In Rev. Proc. 2018-48, the IRS has determined, under its Sec. 856(c)(5)(J)(ii) authority, that the Subpart F inclusions, passive foreign investment company (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 Sec. 856(c)(2). In addition, the IRS determined, under Sec. 856(n)(3)(C), that Sec. 986(c) foreign currency gains recognized on distributions of previously taxed earnings and profits of foreign corporations are excluded from gross income for purpose of the 95% income test.
Gross income under Sec. 856(c)
Under Sec. 856(c), a REIT must: (1) derive at least 95% of its gross income (excluding gross income from prohibited transactions) from sources listed in Sec. 856(c)(2), which include dividends, interest, rents from real property, and certain other items; and (2) derive at least 75% of its gross income (excluding gross income from prohibited transactions) from sources listed in Sec. 856(c)(3), which include rents from real property and certain other items.
Sec. 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 Sec. 856(c)(2) and/or the 75% income test under Sec. 856(c)(3) may nevertheless be considered as: (1) not constituting gross income for purposes of the 95% or 75% income tests; or (2) qualifying income for purposes of the 95% or 75% income tests.
Foreign income inclusions
Some REITs are U.S. shareholders in one or more controlled foreign corporations (CFCs), and/or own stock in domestic partnerships or trusts that are U.S. shareholders of CFCs. REITs may also own stock in foreign corporations that are PFICs. As U.S. persons owning stock (or treated as owning stock) in a foreign corporation, REITs may be required (under Secs. 951 to 965 and Secs. 1291 to 1298) to include in gross income certain types of income of the foreign corporation, including GILTI under Sec. 951A, which was added to the Code in 2017 by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97.
Under Sec. 986(c)(1), foreign currency gain or loss from 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. Sec. 856(n)(1)(a) specifies that passive foreign exchange gain (as defined in Sec. 856(n)(3)) for any tax year is not gross income for purposes of Sec. 856(c)(2). Amounts included in gross income under Sec. 986(c), however, are not listed in Sec. 856(n)(3)(A) or (B).
Income from sources under Sec. 951(a)(1), 951A(a), 986(c), 1291(a), 1293(a)(1), or 1296(a) is not among the qualifying sources enumerated in Sec. 856(c)(2) or (c)(3). Under Sec. 965(m)(1)(A), however, amounts required to be included in gross income under Sec. 951(a) by reason of the TCJA's required deemed repatriation of deferred foreign income under Sec. 965(a) are not taken into account as gross income of a REIT for purposes of applying Secs. 856(c)(2) and (3).
The IRS has received requests to exercise its authority under Secs. 856(c)(5)(J) and (n)(3)(C) to treat certain amounts determined under Secs. 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 Sec. 856(c)(2).
Guidance on REIT foreign income inclusions
In accordance with requests received by the IRS, Rev. Proc. 2018-48 provides guidance on the treatment by REITs of certain foreign income inclusions. Specifically, it provides that:
- Under Sec. 856(c)(5)(J)(ii), any amounts a REIT is required to include in gross income under Sec. 951(a)(1) (except by reason of Sec. 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 Sec. 856(c)(2).
- Under Sec. 856(n)(3)(C), any amounts a REIT is required to take into account under Sec. 986(c) as foreign currency gain from distributions of previously taxed earnings and profits (as described in Sec. 959 or 1293(c)) are considered passive foreign exchange gain (as defined in Sec. 856(n)(3)) and, therefore, do not constitute gross income for purposes of Sec. 856(c)(2).
Rev. Proc. 2018-48 is effective for tax years beginning after Sept. 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 14 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 the character of the underlying Subpart F income or PFIC income had on those conclusions. In addition, neither the underlying legislative history nor subsequently issued guidance addressed the REIT income testing treatment of GILTI inclusions, required under Sec. 951A, which was recently enacted under the TCJA. Accordingly, the IRS's determination in Rev. Proc. 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 advisers. 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.
EditorNotes
Michael Dell is a partner at Ernst & Young LLP in Washington.
For additional information about these items, contact Mr. Dell at 202-327-8788 or michael.dell@ey.com.
Unless otherwise noted, contributors are members of or associated with Ernst & Young LLP. Ernst & Young previously published versions of these items as Tax Alerts.
