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In giving relief to security investment trusts, the conduit theory was further applied by recognizing that to a certain extent the distributions retained the same character in the hands of the shareholders as they did when received by the trusts. For example, in the case of the provisions with regard to security investment trusts, under section 362 (b) (7) of the code such trusts are permitted to distribute capital gains received and the shareholders in turn are permitted to treat such distributions as long term capital gains in their individual income tax returns.

Since the conduit theory has been applied to security investment trusts so as to grant relief from corporate tax on the interest, dividends and gains received by them and distributed to their shareholders, the real estate investment trusts should be exempted from corporate tax on the rents as well as interest, dividends and gains received by them and distributed to their beneficiaries.

4. Rental real estate and real estate mortgages are as much investments as are stocks and bonds

The investments of regulated investment companies under section 362 are confined to stocks and bonds. The investments of real estate trusts are confined largely to rental real estate or interests in real estate, including real estate mortgages, and shares of real estate trusts or real estate associations. From time to time available funds of real estate trusts are also invested in stocks and bonds, and certainly at least the dividends and interest on such investments should be exempt from corporate tax, the same as similar income of stock investment companies.

Rental real estate and real estate mortgages have for generations been recognized as investments. Individuals, as well as trustees under wills and trustees under inter vivos trusts, have long recognized real estate as a sound investment. As has been stated above, interest is received for the use of money. On the other hand, rent is received for the use of property. In either instance the income is distributed by the trust to its beneficiaries.

Accordingly, the rent received by a real estate investment trust should be relieved from the corporate tax, just as much as interest received by a security investment trust is relieved from the corporate tax.

5. Real estate trusts and security investment trusts were both formed to provide centralized management, diversification of investments and minimizing of risks

Both real estate trusts and security investment trusts were formed to provide centralized management, diversification of investment, and the minimizing of risk. Real estate trusts are analogous to stock investment trusts in that the purpose of each is to provide competent centralized management of investments. The average small investor is unable to give the time and attention to the management of such investments. When the investment is with respect to an interest in real estate, such management is most essential. It is also essential in connection with selecting the real estate to be invested in. Although some real estate trusts have an investment in only one property, many real estate trusts have investments in several properties. From time to time these properties may be sold and the proceeds reinvested in other properties.

Just as with investments in stocks and bonds, diversification is desirable in real estate investments. This diversification has been achieved by setting up real estate trusts, so that no one investor would have too large a percentage of his investments in any one property, and could invest in a real estate trust owning several properties, or in several trusts owning single properties. In this respect the real estate trusts are analogous to the stock investment trusts. Additional diversification is obtained in that a multiple building has numerous tenants engaged in different businesses. When one business is off the others may be good and thus the risk is minimized.

Historically, real estate trusts were formed as the result of two different types of situations, but both had the fundamental purposes of providing centralized management, diversification, and minimizing of risks.

First, are the real estate trusts which were set up in order to enable investors to pool their funds and acquire and build real estate developments, office buildings, individual stores, or blocks of stores, apartments, etc., in major cities. Many of the real estate trusts which were set up in the eastern seaboard in the early days were partly responsible for the development of the major cities in the West such as Chicago, St. Paul, Minneapolis, Seattle, etc. Small investors thus pooled their resources, contributed them into a real estate trust, and the trustees then proceeded to carry out the investment of these funds in real estate.

In many cases these investors were trustees of individual testamentary or inter vivos trusts who desired to invest part of their trust funds in real estate. Since they did not want to put too large an amount of their trust funds in any one property, they participated in the formation of real estate investment trusts in order to obtain diversification and minimize the risks.

A second cause of the formation of real estate trusts arose from situations where a long-term testamentary or inter vivos trust terminated and the many remaindermen involved suddenly found themselves as tenants in common with an undivided interest in certain real-estate properties. It was wholly impractical for such individuals to join together in signing leases or deeds or managing these properties. In many instances the remaindermen were minors and it was necessary to get guardians appointed for them. As a means of securing centralized management of these properties, all of the individuals involved got together and formed a real estate trust. They designated one or more trustees who would manage the properties, collect the rents, pay the expenses, and distribute the net income to the beneficiaries. In some instances the beneficiaries held no actual certificates but had merely a pecentage beneficial interest. other cases certificates of beneficial interest were distributed which facilitated the transfer of such certificates to members of the family either during their lifetime or upon their death.

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In both of the foregoing types of situations in which real estate trusts were formed, the same principles of centralized management, diversification of investment, and minimizing of risks in real estate investments prevailed, as is the case with security investment trusts.

6. Present law favors the large real-estate investor as opposed to the small investor

Since rental real estate is just as much an investment as stocks and bonds, there is no reason why the small investor who wishes to put part of his funds into real estate should not have the privilege of pooling his funds with others similarly situated in a real-estate investment trust and not suffer the burdens of the corporate tax.

Under present law, a wealthy investor can purchase a building individually without the imposition of a corporate tax. If a group of small investors pool their funds and form a real-estate investment trust and buy the same building, they are penalized by the corporate tax. For example, if the building shows a 6-percent net return on the investment to the wealthy investor, the individuals who pool their funds, form a real-estate investment trust, and buy the same building are penalized by a 50-percent Federal tax and thus secure only a maximum return of 3 percent by way of distributions from the real-estate investment trust.

The small investor who wishes to put part of his assets into real estate cannot obtain an interest in a large office building or other large property without pooling his investment with others similarly situated. This privilege has been granted to small investors in security investment trusts and should be granted to the small investors in real-estate investment trusts.

7. The holding and renting of real estate as an investment is clearly distinguishable from ordinary business operations

Rental real estate held for investment, by its very nature, requires management, such as the making of leases, collecting rents, making repairs, and servicing the property.

Individuals or groups owning rental real estate frequently employ a real-estate management firm or bank as agent or trustee to make leases, collect rents, make repairs, and service the property-in other words, to manage the real-estate investment.

An owner of a manufacturing or sales company, on the other hand, would not employ a management firm or bank to operate such a company because it is a business and not something held for investment.

Actually, the beneficiaries or shareholders of a real-estate trust have merely employed the trustees to manage their property, just as a single individual or a partnership would do. The underlying rental real estate is still an investment, just as the underlying securities of a security investment trust are investments. It is significant that in most instances, when a management firm manages rental real estate, the service employees, such as janitor, elevator operator, porters, and cleaners, are on the payroll of the management company and not on the payroll of the owner of the building. The owner merely has an

investment in rental real estate and employs a management firm as agents or trustees to manage the investment.

If an individual or joint owner of real estate can employ a real-estate management firm to manage his real-estate investments without being subjected to a corporate tax, certainly a group of investors in real estate should be permitted to form a real-estate investment trust and have trustees, or a management firm of trustees, manage the real-estate investment.

Such a situation is clearly distinguishable from that in which shareholders of a manufacturing or sales company invest in that business. There the operation is a business operation-manufacturing, buying, selling, etc.-which is clearly distinguishable from the management of an investment, such as securities or rental real estate.

8. The duties of management of trustees of real-estate trusts are substantially similar to duties of trustees of security investment trusts

SECURITIES TRUST

1. Purchase of securities.

2. Sale of securities.

3. Other management duties:

(a) Expert services and research organization to determine types of business and quality of management of businesses invested in.

(b) Collection of interest and dividends.

(c) Protection of securities, and regular followup of companies invested in, employment of field men to investigate and study operations of companies in which trust holds securities.

(d) Getting up and sending reports to shareholders.

(e) Payment of dividends. (f) Preparation of tax and other Government returns.

(g) Active sales organization for sales of shares of the trust itself.

9. Economic and fiscal effects of the bill

REAL-ESTATE TRUST

1. Purchase of real estate and securities.

2. Sale of real estate and securities. 3. Other management duties:

(a) Expert services and research organization to determine locations of real estate to invest in and type and quality of tenants.

(b) Collection of interest, dividends, and rent.

(c) Protection of real estate by proper insurance and maintenance, and regular followup of tenants' businesses and of rental values.

(d) Same to beneficiaries.

(e) Same to beneficiaries.
(f) Same.

(g) No comparable activity because corporate tax on real-estate trusts discourages investors.

Looking at the question from the broad overall economic point of view, Federal tax laws should encourage investment in real estate, the stimulation of new real estate developments, and the construction of buildings. Many eminent congressional leaders as well as economists and financial leaders have expressed_concern with respect to the difficulties of securing equity venture capital. The granting of relief to real estate trusts would stimulate such venture capital in a field which is most important to the welfare of the country. Only relatively few individuals can by themselves supply the large amount of capital required today to build an office building or an apartment house. However, if the corporate tax were eliminated on real estate trusts, thousands of small investors, each putting in a few hundred or a few thousand dollars, could pool their funds and thus supply the tremendous amounts of capital needed to build new buildings and apartments. The stimulation of activity in this field would be of great help to the economy of the country at this time.

The cost to the revenue, as the result of the adoption of the proposed act may be minor, and, in fact, may ultimately result in an increase rather than a decrease of the revenue. The bill would require that such real estate trusts distribute 90 percent of their net income to the beneficiaries or shareholders. In other words substantially all the tax saving to the trust-by elimination of the corporate tax-would have to be distributed to the shareholders and, in turn, be taxed to them. With individual tax rates as high as they are today the additional distributions which the trusts will be able to make will be subjected to high individual tax rates, which may well enhance the revenue.

When supplement Q was included in the law with respect to the taxation of security investment trusts, some concern was expressed by the Treasury representatives that the revenue might be adversely affected. It is now a matter of common knowledge that as a result of such beneficial tax legislation, the growth of security investment trusts has been enormous. Many people who never owned a share of stock before, have bought shares in security investment trusts with the result that the tremendous distributions by these trusts have swelled the national income and greatly enhanced the tax revenue The growth of real estate investment trusts is now impossible because of the impact of the Federal tax, just as the growth of security investment trusts was impeded by the corporate tax before they secured relief under supplement Q. It is to be anticipated that, if the relief is granted to real estate investment trusts as proposed in H. R. 5418, a comparable growth will be experienced in real estate trusts.

The Treasury Department and the Congress have, for many years, sought to encourage organizations to distribute substantially all their earnings to shareholders or beneficiaries so that the Treasury will obtain taxes at individual rates on such distributions. This was the purpose of the so-called 1936 undistributed-profits tax and also section 102 of the present Internal Revenue Code. A similar object was sought by the so-called 65-day rule applicable to distributions by trusts. Accordingly, the provision in the proposed act requiring real estate trusts to distribute 90 percent of their income to beneficiaries cr stockholders would carry out recognized objectives of the Treasury Department and the Congress.

CONCLUSION

In conclusion it is submitted that the proposed act should be enacted by the Congress and incorporated in H. R. 8300 for the following reasons:

1. It corrects an existing inequity in the revenue law with respect to the taxation of real estate investment trusts.

2. It taxes real estate investment trusts on substantially the same basis as security investment trusts.

3. It will enable small investors to invest in real estate and to get the benefit of experienced centralized management, diversification of investment, and minimizing of risks.

4. It will encourage equity investment in real estate and stimulate activity in the construction industry.

5. It will encourage the distribution of substantially all the income of real estate investment trusts to their beneficiaries.

6. It will not substantially reduce and may in fact increase the revenue. By increasing the income distributed by real estate investment trusts to their bene. ficiaries it would increase the income subject to taxation at individual tax rates.

ALLAN H. W. HIGGINS,
Attorney, Boston, Mass.

(NOTE. The following is a revision of H. R. 5418, containing conditions and safeguards which were not in the original bill.)

[H. R. 5418, 83d Cong., 1st sess.]

A BILL To amend the Internal Revenue Code to provide a special method of taxation for real estate investment trusts and real-estate investment associations with transferable shares or beneficial interests

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, That subchapter C of chapter 1 of the Internal Revenue Code is amended by adding at the end thereof the following new supplement:

"SUPPLEMENT V-TAXATION OF REAL ESTATE INVESTMENT TRUSTS AND REAL ESTATE INVESTMENT ASSOCIATIONS WITH TRANSFERABLE SHARES OR BENEFICIAL INTERESTS

"SEC. 426. DEFINITION.

"(a) IN GENERAL.-For the purposes of this supplement, the terms 'real estate investment trust with transferable shares' and 'real estate investment association with transferable shares' mean a nonincorporated trust or association managed by one or more trustees, the beneficial ownership of which is evidenced by transferable shares or certificates of beneficial interest, and which (except for this supplement) would be taxable as a corporation and the gross income of which

is principally derived from the ownership of real estate or interests in real estate, including real estate mortgages and shares of real estate trusts or real estate associations.

"(b) LIMITATIONS.-Notwithstanding the provisions of subsection (a), a real estate investment trust or real estate investment association shall not be taxed under this supplement for any taxable year unless

"(1) At least 90 per centum of its gross income is derived from dividends, interest (including interest on real estate mortgages), rents of real estate, gains from the sale or other disposition of stock or securities, or real estate, interests in real estate or real estate mortgages or abatements or refunds of local real estate taxes;

"(2) at least 60 per centum of its gross income is derived from rents of real estate, interest on real estate mortgages, gains from the sale or other disposition of real estate or interests in real estate or real estate mortgages, or from dividends or distributions on, or gains from the sale or other disposition of, shares or transferable interests in other real estate trusts or associations, or abatements or refunds of local real estate taxes;

"(3) less than 30 per centum of its gross income comprises net gain from the sale or other disposition of stock or securities held for less than six months; and

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(4) less than 30 per centum of its gross income comprises net gain from the voluntary sale or other disposition of real estate held for less than five years; and

"(5) it distributes to its shareholders or holders of beneficial interests not less than 90 per centum of its net income for the taxable year computed without regard to net long term and net short term gains. "(c) The term 'rents of real estate', as used in subsection (b) (1), shall not include amounts received or accrued by hotels, inns or lodging houses from guests, boarders or lodgers in consideration for the occupancy of furnished rooms or furnished apartments or for food, refreshments, or personal services rendered. "SEC. 427. TAX ON REAL ESTATE INVESTMENT TRUSTS AND REAL ESTATE INVESTMENT ASSOCIATIONS WITH TRANSFERABLE SHARES, AND ON CAPITAL GAIN DISTRIBUTIONS TO SHAREHOLDERS.

"(a) METHODS OF TAXATION OF REAL ESTATE INVESTMENT TRUSTS AND SHAREHOLDERS.-In the case of a real estate investment trust or real estate investment association with transferable shares:

"(1) Its supplement V net income shall be its adjusted net income (computed by excluding the excess, if any, of the net long term capital gain over the net short term capital loss) minus the basic surtax credit (excluding capital gain dividends) computed under section 27 (b) without the application of paragraphs (2) and (3). For the purposes of this paragraph the net income shall be computed without regard to section 47 (c).

"(2) Its supplement V surtax net income shall be its net income (computed by excluding the excess, if any, of the net long term capital gain over the net short term capital loss) minus the dividends (other than capital gain dividends) paid during the taxable year increased by the consent dividends credit provided by section 28. For the purposes of this paragraph and paragraph (5) of this subsection, the amount of the dividends paid credit shall be computed in the same manner as is provided in subsections (d), (e), (f), (g), (h), and (i) of section 27 for the purpose of the basic surtax credit provided in section 27. For the purposes of this paragraph the net income shall be computed without regard to section 47 (c).

"(3) There shall be levied, collected, and paid for each taxable year upon its supplement V net income a tax equal to 30 per centum of the amount thereof.

"(4) There shall be levied, collected, and paid for each taxable year upon its supplement V surtax net income a tax equal to 22 per centum of the amount thereof.

"(5) There shall be levied, collected, and paid for each taxable year a tax of 26 per centum of the excess, if any, of the net long term capital gain over the sum of the net short term capital loss and the amount of the capital gain dividends paid during the year.

45994-54-pt. 3-10

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