Warren Urges IRS to Increase Scrutiny of REITs

Warren Urges IRS to Crack Down on Real Estate Investment Trusts (REITs) Squeezing Health Care and Hotel Industries and Stretching Tax Rules

REITs extracting wealth in health care, hotel industries; subsidized by taxpayers

IRS warns that a REIT breaking tax rules by actively managing lodging facilities “will lose its tax status”

September 4, 2024

Washington, D.C. — U.S. Senator Elizabeth Warren (D-Mass.) urged IRS Commissioner Danny Werfel to increase agency scrutiny to determine whether Real Estate Investment Trusts (REITs) may be violating tax law.

Under the current tax code, REITs can take advantage of lucrative tax breaks at the expense of taxpayers as long as they meet certain passive investment criteria. But earlier this week, the IRS warned against hotel and health care REITs pushing the boundaries of tax law and threatened that such violations would result in loss of their special tax status. In a new letter, Senator Warren applauded the new IRS clarification while urging the agency to increase its scrutiny of private companies' potential abuse of REIT tax breaks.

“Under the tax code, REITs can take advantage of lucrative tax breaks — including avoiding the 21 percent corporate income tax and qualifying for the 20 percent pass-through deduction for investors. REITs are supposed to be passive investment opportunities for smaller-scale investors . . . (but) REITs in the health care and hotel industries may be violating these tax rules,” wrote Senator Warren.

Senator Warren underscores the pattern of REITs in the health care and hotel industries that may have been violating relevant tax rules — from a REIT purchasing hospital properties which later drove Steward Health Care into bankruptcy, to taxable REIT subsidiaries negotiating agreements with hotel operators to influence labor terms.

“In Massachusetts, Medical Properties Trust (MPT) — a REIT that bought hospital properties from Steward Health Care (Steward) in 2016, saddling the hospitals with expensive lease agreements that ultimately drove Steward into bankruptcy — has a complex investment history with Steward that raises questions about whether it has met IRS requirements regarding the limitations on a REIT's ownership of a tenant or an operator. Meanwhile, taxable REIT subsidiaries (TRSs) have negotiated agreements with hotel operators that give the TRS the right to exert significant control over labor terms, including vetoing collective bargaining agreements negotiated with hotel workers and participating in negotiations with hotel employee labor unions,” wrote Senator Warren.

“As the IRS continues to identify massive corporations and businesses that may be violating tax law, I urge you to increase enforcement scrutiny of REITs, especially large health and hospitality REITs that may be illegally claiming significant tax breaks while meddling in the operations of their tenants. Decades-long underfunding of the IRS may have let bad actors feel safe to claim large REIT tax breaks while violating REIT rules, but such tax cheating should not be allowed to continue,” Senator Warren concluded.

Throughout her career, Senator Warren has advocated for strong enforcement against wealthy tax cheats:

• In June 2024, Senators Warren and Markey (D-Mass.) introduced the Corporate Crimes Against Health Care Act of 2024 to root out corporate greed and private equity abuse in the health care system. The bill includes provisions to prohibit payments from federal health programs to entities that sell assets or use assets for a loan collateral made to a REIT, with an exemption for current arrangements; repeal a rule in the Tax Code that allows taxable REIT subsidiaries to exert influence on the operations of health care entities; and remove the 20 percent pass-through deduction, passed in the 2017 Trump tax cuts, for all REIT investors.

• In March 2024, Senators Warren, Markey (D-Mass.), Sanders (I-Vt.), Wyden (D-Ore.), Whitehouse (D-R.I.), and Van Hollen (D-Md.) sent a letter to the Department of Treasury and the IRS, applauding action to increase audits of corporate jet usage and urging both agencies to use their rulemaking authority to close a loophole that allows corporate executives to undervalue, and minimize taxes paid, when they use corporate jets for personal travel.

• In March 2023, Senators Warren, Van Hollen (D-Md.), Sanders (I-Vt.), and Whitehouse (D-R.I.) sent a letter to Treasury Secretary Janet Yellen, urging her to use the full extent of the Treasury Department's regulatory authority to crack down on the ultra-wealthy's use of trusts to dodge paying their fair share in taxes.

• In March 2023, Senators Warren and Angus King (I-Maine) led a letter with 19 other senators to IRS Commissioner Daniel Werfel and Treasury Secretary Janet Yellen, expressing strong support for Secretary Yellen's directive that the IRS not raise audit rates for small businesses or households making under $400,000 annually and that new enforcement funds provided in the Inflation Reduction Act focus on reducing tax avoidance by large corporations and the mega-rich.

• In May 2021, Senator Warren introduced the Restoring the IRS Act of 2021, which would provide the IRS with the resources it needs to go after wealthy tax cheats and close the tax gap. The bill would rebuild and strengthen the IRS by permanently removing the IRS's base budget from the annual appropriations process and providing $31.5 billion in mandatory annual funding — funding which would allow the IRS to fairly enforce the tax code, modernize its IT systems, and improve taxpayer services.

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September 3, 2024

The Honorable Daniel Werfel
Commissioner
Internal Revenue Service
1111 Constitution Ave. NW
Washington, D.C. 20224

Dear Commissioner Werfel:

I write to encourage you to increase scrutiny of potential violations of tax law by Real Estate Investment Trusts (REITs), which experts warn include “financial actors that aggressively buy up property assets and manage them to extract wealth at taxpayers' expense,” including in the health care and hotel industries.¹ Your leadership, and the increased funding for the Internal Revenue Service (IRS) included in the Inflation Reduction Act, are helping to ensure that the wealthy and large businesses pay the taxes they owe.² As part of those ongoing enforcement efforts, I appreciate the IRS's recent warning that REITs must follow tax rules that bar them from managing lodging facilities,³ and I urge you to increase IRS scrutiny of potential abuse of REIT tax breaks by private companies.

Under the tax code, REITs can take advantage of lucrative tax breaks — including avoiding the 21 percent corporate income tax and qualifying for the 20 percent pass-through deduction for investors.⁴ REITs are supposed to be passive investment opportunities for smaller-scale investors and are subject to certain asset and income tests meant to reflect that passivity, including a prohibition on owning securities that represent more than 10 percent of the total voting power or value of a tenant, a ban on directly or indirectly operating or managing a lodging facility, and a ban on owning more than a 35 percent stake in an operator.⁵

REITs in the health care and hotel industries may be violating these tax rules. In Massachusetts, Medical Properties Trust (MPT) — a REIT that bought hospital properties from Steward Health Care (Steward) in 2016, saddling the hospitals with expensive lease agreements that ultimately drove Steward into bankruptcy — has a complex investment history with Steward that raises questions about whether it has met IRS requirements regarding the limitations on a REIT's ownership of a tenant or an operator.⁶ Meanwhile, taxable REIT subsidiaries (TRSs) have negotiated agreements with hotel operators that give the TRS the right to exert significant control over labor terms, including vetoing collective bargaining agreements negotiated with hotel workers and participating in negotiations with hotel employee labor unions.⁷

In an August 26, 2024 letter to Senate Finance Committee Chair Ron Wyden, IRS Chief Counsel Marjorie Rollinson recently warned against such behavior. Rollinson clarified the law and IRS's interpretation of it, warning that some REITs were at risk of losing their special tax status:

The law is clear that a TRS may not directly or indirectly operate or manage a lodging facility. If it does, it will lose its special tax status with potentially severe adverse tax consequences for its REIT owner. If a REIT and TRS avail themselves of the exception to the related party rent rule discussed above, operation and management of the qualified lodging facility must be performed by the eligible independent contractor.⁸

Rollinson continued:

Unfortunately, we have become aware that some in the industry have advocated the view that an appropriate structure is for the TRS to lease the qualified lodging facility from the REIT and indirectly operate the qualified lodging facility. Any TRS that implements such an approach will lose its tax status. That may cause its REIT owner to fail one or more of its qualification requirements. That in turn would cause the REIT to lose its tax status for five years, including the ability to deduct dividends paid to shareholders, and become fully subject to the corporate tax.⁹

I appreciate this clarification of REIT rules, and that “the IRS takes seriously the proper enforcement of the tax rules, including those governing REITs.”¹⁰ As the IRS continues to identify massive corporations and businesses that may be violating tax law, I urge you to increase enforcement scrutiny of REITs, especially large health and hospitality REITs that may be illegally claiming significant tax breaks while meddling in the operations of their tenants. Decades-long underfunding of the IRS may have let bad actors feel safe to claim large REIT tax breaks while violating REIT rules, but such tax cheating should not be allowed to continue

Sincerely,

Elizabeth Warren
United States Senator