The U.S Department of the Treasury and the Internal Revenue Service on June 24, 2020 issued final tax regulations ("Final Regulations") that permit a regulated investment company (“RIC”) to report to its shareholders the portion of the RIC’s dividends paid that constitutes dividend income from real estate investment trusts (REITs). Such shareholders will be entitled to a special 20% deduction against such dividend income. These regulations finalize, with few modifications, proposed regulations issued in February 2019 ("Proposed Regulations").
Section 199A, enacted as part of the 2017 Tax Cuts and Jobs Act, allows individuals and certain estates or trusts a 20% deduction with respect to certain income. This 20% deduction is available to eligible taxpayers with "qualified business income" earned from qualified trades or businesses operated as sole proprietorships or through partnerships, S corporations, trusts or estates, in addition to qualified REIT dividends and income from publicly-traded partnerships (“PTPs”). Of these categories of income, RICs may earn income from REITs or from PTPs. The Final Regulations provide the pass-through rules for RICs receiving REIT dividend income. However, the Final Regulations do not provide authority for RICs to pass-through income earned from investments in PTPs, leaving that subject to another day. Specifically, a RIC that receives a dividend from a REIT that is a qualified REIT dividend may now report dividends paid to the RIC’s shareholders as eligible for the 20% deduction.
If a RIC has certain items of income, the shareholders of the RIC are permitted, subject to certain limitations, to treat dividends paid by a RIC in the same (or similar) manner as if the shareholder had received the items of income directly. This conduit treatment for the special 20% deduction under Section 199A was adopted in the Proposed Regulations, but solely with respect to qualified REIT dividends. The Final Regulations adopt this treatment with respect to qualified REIT dividends. The IRS noted in the Final Regulations that they continue to consider whether similar treatment should be afforded to qualified PTP income or other income of a RIC.
The Final Regulations are effective on August 24, 2020. In lieu of applying the Final Regulations, taxpayers may elect to apply the Proposed Regulations (which are nearly identical to the Final Regulations) for any tax year ending on or before August 24, 2020. However, taxpayers relying on the Proposed Regulations for tax years ending on or before August 24, 2020 must apply the provisions in a consistent manner for each of those tax years.