There are numerous attractions to real estate for investors—potential appreciation, tax advantages, and sometimes passive income. Individual REIT shareholders can effectively gain access to commercial property they would not be able to afford on their own, and can do so without day-to-day interaction with tenants and some of the other quotidian tasks often associated with direct property ownership.
Real Estate Investment Trusts came into view beginning in 1960 and have grown more widespread in the intervening years. Some are privately offered but registered with the SEC, while others trade on securities exchanges and are more widely available. Finally, there is a third type with limited availability accessible only to accredited investors due to the higher risk and limited disclosures.
One advantage of the REIT structure is that the trusts operate as pass-through corporations, meaning that they do not pay federal income taxes as long as they meet these requirements:
The shareholders pay taxes on the income they receive from the REIT and may consider holding those REIT shares in a retirement account with deferred tax recognition.
A captive REIT is one controlled by a single company. Often, the REIT is a subsidiary of a larger organization, and an example might be the real estate division of a corporation with a wide footprint of branch operations. If the parent company complies with the REIT rules, the captive REIT can capture some beneficial tax advantages for the overall organization.
One of the requirements, as noted, is that the REIT must have at least 100 investors or shareholders. Since the captive REIT is a subsidiary of the parent corporation, the parent may name executives as shareholders to meet this requirement. In addition, if the parent pays rent to the REIT, which as a subsidiary owns the properties, the rent payments may be business expenses that are tax deductions for the parent.
In return, the REIT subsidiary earns income that it pays to the executive shareholders (effectively to the parent company) as dividends. Those are not taxable income to the parent corporation. Some individual states have made efforts to limit this tactic in order to preserve their access to revenue.
An outsider (someone who is not an executive in a company using the captive REIT strategy) could indirectly invest by buying shares in a corporation that has a REIT as a subsidiary. Still, an investor would be unlikely to pursue such a narrowly focused approach to selecting investment targets.