Maryland law provides beneficial rules for certain captive REITS: PwC

New Maryland law provides beneficial rules for certain ‘captive’ REITS

May 2023

In brief

SB 968, signed into law on May 9 by Maryland Governor Wes Moore (D), amends the definition of ‘captive REIT’ for purposes of the Maryland corporate income tax. Generally, under federal tax law, an otherwise qualified real estate investment trust (REIT) that distributes at least 90% of its income to shareholders may deduct from taxable income the amount of dividends paid during the tax year (known as the ‘dividends paid deduction’ or DPD), typically eliminating the federal tax on that income at the federal level.

Prior to the enactment of SB 968, Maryland generally disallowed the DPD for certain captive REITs ‒ that is, REITs that are owned or controlled by a single entity that are not qualified REITs or “other entities” exempt from the definition of captive REIT. These captive REITs were required to add back the federal DPD when calculating their Maryland taxable income. SB 968 provides the DPD for certain qualifying captive REITs that meet foreign ownership requirements and exemptions for tax year 2023 and beyond.

The takeaway: Certain taxpayers that are owned by foreign entities that are taxed in their country of origin in a manner similar to the US REIT tax regime, other than listed Australian property trusts (LAPT)s, could have previously been determined to be a ‘captive REIT’. These taxpayers were potentially required to add back their federal DPD when calculating Maryland taxable income may now qualify for the DPD. This legislation further expands the definition of excluded entities and brings Maryland in line with other states that have adopted similar statutes consistent with the Multistate Tax Commission model statute.

In detail

Under Maryland law, a ‘captive REIT’ must add back to federal taxable income the DPD allowed under the Internal Revenue Code (IRC). Under Maryland Sec. 10-306.2(a)(1), a captive REIT is defined as a corporation, trust, or association (1) that is considered a real estate investment trust for the tax year under IRC section 856, (2) that is not regularly traded on an established securities market; and (3) more than 50% of the voting power or value of the beneficial interests or shares of which, at any time during the last half of the tax year, is owned or controlled, directly or indirectly, by a single entity that is taxable as a C corporation under the IRC. However, the statute provided exclusions from this definition for certain qualifying entities, excluding a tax-exempt IRC Section 501 entity, a listed Australian property trust, and REITs that are intended to become regularly traded on an established securities market and that meet other requirements.

SB 968 expands the scope of entities that are excluded from the definition of a captive REIT, thereby eliminating the addback of the DPDs for qualifying entities when calculating Maryland corporate income tax. Under the new amendment, the following entities also are excluded from the definition of a ‘captive REIT’:

corporations, trusts, or associations owned or controlled (determined by 50% of the voting power or value of the beneficial interests or shares) by certain ‘qualified foreign entities,’ and

certain trusts directly or indirectly owned or controlled (determined by 75% or more of the voting power or value of beneficial interests or shares) by a listed Australian property trust

‘Qualified foreign entities’ are defined as a corporation, trust, association, or partnership that is organized under the laws of a foreign government if all of the following conditions are met:

at least 75% of the total asset value of the entity at the close of the entity’s tax year is represented by real estate assets, as defined in IRC Section 856, cash and cash equivalents, and US government securities;

is not subject to tax on amounts distributed to the entity’s beneficial owners or is exempt from entity-level taxation;

on an annual basis, the entity distributes at least 85% of the taxable income of the entity, as computed in the jurisdiction in which the entity is organized, to the holders of the shares or certificates of the beneficial interests of the entity;

not more than 10% of the voting power or value of the beneficial interests or shares of the entity is owned or controlled directly, indirectly, or constructively by a single entity or individual, or the beneficial interests or shares of the entity are regularly traded on an established securities market; and

the entity is organized in a foreign country that has a tax treaty with the United States.

NOTE: Maryland HB 337 also proposed changes to the taxation of REITs, which would have required an additional modification under the personal and corporate income tax for amounts deducted for dividends paid for REITs. HB 337 was introduced on January 25, and a public hearing was held February 9; however, the bill did not progress before the legislative session ended in April.