(A) A person who does not own, directly or indirectly, more than 35 percent of the shares, or certificates of beneficial interest, in the real estate investment trust, or

(B) A person, if a corporation, not more than 35 percent of the total combined voting power of whose stock (or 35 percent of the total shares of all classes of whose stock), or, if not a corporation, not more than 35 percent of the interest in whose assets or net profits is owned, directly or indirectly, by one or more persons owning 35 percent or more of the shares or certificates of beneficial interest in the trust.

For purposes of paragraphs (2) and (3), the rules prescribed by section 318 (a) for determining the ownership of stock shall apply in determining the ownership of stock, assets, or net profits of any person; except that "10 percent" shall be substituted for "50 percent" in subparagraph (C) of sections 318(a) (2) and 318(a)(3).

[Sec. 856 as added by sec. 10(a), Act of Sept. 14, 1960 (Pub. Law 86-779, 74 Stat. 1004); amended by sec. 4, Act of Aug. 31, 1964 (Pub. Law 88-554, 78 Stat. 762)]

[T.D. 6598, 27 F.R. 4081, Apr. 28, 1962, as amended by T.D. 6969, 33 F.R. 12000, Aug. 23, 1968]

§ 1.856-1

Definition of real estate investment trust.

(a) In general. The term "real estate investment trust" means an unincorporated trust or unincorporated association which (1) meets the status conditions in section 856 (a) and paragraph (b) of this section, and (2) satisfies the gross income and asset diversification requirements under the limitations of section 856 (c) and § 1.856-2.

(b) Qualifying conditions. To qualify as a "real estate investment trust”, an unincorporated organization must be

one

(1) Which is managed by one or more trustees,

(2) The beneficial ownership of which is evidenced by transferable shares or by transferable certificates of beneficial interest,

(3) Which would be taxable as a domestic corporation but for the provisions of part II, subchapter M, chapter 1 of the Code,

(4) Which does not hold any property primarily for sale to customers in the ordinary course of its trade or business, (5) The beneficial ownership of which is held by 100 or more persons, and

(6) Which would not be a personal holding company (as defined in section

542) if all of its gross income constituted personal holding company income (as defined in section 543).

(c) Determination of status. The conditions described in subparagraphs (1) through (4) of paragraph (b) of this section must be met during the entire taxable year and the condition described in subparagraph (5) of paragraph (b) of this section must exist during at least 335 days of a taxable year of 12 months or during a proportionate part of a taxable year of less than 12 months. The days during which the latter condition must exist need not be consecutive. In determining the minimum number of days during which the condition described in paragraph (b)(5) of this section is required to exist in a taxable year of less than 12 months, fractional days shall be disregarded. For example, in a taxable year of 310 days, the actual number of days prescribed would be 284383 days (310365 of 335). The fractional day is disregarded so that the required condition in such taxable year need exist for only 284 days.

(d) Rules applicable to status requirements. For purposes of determining whether an unincorporated organization meets the conditions and requirements in section 856(a), the following rules shall apply.

(1) Trustee. The term "trustee" means a person who holds legal title to the property of the real estate investment trust, and has such rights and powers as will meet the requirement of "centralization of management" under paragraph (c) of § 301.7701-2 of this chapter (Regulations on Procedure and Administration). Thus, the trustee must have continuing exclusive authority over the management of the trust, the conduct of its affairs, and (except as limited by section 856 (d) (3) and § 1.856-4) the management and disposition of the trust property. For example, such authority will be considered to exist even though the trust instrument grants to the shareholders any or all of the following rights and powers: To elect or remove trustees; to terminate the trust; and to ratify amendments to the trust instrument proposed by the trustee. The existence of a mere fiduciary relationship does not, in itself, make one a trustee for purposes of section 856(a)(1). The trustee will be considered to hold legal title to the property of the trust, for purposes of this subparagraph,

whether the title is held in the name of the trust itself, in the name of one or more of the trustees, or in the name of a nominee for the exclusive benefit of the trust.

Beneficial

(2) Beneficial ownership. ownership shall be evidenced by transferable shares, or by transferable certificates of beneficial interest, and (subject to the provisions of paragraph (c) of this section) must be held by 100 or more persons, determined without reference to any rules of attribution. Provisions in the trust instrument which permit the trustee to redeem shares or to refuse to transfer shares in any case where the trustee, in good faith, believes that a failure to redeem shares or that a transfer of shares would result in the loss of status as a real estate investment trust will not render the shares "nontransferable." For purposes of the regulations under part II of subchapter M, the terms "stockholder," "stockholders," "shareholder," and "shareholders" include holders of beneficial interest in a real estate investment trust and the terms "stock," "shares," and "shares of stock" include certificates of beneficial interest.

(3) Unincorporated organization taxable as a domestic corporation. The determination of whether an unincorporated organization would be taxable as a domestic corporation, in the absence of the provisions of part II of subchapter M, shall be made in accordance with the provisions of section 7701 (a) (3) and (4) and the regulations thereunder and for such purposes an otherwise qualified real estate investment trust is deemed to satisfy the "objective to carry on business" requirement of paragraph (a) of § 301.7701-2 of this chapter (Regulations on Procedure and

Administration).

(4) Property held for sale to customers. A real estate investment trust may not hold any property primarily for sale to customers in the ordinary course of its trade or business. Whether property is held for sale to customers in the ordinary course of the trade or business of a real estate investment trust depends upon the facts and circumstances in each case.

(5) Personal holding company. An unincorporated organization, even though it may otherwise meet the re

quirements of part II of subchapter M, will not be a real estate investment trust if, by considering all of its gross income as personal holding company income under section 543, it would be a personal holding company as defined in section 542. Thus, if at any time during the last half of the trust's taxable year more than 50 percent in value of its outstanding stock is owned (directly or indirectly under the provisions of section 544) by or for not more than 5 individuals, the stock ownership requirement in section 542(a) (2) will be met and the trust would be a personal holding company. See § 1.857-6, relating to record requirements for purposes of determining whether the trust is a personal holding company.

(e) Other rules applicable. To the extent that other provisions of chapter 1 of the Code are not inconsistent with those under part II of subchapter M thereof and the regulations thereunder, such provisions will apply with respect to both the real estate investment trust and its shareholders in the same manner that they would apply to any other unincorporated trust which would be taxable as a domestic corporation. For example:

(1) Taxable income of a real estate investment trust is computed in the same manner as that of a domestic corporation;

(2) Section 301, relating to distributions of property, applies to distributions by a real estate investment trust in the same manner as it would apply to a domestic corporation;

(3) Sections 302, 303, 304, and 331 are applicable in determining whether distributions by a real estate investment trust are to be treated as in exchange for stock;

(4) Section 305 applies to distributions by a real estate investment trust of its own stock;

(5) Section 311 applies to distributions by a real estate investment trust;

(6) Except as provided in section 857 (d), earnings and profits of a real estate investment trust are computed in the same manner as in the case of a domestic corporation;

(7) Section 316, relating to the definition of a dividend, applies to distributions by a real estate investment trust; and

(8) Section 341, relating to collapsible corporations, applies to gain on the sale or exchange of, or a distribution which is in exchange for, stock in a real estate investment trust in the same manner that it would apply to a domestic corporation.

[T.D. 6598, 27 F.R. 4082, Apr. 28, 1962, as amended by T.D. 6928, 32 F.R. 13221, Sept. 19, 1967]

§ 1.856-2 Limitations.

(a) Effective date. The provisions of part II, subchapter M, chapter 1 of the Code, and the regulations thereunder apply only to taxable years of a real estate investment trust beginning after December 31, 1960.

(b) Election. Under the provisions of section 856(c) (1), a trust, even though it satisfies the other requirements of part II of subchapter M for the taxable year, will not be considered a "real estate investment trust" for such year, within the meaning of such part II, unless it elects to be a real estate investment trust for such taxable year, or has made such an election for a previous taxable year which began after December 31, 1960. The election shall be made by the trust by computing taxable income as a real estate investment trust in its return for the first taxable year for which it desires the election to apply, even though it may have otherwise qualified as a real estate investment trust for a prior year. No other method of making such election is permitted. An election once made is irrevocable for such taxable year and all succeeding taxable years.

(b) Interest on obligations secured by mortgages on real property;

(c) Gain from the sale or other disposition of real property and interests in mortgages on real property;

(d) Dividends or other distributions on, and gain from the sale or other disposition of, transferable shares in another qualified real estate investment trust which is so qualified for its taxable year to which the dividends or other distributions relate or during which the gain was realized; and

(e) Abatements and refunds of taxes on real property; and

(iii) Less than 30 percent of its gross income is derived from the sale or other disposition of—

(a) Stock or securities held for less than 6 months; and

(b) Real property, not compulsorily or involuntarily converted within the meaning of section 1033, held for less than 4 years.

All three of the gross income requirements in section 856 (c) and this subparagraph must be met for the taxable year. Thus, at least 75 percent of gross income must be derived from the sources described in section 856 (c) (3) and another 15 percent of gross income must likewise be derived from such sources or from the sources described in section 856(c) (2), or from a combination of such sources. A maximum of 10 percent of gross income is not restricted as to source.

(2) In determining whether the gross income of a real estate investment trust satisfies the percentage requirements in section 856(c) and subparagraph (1) of this paragraph, the term "gross income" has the same meaning as that term has under section 61 and the regulations thereunder for purposes of the denominator in the computation of the specified percentages, but for purposes of the various numerators in such computations the following rules shall apply:

(i) Dividends. The 90-percent requirement in section 856(c) (2) (A) permits the inclusion of dividends generally while the 75-percent requirement in section 856(c) (3) (D) includes dividends only to the extent that they represent dividends or other distributions on transferable shares in other qualified real estate investment trusts.

(ii) Interest. In computing the percentage requirements in section 856(c)

(2)(B) and (3) (B) there shall be included as interest only the amount which constitutes lawful interest for the loan or forbearance of money. Thus, for example, usurious or illegal interest, or fees imposed upon borrowers which are in fact a charge for services in addition to the charge for the use of borrowed money, shall not be included as interest. To the extent limited by this subdivision, the 90percent requirement in section 856(c) (2) (B) permits the inclusion of interest generally, while the 75-percent requirement in section 856 (c) (3) (B) includes interest only to the extent that it relates to obligations secured by mortgages on real property. Where a mortgage covers both real and other property an apportionment of the interest income must be made for purposes of the 75-percent requirement.

(iii) Rents from real property. See § 1.856-4 for the definition of rents from real property.

(iv) Gain from sale or other disposition of property. The 90-percent requirement in section 856(c) (2) (D) permits the inclusion of net gain from the sale or other disposition of stock, securities, and real property, while the 75percent requirement in section 856(c) (3) (C) limits the includible amount to the net gain from the sale or other disposition of only real property and transferable shares in other qualified real estate investment trusts.

(v) Gross income from sale or other disposition of property. For purposes of the 30-percent limitation in section 856 (c) (4), a loss from the sale or other disposition of the property described in such section is not netted with gain from the sale or other disposition of such property. A determination of the period for which such property has been held shall be governed by the provisions of section 1223 and the regulations thereunder.

(d) Diversification of investment requirements-(1) 75-percent test. Section 856 (c) (5) (A) requires that at the close of each quarter of the taxable year at least 75 percent of the value of the total assets of the trust be represented by one or more of the following: (i) Real estate assets;

(ii) Government securities; and (iii) Cash and cash items (including receivables).

For purposes of this subparagraph the term "receivables" means only those re

ceivables which arise in the ordinary course of the trust's operation and does not include receivables purchased from another person. Subject to the limitations in section 856 (c) (5) (B) and subparagraph (2) of this paragraph, the character of the remaining 25 percent (or less) of the value of the total assets is not restricted.

(2) Limitations on certain securities. Under section 856 (c) (5) (B), not more than 25 percent of the value of the total assets of the trust may be represented by securities other than those described in section 856(c) (5) (A). The ownership of securities under the 25-percent limitation in section 856 (c) (5) (B) is further limited in respect of any one issuer to an amount not greater in value than 5 percent of the value of the total assets of the trust and to not more than 10 percent of the outstanding voting securities of such issuer. Thus, if the real estate investment trust meets the 75-percent asset diversification requirement in section 856 (c) (5) (A), it will also meet the first test under section 856(c) (5) (B) since it will, of necessity, have not more than 25 percent of its total assets represented by securities other than those described in section 856 (c) (5) (A). However, the trust must also meet two additional tests under section 856 (c) (5) (B), i.e. it cannot own the securities of any one issuer in an amount (i) greater in value than 5 percent of the value of the trust's total assets, or (ii) representing more than 10 percent of the outstanding voting securities of such issuer.

(3) Determination of investment status. The term "total assets" means the gross assets of the trust determined in accordance with generally accepted accounting principles. In order to determine the effect, if any, which an acquisition of any security or other property may have with respect to the status of a trust as a real estate investment trust, section 856(c) (5) requires a revaluation of the trust's assets at the end of the quarter in which such acquisition was made. A revaluation of assets is not required at the end of any quarter during which there has been no acquisition of a security or other property since the mere change in market value of property held by the trust does not, of itself, affect the status of the trust as a real estate investment trust. A change in the nature of "cash items", for example, the prepay

66-054-72

ment of insurance or taxes, does not constitute the acquisition of "other property" for purposes of this subparagraph. A real estate investment trust shall keep sufficient records as to investments so as to be able to show that it has complied with the provisions of section 856 (c) (5) during the taxable year. Such records shall be kept at all times available for inspection by any internal revenue officer or employee and shall be retained so long as the contents thereof may become material in the administration of any internal revenue

Trust G meets the 75-percent requirement of section 856 (c) (5) (A), but does not meet the requirements of section 856(c) (5) (B) because its investment in the voting securities of Corporation M exceeds 10 percent of Corporation M's outstanding voting securities.

Example (4). Real Estate Investment Trust R, at the close of the first quarter of its taxable year (i.e. calendar year), is a qualified real estate investment trust and has its assets invested as follows:

Percent

Receivables___.

4,000

6

Real estate assets..

68,000

7

Securities of Corporation P..

4,000

63

Securities of Corporation O.

5,000

Securities of Corporation U.

5,000

Securities of Corporation T.

5,000

Securities of various corporations (not exceeding, with respect to any one issuer, 5 percent of the value of the total assets of the trust nor 10 percent of the outstanding voting securities of such issuer).

24

During the second calendar quarter the stock in Corporation P increases in value to $50,000 while the value of the remaining assets has not changed. If Real Estate Investment Trust R has made no acquisition of stock or other property during such second quarter it will not lose its status as a real estate investment trust merely by reason of the appreciation in the value of P's stock. If, during the third quarter, Trust R acquires stock of Corporation S worth $2,000, such acquisition will necessitate a revaluation of all of the assets of Trust R as follows:

Percent

6

7

63

Trust P meets the requirement of section 856 (c) (5) (A) since at least 75 percent of the value of the total assets is represented by cash, Government securities, and real estate assets. However, Trust P does not meet the diversification requirements of section 856 (c) (5) (B) because its investment in the voting securities of Corporation Z exceeds 5 percent of the value of the trust's total assets.

Example (3). Real Estate Investment Trust G, at the close of the first quarter of its taxable year, has its assets invested as follows:

Securities in Corporation P-Securities in Corporation O-. Securities in Corporation U.. Securities in Corporation T.. Securities in Corporation S.

Total assets..

$3,000

4,000

4,000

68,000

50,000

5,000

5,000

5,000

2,000

146,000

Because of the discrepancy between the value of its various investments and the 25-percent limitation in section 856(c) (5), resulting in part from the acquisition of the stock of Corporation S, Trust R, at the end of the third quarter, loses its status as a real estate investment trust. However, if Trust R, within 30 days after the close of such quarter,