26 CFR § 1.856-2 - Limitations.
(a) Effective date. The provisions of part II, subchapter M, chapter 1 of the Code, and the regulations thereunder apply only to taxable years of a real estate investment trust beginning after December 31, 1960.
(b) Election. Under the provisions of section 856(c)(1), a trust, even though it satisfies the other requirements of part II of subchapter M for the taxable year, will not be considered a “real estate investment trust” for such year, within the meaning of such part II, unless it elects to be a real estate investment trust for such taxable year, or has made such an election for a previous taxable year which has not been terminated or revoked under section 856(g)(1) or (2). The election shall be made by the trust by computing taxable income as a real estate investment trust in its return for the first taxable year for which it desires the election to apply, even though it may have otherwise qualified as a real estate investment trust for a prior year. No other method of making such election is permitted. An election cannot be revoked with respect to a taxable year beginning before October 5, 1976. Thus, the failure of an organization to be a qualified real estate investment trust for a taxable year beginning before October 5, 1976, does not have the effect of revoking a prior election by the organization to be a real estate investment trust, even though the organization is not taxable under part II of subchapter M for such taxable year. See section 856(g) and § 1.856-8 for rules under which an election may be revoked with respect to taxable years beginning after October 4, 1976.
(c) Gross income requirements. Section 856(c) (2), (3), and (4), provides that a corporation, trust, or association is not a “real estate investment trust” for a taxable year unless it meets certain requirements with respect to the sources of its gross income for the taxable year. In determining whether the gross income of a real estate investment trust satisfies the percentage requirements of section 856(c) (2), (3), and (4), the following rules shall apply:
(1) Gross income. For purposes of both the numerator and denominator in the computation of the specified percentages, the term “gross income” has the same meaning as that term has under section 61 and the regulations thereunder. Thus, in determining the gross income requirements under section 856(c) (2), (3), and (4), a loss from the sale or other disposition of stock, securities, real property, etc. does not enter into the computation.
(2) Lapse of options. Under section 856(c)(6)(C), the term “interests in real property” includes options to acquire land or improvements thereon, and options to acquire leaseholds of land and improvements thereon. However, where a corporation, trust, or association writes an option giving the holder the right to acquire land or improvements thereon, or writes an option giving the holder the right to acquire a leasehold of land or improvements thereon, any income that the corporation, trust, or association recognizes because the option expires unexercised is not considered to be gain from the sale or other disposition of real property (including interests in real property) for purposes of section 856(c) (2)(D) and (3)(C). The rule in the preceding sentence also applies for purposes of section 856(c)(4)(C) in determining gain from the sale or other disposition of real property for the 30-percent-of-gross-income limitation.
(3) Commitment fees. For purposes of section 856(c) (2)(G) and (3)(G), if consideration is received or accrued for an agreement to make a loan secured by a mortgage covering both real property and other property, or for an agreement to purchase or lease both real property and other property, an apportionment of the consideration is required. The apportionment of consideration received or accrued for an agreement to make a loan secured by a mortgage covering both real property and other property shall be made under the principles of § 1.856-5(c), relating to the apportionment of interest income.
(4) Holding period of property. For purposes of the 30-percent limitation of section 856(c)(4), the determination of the period for which property described in such section has been held is governed by the provisions of section 1223 and the regulations thereunder.
(5) Rents from real property and interest. See §§ 1.856-4 and 1.856-5 for rules relating to rents from real property and interest.
(d) Diversification of investment requirements—(1) 75-percent test. Section 856(c)(5)(A) requires that at the close of each quarter of the taxable year at least 75 percent of the value of the total assets of the trust be represented by one or more of the following:
(i) Real estate assets;
(ii) Government securities; and
(iii) Cash and cash items (including receivables).
(2) Limitations on certain securities. Under section 856(c)(5)(B), not more than 25 percent of the value of the total assets of the trust may be represented by securities other than those described in section 856(c)(5)(A). The ownership of securities under the 25-percent limitation in section 856(c)(5)(B) is further limited in respect of any one issuer to an amount not greater in value than 5 percent of the value of the total assets of the trust and to not more than 10 percent of the outstanding voting securities of such issuer. Thus, if the real estate investment trust meets the 75-percent asset diversification requirement in section 856(c)(5)(A), it will also meet the first test under section 856(c)(5)(B) since it will, of necessity, have not more than 25 percent of its total assets represented by securities other than those described in section 856(c)(5)(A). However, the trust must also meet two additional tests under section 856(c)(5)(B), i.e. it cannot own the securities of any one issuer in an amount (i) greater in value than 5 percent of the value of the trust's total assets, or (ii) representing more than 10 percent of the outstanding voting securities of such issuer.
(3) Determination of investment status. The term “total assets” means the gross assets of the trust determined in accordance with generally accepted accounting principles. In order to determine the effect, if any, which an acquisition of any security or other property may have with respect to the status of a trust as a real estate investment trust, section 856(c)(5) requires a revaluation of the trust's assets at the end of the quarter in which such acquisition was made. A revaluation of assets is not required at the end of any quarter during which there has been no acquisition of a security or other property since the mere change in market value of property held by the trust does not, of itself, affect the status of the trust as a real estate investment trust. A change in the nature of “cash items”, for example, the prepayment of insurance or taxes, does not constitute the acquisition of “other property” for purposes of this subparagraph. A real estate investment trust shall keep sufficient records as to investments so as to be able to show that it has complied with the provisions of section 856(c)(5) during the taxable year. Such records shall be kept at all times available for inspection by any internal revenue officer or employee and shall be retained so long as the contents thereof may become material in the administration of any internal revenue law.
(4) Illustrations. The application of section 856(c)(5) and this paragraph may be illustrated by the following examples:
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|---|---|
| Cash | 6 |
| Government securities | 7 |
| Real estate assets | 63 |
| Securities of various corporations (not exceeding, with respect to any one issuer, 5 percent of the value of the total assets of the trust nor 10 percent of the outstanding voting securities of such issuer) | 24 |
| Total | 100 |
|
|
|
|---|---|
| Cash | 6 |
| Government securities | 7 |
| Real estate assets | 63 |
| Securities of Corporation Z | 20 |
| Securities of Corporation X | 4 |
| Total | 100 |
|
|
|
|---|---|
| Cash | 4 |
| Government securities | 9 |
| Real estate assets | 70 |
| Securities of Corporation S | 5 |
| Securities of Corporation L | 4 |
| Securities of Corporation U | 4 |
| Securities of Corporation M (which equals 25 percent of Corporation M's outstanding voting securities) | 4 |
| Total | 100 |
| Cash | $5,000 |
|---|---|
| Government securities | 4,000 |
| Receivables | 4,000 |
| Real estate assets | 68,000 |
| Securities of Corporation P | 4,000 |
| Securities of Corporation O | 5,000 |
| Securities of Corporation U | 5,000 |
| Securities of Corporation T | 5,000 |
| Total assets | 100,000 |
| Cash | $3,000 |
|---|---|
| Government securities | 4,000 |
| Receivables | 4,000 |
| Real estate assets | 68,000 |
| Securities in Corporation P | 50,000 |
| Securities in Corporation O | 5,000 |
| Securities in Corporation U | 5,000 |
| Securities in Corporation T | 5,000 |
| Securities in Corporation S | 2,000 |
| Total assets | 146,000 |
| Cash | $4,000 |
|---|---|
| Government securities | 4,000 |
| Receivables | 4,000 |
| Real estate assets | 68,000 |
| Securities in Corporation P | 10,000 |
| Securities in Corporation O | 5,000 |
| Securities in Corporation U | 5,000 |
| Securities in Corporation T | 5,000 |
| Securities in Corporation S | 1,000 |
| Total assets | 106,000 |