A real estate investment trust (REIT) allows investors to pool their capital and invest in real estate assets without directly purchasing properties. These entities are unique because they allow investors to benefit from real estate income without the hassle of property management.
However, due to the potential tax advantages and extensive public participation in REITs, the legal requirements for forming and operating them are strict. Investors and entrepreneurs considering setting up a REIT should make an effort to understand these concerns to help ensure compliance and maximize profitability.
Formation and structuring
Before setting up a REIT, sponsors must choose a legal structure that aligns with federal requirements. REITs can be organized as:
- Corporations
- Partnerships
- Trusts
However, they generally operate as publicly traded corporations due to tax and capital-raising advantages. REITs must adhere to the guidelines set by the Internal Revenue Service (IRS) and the Securities and Exchange Commission (SEC). These guidelines specify that the entity must be managed by a board of trustees or directors, further reinforcing corporate governance standards.
Compliance with tax regulations
REITs enjoy tax benefits by avoiding double taxation—one of their most significant appeals. However, this tax-exempt status is contingent upon meeting strict IRS requirements under the Internal Revenue Code (IRC), specifically sections 856 through 859.
Key criteria include the obligation to distribute at least 90% of taxable income to shareholders annually, which enables REITs to be taxed only at the shareholder level, not at the entity level. Additionally, at least 75% of a REIT’s total assets must be invested in:
- Real estate
- Cash
- Government securities
Failure to comply with these rules can lead to heavy penalties or loss of REIT status, resulting in conventional corporate tax rates.
Ownership and securities laws
REITs generally require a broad ownership base to prevent concentration of control and help ensure public participation. These requirements aim to prevent private control of publicly accessible assets, encouraging transparency and shareholder participation.
Furthermore, a publicly traded REIT must register its securities with the SEC and comply with federal securities laws. However, even non-public REITs are subject to stringent state and federal securities regulations, including disclosure requirements to potential investors.
Before launching a REIT, potential sponsors should consult with a trusted legal team to help ensure that all regulatory requirements are met. By understanding and adhering to these legal considerations, REITs can effectively maximize their benefits and cultivate a robust platform for investment in real estate while avoiding costly compliance issues.