Advantages to Converting Your Private Money Mortgage Pool to a REIT
(Conversion can mean up to a 70 basis point increase in After Tax Yield and is a UBTI Blocker)

Dennis DossBy:

By: Dennis H. Doss and Christopher J. Donovan

           DOSS LAW, LLP

President Trump’s Tax Cuts and Jobs Act (“TCJA”) Public Law No: 115-97 (signed into law on 12/22/2017) provides substantial tax savings to real estate investment trust (“REIT”) investors. The Act (Section 199A) allows individuals to deduct up to 20% of ordinary REIT dividends, with the remainder of the income taxed at the filer’s marginal rate. Investors in traditional, limited liability mortgage pools, are disadvantaged because they cannot take this deduction. The effect of the new law on REIT investors who paid the top income tax-rate of 39.6% on 2017 distributions will be a drop in taxable rate to 29.6%, producing an after-tax savings of 25.3%.

To illustrate, a $100,000 REIT investment under the new tax act would have an after-tax yield that is 70 basis points higher than the same investment in 2017.In addition, as a general rule distributions from REITs to ERISA investors like pension plans are not subject to Unrelated Business Taxable Income (“UBTI”), a pain in the side of most leveraged mortgage pools today.

Qualifying as a Mortgage REIT (mREIT)

To qualify as a mortgage REIT, a mortgage pool must:

  • Be managed by one or more trustees or directors (pool managers);
  • Get 75% or more of income from investment in mortgages;
  • Pay 90% or more of its taxable income to its investors;
  • Have a minimum of 100 investors after its first year of existence (which can be purchased from services);
  • Have no more than 50% of its shares held by five or fewer individuals during the last half of the taxable year; and
  • Make the REIT election with its tax return 1120-REIT (which is still available for 2018).

Most mortgage pools could easily qualify as REITs.  All they need to do is amend their operating agreements, change their PPMs (to add REIT disclosures) and secure a majority of their investors’ votes for the approval of the conversion. All of this can be done in the current tax year. Of course, pool managers would want to coordinate the conversion with the pool’s accountant and auditor.

Maintaining REIT Status

REITs must continuously comply with all of the requirements above.  After the first year REITs must have a minimum of 100 investors, but that condition can easily be met by service providers who will provide any shortfall for a fee.  REITs must poll their investors each January to determine the identity of the beneficial owners of each pool account.

REIT is a UBTI Blocker

Many mortgage pools employ leverage to one degree or another to manage cash or boost yields.  Leverage can result in UBTI for tax exempt fund members (e.g. pension plans).  The reporting is painstaking.  The IRS has ruled that dividends from REITs are not considered UBTI as long as: (1) no single ERISA plan owns more than 50% of the REIT and (2) the REIT is not 50% owned by ERISA plan members who each own 10% or more of the REIT.  See IRS Code 856(h)(3)(C).

 © Doss Law. Attorney advertising materials. These materials have been prepared for educational purposes only and are not legal advice.  This information is not intended to create an attorney-client relationship.  Consult a knowledgeable lawyer before implementing any of the ideas in this publication.

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