IRS Modifies Safe Harbor to Help REITs
Meet 75-Percent Asset Test The IRS has modified the asset test safe harbor for real estate investment trusts (REITs) to ensure that an increase in the value of the REIT’s real property does not inadvertently reduce compliance with the 75-Percent Asset Test. The revised revenue procedure also provides that a modification of a mortgage loan to reduce the risk of default will not be treated as a new loan or as a prohibited transaction. CCH Take Away. Code Sec. 856(c)(4) requires that, at the close of each calendar quarter, at least 75 percent of the value of the REIT’s assets must be represented by qualifying assets—real estate assets, cash items, and government securities. A real estate asset includes a loan secured by real property. The IRS determined that, under the previous safe harbor test provided in Rev. Proc. 2011-16, an increase in the value of the real property securing a loan reduced the percentage of assets treated as a qualifying asset. The modification of the safe harbor test in Rev. Proc. 2014-51 will avoid this result. Asset test safe harbor Rev. Proc. 2011-16 provided that the IRS will not challenge a REIT’s treatment of a loan as "a real estate asset" for the 75-Percent Asset Test, if the REIT treats the value of the loan as the lesser of: the "value of the loan" determined under Reg. §1.856-3(a); or the "loan value of the real property" securing the loan. The value of the loan generally rises as the value of the property securing the loan increases, while the loan value of the property is fixed on the date that the REIT commits to make or purchase the loan and does not vary with increases in the value of the real property collateral. Thus, the numerator of the asset test does not vary with increases, but the denominator of the asset test does increase if the value of the collateral increases, and the portion of a mortgage loan that is a qualifying asset decreases. To prevent this "anomalous" result, Rev. Proc. 2014-51 modifies the asset test safe harbor. The loan is a real estate asset in an amount equal to the lesser of: the value of the loan under Reg. §1.856-3(a), or the greater of the current value of the collateral, or the loan value of the collateral determined under Reg. §1.856-5(c). Modifications Under Rev. Proc. 2014-51, a modification because of default or potential default is not a significant modification. Therefore, it is not a new commitment to make or purchase a loan, and the "loan value of the property" does not change. Furthermore, the modification of the loan is not a prohibited transaction, which can be subject to a 100-percent tax.