Can a REIT's federally disregarded subsidiary take the REIT dividends-paid deduction — or the public-REIT exclusion or exemption — when figuring its Tennessee excise tax?

Plain-English summary

This advisory revenue ruling deals with subsidiaries of real estate investment trusts (REITs) that do sale-leaseback financing — a company sells its real estate to the subsidiary for cash and immediately leases it back long-term — and that own real estate in Tennessee. The wrinkle: each subsidiary is disregarded for federal income tax (it doesn't file its own federal return; its results roll up onto the parent REIT's federal return), yet Tennessee treats it as a separate taxpayer for franchise & excise (F&E) tax. The Department answered two questions, and said no to both.

Background — how Tennessee figures excise "net earnings." Tennessee's 6.5% excise tax is imposed on a taxpayer's net earnings (§ 67-4-2007(a)). For an entity that files federally on some version of Form 1120, net earnings start from federal taxable income before the net-operating-loss and special deductions, then adjust (§ 67-4-2006(a)(1)). So Tennessee largely follows the federal numbers — which means it matters a great deal what kind of entity you are for federal purposes.

Question 1 — Can the subsidiary use the REIT "dividends paid deduction"? NO.

• A REIT gets a special federal break: it can deduct the dividends it pays out (the dividends-paid deduction, I.R.C. § 561) when computing its "real estate investment trust taxable income" (I.R.C. § 857(b)). Through Tennessee's federal-conformity starting point, that deduction normally flows into a real REIT's Tennessee net earnings too (except for captive REITs, which must add it back — § 67-4-2006(b)(1)(O)).
• But these subsidiaries are disregarded to their REIT parents, not REITs themselves. To figure its Tennessee net earnings, a disregarded-but-separate-for-Tennessee entity must compute a "pro forma" federal taxable income as if it had filed its own separate federal return. Using the parent's Form 1120-REIT only as support does not make the subsidiary a REIT.
• And the subsidiary could not be a REIT on its own: a REIT must meet I.R.C. § 856(a) and elect REIT status (§ 856(c)(1)), which requires at least 100 beneficial owners — these entities have only one or two owners. Since it isn't (and can't be) a REIT, it can't use the § 857(b)(2) dividends-paid deduction on a separate basis. So the deduction cannot reduce its Tennessee excise net earnings.

Question 2 — Does a public-REIT-owned limited partnership get Tennessee's public-REIT exclusion or exemption? NO (when it's disregarded).

• Tennessee gives two breaks tied to public REITs: a taxpayer may exclude from net earnings amounts distributed to a public REIT (§ 67-4-2006(a)(5)), and a taxpayer that distributes 100% of its net earnings/losses to a public REIT is entirely exempt from excise tax (§ 67-4-2019). Both require that the taxpayer be "treated as a partnership for federal tax purposes."
• Here the entities are limited partnerships that are disregarded federally. A disregarded entity is not a federal partnership — it's treated as a division/branch of its single owner (Treas. Reg. § 301.7701-2). So even though a public REIT owns them, they don't qualify for either the exclusion or the exemption.

The throughline: Tennessee F&E tax tracks an entity's federal classification. A REIT subsidiary that is disregarded federally is, for Tennessee, neither a REIT (no dividends-paid deduction) nor a partnership (no public-REIT exclusion/exemption) — it's treated like a division of its owner, and computes its own Tennessee tax as an ordinary separate corporation would. (Companion REIT ruling in the corpus: RR 14-07 on captive vs. public REITs.)

What this means for you

REITs and their subsidiaries operating in Tennessee

If you hold Tennessee real estate in a disregarded subsidiary under a REIT, don't assume the REIT's federal tax advantages travel down to that subsidiary for Tennessee. For its own Tennessee F&E return, the subsidiary computes net earnings as if it filed a separate federal return — and on that basis it is not a REIT and gets no dividends-paid deduction. The public-REIT exclusion and exemption are likewise off the table unless the entity is actually treated as a partnership federally.

The principle: Tennessee F&E follows your federal classification

Whether you're a REIT, a partnership, a corporation, or a disregarded entity federally drives your Tennessee result. A single-owner disregarded entity is a division of its owner for federal purposes — so federal benefits keyed to being a "REIT" or a "partnership" simply don't apply to it, even though Tennessee makes it file separately. If you want partnership or REIT treatment for Tennessee, the federal classification has to actually be there.

Accountants and tax professionals

Tennessee net earnings start from federal taxable income (§ 67-4-2006(a)(1); excise § 67-4-2007(a)). The REIT dividends-paid deduction (I.R.C. § 561, via § 857(b)(2)(B)) reaches a real REIT's Tennessee base by conformity, but a federally disregarded subsidiary computes pro forma separate-entity FTI and cannot claim it — it isn't a REIT and can't make the § 856(c)(1) election (the § 856(a)(5) 100-owner test fails). The § 67-4-2006(a)(5) exclusion and § 67-4-2019 exemption both require federal partnership treatment, which a disregarded entity lacks (Treas. Reg. § 301.7701-2). Note the captive-REIT add-back (§ 67-4-2006(b)(1)(O)) and the public/captive-REIT definitions (§ 67-4-2004(39), (7)). This is advisory — a revenue ruling, not binding. Companion: RR 14-07 (captive vs. public REIT).

Common questions

Q: Can a REIT's disregarded subsidiary deduct dividends it (or its parent) pays, for Tennessee excise tax?
A: No. The dividends-paid deduction belongs to an actual REIT. A subsidiary that is disregarded federally isn't a REIT and can't make a REIT election, so on a separate (pro forma) basis it gets no dividends-paid deduction — and therefore can't apply it against its Tennessee net earnings.

Q: My entity is owned by a public REIT — doesn't that get me Tennessee's public-REIT exclusion or exemption?
A: Only if your entity is "treated as a partnership for federal tax purposes." If it's a disregarded entity, it's treated as a division of its owner — not a partnership — so it doesn't qualify for the § 67-4-2006(a)(5) exclusion or the § 67-4-2019 exemption.

Q: Why does federal tax classification matter so much for a Tennessee tax?
A: Because Tennessee computes excise net earnings starting from federal taxable income (§ 67-4-2006(a)(1)). The federal characterization of the entity — REIT, partnership, corporation, or disregarded — controls what deductions and benefits show up in that starting number.

Q: Is this ruling binding?
A: No. This is a Revenue Ruling — advisory only and not binding on the Department; no taxpayer can rely on it as binding. (That's different from a Letter Ruling, which binds the Department as to the specific taxpayer it addresses.) Confirm your own facts with a tax professional.

Citations and references

Tennessee franchise & excise tax statutes (Tenn. Code Ann., Title 67, Chapter 4):

• § 67-4-2006(a)(1) (net earnings start from federal taxable income before NOL/special deductions); § 67-4-2007(a) (excise tax — 6.5% of net earnings); § 67-4-2004(38) ("person")
• § 67-4-2006(a)(5) (exclusion for distributions to a public REIT — requires federal partnership treatment); § 67-4-2019 (exemption for distributing 100% to a public REIT — requires federal partnership treatment)
• § 67-4-2004(39) ("public REIT"); § 67-4-2004(7) ("captive REIT"); § 67-4-2006(b)(1)(O) (captive-REIT dividends-paid-deduction add-back, with the bank/BHC/public-REIT exception)

Federal law referenced:

• I.R.C. § 561 (dividends-paid deduction); I.R.C. § 857(b)(1)-(2)(B) (REIT taxable income and its dividends-paid deduction); I.R.C. § 856(a), (a)(5), (c)(1) (REIT requirements — ≥100 beneficial owners, REIT election); Treas. Reg. § 301.7701-2 (a disregarded single-owner entity is treated as a division/branch of its owner)

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/fae/13-22fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
REVENUE RULING # 13-22

Revenue rulings are not binding on the Department. This ruling is based on the particular
facts and circumstances presented, and is an interpretation of the law at a specific point in
time. The law may have changed since this ruling was issued, possibly rendering it obsolete.
The presentation of this ruling in a redacted form is provided solely for informational
purposes, and is not intended as a statement of Departmental policy. Taxpayers should
consult with a tax professional before relying on any aspect of this ruling.
SUBJECT
The calculation of net earnings or loss for Tennessee excise tax purposes by federally
disregarded subsidiaries of real estate investment trusts.
SCOPE
Revenue Rulings are statements regarding the substantive application of law and statements of
procedure that affect the rights and duties of taxpayers and other members of the public. Revenue
Rulings are advisory in nature and are not binding on the Department.
FACTS
The Taxpayers are the direct or indirect subsidiaries of real estate investment trusts (“REITs”).
Each Taxpayer’s business consists of a form of financing known as “sale-leaseback” in which a
company sells its real estate to the Taxpayer in exchange for cash and simultaneously signs a
long-term lease with the taxpayer. None of the Taxpayers are owned by captive REITs, as
defined by TENN. CODE ANN. § 67-4-2004(7) (2013). While the factual circumstances
surrounding each Taxpayer differ, the Taxpayer in each case is a federally disregarded entity that
files on the parent REIT’s federal income tax return. Additionally, the Taxpayer in each case is
treated as a separate entity for Tennessee franchise and excise tax purposes. The facts can be
divided into four scenarios.
Scenario 1:
The Taxpayer is a limited partnership owned by two partners. The first partner is a REIT that
does not come within the definition of “public REIT” under TENN. CODE ANN. § 67-4-2004(39).
The second partner is either a corporation wholly owned by the REIT or a single-member limited
liability company (“SMLLC”) whose single member is the REIT. The Taxpayer owns real
property in Tennessee, but the partners have no contacts in Tennessee beyond the activities of the
Taxpayer.
Scenario 2:
The Taxpayer is a corporation wholly owned by a REIT that does not come within the definition
of “public REIT” under TENN. CODE ANN. § 67-4-2004(39). The Taxpayer is disregarded to the

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REIT for federal tax purposes. The Taxpayer owns real property in Tennessee, but the REIT has
no contacts in Tennessee beyond the activities of the Taxpayer.
Scenario 3:
The Taxpayer is a limited liability company with two members. The first member is a REIT that
does not come within the definition of “public REIT” under TENN. CODE ANN. § 67-4-2004(39).
The second member is a corporation wholly owned by the REIT. The Taxpayer owns real
property in Tennessee, but the members have no contacts in Tennessee beyond the activities of
the Taxpayer.
Scenario 4:
The Taxpayer is a limited partnership owned by two partners. The first partner is a public REIT,
as defined in TENN. CODE ANN. § 67-4-2004(39) (2013). The second partner is a corporation
wholly owned by the public REIT. The Taxpayer owns real property in Tennessee, but the
partners have no contacts in Tennessee beyond the activities of the Taxpayer.
RULINGS
1.

If the Taxpayer uses a pro forma Federal Form 1120-REIT (U.S. Income Tax Return for
Real Estate Investment Trusts) as support for its Tennessee franchise and excise tax
return, may the Taxpayer apply the dividends paid deduction from Form 1120-REIT,
Line 21b, in the computation of its net earnings or loss for Tennessee excise tax
purposes?
Ruling: No. If the Taxpayer uses a pro forma Federal Form 1120-REIT (U.S. Income Tax
Return for Real Estate Investment Trusts) as support for its Tennessee franchise and
excise tax return, the Taxpayer may not apply the dividends paid deduction from Federal
Form 1120-REIT, Line 21b, in the computation of its net earnings or loss for Tennessee
excise tax purposes.

2.

Do limited partnerships owned by public REITs, as defined under TENN. CODE ANN.
§ 67-4-2004(39) (2013), and disregarded for federal tax purposes qualify for the
exclusion provided under TENN. CODE ANN. § 67-4-2006(a)(5) (2013) or the exemption
provided under TENN. CODE ANN. § 67-4-2019 (2013)?
Ruling: No. Only entities treated as partnerships for federal tax purposes may qualify for
the exclusion or exemption provided by TENN. CODE ANN. §§ 67-4-2006(a)(5), -2019.
Since the limited partnerships are for federal tax purposes disregarded to public REITs,
they are treated for federal tax purposes as divisions of public REITs rather than
partnerships.
ANALYSIS

1.

Computation of net earnings or loss for Tennessee excise tax purposes

If the Taxpayer uses a pro forma Federal Form 1120-REIT (U.S. Income Tax Return for Real
Estate Investment Trusts) as support for its Tennessee franchise and excise tax return, the
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Taxpayer may not apply the dividends paid deduction from Federal Form 1120-REIT, Line 21b,
in the computation of its net earnings or loss for Tennessee excise tax purposes.
Tennessee imposes an excise tax at the rate of 6.5% on the net earnings of all persons, as defined
under TENN. CODE ANN. § 67-4-2004(38) (2013), doing business within Tennessee.1 For
corporations and other persons that file federally on any variant of Federal Form 1120 (U.S.
Corporation Income Tax Return), TENN. CODE ANN. § 67-4-2006(a)(1) (2013) defines “net
earnings” as “federal taxable income or loss before the operating loss deduction and special
deductions provided for in 26 U.S.C. §§ 241, 242 [repealed], 243-347, and as adjusted by
subsections (b) and (c).”
The federal dividends paid deduction, defined under I.R.C. § 561, is only allowed in specific
circumstances. With respect to REITs, the deduction is applied in the determination of “real
estate investment trust taxable income,” which is subject to taxation under I.R.C. § 857(b)(1).
This provision imposes the federal corporate income tax on the “real estate investment trust
taxable income of every real estate investment trust.” I.R.C. § 857(b)(2) defines “real estate
investment trust taxable income” as the taxable income of a real estate investment trust,2 with
certain statutory adjustments. Among these adjustments is the dividends paid deduction.
Specifically, I.R.C. § 857(b)(2)(B) allows a REIT the dividends paid deduction, as defined under
I.R.C. § 561, in the computation of its federal real estate investment trust taxable income.
Thus, an entity that has filed an election to be a REIT is subject to taxation under I.R.C.
§ 857(b)(1) with respect to its real estate investment trust taxable income, which is determined
by applying the dividends paid deduction. Except in the case of captive REITs,3 Tennessee’s
excise tax laws neither expressly adopt nor disallow the federal dividends paid deduction.4
Rather, the dividends paid deduction is taken into account in the computation of the REIT’s net
earnings or loss for Tennessee excise tax purposes by virtue of the REIT having utilized the
deduction at the federal level.
The facts indicate that the Taxpayer is disregarded for federal income tax purposes to its REIT
parent, but is treated as a separate entity for Tennessee franchise and excise tax purposes. Since
the Taxpayer federally files on its parent’s Federal Form 1120-REIT, which is a variant of
Federal Form 1120, TENN. CODE ANN. § 67-4-2006(a)(1) applies to the Taxpayer and dictates
that the starting point for calculating the Taxpayer’s net earnings or loss is its federal taxable

1

TENN. CODE ANN. § 67-4-2007(a) (2013).

2

To be a REIT, an entity must meet the requirements of I.R.C. § 856(a) and file an election in accordance with
I.R.C. § 856(c)(1).
3

“Captive REIT” means “an entity with an election in effect under § 856(c)(1) of the Internal Revenue Code,
codified in 26 U.S.C. § 856(c)(1), in which any other entity or individual, directly or indirectly, has at least eighty
percent (80%) ownership interest by value determined in accordance with generally accepted accounting principles
and whose shares are not traded on a national stock exchange.” TENN. CODE ANN. § 67-4-2004(7).
4

A captive REIT is required to add to Tennessee net earnings or loss “any deduction by a captive REIT for
dividends paid, as defined under 26 U.S.C. § 561, that is allowed and taken under 26 U.S.C. § 857(b(2)(B).” TENN.
CODE ANN. § 67-4-2006(b)(1)(O). Note that this requirement does not apply to captive REITs owned by a bank,
bank holding company, or a public REIT. Id.

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income or loss before the operating loss deduction and special deductions provided for in I.R.C.
§§ 241 and 243-347.
To determine its net earnings or loss, the Taxpayer must first compute its pro forma federal
taxable income as though it had filed separately for federal tax purposes. A taxpayer that is
federally disregarded but treated as a separate entity for Tennessee franchise and excise tax
purposes will compute its net earnings or loss under TENN. CODE ANN. § 67-4-2006 using as
support the federal form filed by the parent. However, this does not imply that the taxpayer is
treated for Tennessee tax purposes as though it were the same type of entity as the parent. In
other words, a taxpayer federally disregarded to a REIT is not itself considered to be a REIT for
Tennessee tax purposes. Rather, the taxpayer will simply use the Federal Form 1120-REIT as
support in the calculation of its pro forma federal taxable income.
Importantly, if the Taxpayer were to report its federal income tax on a separate entity basis, it
would not do so as a REIT. To be a REIT, an entity must meet the requirements of I.R.C.
§ 856(a) and file an election in accordance with I.R.C. § 856(c)(1). Not only has the Taxpayer
not filed such an election, it would be unable to do so as a separate entity.5
Since the Taxpayer is not a REIT, the Taxpayer would not be able to utilize the dividends paid
deduction under I.R.C. § 857(b)(2) in the determination of its federal taxable income on a
separate entity basis. The dividends paid deduction is therefore not allowed in the computation of
the Taxpayer’s pro forma federal taxable income. As a result, the dividends paid deduction may
not be applied in the computation of the Taxpayer’s net earnings or loss for Tennessee excise tax
purposes.
2.

Limited Partnerships and TENN. CODE ANN. §§ 67-4-2006(a)(5), -2019

Limited partnerships owned by public REITs, as defined under TENN. CODE ANN. § 67-42004(39) (2013), and disregarded for federal tax purposes do not qualify for the exclusion
provided under TENN. CODE ANN. § 67-4-2006(a)(5) (2013) or the exemption provided under
TENN. CODE ANN. § 67-4-2019 (2013).
For Tennessee excise tax purposes, TENN. CODE ANN. § 67-4-2006(a)(5) (2013) permits a
taxpayer to exclude from net earnings or loss any amounts “distributed either directly or
indirectly to a public REIT,” provided that the taxpayer is “treated as a partnership for federal
tax purposes.” Additionally, any taxpayer that “directly or indirectly distributes one hundred
percent (100%) of its net earnings or net losses to a public REIT” is entirely exempt from the
Tennessee excise tax under TENN. CODE ANN. § 67-4-2019 (2013), provided that the taxpayer is
“treated as a partnership for federal tax purposes.”
Thus, even if a Taxpayer is owned by a public REIT, to take advantage of the exclusion or
exemption under TENN. CODE ANN. §§ 67-6-2006(a)(5), -2019, the Taxpayer must be treated as a
partnership for federal tax purposes. In the question presented, the Taxpayers are described as
limited partnerships that are disregarded for federal tax purposes. As disregarded entities, such
5

In particular, I.R.C. § 856(a)(5) requires that the entity making the REIT election have at least 100 beneficial
owners. Here, none of the Taxpayers described have more than two owners.

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Taxpayers are not treated as partnerships for federal tax purposes but as divisions of the public
REITs.6
Since such federally disregarded Taxpayers are not treated as partnerships for federal tax
purposes, they cannot qualify for the exclusion or exemption under TENN. CODE ANN. §§ 67-42006(a)(5), -2109 even if owned by a public REIT.

Robert C. Guth
Assistant General Counsel
for Taxation

6

APPROVED:

Richard H. Roberts
Commissioner of Revenue

DATE:

12-4-2013

Treas. Reg. § 301.7701-2 clarifies the federal treatment of various business entities, stating that “[a] business entity
with two or more members is classified for federal tax purposes as either a corporation or a partnership,” but that
“[a] business entity with only one owner is classified as a corporation or is disregarded; if the entity is disregarded,
its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner.”

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