What is a REIT?
REIT is an acronym that stands for Real Estate Investment Trust. As a legal entity, a REIT can be a corporation, a trust, or an association. Each year, the REIT must distribute, as dividends to its shareholders, 90% or more of the taxable income earned.
Many think that REIT’s are only part of huge Wall Street operations. It is true that there are very substantial REIT’s in America that manage billions of dollars in real estate. While there are very specific compliance requirements that cover operations, organizational structure, and dividend distributions, there is no specific minimum or maximum limit for the financial size of a REIT. A REIT can own thousands of properties or only own a single property.
The usefulness of a REIT is, as a proper legal entity for raising capital to acquire real estate, which is partially owned by many investors. One of the popular uses of a REIT is to own income-producing commercial properties, such as office buildings, shopping malls, restaurant chains, or hotels.
A REIT can be privately owned and supported by accredited investors. When it meets the qualifications necessary, a REIT can enjoy an Initial Public Offering (IPO) to sell stock to the public.
Here are the steps to form a REIT:
1. Create a real estate partnership agreement, which states the ownership percentage, management responsibilities, and investment contribution of each partner. A REIT needs to have a minimum of one hundred investors, but can start out as a management company with fewer investors in the beginning, and then convert to a REIT later.
2. Incorporate in the state where the company will own real estate. To qualify as a REIT the company must have 75% of its assets invested in real estate and receive 95% of its income from those investments.
3. Create a written prospectus to use as an offering document to raise capital from investors. Some states require written notification and filing of the prospectus with the state authorities, before using it to raise investment money from residents in that state. This is commonly called the “blue sky” law.
4. Market the offering to qualified investors.
5. Once the minimum of one hundred investors is reached, amend the state incorporation documents to change the management company into a REIT. File form 1120 with the IRS.
After approval as a REIT, the REIT will not pay any income tax, as long as 90%+ of its taxable annual income is paid out as dividends, which are paid directly to its owners.
Summary
A REIT structure is advantageous for its tax benefits and the ability to use it to raise capital to acquire real estate. Be sure to use a competent accountant for bookkeeping and tax filings, as well as a qualified real estate attorney to prepare legal documentation. Create the REIT correctly and manage it properly to make sure the activities comply with all the rules and regulations of the IRS and state security laws.