Mack Introduces REIT Modernization Bill

Cosponsors include Finance Committee members Bob Graham, R-Fla., Orrin G. Hatch, R-Utah, and 12 other Finance members of both parties.

The bill also modifies the treatment of health care facilities to ensure that patients' lives are not disrupted if a lease expires, and it restores the 90 percent distribution rules that had previously applied to REITs, Graham told the Senate. Ranking Finance Committee Democrat Daniel Patrick Moynihan of New York also addressed the Senate and spoke in support of the bill.

REAL ESTATE INVESTMENT TRUST MODERNIZATION ACT OF 1999

Mr. MACK. Mr. President, today Senator Bob Graham and I, along with 17 of our colleagues, are introducing legislation to modernize the tax rules that apply to real estate investment trusts ("REITs").

This legislation is designed to remove barriers in the tax laws that impose unnecessary administrative burdens and make it more difficult for REITs to compete in an evolving marketplace. Our bill is similar to a proposal included in the President's Fiscal Year 2000 budget that permits REITs to establish a new type of subsidiary called a "taxable REIT subsidiary" ("TRS"). As with the President's proposal, the legislation we introduce today would permit REITs to establish a TRS to provide non-customary services to their tenants and to provide services to third parties. In return for these new rules, the TRS would be subject to a number of rules designed to prevent any income from being shifted out of the taxable subsidiary to the REIT.

Congress created REITs in 1960 to enable small investors to invest in real estate. The REIT provisions were modeled after the rules that applied to mutual funds. If a number of requirements are met, a corporation electing to be a REIT may deduct all dividends paid to its shareholders. One of the major requirements for REIT status is that REITs must distribute virtually all of their taxable income to their shareholders. Thus, unlike other C corporations that tend to retain most of their earnings, the income tax burden for REITs is shifted to the shareholder level. Unlike partnerships, REITs cannot pass losses through to their investors.

REITs are subject to a number of rules to ensure their primary focus is real estate activities. For example, at least 75% of a REIT's assets must be comprised of rental real estate, mortgages, cash items and government securities. A REIT also must satisfy two income tests. First, at least 75% of a REIT's annual gross income must consist of real property rents, mortgage interest, gain from the sale of a real estate asset and certain other real estate-related sources. Second, at least 95% of a REIT's annual gross income must be derived from the income items from the above 75% test plus other "passive income" sources such as dividends and any type of interest. In addition, a REIT cannot own more than 10% of the voting securities of a non-REIT corporation, and the securities of a single non-REIT corporation cannot be worth more than 5% of the REIT's assets.

Although REITs were created in 1960, they did not really become a significant part of the real estate marketplace until the 1990s -- partly because the original legislation did not permit REITs to manage their own property. The Tax Reform Act of 1986 changed this, by permitting REITs to manage their own properties through the provision of "customary services" to tenants.

The market capitalization of REITs grew from about $13 billion at the end of 1991 to over $140 billion today. The taxes generated from REITs similarly have increased, with dividends from public REITs increasing from about $1 billion in 1991 to more than $8 billion today. While REITs remain a small portion of the entire real estate sector -- in the range of 10% nationally -- they account for as much as half of some sectors that require immense amounts of capital, such as shopping centers. While the REIT industry has come a long way in recent years, it continues to fulfill its original mission: permitting small investors access to attractive real estate investments. Almost 90% of REIT shareholders are individuals either investing directly or through mutual funds.

Although REITs have seen remarkable growth in the 1990s, their ability to meet new competitive pressures in the real estate sector is in question as a result of tax law limitations on their activities. These rules limit the ability of REITs to provide full services to their tenants and to third parties. In general, REITs may only provide services to their tenants which the IRS has determined to be "customary" in the business, meaning services already provided by the typical real estate company in the market. REITs may only provide real estate-related services to third parties through preferred stock subsidiaries which they can own but not control. REITs are thus prohibited from offering leading edge, full service options to their tenants and limited in the use of their expertise to serve third parties. This presents competitive problems for REITs as the real estate marketplace has evolved and property owners have sought to provide a range of services to their tenants and other customers.

As a result, REITs increasingly have been unable to compete with privately-held partnerships and other more exclusive forms of ownership. Today, the rules prevent REITs from offering the same types of customer services as their competitors, even as such services are becoming more central to marketing efforts. Examples abound: (1) offering concierge services to office and apartment tenants to pick up tickets or dry cleaning, to walk pets, etc.; (2) offering a branded credit card at shopping malls, with rebates to be used as store credits at stores in the mall; (3) high speed Internet hook-ups, including enhanced telecommunications services (e.g., creating and maintaining a website) offered by a landlord's partner; (4) partnering with an office supply provider to offer reduced prices on office supplies; and (5) pick-up and delivery services at self- storage rentals.

Without greater flexibility to provide competitive services to tenants and other customers, REITs will become less and less competitive with others in the real estate marketplace. REITs will have to wait for services to be deemed "customary." As a practical matter, that means a REIT must wait until the IRS concludes that almost everybody else has been providing the service. If a REIT is forced to lag the market, it can be neither competitive nor provide its investors with a satisfactory return on their investment. Certainly, this is not consistent with what Congress intended when it created REITs, and when it modified the REIT rules over the years. In keeping with the Congressional mandate to provide a sensible and effective way for the average investor to benefit from ownership of income-producing real estate, REITs should be able to provide a range of services through taxable subsidiaries.

The Administration's proposed Fiscal Year 2000 Budget acknowledges this problem. The Administration proposes modernizing REIT rules to permit REITs, on a limited basis, to use taxable subsidiaries to provide the services necessary to compete in the evolving real estate marketplace. The Administration proposal is a good start, but I believe additional refinements would further promote competitiveness. The legislation that we are introducing today builds upon the Administration proposal. Our bill addresses the appropriate needs of the REIT industry and its investors in a manner consistent with the underlying rationale for REITs and the requirements of the highly competitive, evolving real estate marketplace.

This legislation would give greater flexibility to REITs by permitting them to establish "taxable REIT subsidiaries" ("TRSs") that could provide non-customary services to tenants and services to third parties. The 5% and 10% asset tests would not apply to the TRS. REITs would continue to be subject to the 75% asset tests so the value of their TRS, together with the value of other non-real estate assets, could not exceed 25% of the total value of a REIT's assets. In addition, the REIT would have to continue to satisfy the 95% and 75% income tests, with dividends or interest from a TRS to a REIT counting towards the 95% test, but not the 75% test. Accordingly, at least 75% of a REIT's gross income would continue to consist of rents, mortgage interest, real estate capital gains and the other miscellaneous real estate-related items already listed in the Code. The income a TRS would receive from both third parties and REIT tenants would be fully subject to corporate tax.

To ensure that a TRS could not inappropriately reduce its corporate tax liability by shifting income to the REIT, the bill includes a number of stringent rules that limit the relationship between the REIT and the TRS. To prevent the TRS from making excessive intra-party interest payments to its affiliated REIT, the proposal contains two safeguards. One, it would apply the current anti-earnings stripping provisions of Code section 163(j) to payments between a REIT and its TRS. This would prevent the TRS from deducting intra-party interest beyond a modest amount regulated by objective criteria in the Code. Two, a 100% excise tax would be imposed on any interest payments by a TRS to its affiliated REIT to the extent the interest rate was above a commercially-reasonable rate.

Also, to be certain that a TRS could not reduce its tax obligations by deducting rents to its affiliated REIT, our legislation would retain the current rules under which any payments to a REIT by a related party would not be considered qualified rents for purposes of the REIT gross income tests. The only exception would be when a TRS rents less than 10% of a REIT-owned property and pays rents to the REIT comparable to the rents the REIT charges to its unrelated tenants at the same property. Under this exception, any rents paid to the REIT that turn out to be above comparable rents would be subject to a 100% excise tax.

Under our bill, a 100% excise tax is also imposed on any rents a REIT charges its tenants that are inflated to disguise charges for services rendered to the tenant by its affiliated TRS. Limited exceptions would be made when: (1) the TRS charges the same amounts for its services to both REIT tenants and third parties; (2) rents for comparable space are the same regardless of whether the TRS provides a service to the tenant; and (3) the TRS recognizes income for its services at least equal to 150% of its direct costs of providing the service to an affiliated REIT's tenants.

To discourage a REIT from allocating its expenses to its TRS (which would reduce the TRS's corporate tax obligation), the proposal would impose a 100% excise tax on any improper cost allocations between a REIT and its TRS. The Treasury Department would issue guidance on proper ways to allocate such costs.

Finally, the bill proposes to eliminate the use of preferred stock subsidiaries by REITs. These subsidiaries, which have been established pursuant to IRS letter rulings since 1988, allow a REIT to provide services to third parties. While the asset test rules prevent a REIT from owning more than 10% of the voting securities of these subsidiaries, they typically own more than 95% of the value of the subsidiary. We propose to eliminate these subsidiaries by prohibiting REITs from owning more than 10% of the vote or the value in another corporation other than a TRS. REITs would be given three years to convert, tax-free, their preferred stock subsidiaries to taxable REIT subsidiaries.

In addition, the bill includes some miscellaneous changes to the REIT rules that were under consideration when Congress approved a REIT simplification package a few years ago. The first provision deals with health care property. Under current law, a REIT can conduct a trade or business using property acquired through foreclosure for 90 days after it acquired such property, if it makes a "foreclosure property" election. After this period, the REIT can only conduct the trade or business through an independent contractor from whom the REIT does not derive any income. A health care REIT faces special challenges in using these rules when its lease of a nursing home or other health care property expires.

To remedy these challenges and to ensure that care to patients remains uninterrupted, the proposal would make two technical changes to the REIT foreclosure rules. First, the foreclosure property rules would be extended to include leases that terminate (they already apply to leases that are breached). Second, for purposes of the foreclosure rules, a health care provider would not be disqualified as an independent contractor solely because the REIT receives rental income from the provider with respect to one or more other properties. For this purpose, other rules would be made to ensure that the terms of leases of other properties could not be manipulated to circumvent this rule.

Another provision deals with the 95% distribution rule. From 1960 through 1980, REITs and mutual funds shared a requirement to distribute at least 90% of their taxable income. Since 1980, REITs have had to distribute 95% of their taxable income. The proposal would restore the 90% distribution requirement.

Mr. President, I believe this is a major improvement in the REIT rules that preserves the original intent of Congress when it first created REITs in 1960, while permitting the industry to adapt to a changing marketplace. Most importantly, these REIT modernization rules would not expand the activities that can be conducted within the REIT, they simply give the REIT greater flexibility to establish fully-taxable subsidiaries that will enable the REIT to better serve its customers.

This legislation is supported by the American Resort Development Association, the International Council of Shopping Centers, the National Apartment Association, the National Association of Real Estate Investment Trusts, the American Seniors Housing Association, the Mortgage Bankers Association of America, the National Association of Industrial and Office Properties, the National Association of Realtors, the National Multi Housing Council, and the National Realty Committee.

Mr. President, I ask unanimous consent that the text of the bill be printed in the Record.

There being no objection, the bill was ordered to be printed in the Record, as follows:

S. 1057

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE.

(a) Short Title. -- This Act may be cited as the "Real Estate Investment Trust Modernization Act of 1999".

(b) Amendment of 1986 Code. -- Except as otherwise expressly provided, whenever in this Act an amendment or repeal is expressed in terms of an amendment to, or repeal of, a section or other provision, the reference shall be considered to be made to a section or other provision of the Internal Revenue Code of 1986.

TITLE I -- TREATMENT OF INCOME AND SERVICES PROVIDED BY TAXABLE REIT SUBSIDIARIES

SEC. 101. MODIFICATIONS TO ASSET DIVERSIFICATION TEST.

Subparagraph (B) of section 856(c)(4) is amended to read as follows:

"(B)(i) not more than 25 percent of the value of its total assets is represented by securities (other than those includible under subparagraph (A)), and

"(ii) except with respect to a taxable REIT subsidiary and securities includible under subparagraph (A) --

"(I) not more than 5 percent of the value of its total assets is represented by securities of any 1 issuer,

"(II) the trust does not hold securities possessing more than 10 percent of the total voting power of the outstanding securities of any 1 issuer, and

"(III) the trust does not hold securities having a value of more than 10 percent of the total value of the outstanding securities of any 1 issuer."

SEC. 102. TREATMENT OF INCOME AND SERVICES PROVIDED BY TAXABLE REIT SUBSIDIARIES.

(a) Income From Taxable REIT Subsidiaries Not Treated as Impermissible Tenant Service Income. -- Clause (i) of section 856(d)(7)(C) (relating to exceptions to impermissible tenant service income) is amended by inserting "or through a taxable REIT subsidiary of such trust" after "income".

(b) Certain Income From Taxable REIT Subsidiaries Not Excluded From Rents From Real Property. --

(1) In general. -- Subsection (d) of section 856 (relating to rents from real property defined) is amended by adding at the end the following new paragraphs:

"(8) Special rule for taxable reit subsidiaries. -- For purposes of this subsection, amounts paid to a real estate investment trust by a taxable REIT subsidiary of such trust shall not be excluded from rents from real property by reason of paragraph (2)(B) if the requirements of subparagraph (A) or (B) are met.

"(A) Limited rental exception. -- The requirements of this subparagraph are met with respect to any property if at least 90 percent of the leased space of the property is rented to persons other than taxable REIT subsidiaries of such trust and other than persons described in section 856(d)(2)(B). The preceding sentence shall apply only to the extent that the amounts paid to the trust as rents from real property (as defined in paragraph (1) without regard to paragraph (2)(B)) from such property are substantially comparable to such rents made by the other tenants of the trust's property for comparable space.

"(B) Exception for certain lodging facilities. -- The requirements of this subparagraph are met with respect to an interest in real property which is a qualified lodging facility leased by the trust to a taxable REIT subsidiary of the trust if the property is operated on behalf of such subsidiary by a person who is an eligible independent contractor.

"(9) Eligible independent contractor. -- For purposes of paragraph (8)(B) --

"(A) In general. -- The term 'eligible independent contractor' means, with respect to any qualified lodging facility, any independent contractor if, at the time such contractor enters into a management agreement or other similar service contract with the taxable REIT subsidiary to operate the facility, such contractor (or any related person) is actively engaged in the trade or business of operating qualified lodging facilities for any person who is not a related person with respect to the real estate investment trust or the taxable REIT subsidiary.

"(B) Special rules. -- Solely for purposes of this paragraph and paragraph (8)(B), a person shall not fail to be treated as an independent contractor with respect to any qualified lodging facility by reason of any of the following:

"(i) The taxable REIT subsidiary bears the expenses for the operation of the facility pursuant to the management agreement or other similar service contract.

"(ii) The taxable REIT subsidiary receives the revenues from the operation of such facility, net of expenses for such operation and fees payable to the operator pursuant to such agreement or contract.

"(iii) The real estate investment trust receives income from such person with respect to another property that is attributable to a lease of such other property to such person that was in effect as on the later of --

"(I) January 1, 1999, or

"(II) the earliest date that any taxable REIT subsidiary of such trust entered into a management agreement or other similar service contract with such person with respect to such qualified lodging facility.

"(C) Renewals, etc., of existing leases. -- For purposes of subparagraph (B)(iii) --

"(i) a lease shall be treated as in effect on January 1, 1999, without regard to its renewal after such date, so long as such renewal is pursuant to the terms of such lease as in effect on whichever of the dates under subparagraph (B)(iii) is the latest, and

"(ii) a lease of a property entered into after whichever of the dates under subparagraph (B)(iii) is the latest shall be treated as in effect on such date if --

"(I) on such date, a lease of such property from the trust was in effect, and

"(II) under the terms of the new lease, such trust receives a substantially similar or lesser benefit in comparison to the lease referred to in subclause (I).

"(D) Qualified lodging facility. -- For purposes of this paragraph --

"(i) In general. -- The term 'qualified lodging facility' means any lodging facility unless wagering activities are conducted at or in connection with such facility by any person who is engaged in the business of accepting wagers and who is legally authorized to engage in such business at or in connection with such facility.

"(ii) Lodging facility. -- The term 'lodging facility' means a hotel, motel, or other establishment more than one-half of the dwelling units in which are used on a transient basis.

"(iii) Customary amenities and facilities. -- The term 'lodging facility' includes customary amenities and facilities operated as part of, or associated with, the lodging facility so long as such amenities and facilities are customary for other properties of a comparable size and class owned by other owners unrelated to such real estate investment trust.

"(E) Operate includes manage. -- References in this paragraph to operating a property shall be treated as including a reference to managing the property.

"(F) Related person. -- Persons shall be treated as related to each other if such persons are treated as a single employer under subsection (a) or (b) of section 52.".

(2) Conforming amendment. -- Subparagraph (B) of section 856(d)(2) is amended by inserting "except as provided in paragraph (8)," after "(B)".

SEC. 103. TAXABLE REIT SUBSIDIARY.

(a) In General. -- Section 856 is amended by adding at the end the following new subsection:

"(l) Taxable Reit Subsidiary. -- For purposes of this part --

"(1) In general. -- The term 'taxable REIT subsidiary' means, with respect to a real estate investment trust, a corporation (other than a real estate investment trust) if --

"(A) such trust directly or indirectly owns stock in such corporation, and

"(B) such trust and such corporation jointly elect that such corporation shall be treated as a taxable REIT subsidiary of such trust for purposes of this part. Such an election, once made, shall be irrevocable unless both such trust and corporation consent to its revocation. Such election, and any revocation thereof, may be made without the consent of the Secretary.

"(2) 35 percent ownership in another taxable reit subsidiary. -- The term 'taxable REIT subsidiary' includes, with respect to any real estate investment trust, any corporation (other than a real estate investment trust) with respect to which a taxable REIT subsidiary of such trust owns directly or indirectly --

"(A) securities possessing more than 35 percent of the total voting power of the outstanding securities of such corporation, or

"(B) securities having a value of more than 35 percent of the total value of the outstanding securities of such corporation. The preceding sentence shall not apply to a qualified REIT subsidiary (as defined in subsection (i)(2)).

"(3) Exceptions. -- The term 'taxable REIT subsidiary' shall not include --

"(A) any corporation which directly or indirectly operates or manages a lodging facility or a health care facility, and

"(B) any corporation which directly or indirectly provides to any other person (under a franchise, license, or otherwise) rights to any brand name under which any lodging facility or health care facility is operated.

Subparagraph (B) shall not apply to rights provided to an eligible independent contractor to operate or manage a lodging facility if such rights are held by such corporation as a franchisee, licensee, or in a similar capacity and such lodging facility is either owned by such corporation or is leased to such corporation from the real estate investment trust.

"(4) Definitions. -- For purposes of paragraph (3) --

"(A) Lodging facility. -- The term 'lodging facility' has the meaning given to such term by paragraph (9)(D)(ii).

"(B) Health care facility. -- The term 'health care facility' has the meaning given to such term by subsection (e)(6)(D)(ii).".

(b) Conforming Amendment. -- Paragraph (2) of section 856(i) is amended by adding at the end the following new sentence: "Such term shall not include a taxable REIT subsidiary."

SEC. 104. LIMITATION ON EARNINGS STRIPPING.

Paragraph (3) of section 163(j) (relating to limitation on deduction for interest on certain indebtedness) is amended by striking "and" at the end of subparagraph (A), by striking the period at the end of subparagraph (B) and inserting ", and", and by adding at the end the following new subparagraph:

"(C) any interest paid or accrued (directly or indirectly) by a taxable REIT subsidiary (as defined in section 856(l)) of a real estate investment trust to such trust.".

SEC. 105. 100 PERCENT TAX ON IMPROPERLY ALLOCATED AMOUNTS.

(a) In General. -- Subsection (b) of section 857 (relating to method of taxation of real estate investment trusts and holders of shares or certificates of beneficial interest) is amended by redesignating paragraphs (7) and (8) as paragraphs (8) and (9), respectively, and by inserting after paragraph (6) the following new paragraph:

"(7) Income from redetermined rents, redetermined deductions, and excess interest. --

"(A) Imposition of tax. -- There is hereby imposed for each taxable year of the real estate investment trust a tax equal to 100 percent of redetermined rents, redetermined deductions, and excess interest.

"(B) Redetermined rents. --

"(i) In general. -- The term 'redetermined rents' means rents from real property (as defined in subsection 856(d)) the amount of which would (but for subparagraph (E)) be reduced on distribution, apportionment, or allocation under section 482 to clearly reflect income as a result of services furnished or rendered by a taxable REIT subsidiary of the real estate investment trust to a tenant of such trust.

"(ii) Exception for certain services. -- Clause (i) shall not apply to amounts received directly or indirectly by a real estate investment trust for services described in paragraph (1)(B) or (7)(C)(i) of section 856(d).

"(iii) Exception for de minimis amounts. -- Clause (i) shall not apply to amounts described in section 856(d)(7)(A) with respect to a property to the extent such amounts do not exceed the one percent threshold described in section 856(d)(7)(B) with respect to such property.

"(iv) Exception for comparably priced services. -- Clause (i) shall not apply to any service rendered by a taxable REIT subsidiary of a real estate investment trust to a tenant of such trust if --

"(I) such subsidiary renders a significant amount of similar services to persons other than such trust and tenants of such trust who are unrelated (within the meaning of section 856(d)(8)(F)) to such subsidiary, trust, and tenants, but

"(II) only to the extent the charge for such service so rendered is substantially comparable to the charge for the similar services rendered to persons referred to in subclause (I).

"(v) Exception for certain separately charged services. -- Clause (i) shall not apply to any service rendered by a taxable REIT subsidiary of a real estate investment trust to a tenant of such trust if --

"(I) the rents paid to the trust by tenants (leasing at least 25 percent of the net leasable space in the trust's property) who are not receiving such service from such subsidiary are substantially comparable to the rents paid by tenants leasing comparable space who are receiving such service from such subsidiary, and

"(II) the charge for such service from such subsidiary is separately stated.

"(vi) Exception for certain services based on subsidiary's income from the services. -- Clause (i) shall not apply to any service rendered by a taxable REIT subsidiary of a real estate investment trust to a tenant of such trust if the gross income of such subsidiary from such service is not less than 150 percent of such subsidiary's direct cost in furnishing or rendering the service.

"(vii) Exceptions granted by secretary. -- The Secretary may waive the tax otherwise imposed by subparagraph (A) if the trust establishes to the satisfaction of the Secretary that rents charged to tenants were established on an arms' length basis even though a taxable REIT subsidiary of the trust provided services to such tenants.

"(viii) No inference with respect to rents not within exceptions. -- In determining whether rents are subject to reduction upon distribution, apportionment, or allocation under section 482 for purposes of subparagraph (B), the fact that rents from real property do not meet the requirements of clauses (ii) through (vii) shall not be taken into account; and such determination, in the case of rents not meeting such requirements, shall be made as if such clauses had not been enacted.

"(ix) No inference as to whether redetermined rent is rent from real property. -- Rent received by a real estate investment trust shall not fail to qualify as rents from real property under section 856(d) by reason of the fact that all or any portion of such rent is determined to be redetermined rent.

"(C) Redetermined deductions. -- The term 'redetermined deductions' means deductions (other than redetermined rents) of a taxable REIT subsidiary of a real estate investment trust if the amount of such deductions would (but for subparagraph (E)) be increased on distribution, apportionment, or allocation under section 482 to clearly reflect income as between such subsidiary and such trust.

"(D) Excess interest. -- The term 'excess interest' means any deductions for interest payments by a taxable REIT subsidiary of a real estate investment trust to such trust to the extent that the interest payments are in excess of a rate that is commercially reasonable.

"(E) Coordination with section 482. -- The imposition of tax under subparagraph (A) shall be in lieu of any distribution, apportionment, or allocation under section 482.

"(F) Regulatory authority. -- The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this paragraph. Until the Secretary prescribes such regulations, real estate investment trusts and their taxable REIT subsidiaries may base their allocations on any reasonable method.".

(b) Amount Subject to Tax Not Required To Be Distributed. -- Subparagraph (E) of section 857(b)(2) (relating to real estate investment trust taxable income) is amended by striking "paragraph (5)" and inserting "paragraphs (5) and (7)".

SEC. 106. EFFECTIVE DATE.

(a) In General. -- The amendments made by this title shall apply to taxable years beginning after the date of enactment of this Act.

(b) Transitional Rules Related to Section 101. --

(1) Existing arrangements. --

(A) In general. -- Except as otherwise provided in this paragraph, the amendment made by section 101 shall not apply to a real estate investment trust with respect to --

(i) securities of a corporation held directly or indirectly by such trust on April 28, 1999,

(ii) securities received by such trust (or a successor) in exchange for, or with respect to, securities described in clause (i) in a transaction in which gain or loss is not recognized, and

(iii) securities acquired directly or indirectly by such trust as part of a reorganization (as defined in section 368(a)(1) of the Internal Revenue Code of 1986) with respect to such trust if such securities are described in clause (i) or (ii) with respect to any other real estate investment trust.

(B) New trade or business or substantial new assets. -- Subparagraph (A) shall cease to apply to securities of a corporation as of the first day after April 28, 1999, on which such corporation engages in a substantial new line of business, or acquires any substantial asset, other than --

(i) pursuant to a binding contract in effect on such date and at all times thereafter before the acquisition of such asset,

(ii) in a transaction in which gain or loss is not recognized by reason of section 1031 or 1033 of the Internal Revenue Code of 1986, or

(iii) in a reorganization (as so defined) with another corporation the securities of which are described in paragraph (1)(A) of this subsection.

(2) Tax-free conversion. -- If --

(A) at the time of an election for a corporation to become a taxable REIT subsidiary, the amendment made by section 101 does not apply to such corporation by reason of paragraph (1), and

(B) such election first takes effect during the 3-year period beginning on the date of the enactment of this Act, such election shall be treated as a reorganization qualifying under section 368(a)(1)(A) of such Code.

TITLE II -- HEALTH CARE REITS

SEC. 201. HEALTH CARE REITS.

(a) Special Foreclosure Rule for Health Care Properties. -- Subsection (e) of section 856 (relating to special rules for foreclosure property) is amended by adding at the end the following new paragraph:

"(6) Special rule for qualified health care properties. -- For purposes of this subsection --

"(A) Acquisition at expiration of lease. -- The term 'foreclosure property' shall include any qualified health care property acquired by a real estate investment trust as the result of the termination of a lease of such property (other than a termination by reason of a default, or the imminence of a default, on the lease).

"(B) Grace period. -- In the case of a qualified health care property which is foreclosure property solely by reason of subparagraph (A), in lieu of applying paragraphs (2) and (3) --

"(i) the qualified health care property shall cease to be foreclosure property as of the close of the second taxable year after the taxable year in which such trust acquired such property, and

"(ii) if the real estate investment trust establishes to the satisfaction of the Secretary that an extension of the grace period in clause (i) is necessary to the orderly leasing or liquidation of the trust's interest in such qualified health care property, the Secretary may grant 1 or more extensions of the grace period for such qualified health care property.

Any such extension shall not extend the grace period beyond the close of the 6th year after the taxable year in which such trust acquired such qualified health care property.

"(C) Income from independent contractors. -- For purposes of applying paragraph (4)(C) with respect to qualified health care property which is foreclosure property by reason of subparagraph (A) or paragraph (1), income derived or received by the trust from an independent contractor shall be disregarded to the extent such income is attributable to --

"(i) any lease of property in effect on the date the real estate investment trust acquired the qualified health care property (without regard to its renewal after such date so long as such renewal is pursuant to the terms of such lease as in effect on such date), or

"(ii) any lease of property entered into after such date if --

"(I) on such date, a lease of such property from the trust was in effect, and

"(II) under the terms of the new lease, such trust receives a substantially similar or lesser benefit in comparison to the lease referred to in subclause (I).

"(D) Qualified health care property. --

"(i) In general. -- The term 'qualified health care property' means any real property (including interests therein), and any personal property incident to such real property, which --

"(I) is a health care facility, or

"(II) is necessary or incidental to the use of a health care facility.

"(ii) Health care facility. -- For purposes of clause (i), the term 'health care facility' means a hospital, nursing facility, assisted living facility, congregate care facility, qualified continuing care facility (as defined in section 7872(g)(4)), or other licensed facility which extends medical or nursing or ancillary services to patients and which, immediately before the termination, expiration, default, or breach of the lease of or mortgage secured by such facility, was operated by a provider of such services which was eligible for participation in the medicare program under title XVIII of the Social Security Act with respect to such facility."

(b) Effective Date. -- The amendment made by this section shall apply to taxable years beginning after the date of enactment of this Act.

TITLE III -- CONFORMITY WITH REGULATED INVESTMENT COMPANY RULES

SEC. 301. CONFORMITY WITH REGULATED INVESTMENT COMPANY RULES.

(a) Distribution Requirement. -- Clauses (i) and (ii) of section 857(a)(1)(A) (relating to requirements applicable to real estate investment trusts) are each amended by striking "95 percent (90 percent for taxable years beginning before January 1, 1980)" and inserting "90 percent".

(b) Imposition of Tax. -- Clause (i) of section 857(b)(5)(A) (relating to imposition of tax in case of failure to meet certain requirements) is amended by striking "95 percent (90 percent in the case of taxable years beginning before January 1, 1980)" and inserting "90 percent".

(c) Effective Date. -- The amendments made by this section shall apply to taxable years beginning after the date of enactment of this Act.

TITLE IV -- CLARIFICATION OF DEFINITION OF INDEPENDENT CONTRACTOR

SEC. 401. CLARIFICATION OF DEFINITION OF INDEPENDENT CONTRACTOR.

(a) In General. -- Paragraph (3) of section 856(d) (relating to independent contractor defined) is amended by adding at the end the following flush sentence:

"In the event that any class of stock of either the real estate

TITLE V -- MODIFICATION OF EARNINGS AND PROFITS RULES

SEC. 501. MODIFICATION OF EARNINGS AND PROFITS RULES.

(a) Rules for Determining Whether Regulated Investment Company Has Earnings and Profits From Non-RIC Year. -- Subsection (c) of section 852 is amended by adding at the end the following new paragraph:

"(3) Distributions to meet requirements of subsection (a)(2)(B). -- Any distribution which is made in order to comply with the requirements of subsection (a)(2)(B) --

"(A) shall be treated for purposes of this subsection and subsection (a)(2)(B) as made from the earliest earnings and profits accumulated in any taxable year to which the provisions of this part did not apply rather than the most recently accumulated earnings and profits, and

"(B) to the extent treated under subparagraph (A) as made from accumulated earnings and profits, shall not be treated as a distribution for purposes of subsection (b)(2)(D) and section 855.".

(b) Clarification of Application of REIT Spillover Dividend Rules to Distributions To Meet Qualification Requirement. -- Subparagraph (B) of section 857(d)(3) is amended by inserting before the period "and section 858".

(c) Application of Deficiency Dividend Procedures. -- Paragraph (1) of section 852(e) is amended by adding at the end the following new sentence: "If the determination under subparagraph (A) is solely as a result of the failure to meet the requirements of subsection (a)(2), the preceding sentence shall also apply for purposes of applying subsection (a)(2) to the non-RIC year."

(d) Effective Date. -- The amendments made by this section shall apply to taxable years beginning before, on, or after the date of the enactment of this Act.

Mr. GRAHAM. Mr. President, I am pleased to join my colleague, Senator Mack, in the introduction of the REIT Modernization Act, legislation that would modernize the tax rules that apply to real estate investment trusts ("REITs").

REITs were created in 1960 to give small investors the ability to invest in income producing real estate. But it was not until the early part of this decade that REITs emerged as a significant factor in real estate finance. Their rapid growth then contributed in a major way to the development of real estate markets. The real estate industry is experiencing change today as owners seek to maximize returns by taking greater advantage of their employee expertise and tenant base. This bill will better enable REITS to expand their services to tenants and customers.

The Administration's Fiscal Year 2000 budget includes a proposal to change the rules governing REITs. The legislation that we are introducing today is largely based on that proposal. It would permit REITs to establish taxable subsidiaries to offer services that a REIT cannot offer directly to tenants and third parties. Stringent rules are included to ensure that the subsidiary would be fully subject to taxation. Current rules designed to ensure that REIT income is primarily earned from real estate activities would continue to apply. The bill also modifies the treatment of health care facilities to ensure that patients' lives are not disrupted in the event of an expired lease, and restores the 90% distribution rule that had previously applied to REITs.

REITs play a positive role in the real estate economy that has helped to stabilize property values and provide liquidity to the market. As long as the basic limitations on REIT activities are preserved, those tax rules which impose restraints on REIT activities must be modified. In my own state of Florida, REITs have invested more than $13 billion in the Florida economy, and are an important source of investment capital that has reinvigorated real estate markets.

I want to thank Senator Mack for his leadership on this issue and I welcome the bipartisan support this measure has received from members of the Senate Finance Committee, along with others, who have joined as cosponsors of the bill. I look forward to working with them in the months ahead.

Mr. MOYNIHAN. Mr. President: I commend the efforts of my respected colleagues from Florida, Senator Mack and Senator Graham, as they work to modernize the tax rules that apply to Real Estate Investment Trusts (REITs). I have worked with the REIT industry over the years and have seen it grow to be a major contributor to the strength of the real estate sector in New York and nationally.

Congress first authorized REITs in 1960 so that investors of modest means could invest in income producing real estate assets. During the last four decades, REITs have provided not only real estate ownership opportunities for individual investors, but also an important source of capital for real estate investment.

As tax policy makers we have the responsibility to make sure that tax laws governing REITs are updated to reflect the realities of a dynamic market and to maintain a proper competitive balance between real estate owned through the REIT structure and through more traditional corporate and partnership structures. But because REITs are pass-through entities, we also have a responsibility to ensure that they are not used as vehicles for sheltering corporate taxes in a manner inconsistent with Congressional intent. In fact, twice in the last Congress the Finance Committee crafted legislation, later signed into law, to stop inappropriate use of the REIT structure in the case of so-called "stapled entities" and liquidating subsidiaries.

The Administration has included a proposal in its FY 2000 budget that would, among other things, allow REITs to own a taxable REIT subsidiary. The legislation introduced by Senators Mack and Graham builds on the Administration proposal, and would expand the permissible business activities of REITs.

The approach taken in the proposals advanced by the Administration and by Senators Mack and Graham warrant consideration. I have asked my staff to review the legislation and work with the authors of the bill. It is my hope that Congress can enact REIT modernization legislation this year.