In a sputtering economy, owners of real estate investment trusts (REITs) may want to consider a novel approach to dividend payouts — use stock to conserve cash. The downside, however, is that the REIT could put its dividend tax deduction in jeopardy if it uses stock, rather than cash, to keep shareholders happy. But buried in the tax code is an obscure rule that may allow REITs to have their cake and eat it too. Consider the following tax facts.
Contrary to popular belief, REITs are not statutorily exempt from tax. To be sure, their favorable tax status is triggered only when certain affirmative actions are taken. In the absence of such actions, tax on a REIT’s taxable income will be imposed. Thus, the IRS provides — in Section 857(b)(1) — that “…there is hereby imposed for each taxable year on the REIT taxable income of every REIT a tax computed as provided in Sec. 11…” Section 11 is the corporate tax section of the IRS code.
Fortunately, REIT taxable income (upon which the corporate tax code is otherwise imposed) is calculated in an eclectic way, and taxable income is adjusted as follows: the deduction for dividends paid, as defined in Section 561, shall be allowed. Therefore, REITs can reduce their REIT taxable income by certain dividends they remit to their shareholders.
For this purpose, however, the term, dividend, shall include only dividends described in Section 316(a). A dividend, within the meaning of Section 316, means any distribution of property made by a corporation to its shareholders out of its earnings and profits.
Again, for this purpose, property — as defined in Section 317(a) — means money, securities, and other property except stock in the corporation making the distribution (or rights to acquire such stock.) So, it would appear that a cash-strapped REIT cannot secure a dividends paid deduction — which will have the effect of reducing its REIT taxable income — with respect to distributions of its stock (or rights to acquire such stock).
Stock as Property
Notwithstanding Section 317(a), a distribution of stock shall be treated as a distribution of property to which Section 301 applies under certain circumstances. The main criteria being that within the meaning of Section 305(b)(1), the distribution is payable either in its stock or in property at the election of any of the shareholders. In fact, Regulation Section 1.305-2 elucidates this cryptic rule.