Regulations Clarify How REITs Can Sell or Transfer Key Tax Credits

On April 25, 2024, the Treasury Department released final regulations under Internal Revenue Code Section 6418, providing clarity regarding the transfer and sale of certain tax credits by, or on behalf of, a Real Estate Investment Trust (REIT). The overview below illustrates how these clarifications equate to a win, particularly for environmentally conscious REITs.

What Do the REIT Regulations Say About Selling or Transferring Certain Tax Credits?

The final regulations clarify two important aspects of a REIT selling or transferring tax credits. The regulations specify that:

1. Any consideration, such as cash, received in the transaction is excluded from the calculation of a REIT’s gross income.
2. The sale or transfer of a credit(s) is not considered a prohibited transaction as defined in the tax code. That means the sale or transfer will not count as one of the seven allowable sales described in those provisions.

Why Are These Clarifications Important for REITs?

Certain assets are disregarded in determining whether a REIT meets the asset tests referenced within Section 856(c)(4). For example, REITs may earn eligible credits — such as the advanced manufacturing production credit under Section 45X, the clean electricity production credit under Section 45Y or the clean fuel production credit under Section 45Z — and elect to transfer all or a portion of an eligible credit to an unrelated taxpayer. Eligible credits that have not been transferred are disregarded for purposes of the REIT asset tests. Additionally, the value of those credits is excluded in determining the value of the REIT’s total assets under Section 856(c)(4). In other words, the exclusion will have no impact on a REIT’s qualification tests.

Further, a REIT may be eligible to claim several tax credits, including:

• Investment tax credit for investing in solar assets under Section 48, and
• Credit for electric vehicle charging stations

However, the ability to benefit from the credits through a reduction of taxes payable may be limited, since a REIT will generally not pay federal income tax if it distributes 100% of its REIT taxable income.

What are the Facts Within the Final Regulations?

Section 856(c)(5)(J)(ii) provides the Secretary of the Treasury with the authority to determine whether any item of income or gain that would otherwise constitute nonqualifying income under the gross income tests should be considered qualifying gross income under both the 75% and 95% income tests.

Recent examples of the exercise of this authority can be found in Private Letter Ruling 202405001, whereby a REIT had zero basis in bonds received from, and issued by, a local governmental body to finance construction costs of certain property. The secretary ruled the gain from the bonds, including gain from receipt of partial principal payments, constituted qualifying income for purposes of the 75% and 95% tests.

What is the Ultimate Impact of These Regulations on REITs?

As previously referenced, a REIT may be eligible to claim certain tax credits, for example, from its investments in solar assets or a credit for electric vehicle charging stations. However, a REIT’s ability to benefit from the credits may be limited, as a REIT will generally not pay federal income taxes if it distributes 100% of its REIT income.

The final regulations make it clear that eligible tax credits, which have yet to be sold or transferred by a REIT, are disregarded for purposes of the asset tests under Section 856(c)(4). Further Section 6418, enacted as part of the Inflation Reduction Act of 2022, allows eligible taxpayers to transfer all or a portion of eligible credits to unrelated taxpayers in exchange for cash beginning after December 31, 2022. In turn, the transferee(s) are allowed to claim the transferred credits on their tax returns. Additionally, the cash payments are excluded from gross income of the eligible taxpayers and are not deductible by the unrelated taxpayers.

The final regulations apply to tax years ending on or after April 30, 2024, and make it clear that participation in these credit programs should not cause a REIT to run afoul of the prohibited transaction rules causing a REIT to pay a 100% tax on the transaction.

This ruling is a win for REITs, especially a REIT’s management team that prioritizes and implements environmentally friendly choices. These values are top of mind for investors and are equally as important for the REIT industry.

Contact Dave Sobochan or a member of your service team to discuss this topic further.

Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.