In a prior post, we discussed the interaction of Subchapter T (governing cooperatives) and Subchapter M (governing REITs). As explained in the prior post, REITs are Real Estate Investment Trusts that are required to generate a sufficient amount of gross income from real estate-related income (“REIT Income Tests”). In a very similar and recent ruling, the Service concluded that a timber REIT’s receipt of patronage dividends from a financing cooperative should be excluded for purposes of the REIT Income Tests.
The REIT’s primary business is to own and manage timberland properties. It entered into a credit agreement with a financing cooperative to finance its operations. It uses patronage dividends from the financing cooperative to pay off a mortgage of its affiliate. While the REIT and the Service agreed that such patronage dividends constitute gross income, the REIT argued that they should not be considered for purposes of the REIT Income Test.
The REIT argued that because it treated patronage dividends as a reduction in interest expense, it should not incorporate such patronage dividends in the REIT Income Tests. The Service agreed, concluding that even though such dividends are gross income and thus taxable, they are not to be considered for the REIT Income Tests. The Service reasoned that such patronage dividends are effectively refunds of interest paid or reductions in the cost of borrowing from the financing cooperative. In addition, such treatment does not undermine the Congressional policy behind the REIT Income Tests.