In order to maintain its status, a real estate investment trust (REIT) must distribute 90 percent of its taxable income (excluding net capital gain and income from foreclosures but reduced by noncash income). Generally, only dividends actually paid during the taxable year are considered when performing this calculation. Certain events, such as the receipt of a large prepaid rent amount near the end of the tax year, can cause a REIT to fail to meet the distribution requirement.
There are two provisions available to a REIT that fails to meet its distribution requirement. These provisions result in the payment of what are commonly referred to as either year-end dividends or subsequent-year dividends (dividends paid in the following tax year but treated as distributed in the current year).
There are two provisions allowed by the Internal Revenue Code if a REIT fails to meet its distribution requirement.
Section 857(b)(9) of the Internal Revenue Code allows a REIT to treat dividends declared in October, November, or December, and payable to shareholders of record on a specified date within such months, to be deemed paid by the REIT on December 31 of the tax year. In order to qualify, these dividends must be paid during January of the following tax year. While this provision does not allow the REIT to change the amount of the dividend, which has already been declared, it does allow a dividend paid in January to be considered as paid by December 31st of the prior year.
Section 858 of the Internal Revenue Code provides even more flexibility, allowing the REIT to elect a specified dollar amount of a dividend declared in the following year to be treated as having been paid in the current year. This is permitted provided that the dividend is paid before the due date of the REIT’s tax return, including extensions, and prior to its first regular dividend made after such declaration for that subsequent year. These dividends are commonly referred to as “subsequent year” or “spill-over dividends.” The REIT shareholders would report these dividends in the year that they are received by the shareholders.
Due to the fact that the REIT will be able to reduce its taxable income in the current year by a dividend that will not be recognized as income by the shareholder until the following tax year, an interest charge will be assessed on the income reduction resulting from the subsequent year dividend.