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IRS Issues Final Rules on Exceptions From REIT or RIC Built-in Gain Recognition

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On Thursday, the IRS issued final regulations that provide guidance on the recognition of built-in gain in certain transfers of property from a C corporation to a regulated investment company (RIC) or real estate investment trust (REIT) (T.D. 9626). The final regulations adopt proposed regulations issued in April 2012 (REG-139991-08) with one clarification.

Regs. Sec. 1.337(d)-7 generally provides that if C corporation property becomes property of a REIT or a RIC through either the C corporation’s converting to qualify as a REIT or RIC or the C corporation’s transferring assets to a RIC or REIT, the RIC or REIT will be subject to built-in-gains tax under Sec. 1374 on the property. (The recognition rule does not apply if the C corporation transferor makes a deemed sale election under Regs. Sec. 1.337(d)-7(c) to recognize gain or loss as if it sold the property to an unrelated person at fair market value—the deemed-sale rule.)

The final regulations amend Regs. Sec. 1.337(d)-7 to provided two exceptions:

  • Gain is not recognized to the extent the conversion transaction qualifies for nonrecognition treatment under Sec. 1031 (like-kind exchanges) or Sec. 1033 (involuntary conversions) (referred to as the exchange exception).
  • A conversion transaction involving a C corporation that is a tax-exempt entity under Regs. Sec. 1.337(d)-4(c)(2) (which contains a list of eight categories of tax-exempt entities, including organizations exempt under Sec. 501(a) or 529 and charitable remainder trusts) is not subject to the rule if the entity would not be subject to tax (as under the unrelated business income tax rules of Sec. 511) on gain had the deemed-sale election to recognize gain been made.

In response to a comment on the proposed regulations, the final regulations clarify that the general rule does not apply to a conversion transaction in which the C corporation that owned the converted property is a tax-exempt entity to the extent that gain would not be subject to tax.

The new rules apply to conversion transactions that occur on or after Aug. 2, 2013 (the date the regulations are published in the Federal Register), but taxpayers can apply the rules retroactively.