SECTION 2. BACKGROUND

.01 Many REITs invest in real estate by making loans that are secured by real property. In certain cases because of financing arrangements and restrictive loan covenants, REITs make loans to the owners of entities that hold real property instead of making loans that are secured directly by real property. These loans are secured by a pledge of the borrowers' ownership interests in the property-owning entities.

.02 Section 856(a) provides that an entity shall not be considered a REIT for any taxable year unless certain requirements are satisfied. One requirement is a test contained in § 856(c)(4)(A) that provides that at the close of each quarter of its taxable year, at least 75 percent of the value of a REIT's total assets must be represented by

real estate assets, cash and cash items (including receivables), and government securities.

.03 Section 856(c)(5)(B) provides that the term “real estate assets” means real property (including interests in real property and interests in mortgages on real property) and shares (or transferable certificates of beneficial interest) in other REITs that meet the requirements of §§ 856 through 859. Section 1.856–3(d) of the Income Tax Regulations provides that the term “real property” means land or improvements thereon, such as buildings and that the term “real property” includes interests in real property. Section 1.856–3(d) further provides that local law definitions will not be controlling for purposes of determining the meaning of the term “real property” as used in § 856 and the regulations thereunder.

.04 Section 856(c)(3)(B) provides that at least 75 percent of a REIT's gross income must be derived from certain items, including interest on obligations secured by mortgages on real property or on interests in real property.

.05 Section 1.856–5(c)(1) provides that if a mortgage covers both real property and other property, an apportionment of the interest income must be made for purposes of the 75-percent requirement of § 856(c)(3). Section 1.856–5(c)(1)(i) provides that if the loan value of the real property is equal to or exceeds the amount of the loan, the entire interest income shall be apportioned to the real property. Section 1.856–5(c)(2) provides that the loan value of the real property is the fair market value of the property, determined on the date the commitment by the trust to make the loan becomes binding on the trust.

.06 Under § 301.7701–3(b)(1)(ii) of the Procedure and Administration Regulations, certain entities (including limited liability companies) with a single member that do not elect to be treated as corporations will be disregarded as entities separate from their owners for federal tax purposes.

.07 Section 1.856–3(g) provides that in the case of a REIT that is a partner in a partnership, the REIT will be deemed to own its proportionate share of each of the assets of the partnership and will be deemed to be entitled to the income of the partnership attributable to such share. For purposes of § 856, the interest of a partner in

August 11, 2003 336 2003-32 I.R.B.

constitutes compensation for the use or forbearance of money, and, subject to the exception contained in § 1.856–5(d), the determination of the amount does not depend in whole or in part on the income or profits of any person.