. 
Congress further liberalized these rules in 1978 and 1986 to better 
comport with industry practice and to simplify a REIT's ability to sell 
long-term investment property without fear of being taxed at a 100 
percent rate. The current safe harbor exceptions for rental property 
and timber provide that a sale may avoid being classified as a 
prohibited transaction if it meets several requirements, including that 
the REIT own the property for at least 4 years and that each year it 
sell either less than seven properties or 10 percent of its portfolio, 
as measured by tax basis.
  Largely because commercial real estate is increasingly recognized as 
a separate asset class that provides substantial diversification and 
performance benefits for retirement savings, the real estate market has 
achieved greater levels of liquidity than ever before. This increased 
liquidity has provided real estate owners who have invested for the 
long term with more and more opportunities to maximize value by selling 
assets sooner than originally expected. REITs that rely on the safe 
harbor have been precluded from selling some of their investment assets 
because of the current 4-year requirement.
  The safe harbor is intended to provide a clear dividing line between 
a REIT acting as an investor rather than a dealer. However, the 4-year 
requirement is arbitrary and not consistent with other Code provisions 
that define whether property is held for long term investments, e.g., 
the 1-year holding period to determine long-term capital gains 
treatment for individuals, and the 2-year holding period to distinguish 
whether the sale of a home is taxable because it is held for investment 
purposes. A 2-year holding period better reflects current economic 
realities.
  In addition, the 10 percent limit that is now based on tax basis 
negatively impacts companies that are the least likely to have engaged 
in ``dealer'' activity. The most established REITs have typically held 
their properties the longest, resulting in low adjusted bases due to 
depreciation or amortization deductions. Thus, the aggregate bases of 
all the REITs properties will be relatively much lower for purposes of 
the safe harbor exception than for a REIT that routinely turns over its 
properties every 4 years. Accordingly, the REIT that holds its 
properties for the longer term is penalized.
  In 1999, Congress adopted a provision that utilizes fair market value 
rules for purposes of calculating personal property rents associated 
with the rental of real property. The measurement change in Title III 
to the 10 percent test from tax basis to fair value is fully consistent 
with this 1999 provision.
  Title IV parallels the treatment under the REIT rules of health care 
facilities to lodging facilities. Payments made from a subsidiary owned 
by a REIT to that REIT usually are not considered qualified income for 
REIT purposes. Congress in 1999 carved out an exception under which a 
REIT may establish a

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TRS that can lease lodging facilities from a REIT holding a controlling 
interest, with the payments to the REIT considered good ``rents'' under 
the REIT rules. Under these rules, a TRS is not allowed to operate or 
manage lodging or health care facilities; instead an independent 
contractor must do so.
  When this change was made in 1999, health care operators did not 
object to bearing the risks associated with being liable as a long-term 
lessee. Recently, many operators of health care assets such as assisted 
living facilities have indicated that they would rather be independent 
operators of the facilities and instead rely on a REIT to bear all real 
estate-related financial risks. Most health care REITs now believe that 
the TRS restriction is interfering with their ability to manage their 
operations in the most efficient manner.
  Title IV would allow a REIT's TRS to lease health care facilities 
from its controlling REIT so long as the facilities are operated and 
managed by an independent contractor. It also clarifies that a TRS's 
mere possession of a license which, for example, is sometimes required 
for State purposes, is not considered the operation or management of 
the facilities.
  Governments around the world have recognized the success of REITs in 
the United States as creating ``liquid real estate'' for the first time 
in history. More than 20 countries have adopted REIT legislation, with 
the United Kingdom making the leap on January 1 and Germany expected to 
follow suit later this year. Although the Tax Code treats stock in a 
U.S. REIT as a qualified asset that generates qualifying income, 
current law does not afford the same treatment to the stock of non-U.S. 
REITs.
  Instead of investing abroad either directly or in a joint venture, a 
U.S. REIT might want to invest through a REIT organized in that 
country. However, a company could lose its status as a U.S. REIT if it 
owns more than 10 percent of a foreign REIT's securities, even though 
the foreign company is the equivalent of a U.S. REIT. A U.S. REIT 
should have the flexibility in deciding what form its overseas real 
estate investment should take.
  Title V would allow a U.S. REIT to acquire securities in a foreign 
REIT so long as that REIT has the same core attributes as a U.S. REIT. 
The Treasury Department would have the responsibility to analyze the 
foreign laws and rules to determine if the REITs organized in a 
particular country meet this test, much as it does in determining 
whether entities organized abroad are ``per se'' corporations under the 
``check the box'' entity classification rules. In making these 
determinations, the Secretary should take into account whether the 
laws, stock market requirements, or market preferences in a country 
imbue listed foreign REITs with these characteristics: (1) At least 75 
percent of the company's assets must be invested in real estate assets; 
(2) the foreign REIT either receives a dividends paid deduction or is 
exempt from corporate level tax; and (3) the foreign REIT is required 
to distribute at least 85 percent of its taxable income to shareholders 
on an annual basis.
  Madam Speaker, I am pleased to introduce this bipartisan legislation.

                          ____________________