SECTION 2. BACKGROUND

.01 To qualify as a REIT for a taxable year, at least 95 percent of an entity’s gross income must be derived from the types of qualifying income listed in section 856(c)(2) of the Internal Revenue Code, and at least 75 percent of its gross income must be derived from the types of qualifying income listed in section 856(c)(3). Specifically, all interest is qualifying income for the 95 percent income test under section 856(c)(2); and interest on obligations secured by mortgages on real property or on interests in real property is qualifying income for purposes of the 75 percent income test under section 856(c)(3).

.02 Section 856(c)(4)(A) 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 Under section 856(c)(5)(B), the term “real estate assets” includes 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.

.04 Section 856(c)(5)(C) provides that the term “interests in real property” includes fee ownership and co-ownership of land or improvements thereon, leaseholds of land or improvements thereon, options to acquire land or improvements thereon, and options to acquire leaseholds of land or improvements thereon, but does not include mineral, oil, or gas royalty interests.

.05 If a mortgage loan is secured by both real property and other property, then, for purposes of section 856(c)(3), § 1.856–5(c) of the Income Tax Regulations provides rules for apportioning the interest on the loan between interest on an obligation that is secured by real property (or by an interest in real property) and interest on an obligation that is not so secured. Under this apportionment test, the “loan value of the real property” is compared to the “amount of the loan.” If the loan value of the real property is equal to or exceeds the amount of the loan, then all of the interest income from the loan is apportioned to the real property. If the amount of the loan exceeds the loan value of the real property, the interest income apportioned to the real property is an amount equal to the interest income multiplied by a fraction the numerator of which is the loan value of the real property and the denominator of which is the amount of the loan. The interest income apportioned to the other property is the excess of the total interest income over the interest income apportioned to the real property.

.06 For purposes of the apportionment test, § 1.856–5(c)(2) generally defines the “loan value of the real property” that secures a loan as the fair market value of the real property, determined as of the date on which a commitment became binding on the REIT either to make the loan or to purchase the loan, as the case may be. Section 1.856–5(c)(3) defines the “amount of the loan” as the highest principal amount of the loan outstanding during the taxable year.

.07 Section 1.1001–3(c)(1)(i) defines a “modification” of a debt instrument as any alteration, including any deletion or addition, in whole or in part, of a legal right or obligation of the issuer or holder of the debt instrument, whether the alteration is evidenced by an express agreement (oral or written), conduct of the parties, or otherwise. Section 1.1001–3(e) governs which modifications of debt instruments are “significant.” Under § 1.1001–3(b), for most federal income tax purposes, a significant modification produces a deemed exchange of the original debt instrument for a new debt instrument.

.08 Section 1.860G–2(b)(1) concerns modifications of mortgages held by real estate mortgage investment conduits (REMICs). Certain loan modifi

2011–5 I.R.B. 440 January 31, 2011

that there is a significant risk of default even if the loan is performing, and

(b) Based on all the facts and circumstances, the REIT or servicer reasonably believes that the modified loan presents a substantially reduced risk of default, as compared with the pre-modified loan.

.02 Section 4.02 of this revenue procedure applies to any corporation that has elected to be taxed as a REIT.