In Revenue Procedure 2018-48, the IRS has determined, under its Section 856(c)(5)(J)(ii) authority, that the subpart F inclusions, passive foreign investment companies (PFIC) inclusions and global intangible low-taxed income (GILTI) inclusions attributable to investment by a real estate investment trust (REIT) in foreign corporations constitute qualifying income for purposes of the 95% income test in Section 856(c)(2). In addition, the IRS determined, under Section 856(n)(3)(C), that Section 986(c) foreign currency gains recognized with respect to distributions of previously taxed earnings and profits of foreign corporations are excluded from gross income for purpose of the 95% income test.

Background

Gross income under Section 856(c)

Under Section 856(c), a REIT must: (i) derive at least 95% of its gross income (excluding gross income from prohibited transactions) from sources listed in Section 856(c)(2), which include dividends, interest, rents from real property and certain other items; and (ii) derive at least 75% of its gross income (excluding gross income from prohibited transactions) from sources listed in Section 856(c)(3), which include rents from real property and certain other items.

Section 856(c)(5)(J) authorizes the Treasury Secretary to determine, solely for purposes of the REIT provisions of the Code, whether any item of income or gain that does not qualify for the 95% income test under Section 856(c)(2) and/or the 75% income test under Section 856(c)(3) may nevertheless be considered as: (i) not constituting gross income for purposes of the 95% or 75% income tests; or (ii) qualifying income for purposes of the 95% or 75% income tests.

Foreign income inclusions

Some REITs are US shareholders in one or more controlled foreign corporations (CFCs), and/or own stock in domestic partnerships or trusts that are US shareholders of CFCs. REITs may also own stock in foreign corporations that are PFICs. As US persons owning stock (or treated as owning stock) in a foreign corporation, REITs may be required (under Sections 951 to 965 and Sections 1291 to 1298) to include in gross income certain types of income of the foreign corporation, including GILTI under Section 951A, which was added to the Code in 2017 by the Tax Cuts and Jobs Act (TCJA).

Under Section 986(c)(1), foreign currency gain or loss with respect to distributions of previously taxed earnings and profits attributable to movements in exchange rates between the times of the deemed and actual distribution are recognized and treated as ordinary income or loss from the same source as the associated income inclusion. Section 856(n)(1)(a) specifies that passive foreign exchange gain (as defined in Section 856(n)(3)) for any tax year is not gross income for purposes of Section 856(c)(2). Amounts included in gross income under Section 986(c), however, are not listed in Section 856(n)(3)(A) or (B).

Income from sources under Sections 951(a)(1), 951A(a), 986(c), 1291(a), 1293(a)(1) or 1296(a) are not among the qualifying sources enumerated in Section 856(c)(2) or (c)(3). Under Section 965(m)(1)(A), however, amounts required to be included in gross income under Section 951(a) by reason of the TCJA's required deemed repatriation of deferred foreign income under Section 965(a) are not taken into account as gross income of a REIT for purposes of applying Section 856(c)(2) and (3).

The IRS has received requests to exercise its authority under Section 856(c)(5)(J) and (n)(3)(C) to treat certain amounts determined under Sections 951(a)(1), 951A(a), 986(c), 1291(a) and 1293(a)(1) either as not constituting gross income or as qualifying gross income for purposes of Section 856(c)(2).

Guidance on REIT foreign income inclusions

In accordance with requests received by the IRS, Revenue Procedure 2018-48 provides guidance on the treatment by REITs of certain foreign income inclusions. Specifically, it provides that:

(1) Under Section 856(c)(5)(J)(ii), any amounts required to be included in gross income by a REIT under Sections 951(a)(1) (except by reason of Section 965) (GILTI inclusions), 951A(a) (Subpart F inclusions), 1291(a), 1293(a)(1) or 1296(a) (PFIC inclusions) are treated as qualifying income for purposes of Section 856(c)(2)

(2) Under Section 856(n)(3)(C), any amounts required to be taken into account by a REIT under Section 986(c) as foreign currency gain with respect to distributions of previously taxed earnings and profits (as described in Sections 959 or 1293(c)) are considered passive foreign exchange gain (as defined in Section 856(n)(3)) and, therefore, do not constitute gross income for purposes of Section 856(c)(2)

Revenue Procedure 2018-48 is effective for tax years beginning after September 13, 2018. In addition, however, REITs to which the revenue procedure applies may choose to apply its guidance to any prior tax years.

Implications

The IRS previously issued 13 private letter rulings in which it ruled that certain subpart F inclusions and PFIC inclusions constituted qualifying income for purposes of the 95% income test. It was unclear, however, what effect, if any, the character of the underlying subpart F income or PFIC income had on the conclusions. In addition, neither the underlying legislative history nor subsequently issued guidance addressed the REIT income testing treatment of GILTI inclusions, required under Section 951A, which was recently enacted under the TCJA. Accordingly, the IRS's determination in Revenue Procedure 2018-48 that subpart F inclusions, PFIC inclusions and GILTI inclusions constitute qualifying income for purposes of the 95% income test is welcome news for REITs and their advisors. It appears that the IRS decided that these inclusions are "dividend-like" income and thus, should be given the same treatment under the REIT income tests as dividend income received from a C corporation.

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