Group Asks IRS to Add REIT Guidance to 2005-2006 Guidance Plan

Dear Sir or Madam:

The National Association of Real Estate Investment Trusts® (NAREIT) greatly appreciates the opportunity pursuant to Notice 2005-25, to offer our suggestions regarding regulatory guidance to be placed on the 2005-06 Priority Guidance Plan that would carry out Congressional intent while saving both taxpayers and the Administration time and resources in complying with the real estate investment trust (REIT) tax tests.

NAREIT respectfully requests that the government issue guidance regarding: 1) foreign currency issues in applying the REIT gross income and asset tests for REITs that engage in real estate activities outside the United States; and, 2) guidance to clarify that a REIT is not a "pass-thru entity" with the context of section 168(h)(6)(E) to prevent the unintended application of the loss limitation rules of new section 470 to REITs with tax-exempt or foreign shareholders.

Foreign Currency Guidance

NAREIT has submitted prior requests for guidance concerning foreign currency issues to be placed on the Priority Guidance Plan, and NAREIT very much appreciates that the 2004-2005 Priority Guidance Plan issued July 26, 2004 and re-issued on December 21, 2004 included an item concerning this issue.

Specifically, on April 12, 2004, we submitted two draft revenue procedures concerning this issue. After meeting with you during 2004, we also submitted a letter on December 15, 2004 that provided additional authority to support the exercise of regulatory authority in this context.

Of particular concern is the application of the income test and the asset test to what are fundamental REIT transactions. For example, if a REIT (through a qualified business unit) manages rental property overseas, there is no clear guidance on how a REIT should the REIT apply the income test to rental income that is denominated in a foreign currency or how a REIT should apply the income test when it receives payments of principal and interest on a mortgage note secured by overseas real estate assets when the payment is denominated in a non-functional currency. Similarly, there is no clear guidance on how a REIT determines its compliance with the asset test with respect to assets that are denominated in a foreign currency.

Our earlier submissions set forth in detail our proposals regarding guidance in these contexts. NAREIT continues to believe that the government has the regulatory authority to provide guidance in this area, as shown by the many citations in analogous areas in our letter dated December 15, 2004. We would happy to discuss our proposals in more detail if appropriate.

Section 470¹and REITs

By way of background, new section 470 was enacted as part of the American Jobs Creation Act of 2004² (the Act). It limits the deductions allocable to property used by governmental or other tax-exempt entities. Section 470 prohibits a taxpayer from claiming a deduction in excess of the taxpayer's gross income with respect to the lease of "tax-exempt use property."³ The term "tax-exempt use property" is defined by reference to section 168(h), which includes: i) tangible property leased to tax-exempt entities;⁴ and, ii) any property owned by a pass-thru entity with a tax-exempt entity as an owner if the pass-thru entity's allocation of items to the tax-exempt does not constitute a qualified allocation.⁵ Thus, under section 168(h) and, in turn, section 470, tax-exempt use property includes not only real property leased to tax-exempt entities but also all other real property, regardless of its use, owned by a pass-thru entity with a tax-exempt or foreign owner.⁶ The term "pass-thru entity" is not defined. Section 470 applies to leases entered into after March 12, 2004.

On February 25, 2005, NAREIT submitted a letter to the IRS and Treasury Department requesting that you issue appropriate guidance to clarify that, for purposes of section 470, a REIT is not a pass-thru entity within the context of section 168(h)(6)(E). Such guidance is necessary to avoid the unintended application of the loss limitation rules of section 470 to REITs with tax-exempt or foreign shareholders. We respectfully request that the IRS and Treasury Department add an item on the 2005-2006 Priority Guidance Plan concerning the application of section 470 to REITs.

In the contexts of both the treatment of foreign currency gains and the interpretation of "pass-thru entity" under section 470, the recommended guidance would resolve significant issues relevant to many taxpayers, promote sound tax administration, could be drafted in an easily understandable manner, could be administered uniformly, and would reduce controversy and lessen the burden on taxpayers and the IRS.

NAREIT would welcome the opportunity to discuss these issues with you in more detail. Please contact me at (202) 739-9408 or Dara Bernstein at (202) 739-9446 to arrange a meeting or telephone conference. Thank you in advance.

² Pub. L. No. 108-357, § 848.

³ I.R.C. § 470(a).

⁴Id. § 168(h)(1).

⁵Id. §§ 168(h)(6)(A), (E).

⁶Id. § 168(h)(6)(A).