To amend the Internal Revenue Code of 1986 to simplify certain provisions applicable to real estate investment trusts.

August 1 (legislative day, JULY 21), 2003

Mr. HATCH (for himself, Mr. BREAUX, Mr. SMITH, Mr. LOTT, and Ms. SNOWE) introduced the following bill; which was read twice and referred to the Committee on Finance

To amend the Internal Revenue Code of 1986 to simplify certain provisions applicable to real estate investment trusts.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE.

This Act may be cited as the `Real Estate Investment Trust Improvement Act of 2003'.

SEC. 2. AMENDMENT OF 1986 CODE.

Except as otherwise expressly provided, whenever in the Act an amendment or repeal is expressed in terms of an amendment to, or repeal of, a section or other provision, the reference shall be considered to be made to a section or other provision of the Internal Revenue Code of 1986.

TITLE I--REIT CORRECTIONS

SEC. 101. REVISIONS TO REIT ASSET TEST.

(a) EXPANSION OF STRAIGHT DEBT SAFE HARBOR- Section 856 (defining real estate investment trust) is amended--

(1) in subsection (c) by striking paragraph (7), and

(2) by adding at the end the following new subsection:

`(m) SAFE HARBOR IN APPLYING SUBSECTION (c)(4)-

`(1) IN GENERAL- In applying subclause (III) of subsection (c)(4)(B)(iii), except as otherwise determined by the Secretary in regulations, the following shall not be considered securities held by the trust:

`(A) Straight debt securities of an issuer which meet the requirements of paragraph (2).

`(B) Any loan to an individual or an estate.

`(C) Any section 467 rental agreement (as defined in section 467(d)), other than with a person described in subsection (d)(2)(B).

`(D) Any obligation to pay rents from real property (as defined in subsection (d)(1)).

`(E) Any security issued by a State or any political subdivision thereof, the District of Columbia, a foreign government or any political subdivision thereof, or the Commonwealth of Puerto Rico, but only if the determination of any payment received or accrued under such security does not depend in whole or in part on the profits of any entity not described in this subparagraph or payments on any obligation issued by such an entity.

`(F) Any security issued by a real estate investment trust.

`(G) Any other arrangement as determined by the Secretary.

`(2) SPECIAL RULES RELATING TO STRAIGHT DEBT SECURITIES-

`(A) IN GENERAL- For purposes of paragraph (1)(A), securities meet the requirements of this paragraph if such securities are straight debt, as defined in section 1361(c)(5) (without regard to subparagraph (B)(iii) thereof).

`(B) SPECIAL RULES RELATING TO CERTAIN CONTINGENCIES- For purposes of subparagraph (A), any interest or principal shall not be treated as failing to satisfy section 1361(c)(5)(B)(i) solely by reason of the fact that the time of payment of such interest or principal is subject to a contingency, but only if--

`(i) any such contingency does not have the effect of changing the effective yield to maturity, as determined under section 1272, other than a change in the annual yield to maturity which either--

`(I) does not exceed the greater of 1/4 of 1 percent or 5 percent of the annual yield to maturity, or

`(II) results solely from a default or the exercise of a prepayment right by the issuer of the debt, or

`(ii) neither the aggregate issue price nor the aggregate face amount of the issuer's debt instruments held by the trust

exceeds $1,000,000 and not more than 12 months of unaccrued interest can be required to be prepaid thereunder.

`(C) SPECIAL RULES RELATING TO CORPORATE OR PARTNERSHIP ISSUERS- In the case of an issuer which is a corporation or a partnership, securities that otherwise would be described in paragraph (1)(A) shall be considered not to be so described if the trust holding such securities and any of its controlled taxable REIT subsidiaries (as defined in subsection (d)(8)(A)(iv)) hold any securities of the issuer which--

`(i) are not described in paragraph (1) (prior to the application of paragraph (1)(C)), and

`(ii) have an aggregate value greater than 1 percent of the issuer's outstanding securities.

`(3) LOOK-THROUGH RULE FOR PARTNERSHIP SECURITIES-

`(A) IN GENERAL- For purposes of applying subclause (III) of subsection (c)(4)(B)(iii)--

`(i) a trust's interest as a partner in a partnership (as defined in section 7701(a)(2)) shall not be considered a security, and

`(ii) the trust shall be deemed to own its proportionate share of each of the assets of the partnership.

`(B) DETERMINATION OF TRUST'S INTEREST IN PARTNERSHIP ASSETS- For purposes of subparagraph (A), with respect to any taxable year beginning after the date of the enactment of this subparagraph--

`(i) the trust's interest in the partnership assets shall be the trust's proportionate interest in any securities issued by the partnership (determined without regard to subparagraph (A)(i) and paragraph (4), but not including securities described in paragraph (1)), and

`(ii) the value of any debt instrument shall be the adjusted issue price thereof, as defined in section 1272(a)(4).

`(4) CERTAIN PARTNERSHIP DEBT INSTRUMENTS NOT TREATED AS A SECURITY- For purposes of applying subclause (III) of subsection (c)(4)(B)(iii)--

`(A) any debt instrument issued by a partnership and not described in paragraph (1) shall not be considered a security to the extent of the trust's interest as a partner in the partnership, and

`(B) any debt instrument issued by a partnership and not described in paragraph (1) shall not be considered a security if at least 75 percent of the partnership's gross income (excluding gross income from prohibited transactions) is derived from sources referred to in subsection (c)(3).

`(5) SECRETARIAL GUIDANCE- The Secretary is authorized to provide guidance (including through the issuance of a written determination, as defined in section 6110(b)) that an arrangement shall not be considered a security held by the trust for purposes of applying subclause (III) of subsection (c)(4)(B)(iii) notwithstanding that such arrangement otherwise could be considered a security under subparagraph (F) of subsection (c)(5).'.

SEC. 102. CLARIFICATION OF APPLICATION OF LIMITED RENTAL EXCEPTION.

Subparagraph (A) of section 856(d)(8) (relating to special rules for taxable REIT subsidiaries) is amended to read as follows:

`(A) LIMITED RENTAL EXCEPTION-

`(i) IN GENERAL- The requirements of this subparagraph are met with respect to any property if at least 90 percent of the leased space of the property is rented to persons other than taxable REIT subsidiaries of such trust and other than persons described in paragraph (2)(B).

`(ii) RENTS MUST BE SUBSTANTIALLY COMPARABLE- Clause (i) shall apply only to the extent that the amounts paid to the trust as rents from real property (as defined in paragraph (1) without regard to paragraph (2)(B)) from such property are substantially comparable to such rents paid by the other tenants of the trust's property for comparable space.

`(iii) TIMES FOR TESTING RENT COMPARABILITY- The substantial comparability requirement of clause (ii) shall be treated as met with respect to a lease

to a taxable REIT subsidiary of the trust if such requirement is met under the terms of the lease--

`(I) at the time such lease is entered into,

`(II) at the time of each extension of the lease, including a failure to exercise a right to terminate, and

`(III) at the time of any modification of the lease between the trust and the taxable REIT subsidiary if the rent under such lease is effectively increased pursuant to such modification.

With respect to subclause (III), if the taxable REIT subsidiary of the trust is a controlled taxable REIT subsidiary of the trust, the term `rents from real property' shall not in any event include rent under such lease to the extent of the increase in such rent on account of such modification.

`(iv) CONTROLLED TAXABLE REIT SUBSIDIARY- For purposes of clause (iii), the term `controlled taxable REIT subsidiary' means, with respect to any real estate investment trust, any taxable REIT subsidiary of such trust if such trust owns directly or indirectly--

`(I) stock possessing more than 50 percent of the total voting power of the outstanding stock of such subsidiary, or

`(II) stock having a value of more than 50 percent of the total value of the outstanding stock of such subsidiary.

`(v) CONTINUING QUALIFICATION BASED ON THIRD PARTY ACTIONS- If the requirements of clause (i) are met at a time referred to in clause (iii), such requirements shall continue to be treated as met so long as there is no increase in the space leased to any taxable REIT subsidiary of such trust or to any person described in paragraph (2)(B).

`(vi) CORRECTION PERIOD- If there is an increase referred to in clause (v) during any calendar quarter with respect to any property, the requirements of clause (iii) shall be treated as met during the quarter and the succeeding quarter if such requirements are met at the close of such succeeding quarter.'.

SEC. 103. DELETION OF CUSTOMARY SERVICES EXCEPTION.

Subparagraph (B) of section 857(b)(7) (relating to redetermined rents) is amended by striking clause (ii) and by redesignating clauses (iii), (iv), (v), (vi), and (vii) as clauses (ii), (iii), (iv), (v), and (vi), respectively.

SEC. 104. CONFORMITY WITH GENERAL HEDGING DEFINITION.

(a) DEFINITION- Subparagraph (G) of section 856(c)(5) (relating to treatment of certain hedging instruments) is amended to read as follows:

`(G) TREATMENT OF CERTAIN HEDGING INSTRUMENTS- Except to the extent provided by regulations, any income of a real estate investment trust from a hedging transaction (as defined in clause (ii) or (iii) of section 1221(b)(2)(A)) which is clearly identified pursuant to section 1221(a)(7), including gain from the sale or disposition of such a transaction, shall not constitute gross income under paragraph (2) to the extent that the transaction hedges any indebtedness incurred or to be incurred by the trust to acquire or carry real estate assets.'.

SEC. 105. CONFORMITY WITH REGULATED INVESTMENT COMPANY RULES.

Clause (i) of section 857(b)(5)(A) (relating to imposition of tax in case of failure to meet certain requirements) is amended by striking `90 percent' and inserting `95 percent'.

SEC. 106. PROHIBITED TRANSACTIONS PROVISIONS.

(a) EXPANSION OF PROHIBITED TRANSACTION SAFE HARBOR- Section 857(b)(6) (relating to income from prohibited transactions) is amended by redesignating subparagraphs (D) and (E) as subparagraphs (E) and (F), respectively, and by inserting after subparagraph (C) the following new subparagraph:

`(D) CERTAIN SALES NOT TO CONSTITUTE PROHIBITED TRANSACTIONS- For purposes of this part, the term `prohibited transaction' does not include a sale of property which is a real estate asset (as defined in section 856(c)(5)(B)) if--

`(i) the trust held the property for not less than 4 years in connection with the trade or business of producing timber,

`(ii) the aggregate expenditures made by the trust, or a partner of the trust, during the 4-year period preceding the date of sale which--

`(I) are includible in the basis of the property (other than timberland acquisition expenditures), and

`(II) are directly related to operation of the property for the production of timber or for the preservation of the property for use as timberland,

do not exceed 30 percent of the net selling price of the property,

`(iii) the aggregate expenditures made by the trust, or a partner of the trust, during the 4-year period preceding the date of sale which--

`(I) are includible in the basis of the property (other than timberland acquisition expenditures), and

`(II) are not directly related to operation of the property for the production of timber, or for the preservation of the property for use as timberland,

do not exceed 5 percent of the net selling price of the property,

`(iv)(I) during the taxable year the trust does not make more than 7 sales of property (other than sales of foreclosure property or sales to which section 1033 applies), or

`(II) the aggregate adjusted bases (as determined for purposes of computing earnings and profits) of property (other than sales of foreclosure property or sales to which section 1033 applies) sold during the taxable year does not exceed 10 percent of the aggregate bases (as so determined) of all of the assets of the trust as of the beginning of the taxable year,

`(v) in the case that the requirement of clause (iv)(I) is not satisfied, substantially all of the marketing expenditures with respect to the property were made through an independent contractor (as defined in section 856(d)(3)) from whom the trust itself does not derive or receive any income, and

`(vi) the sales price of the property sold by the trust to its taxable REIT subsidiary is not based in whole or in part on the income or profits of the subsidiary or the income or profits that the subsidiary derives from the sale or operation of such property.'.

SEC. 107. EFFECTIVE DATES.

(a) IN GENERAL- Except as provided in subsection (b), the amendments made by this title shall apply to taxable years beginning after December 31, 2000.

(b) SECTIONS 103 THROUGH 106- The amendments made by sections 103, 104, 105 and 106 shall apply to taxable years beginning after the date of the enactment of this Act.

TITLE II--FIRPTA CORRECTION

SEC. 201. MODIFICATION OF THE TREATMENT OF CERTAIN REIT DISTRIBUTIONS ATTRIBUTABLE TO GAIN FROM SALES OR EXCHANGES OF UNITED STATES REAL PROPERTY INTERESTS.

(a) IN GENERAL- Paragraph (1) of section 897(h) (relating to look-through of distributions) is amended by inserting before the period at the end the following: `, except that any distribution by a REIT with respect to any class of stock which is regularly traded on an established securities market located in the Unites States shall not be treated as gain recognized from the sale or exchange of a United States real property interest if the shareholder did not own more than 5 percent of such class of stock during the taxable year.'.

(b) EFFECTIVE DATE- The amendment made by this section shall apply to taxable years beginning after the date of the enactment of this Act.

TITLE III--REIT SAVINGS PROVISIONS

SEC. 301. REVISIONS TO REIT PROVISIONS.

(a) RULES OF APPLICATION FOR FAILURE TO SATISFY SECTION 856(c)(4)- Section 856(c) (relating to definition of real estate investment trust), as amended by section 101, is amended by inserting after paragraph (6) the following new paragraph:

`(7) RULES OF APPLICATION FOR FAILURE TO SATISFY PARAGRAPH (4)-

`(A) DE MINIMIS FAILURE- A corporation, trust, or association that fails to meet the requirements of paragraph (4)(B)(iii) for a particular quarter shall nevertheless be considered to have satisfied the requirements of such paragraph for such quarter if--

`(i) such failure is due to the ownership of assets the total value of which does not exceed the lesser of--

`(I) 1 percent of the total value of the trust's assets at the end of the quarter for which such measurement is done, and

`(II) $10,000,000, and

`(ii)(I) the corporation, trust, or association, following the identification of such failure, disposes of assets in order to meet the requirements of such paragraph within 6 months after the last day of the quarter in which the corporation, trust or association's identification of the failure to satisfy the requirements of such paragraph occurred or such other time period prescribed by the Secretary and in the manner prescribed by the Secretary, or

`(II) the requirements of such paragraph are otherwise met within the time period specified in subclause (I).

`(B) FAILURES EXCEEDING DE MINIMIS AMOUNT- A corporation, trust, or association that fails to meet the requirements of paragraph (4) for a particular quarter shall nevertheless be considered to have satisfied the requirements of such paragraph for such quarter if--

`(i) such failure involves the ownership of assets the total value of which exceeds the de minimis standard described in subparagraph (A)(i) at the end of the quarter for which such measurement is done,

`(ii) following the corporation, trust, or association's identification of the failure to satisfy the requirements of such paragraph for a particular quarter, a description of each asset that causes the corporation, trust, or association to fail to satisfy the requirements of such paragraph at the close of such quarter of any taxable year is set forth in a schedule for such quarter filed in accordance with regulations prescribed by the Secretary,

`(iii) the failure to meet the requirements of such paragraph for a particular quarter is due to reasonable cause and not due to willful neglect,

`(iv) the corporation, trust, or association pays a tax computed under subparagraph (C), and

`(v)(I) the corporation, trust, or association disposes of the assets set forth on the schedule specified in clause (ii) within 6 months after the last day of the quarter in which the corporation, trust or association's identification of the failure to satisfy the requirements of such paragraph occurred or such other time period prescribed by the Secretary and in the manner prescribed by the Secretary, or

`(II) the requirements of such paragraph are otherwise met within the time period specified in subclause (I).

`(C) TAX- For purposes of subparagraph (B)(iv)--

`(i) TAX IMPOSED- If a corporation, trust, or association elects the application of this subparagraph, there is hereby imposed a tax on the failure described in subparagraph (B) of such corporation, trust, or association. Such tax shall be paid by the corporation, trust, or association.

`(ii) TAX COMPUTED- The amount of the tax imposed by clause (i) shall be the greater of--

`(I) $50,000, or

`(II) the amount determined (pursuant to regulations promulgated by the Secretary) by multiplying the net income generated by the assets described in the schedule specified in subparagraph (B)(ii) for the period specified in clause (iii) by the highest rate of tax specified in section 11.

`(iii) PERIOD- For purposes of clause (ii)(II), the period described in this clause is the period beginning on the first date that the failure to satisfy the requirements of such paragraph (4) occurs as a result of the ownership of such assets and ending on the earlier of the date on which the trust disposes of such assets or the end of the first quarter when there is no longer a failure to satisfy such paragraph (4).

`(iv) ADMINISTRATIVE PROVISIONS- For purposes of subtitle F, the taxes imposed by this subparagraph shall be treated as excise taxes with respect to which the deficiency procedures of such subtitle apply.'.

(b) MODIFICATION OF RULES OF APPLICATION FOR FAILURE TO SATISFY SECTIONS 856(c)(2) OR 856(c)(3)- Paragraph (6) of section 856(c) (relating to definition of real estate investment trust) is amended by striking subparagraphs (A) and (B), by redesignating subparagraph (C) as subparagraph (B), and by inserting before subparagraph (B) (as so redesignated) the following new subparagraph:

`(A) following the corporation, trust, or association's identification of the failure to meet the requirements of paragraph (2) or (3), or of both such paragraphs, for any taxable year, a description of each item of its gross income described in such paragraphs is set forth in a schedule for such taxable year filed in accordance with regulations prescribed by the Secretary, and'.

(c) REASONABLE CAUSE EXCEPTION TO LOSS OF REIT STATUS IF FAILURE TO SATISFY REQUIREMENTS- Subsection (g) of section 856 (relating to termination of election) is amended--

(1) in paragraph (1) by inserting before the period at the end of the first sentence the following: `unless paragraph (5) applies', and

(2) by adding at the end the following new paragraph:

`(5) ENTITIES TO WHICH PARAGRAPH APPLIES- This paragraph applies to a corporation, trust, or association--

`(A) which is not a real estate investment trust to which the provisions of this part apply for the taxable year due to one or more failures to comply with one or more of the provisions of this part (other than subsection (c)(6) or (c)(7) of section 856),

`(B) such failures are due to reasonable cause and not due to willful neglect, and

`(C) if such corporation, trust, or association pays (as prescribed by the Secretary in regulations and in the same manner as tax) a penalty of $50,000 for each failure to satisfy a provision of this part due to reasonable cause and not willful neglect.'.

(d) DEDUCTION OF TAX PAID FROM AMOUNT REQUIRED TO BE DISTRIBUTED- Subparagraph (E) of section 857(b)(2) is amended by striking `(7)' and inserting `(7) of this subsection, section 856(c)(7)(B)(iii), and section 856(g)(1).'.

(e) EXPANSION OF DEFICIENCY DIVIDEND PROCEDURE- Subsection (e) of section 860 is amended by striking `or' at the end of paragraph (2), by striking the period at the end of paragraph (3) and inserting `; or', and by adding at the end the following new paragraph:

`(4) a statement by the taxpayer attached to its amendment or supplement to a return of tax for the relevant tax year.'.

(f) EFFECTIVE DATE- The amendments made by this section shall apply to taxable years beginning after date of the enactment of this Act.

END