What is a Captive Real Estate Investment Trust

A captive real estate investment trust is a REIT that is controlled by a single company and is established for tax purposes. This tax mitigation strategy is generally used by large retailers and banks that have many stores or branches.

BREAKING DOWN Captive Real Estate Investment Trust

A captive real estate investment trust is created to take advantage of tax breaks provided to REITs. There are two types of captive REITs: rental REITs, which are typically used by multi-state retailers, and mortgage REITs, which are used by large banks.

Captive Real Estate Investment Trust And REITs

A captive real estate investment trust is a REIT created for tax purposes. A REIT is a company that has at least three-quarters of its assets made up of real estate and generates three-quarters of gross income from property rents. They must also pay at least 90% of their taxable income as dividends.

Companies use captive real estate investment trusts by transferring their real estate to REITs then they rent the properties from those REITs. This allows the companies to be able to reduce their taxable income by deducting rental payments.

Companies sometimes have to take unusual steps to make this strategy work. For example, to gain the normal tax advantages afforded to REITs the REIT must have at least 100 shareholders. Companies have in some cases named company executives as shareholders in order to meet this requirement.

Captive Real Estate Investment Trust Tax Benefits

A captive real estate investment trust provides certain favorable tax treatments. For example, with a captive REIT, the parent company makes rent payments to the REIT for individual stores or branches. Even those payments are made to its own business entity, these rent payments are then deducted as a business expense, which lowers the parent's taxable income.

Another tax benefit for the parent company is that dividends paid by the REIT to its owners are not subject to corporate income tax. So, the parent company that receives the dividends can use that dividend income to reduce state taxes.

Captive Real Estate Investment Trust And State Law

The federal government eliminated this loophole years ago, but large retailers such as Walmart have used this strategy to reduce their state income taxes. Some states have taken steps to eliminate this tax avoidance tactic, placing restrictions on captive real estate investment trusts.

That is, some states don’t allow REIT dividends to reduce taxable income. States have their own meaning of what defines a captive real estate investment trust, but broadly, it’s any REIT where a single corporation owns more than 50%. Some have disallowed dividend payment deductions for all non-publicly traded REITs in an effort to close the captive real estate investment trust loophole.