Legal Lingo - Real estate taxation: a REIT good idea

Being an aspiring commercial lawyer often means being confronted by complex, often abstract, concepts leading to an often impenetrable wall of jargon for students and trainees. Next up in our Legal Lingo series, which we've introduced to help break down this jargon, is an explanation of what REITs are.

UK Real estate investment trusts (REITs), despite the name, are not trusts. They are companies that carry on a property rental business; they typically own and operate income-producing real estate with money that has been pooled from a large number of investors.

In common with various other jurisdictions, the UK has a specific REIT regime which enables qualifying companies and groups of companies to elect to be treated as REITs for tax purposes.

The range of tax benefits that results from election to be treated as a REIT is a key driver in structuring real estate investment through this vehicle. The tax treatment of REITs includes:

• Exemption from UK corporation tax on the profits (income and capital gains) derived from their qualifying property rental business.
• Instead, distributions of income profits and capital gains by REITs are treated as income from a property business in the hands of the REIT’s shareholders (the investors).
• 20% withholding tax is imposed on any “property income distributions” made to REIT investors, subject to exceptions and reduced rates for some treaty qualified investors (and with a credit against income tax).

This means that qualifying property rental business profits are not taxed at the REIT level and are only taxed once distributed to investors, i.e., subject to income tax for UK individuals (maximum rate of 45%) or corporation tax for UK companies (19% but rising to 25% in April 2023). 

In most cases, the withholding tax acts as a final UK tax for non-UK investors. The policy rationale of the regime is to shift the tax burden up a level, to the investors. To achieve this, REITs must distribute 90% of their tax-exempt income profits each year (gains can be rolled up in the vehicle). 

As the profits are not being taxed at the REIT level, there should be more profits available for distribution while transfers of property-owning REIT subsidiaries should also not carry any “latent” capital gains. This can make REITS a very attractive holding vehicle for UK real estate investments.

REITs are typically listed on a stock exchange, but since April 2022 – and a liberalisation of the rules – it has been possible to have unlisted REITs where certain “institutional investors” hold at least 70% of the ordinary share capital. This liberalisation and the pending increase in UK corporation tax rates means that smaller, private REITs are attracting investor interest.