When a single company or investor controls a real estate investment trust, it is known as a
captive real estate investment trust. It is set up to take ownership of the real estate assets
of the parent company for tax purposes.
A company that has ownership in business-related real estate may find this process of
bundling the property into a REIT for special tax breaks. This tax cushioning is usually used
by banks and retailers with many branches or stores.
How does a Captive Real Estate Investment work?
A captive REIT is set up to capitalize on the tax breaks given to REITs. There are two types
of captive REITs.
● Rental REITs
● Mortgage REITs
While large banks make use of mortgage REITs, the majority of the multi-state retailers use
rental REITs. Mortgage REITs (mREITs) provide mortgage capital while promising a
corresponding income, which is actually the basis of REIT revenue.
A company may also choose to use captive real estate investment trust by converting the
real estate into a REIT, and subsequently renting the properties from those REITs.
Companies may choose to hold controlling possession of a REIT or develop a REIT for
captive status. Captive status or controlling status of a REIT is defined as having a voting
stake that is more than 50% of the REIT.
Understanding the difference between Captive REIT and REIT
A captive REIT defines a REIT that is created for the purpose of tax. Beyond that, captive
REITs are just REITs. A REIT refers to a company that owns real estate as most of its assets
and produces rental income from such assets. A company can be classified as a REIT if it
meets the requirement of Title 26 of the Internal Revenue Code and other conditions of the
Internal Revenue Service.
- Direct Real Estate Investing Vs. REITs
- Equity REIT Vs Mortgage REIT
- What Are The Risks Of Real Estate Investment Trusts
- What Are The Different Types Of REITs
REITs can be associations, corporations, or trusts. However, they must all be taxed as
corporations. 90% of the taxable income generated by REITs has to be paid as dividends.
Companies utilize captive REIT by transferring their real estate to a real estate investment
trust and then rent out those properties from the REITs. This helps the companies to
decrease their income tax by subtracting rental payments.
Many times companies have to take unique steps for their strategy of paying less tax to
work. For example, if a REIT needs to gain the normal tax benefits given to all real estate
investments trusts, it would need to have a minimum of a hundred shareholders. There are
instances where the company has named company executives as shareholders so as to
satisfy this requirement.
Tax benefits of Captive Real Estate Investment Trust
Captive REITs are considered subsidiaries, and their ownership is accounted for in the
parent company’s financials in three ways. The parent company can report consolidated
financial statements, or the company can account for the ownership through the cost method
or equity method.
Captive REITs provide some favorable tax treatments. With captive real estate investment
trusts, the parent company pays rent to the REIT for their individual branches and stores.
These payments are remitted to the business entity, post which the rental payments are
subtracted as business expenses. This helps in lowering the taxable income of the parent
The other tax benefit that the parent company enjoys is the fact that the dividends that the
REIT pays to its owner aren’t subject to corporate income tax. This makes the parent
company receiving the dividends capable of reducing state taxes by utilizing the dividend
Laws governing Captive Real Estate Investment Trust
Captive REIT subsidiaries have the potential of creating several advantages and hence
there are certain federal and state provisions that target REITs investment. Normally, most
legislation states captive as controlling ownership of 50% or more. Federal laws state that all
treatments should be fair and in line with property valuations and suitable negotiations.
Some states, however, have their own special requirements. In some scenarios, there are
limitations that could eliminate tax avoidance strategies by parent companies
comprehensively. Different states have different meanings about what a captive REIT is, but
broadly speaking, it is any real estate investment trust where only a single corporation owns
more than 50% of the shares.
Accounting and tax professionals should always ensure that captive REIT and captive REIT
accounting is fully compliant with federal and state laws.