On Aug. 24, the IRS issued Rev. Proc. 2014-51, which supersedes Rev. Proc. 2011-16, concerning the treatment of safe harbors for purposes of determining real estate investment trust (REIT) qualifications.

Rev. Proc. 2014-51 provides that the IRS will not challenge a REIT's treatment of a loan as being a real estate asset for purposes of the Section 856(c)(4) asset test so long as the REIT treats the loan as being a real estate asset in an amount equal to the lesser of: (i) the value of the loan determined under Treas. Reg. Sec. 1.856-3(a); or (ii) the greater of:

  1. the current value of the real property securing the loan
  2. the loan value of the real property securing the loan as determined under the Section 856(c)(2) apportionment rule.

To qualify as a REIT for a given taxable year, Section 856(c)(4)(A) provides that at the close of each quarter in a taxable year, at least 75% of the value of a REIT's total assets must be represented by (i) real estate assets; (ii) cash and cash items (including receivables); and (iii) government securities. This is known as the asset test.

If a mortgage loan is secured by both real property and other property, Treas. Reg. Sec. 1.856-5(c) provides rules to apportion the debt to real property for purposes of the REIT income test under Section 856(c)(2), which is known as the apportionment rule.

The now-superseded Rev. Proc. 2011-16 provided safe harbors for REITs to apply the asset test after certain modifications of a mortgage loan. Specifically, Rev. Proc. 2011-16 provided a safe harbor that, upon a modification within the scope of the Rev. Proc., the IRS would not challenge a REIT's treatment of a loan as being a "real estate asset" for purposes of the asset test in an amount equal to the lesser of (a) the value of the loan determined under Treas. Reg. Sec. 1.856-3(a); or (b) the loan value of the real property securing the loan as determined under the apportionment rule.

The IRS indicated in the new Rev. Proc. 2014-51 that it had become aware that the safe harbor may produce anomalous results. Specifically, the safe harbor addressed the numerator of the asset test, which would generally not vary if there was an increase of the value of the real property collateral. In contrast, the denominator of the asset test (i.e., the "total assets" of the REIT) would vary if the value of the real property collateral increased.

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