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REITS Catch a Break From Congress

REIT managers' jobs will get a little bit easier thanks to provisions that were tacked onto the American Jobs Creation Act of 2004 that both the House and Senate passed last week. Most significantly, REITs will be able to avoid the fate that almost befell Pennsylvania REIT earlier this year when the mall owner nearly forfeited its REIT status due to a minor accounting mistake.

Other provisions in the REIT Improvement Act drop tax restrictions on foreign investment in REITs and reduce the depreciation period on leasehold improvements from 39.5 years to 15 years. Stephen Renna, senior vice president and counsel for The Real Estate Roundtable says President Bush could sign the bill into law as early as Friday, although others thought he might wait until after the election.

The bill clarifies disputed portions of the law brought to light in the five years since Congress passed the REIT Modernization Act. Specifically, the law mandates that REITs can not own more than 10 percent of the securities of a company that is not a taxable REIT subsidiary. In February, PREIT was in jeopardy of losing its REIT status when it discovered that it did not treat a corporation, in which it has had a 50 percent interest since October 2001, as a taxable REIT subsidiary. The company was forced to cancel a planned secondary offering. The Internal Revenue Service eventually ruled that PREIT could retain its REIT status. Losing REIT status would have forced the company to pay back taxes on its income for the past three years.

"Under the current law, there's a disproportionate and draconian result from an innocent mistake," says Tony Edwards, senior vice president and general counsel for the National Association of Real Estate Investment Trusts. "What this bill would do instead is substitute penalties in many cases."

Under the new rules, REITs that make similar errors will be subject to $50,000 fines, but the mistake will not jeopardize their status.

The leasehold provision adjustment is also significant. Now it takes nearly 40 years to depreciate the amount spent on leasehold improvements even though most tenants' terms are much shorter than that.

"It brings the tax treatment more closely in line with the economic life of the asset," Renna said. "Under the old law, an owner would have 39 years to recoup the cost, whereas the lease may last only three-to-seven years. It doesn't seem fair to the owner."

The Real Estate Roundtable estimates the legislation would save property owners $1.5 billion in taxes next year. But the provision would only be effective for 2006. The lobbying group plans to push for an extension.

"What this has done is that Congress has made a statement by enacting into law what the proper depreciation should be for leasehold improvements," Renna says.

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