Commercial Investment Real Estate March/April 2019 | Page 18

INVESTMENT
A N A LYSIS
REIT Due Diligence
Buyers and sellers alike must look beyond operational functions
to ensure compliance.
T
he complex rules governing real estate investment
trusts add a challenging aspect to any entity- or prop-
erty-level due diligence. Buyers of REITs or property
to be held by a REIT must navigate ambiguous rules
governing tenant services, make determinations regarding the
customary nature of how the properties are operated, and con-
sider all business relationships with tenants and contractors.
Looking past the operational aspects of the properties, the
administrative function of ensuring compliance is essential to
REIT buyers and sellers.
Income Test
Defining “rents from real property,” which include, in part,
charges for services customarily furnished or rendered in con-
nection with the rental of real property, is central to the REIT
income test requirements. Whether services are “customary” is
subjective in nature, and little guidance is given. In fact, private
letter rulings issued by the IRS are the most common sources
of information; however, such rulings may be relied on only
with respect to the taxpayer for which the ruling was issued.
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March | April 2019
Ultimately, buyers and sellers may disagree on the treatment,
and as such, all determinations of “customary services” should
be well documented, specifically citing what the norm is for the
asset class in that geographical area.
REIT rules allow for an independent contractor exception,
whereas non-customary services can be provided by the inde-
pendent contractor to the tenants. In addition to REIT owner-
ship thresholds of the independent contractor that cannot be
crossed, a REIT generally cannot receive income (such as rent
or dividend income) from the independent contractor; all costs
for non-customary services must be borne by the independent
contractor, and a separate charge must be made for the service.
Relationships with independent contractors and tenants can
exist without others’ knowledge. The attribution rules pro-
vided by the Internal Revenue Code may result in a REIT
being treated as owning a portion of a tenant or independent
contractor if a shareholder owns a portion of the REIT and
also owns a tenant or independent contractor. For this pur-
pose, a REIT could run afoul of the 35 percent independent
contractor threshold or 10 percent related party rent threshold.
COMMERCIAL INVESTMENT REAL ESTATE
by Stephen Bertonaschi