Was a privately held REIT a Virginia captive REIT when no partner owned more than 50% and the general partner lacked majority voting or value control?

Subject

Captive Real Estate Investment Trusts

Plain-English summary

REIT 1 was not a captive REIT under Virginia's addback rule. The taxpayer conceded that the REIT was not regularly traded and that more than 25% of its income consisted of real-property rents. The disputed requirement was whether one taxable corporate entity owned or controlled more than 50% of its voting power, value, or beneficial interests.

The REIT was owned through a fund organized as a limited partnership with more than 200 partners, and no partner held more than a 50% share. Applying the federal constructive-ownership rules specified by the Virginia statute, no partner was attributed majority ownership or control.

The fund's general partner could make some decisions without a partner vote, but the facts did not show that it controlled more than 50% of voting power or value. Because the ownership-or-control condition was not met, the REIT did not have to be treated as a captive REIT for the cited dividends-paid-deduction addback.

What this means for you

• Virginia's captive-REIT definition required all statutory conditions to be met.
• Partnership ownership was traced proportionately to the partners under the incorporated federal attribution rules.
• General-partner authority did not automatically equal majority control of voting power or value.
• The conclusion depended on the stated ownership and governance facts; a different concentration of interests or control could change it.

Common questions

Did the REIT avoid captive status because its investors were tax-exempt entities?

The ruling's conclusion turned on the lack of more-than-50% ownership or control by a single qualifying entity, not simply on the investors' exempt status.

Did the general partner's unilateral decision authority create control?

No under the facts described. The Department found that the authority did not appear to control more than 50% of voting power or value.

Citations and references

• Va. Code § 58.1-402(B)(10).
• IRC § 318(a), as modified by IRC § 856(d)(5).
• IRC §§ 856(d), 115, and 501.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 10-246

Original ruling text

October 26, 2010

Re: Ruling Request: Addback for Captive REITs

Dear *:

This is in response to your letter requesting a ruling on the application of Virginia's addback requirement pertaining to Captive Real Estate Investment Trusts ("REITs").

FACTS

A limited partnership (the "Fund") owns membership interests in three separate REITs, which are organized as limited liability companies. One of the REITs, * ("REIT 1 "), derives a portion of its income from properties located in Virginia. REIT 1 owns a 99.9 percent limited partnership interest in *** ("REIT OP"). REIT OP owns single member limited liability companies ("SMLLCs") that are treated as disregarded entities for federal tax purposes and other joint venture interests. It is these SMLLCs and joint ventures that hold the property and income that is sourced to Virginia.

The remaining 0.1 percent general partnership interest in REIT OP is owned by REIT 1's wholly owned subsidiary, * ("REIT GP"). REIT GP is taxed as a corporation for federal income tax, purposes.

The Fund's general partner, * (the "General Partner") is a wholly owned subsidiary of *** (the "Taxpayer"), which is a C corporation. General Partner holds no units in the Fund; but as the general partner of the Fund, General Partner can make certain decisions for the Fund that do not require votes from the rest of the owners.

The limited partners of the Fund are tax-exempt entities, including state and local governmental pension plans exempt under Internal Revenue Code ("IRC") § 115, corporate and multi-employer (Taft-Hartley) pension plans exempt under IRC § 501, and foundations and endowments exempt under IRC § 501. The Fund has over 200 partners and no one partner owns more than a 50 percent share in the Fund.

You request a ruling as to whether REIT 1 is considered a Captive REIT for the purposes of the addback requirement in Va. Code § 58.1-402(B)(10). You contend that it is not, as it is not owned or controlled by a taxable corporate entity and is not used for tax-avoidance purposes.

DETERMINATION

Virginia Code § 58.1-402(B)(10) requires a Captive REIT to add to its federal taxable income the dividends paid deduction allowed under the Internal Revenue Code. A REIT is considered a Captive REIT if it meets the following conditions:

It is not regularly traded on an established securities market;

More than 50 percent of the voting power or value of beneficial interests or shares of which, at any time during the last half of the taxable year, is owned or controlled, directly or indirectly, by a single entity that is (i) a corporation or an association taxable as a corporation under the Internal Revenue Code; and (ii) not exempt from federal income tax pursuant to § 501 (a) of the Internal Revenue Code; and

More than 25 percent of its income consists of rents from real property as defined in § 856(d) of the Internal Revenue Code.

You concede that REIT 1 meets the first and third conditions listed above. You contend, however, that it does not meet the second condition. In order to determine if this position is correct, we must examine the ownership and control of REIT 1.

In determining ownership, Va. Code § 58.1-402(B)(10)(c) states that "the constructive ownership rules prescribed under § 318(a) of the Internal Revenue Code, as modified by § 856(d)(5) of the Internal Revenue Code, shall apply in determining the ownership of stock, assets, or net profits of any person." Under the provisions of IRC § 318(a), stock owned directly or indirectly by or for a partnership is considered as owned proportionately by its partners.

Thus, because REIT 1 is owned by the Fund, which is a limited partnership, we must examine the partners to determine if any of them own a more than 50 percent share in the Fund. You have stated that none of the partners owns more than a 50 percent share. As a result, REIT 1 does not meet the ownership condition of Va. Code § 58.1-402(B)(10)(a).

In determining whether or not REIT 1 meets the second condition, however, we must also examine the entities that have control of the voting power or value of beneficial interests or shares. Again, you have stated that no one partner owns more than a 50 percent share in the Fund. Therefore, by using the same attribution rules discussed above, it is clear that no partner controls more than 50 percent of the voting power or value of beneficial interests or shares.

You have also stated that, as the general partner of the Fund, General Partner can make certain decisions for the Fund that do not require votes from the rest of the owners. While it appears that General Partner may make certain decisions for the Fund on its own, it does not appear from your description that General Partner has control over voting power or the value of beneficial interests or shares. Therefore, I find that REIT 1 also does not meet the control condition of Va. Code § 58.1-402(B)(10)(a).

Because REIT 1 does not meet the second condition of Va. Code § 58.1­402(B)(10)(a), it is not a captive REIT. This ruling is based on the facts presented as summarized above. Any change in facts or the introduction of new facts may lead to a different result.

I hope the foregoing has responded to your inquiry. Should you have additional questions, please contact * in the Office of Tax Policy, Policy Development Division, at ***.

Sincerely,

Craig M. Burns

Acting Tax Commissioner

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