Retirement Savings and Benefits
Questions and comments about IRAs, 401k accounts, social security, and other forms of retirement savings and benefits.
REIT income qualify as passive?
Posted by: antboy, August 24, 2007 08:41AM
I have a client with annual losses from a rental property that they are unable to deduct (AGI over $150,000 so the active rental allowance doesn't apply). I'm looking to create passive income to offset it. Of course, if they operated some rental real estate at a profit, they'd be set, but they are looking to keep life simple, and I'm wondering if either investments in REITs (or REIT funds) or some other trouble-free investment can generate the necessary passive income to use the losses (they don't plan to sell the rental with the passive losses, as they eventually plan to move into that as a personal residence in retirement).

Any thoughts on the REITs or another relatively normal investment are appreciated.

Re: REIT income qualify as passive?
Posted by: ruth, August 24, 2007 06:50PM
Passive income does not include investment income (portfolio income). The regulations state that passive income specifically does not include income from the following, including REITs. See section 1.469-2T(c)(3) below.

(3) Items of portfolio income specifically excluded.
(i) In general. Passive activity gross income does not include portfolio income. For purposes of the preceding sentence, portfolio income includes all gross income, other than income derived in the ordinary course of a trade or business (within the meaning of paragraph (c)(3)(ii) of this section), that is attributable toŚ
(A) Interest (including amounts treated as interest under paragraph (e)(2)(ii) of this section, relating to certain payments to partners for the use of capital); annuities; royalties (including fees and other payments for the use of intangible property); dividends on C corporation stock; and income (including dividends) from a real estate investment trust (within the meaning of section 856), regulated investment company (within the meaning of section 851), real estate mortgage investment conduit (within the meaning of section 860D), common trust fund (within the meaning of section 584), controlled foreign corporation (within the meaning of section 957), qualified electing fund (within the meaning of section 1295(a)), or cooperative (within the meaning of section 1381(a));

Re: REIT income qualify as passive?
Posted by: antboy, August 26, 2007 04:16AM
Thanks. It is unfortunate that the direct investment in rental real estate is passive but the exact same activity through an investment trust is not.

not the same
Posted by: jainen, August 26, 2007 05:25AM
>>the exact same activity through an investment trust<<

But it is NOT the same, any more than investing in a mutual fund is the same as being the fire chief of the district whose bonds the fund owns, or for equities, manufacturing the widgets whose sales generate the profits that are passed through to the shareholders. An REIT pays dividends based on rents, not the rents themselves.

Since your clients "are looking to keep life simple" they could acquire commercial property on a triple-net collected by a real estate manager. Pure passive income paid in a monthly check with nary a phone call.

Re: REIT income qualify as passive?
Posted by: antboy, August 26, 2007 07:04PM
Thanks for your comments, but I think a better analogy is between the owner of a REIT holding managed triple net lease properties and the owner of managed triple net lease properties. It is inconsistent to say the latter's income is passive but the former's is not. Okay, okay, that's not really an analogy, but the owner of a bond fund gets the tax character of the underlying bonds (including tax-exempt munis and state-exempt Treasuries). But the law is the law, and there is no need for us to debate the government's "logic" here.

Finding and acquiring commercial property and obtaining a trouble-free long-term tenant on a profitable triple net lease is not as simple as the purchase of a REIT or REIT fund (I have another client who spent years trying to extricate herself from one of these "simple" arrangements with a tenant who proved to be less reliable than expected). But it may the simplest choice that will qualify as passive (the only other possibility that comes to mind would be a real estate limited partnership, also requiring nary a phone call but also dependent on the selection of good managers). Anyway, I think we're all in sync on the tax laws applicable to my question.

Re: REIT income qualify as passive?
Posted by: Bill Brown, August 26, 2007 08:21PM
Analogies are fairly worthless when it comes to predicting what the tax law says in an otherwise unknown area. Expecting consistency is also a worthless activity. Finally, expecting the tax law to meet any particular individual's definition of fairness is a waste of time.

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