Most people think of transfer pricing as an international issue that only applies to global multinationals. But transfer pricing also comes into play for Real Estate Investment Trusts (REITs), which operate largely in the U.S. Some may not be aware that REITs are subject to a number of transfer pricing rules and, when applicable, to onerous penalties.
Established in 1960 by Congress as a real estate-based concept modeled after mutual funds, REITs can be publicly traded or privately held. REITs commonly own and manage properties, including retail centers, office space, warehouses, data centers, hotels, healthcare facilities or other infrastructure, such as cell towers, network infrastructure or even energy pipelines. Like a mutual fund, a REIT is not subject to tax and provides a variety of advantages for investors interested in owning real estate. That said, a REIT must meet strict ownership requirements, compliance requirements, and operational limitations.
Transfer Pricing Requirements for REITs
Internal Revenue Codes (I.R.C.) §856, §857, §858, and §859 establish requirements for electing to be taxed as a REIT and requirements for maintaining REIT status. Since 1999, REITs, and investors considering a REIT election have been subject to modernized rules providing for Taxable REIT Subsidiaries (TRS). Because REITs can only earn rental or interest income, a TRS needs to undertake non-customary activities to preserve the election to be taxed as a REIT.
I.R.C. §857 establishes the requirements for REITs and Taxable REIT Subsidiaries (TRS) or other related parties to clearly reflect income in accordance with I.R.C. §482 and U.S. Treasury Regulations promulgated thereunder, commonly known as the arm’s length standard. The arm’s length standard refers to pricing between related parties aligning with pricing that would be agreed between independent parties in similar circumstances. I.R.C. §857(b)(7)(A) imposes “. . . a tax equal to 100 percent of redetermined rents, redetermined deductions, excess interest, and redetermined TRS service income”, effectively penalizing a REIT for the full amount of any adjustment necessary to align with the arm’s length standard, emphasizing how critical it is for REITs to establish and document arm’s length behavior for any related party transactions.
- A REIT may receive management or other non-customary services from a TRS, but the income generated by these services must meet the arm’s length standard.
- A REIT may share resources with a TRS that benefit both the REIT and other TRS activities, but resources must be shared based on an arm’s length method for allocating deductions.
- A REIT may own qualified lodging or qualified healthcare property and utilize a TRS to provide non-customary activities to maintain compliance with REIT qualifications. Qualified lodging or healthcare REITs typically need to establish arm’s length rent for real estate leased to a TRS that is permitted to earn lodging or healthcare services revenues.
- A REIT may enter into related party loans with a TRS, however, the corresponding interest expense would need to align with the arm’s length standard.
- A REIT may earn certain income from ownership of timber resources, while income from the provision timber cutting services would need to be performed by a TRS, at arm’s length.
Transfer Pricing Reports
By preparing and maintaining current transfer pricing reports, a REIT can document the analysis and evidence that its related party transactions are reflective of true income, thus aligned with the arm’s length standard.
For investors considering the benefits and requirements of electing REIT status, Weaver professionals are knowledgeable about the structuring and compliance complexities of I.R.C. §856, §857, §858, and §859. Contact us for assistance with issues related to establishing arm’s length transfer pricing for related party transactions.