IRC 856 REIT Qualification: Income Tests, Asset Tests, and OBBBA 2026 Changes

1. The REIT Income Tests: 75% and 95% Gross Income Requirements

IRC 856(c)(2) and (c)(3) impose two annual gross income tests on every REIT. Both tests are computed on a gross income basis for the entire taxable year. A REIT must satisfy both simultaneously; failing either test subjects the entity to loss of REIT status unless the reasonable cause exception applies.

The 75% Gross Income Test (IRC 856(c)(3))

At least 75% of a REIT's gross income for each taxable year must be derived from qualifying real estate income sources. The qualifying categories are set out in IRC 856(c)(3)(A) through (J):

• Rents from real property, as defined in IRC 856(d). This category is subject to detailed limitations: rents attributable to personal property leased in connection with real property are qualifying only if the personal property rent does not exceed 15% of the total rents received under the lease; impermissible tenant service income (services rendered to tenants beyond those customary for maintaining the space) must not exceed 1% of the rent; and rents from related-party tenants (generally, tenants in which the REIT owns 10% or more directly or indirectly) are excluded from qualifying rents.
• Interest on obligations secured by mortgages on real property or on interests in real property. Participations in mortgage interest also qualify.
• Gain from the sale or disposition of real property (including interests in real property) that is not dealer property within the meaning of IRC 1221(a)(1). Dealer gain triggers the 100% prohibited transaction excise tax under IRC 857(b)(6) rather than qualifying as 75%-test income.
• Dividends or other distributions on, and gain from the sale of, shares in other qualifying REITs.
• Abatements and refunds of taxes on real property.
• Income and gain from foreclosure property (IRC 856(e)). Foreclosure property is real property acquired at or after default on a mortgage held by the REIT, subject to time limits and elections.
• Commitment fees received for agreeing to make loans secured by real property.
• Gain from qualified hedging instruments that hedge indebtedness or income qualifying under the 75% test, provided the hedging transaction satisfies IRC 856(c)(5)(G).
• Amounts received from a domestically controlled REIT in the case of certain distributions attributable to gain from USRPIs.

The 95% Gross Income Test (IRC 856(c)(2))

At least 95% of a REIT's gross income must be derived from a broader set of passive income sources. All income qualifying under the 75% test automatically qualifies for the 95% test. The 95% test adds the following additional qualifying sources:

• Dividends from any corporation (including non-REIT corporations), not just other REITs. Corporate dividend income from operating company stock qualifies for the 95% test even though it does not qualify for the 75% test.
• Interest from any source, not just mortgage interest. Interest income from unsecured loans, working capital accounts, or money market instruments qualifies for the 95% test.
• Gain from the sale of stock or securities, provided the stock or security is not dealer property. Portfolio capital gain from equities counts toward the 95% test even if it does not count toward the 75% test (unless the underlying securities are interests in real property).

The practical effect of the two-tier structure is that a REIT may hold a portfolio with some non-real-estate income (such as dividend income from operating companies or interest on unsecured notes) without violating the income tests, provided that non-real-estate income does not exceed 5% of total gross income and the 75% real-estate-sourced income floor is independently satisfied.

Prohibited Transaction Carve-Out

Income from prohibited transactions -- defined in IRC 857(b)(6)(B) as gain from the sale or other disposition of property that is stock in trade, property held primarily for sale to customers in the ordinary course of business, or dealer property -- is excluded from qualifying income under both the 75% test and the 95% test. A REIT that sells real property in a pattern that establishes dealer status will have that gain treated as prohibited transaction income: it is subject to a 100% excise tax and simultaneously poisons the income test calculation for the year. There is no cure for prohibited transaction income within the income test framework. The IRS applies a facts-and-circumstances dealer analysis, and the safe harbor provisions of IRC 857(b)(6)(C) (which limit the number of qualifying sales and holding periods) are the primary protection.

2. The Four Quarterly Asset Tests Under IRC 856(c)(4)

IRC 856(c)(4) imposes four separate asset tests that must be satisfied at the close of each calendar quarter of the REIT's taxable year. Unlike the income tests, which are measured annually, asset test compliance is tested four times per year. A single quarterly failure is sufficient to trigger disqualification unless a cure applies.

Test 1: The 75% Real Estate Asset Requirement

At least 75% of the value of the REIT's total assets must consist of "real estate assets" as defined in IRC 856(c)(5)(B). Qualifying real estate assets include: real property (land and improvements on land, including buildings and structural components); interests in real property; interests in mortgages on real property; shares in other REITs that qualify under IRC 856; cash and cash items (including receivables); and United States government obligations. Cash and government securities qualify as real estate assets for the 75% test even though they are not real property -- this is a deliberate policy choice that ensures REITs can hold liquid reserves without contaminating their asset test compliance. Intangible assets closely associated with real property (such as in-place lease intangibles) are treated as real property for this purpose under IRS guidance.

Test 2: The 5% Single-Issuer Securities Cap

No more than 5% of the value of the REIT's total assets may consist of securities of any single issuer (other than securities of a qualified REIT subsidiary or a TRS). This test prevents REITs from functioning as concentrated equity portfolios in a single operating company. The 5% cap applies to the aggregate value of all securities (debt and equity) issued by any one non-TRS, non-QRS issuer. A REIT that wishes to invest in corporate operating companies must manage this cap carefully at each quarter-end.

Test 3: The 10% Vote/Value Limit on Single-Issuer Securities

A REIT may not hold securities representing more than 10% of the total voting power or 10% of the total value of the outstanding securities of any single issuer (other than a qualified REIT subsidiary or a TRS). This test operates independently of the 5% value cap: a REIT could satisfy the 5% cap in value terms while still breaching the 10% voting power cap if the issuer is a small company. The practical constraint is that a REIT cannot take effective control of a non-TRS operating company through securities ownership without triggering this asset test.

Test 4: The TRS Asset Ceiling (Restored to 25% by OBBBA)

The total value of TRS securities held by a REIT may not exceed 25% of the value of the REIT's total assets at the close of each quarter. This ceiling was reduced from 25% to 20% by the Tax Cuts and Jobs Act of 2017. OBBBA, effective for tax years beginning after December 31, 2025, restores the ceiling to 25%. The TRS structure is the primary mechanism by which REITs conduct non-real-estate operating activities without having that income contaminate the income tests: TRS subsidiaries pay corporate tax on their income and remit dividends (which are qualifying 95%-test income) to the parent REIT. Practitioners advising REITs with TRS subsidiaries operating hotels, healthcare facilities, or other active businesses should recalibrate TRS value projections under the restored 25% ceiling for 2026 tax years.

Cure Mechanism for Asset Test Failures

IRC 856(c)(4)(B)(iii) provides a cure path for certain asset test failures. If a REIT fails an asset test due to the acquisition of securities or other property (not merely due to value fluctuations), it must dispose of the asset causing the failure within 30 days after the close of the quarter in which the failure arose. If the failure is due solely to value changes and no new acquisition occurred, the REIT generally has until the close of the immediately following quarter to correct the imbalance. The cure mechanism does not apply to every form of failure and does not prevent the imposition of a tax equal to the greater of $50,000 or the product of the highest corporate rate multiplied by the net income from the non-qualifying assets. Verify the current cure procedure and applicable tax under IRC 856(c)(7) at IRS.gov.

3. Shareholder Tests and the 90% Distribution Requirement

The 100-Shareholder Test (IRC 856(a)(5))

A REIT must be beneficially owned by 100 or more persons during at least 335 days of a taxable year of 12 months (or during a proportionate part of a shorter taxable year). The 100-shareholder test does not apply to the first taxable year for which a REIT election is made. "Persons" for this purpose includes individuals, corporations, trusts, and other entities. Beneficial ownership is determined without reference to constructive ownership rules. A single corporation that issues multiple classes of shares, each held by different beneficial owners, can satisfy this test through its own shareholder count.

The 5/50 Closely Held Test (IRC 856(a)(6) and IRC 856(h))

Not more than 50% of the value of the outstanding shares of a REIT may be owned (directly or indirectly, applying the constructive ownership rules of IRC 544 as modified by IRC 856(h)) by five or fewer individuals during the last half of the taxable year. This prohibition prevents closely held real estate entities from using the REIT structure to achieve pass-through treatment. The constructive ownership rules attribute stock owned by certain entities to the beneficial owners of those entities and attribute stock owned by family members to each other, creating traps for REIT ownership structures involving trusts, partnerships, or concentrated family ownership.

The 90% Distribution Requirement (IRC 857(a)(1))

A REIT must distribute to shareholders as dividends at least 90% of its REIT taxable income for the taxable year (computed without regard to the dividends paid deduction and excluding net capital gain). Failure to satisfy the 90% distribution requirement means the REIT cannot deduct dividends paid and is subject to tax as a regular C corporation on its undistributed taxable income. Because most REITs operate with significant leverage and rely on the dividends paid deduction to eliminate entity-level tax, the 90% requirement is a continuous operational constraint, not simply a year-end filing consideration.

Dividends declared in the last three months of a calendar year and paid on or before January 31 of the following year may be treated as paid on the last day of the preceding year for purposes of the distribution requirement under IRC 857(b)(8). This provides a limited window to cure a potential shortfall after the REIT determines its taxable income for the year.

The 4% Excise Tax on Undistributed Income (IRC 4981)

Separately from the 90% distribution requirement, IRC 4981 imposes a 4% excise tax on the "excess required distribution" for any calendar year. The required distribution is the sum of: (a) 85% of the REIT's ordinary income for the calendar year; (b) 95% of the REIT's capital gain net income for the calendar year; and (c) 100% of any shortfall from the prior calendar year. If actual distributions made during the calendar year are less than the required distribution, the REIT pays a 4% excise tax on the shortfall. The excise tax computation is calendar-year-based and runs independently of the taxable-year income test. A fiscal-year REIT can satisfy the 90% distribution requirement for its fiscal year while still owing the 4% excise tax on calendar year income not distributed by December 31. Practitioners must calendar both computations separately. Verify current excise tax rates and calculation methodology at IRS.gov.

Investor-level note on OBBBA 199A permanence: OBBBA made the 20% IRC 199A deduction on qualified REIT ordinary dividends permanent, effective for tax years beginning after December 31, 2025. Prior law would have allowed the deduction to expire after December 31, 2025. The deduction rate did not change and the requirement that the dividends be ordinary dividends (not capital gain distributions) was not altered. The full individual ordinary income rate continues to apply to REIT capital gain distributions and to the 20% of ordinary dividends not offset by the 199A deduction. Model the investor-level effective rate using the current ordinary income bracket plus the 199A deduction offset; do not assume a flat 20% rate on all REIT distributions. See the companion guide on Section 199A qualified REIT dividends for full deduction mechanics.

4. Domestically Controlled REIT Status and the FIRPTA Look-Through Rule

A REIT's qualification as a "domestically controlled REIT" (DREIT) determines the FIRPTA treatment of gain realized by foreign investors on the sale of REIT shares. The statutory definition and the regulatory framework for testing DREIT status have both been amended significantly in the 2024-2025 period, and a further proposed rulemaking is currently pending.

Statutory Definition of a DREIT

Under IRC 897(h)(4)(B), a REIT qualifies as a domestically controlled REIT if, at all times during the preceding five-year period (or the period the REIT has been in existence, if shorter), less than 50% of the value of its outstanding stock has been held directly or indirectly by foreign persons. A "foreign person" for this purpose includes a nonresident alien individual, a foreign corporation, a foreign partnership, a foreign trust, or a foreign estate, as well as certain other entities defined under the applicable withholding regulations.

If a REIT qualifies as a DREIT, foreign investors who sell shares of the REIT recognize gain that is generally not subject to FIRPTA tax under IRC 897 or withholding under IRC 1445, because DREIT shares are not treated as United States real property interests (USRPIs). This exemption from FIRPTA is one of the most significant structural advantages of the DREIT classification for foreign capital participation in U.S. real estate through REITs.

The Look-Through Rule and April 2024 Final Regulations

Treasury issued final regulations in April 2024 that addressed how to determine the domestic or foreign character of entities holding REIT shares for purposes of computing the less-than-50% foreign ownership threshold. The 2024 final regulations provided look-through rules for certain entities (including RICs and publicly traded partnerships) but also established look-through treatment for domestic C corporations holding REIT shares in specified circumstances. The treatment of domestic C corporations was the most consequential aspect: under certain conditions, a domestic C corporation holding REIT shares could be looked through to its own shareholders for purposes of testing the REIT's domestic ownership percentage.

October 2025 Proposed Regulations (Reg-109742-25)

In October 2025, Treasury issued proposed regulations under Reg-109742-25 that would modify the look-through treatment of domestic C corporations established by the April 2024 final regulations. The proposed regulations would eliminate look-through treatment of domestic C corporations for DREIT testing purposes in specified circumstances. Under the proposal, a domestic C corporation holding REIT shares would generally be treated as a domestic person (not looked through to its shareholders) when determining the REIT's domestic or foreign ownership percentage. The effect of eliminating the look-through rule is to make it easier for REITs to demonstrate less-than-50% foreign ownership, because domestic C corporation holders would count as domestic persons without attribution to potentially foreign ultimate shareholders.

As of July 2026, the October 2025 proposed regulations have not been finalized. The April 2024 final regulations remain the operative rules until the proposed regulations are finalized and effective. Practitioners advising foreign investors in REITs or structuring REIT ownership vehicles should monitor IRS.gov and the Federal Register for finalization of Reg-109742-25. The look-through treatment of other entity types (RICs, publicly traded partnerships) established by the 2024 final regulations is not currently proposed to be modified by the October 2025 rulemaking.

For a complete analysis of FIRPTA withholding obligations, USRPI classifications, and QFPF exemptions, see the companion guide on IRC 897 FIRPTA.

5. OBBBA 2026 REIT Changes: Three Statutory Modifications

The One Big Beautiful Bill Act (OBBBA), enacted July 4, 2025, contains three provisions directly affecting IRC 856 REIT qualification and REIT tax economics, each effective for tax years beginning after December 31, 2025. These changes require practitioners to revisit REIT structures and investor-level models for calendar-year 2026 and beyond.

Change 1: TRS Asset Ceiling Restored from 20% to 25%

Prior law (TCJA, effective 2018-2025): The maximum percentage of total REIT asset value that could consist of TRS securities was 20% of total assets, as set by IRC 856(c)(4)(B)(ii) as amended by the Tax Cuts and Jobs Act of 2017.

OBBBA change (effective for tax years beginning after December 31, 2025): OBBBA restores the TRS asset ceiling to 25%, the level that existed under prior law before the TCJA reduction. The 25% ceiling was the original threshold established when TRS entities were authorized under the REIT Modernization Act of 1999.

Practical impact: REITs with active operating businesses conducted through TRS subsidiaries (hotel operators, healthcare facility operators, and others) had to constrain TRS operations or manage TRS valuation carefully to stay within the 20% ceiling. The restoration of the 25% ceiling provides an additional 5 percentage points of headroom. For a REIT with total assets of $1 billion, the ceiling increases from $200 million to $250 million of permissible TRS value.

Change 2: IRC 199A Deduction on REIT Ordinary Dividends Made Permanent

Prior law (TCJA, effective 2018-2025): Non-corporate shareholders receiving ordinary dividends from a REIT could deduct 20% of those dividends as "qualified REIT dividends" under IRC 199A(e)(4), reducing the effective tax rate on REIT ordinary income distributions. This benefit was scheduled to expire for taxable years beginning after December 31, 2025, along with the rest of the TCJA individual income tax provisions.

OBBBA change (effective for tax years beginning after December 31, 2025): OBBBA makes the 20% IRC 199A deduction on qualified REIT dividends permanent. The deduction applies to ordinary dividends received from a REIT (not to capital gain distributions or return-of-capital distributions). The deduction rate remains 20%; OBBBA did not change the rate or introduce any new limitation. The income thresholds and phase-in provisions applicable to other qualified business income under IRC 199A do not apply to qualified REIT dividends: the REIT dividend deduction is available to all non-corporate shareholders regardless of taxable income level.

Practical impact: Individual investors in the 37% bracket receiving REIT ordinary dividends face an effective rate of 29.6% (37% x 80% retained income share) rather than the 37% rate that would apply without the deduction, assuming the full 20% deduction is available. The permanence eliminates expiration risk for REIT investors and preserves the pricing assumption in REIT capital market models that incorporated the 199A benefit as a permanent feature.

Change 3: IRC 163(j) EBITDA-Based ATI Floor Permanently Restored

Prior law (TCJA, effective 2018-2021 at EBITDA level; 2022-2025 shifted to EBIT level): The business interest deduction limitation under IRC 163(j) is computed as 30% of "adjusted taxable income" (ATI). For 2018-2021, ATI was computed by adding back depreciation and amortization (an EBITDA-based floor). Beginning in 2022 under TCJA's scheduled phase-down, ATI was computed without the depreciation and amortization addback (an EBIT-based floor), making the 163(j) limitation more restrictive for asset-heavy, highly leveraged entities such as REITs.

OBBBA change (effective for tax years beginning after December 31, 2025): OBBBA permanently restores the EBITDA-based ATI computation (addback for depreciation and amortization) for all taxpayers subject to IRC 163(j). The restoration is permanent, not subject to a sunset date.

Practical impact on REITs: REITs are generally "excepted real property trades or businesses" under IRC 163(j)(7)(B) if they make an election to be treated as such (with the consequence that they must use the alternative depreciation system for real property). REITs that have made the real property trade or business election are generally exempt from IRC 163(j) limitation at the entity level. However, TRS subsidiaries (which are taxed as C corporations, not REITs) are subject to IRC 163(j). The EBITDA restoration directly benefits TRS subsidiaries with significant depreciation charges, increasing their allowable interest deduction and reducing TRS-level taxable income. For planning purposes on TRS-level 163(j) compliance, see the companion guide on IRC 469 passive activity rules and the interaction with real estate professional status for REIT investors.

6. REIT Qualification Requirement Matrix

The table below summarizes the primary IRC 856 REIT qualification requirements, applicable thresholds, testing periods, and available cure or remedy mechanisms. Verify current statutory thresholds and regulatory conditions at IRS.gov before relying on any line item below for client advice.

7. Compliance Traps and Planning Notes

The following callouts identify the most consequential errors and planning opportunities that arise in REIT qualification engagements.

For practitioners advising REITs that conduct significant property sales, the intersection of REIT dealer status with the IRC 1031 like-kind exchange safe harbor is an active planning area. A REIT that exchanges appreciated real property in a qualifying 1031 exchange recognizes no gain at the time of the exchange, thereby avoiding the prohibited transaction analysis for those disposed properties. However, the replacement property received in the exchange is subject to the basis carry-over rules, and eventual disposition of the replacement property requires the same dealer-status analysis.

For REIT cost-segregation strategies, the interaction of REIT asset classification with IRC 1245/1250 depreciation recapture affects both REIT-level and shareholder-level tax outcomes: distributions attributable to Section 1250 unrecaptured gain are taxed at 25% at the shareholder level rather than at the lower long-term capital gain rate, and cost-segregation studies that accelerate depreciation increase the portion of future REIT distributions subject to this higher recapture rate. Model this at the investor level before completing aggressive cost-segregation elections.

8. Frequently Asked Questions: IRC 856 REIT Qualification