REIT Qualification: The 75/95 Income and Asset Tests

Introduction

The tax break that makes a REIT a REIT, full pass-through of income with no entity-level corporate tax, is contingent every single year on passing three tests, and the one that catches sponsors is rarely the one they worry about. Most analysts fixate on the headline 90% distribution requirement. The tests that actually constrain what a REIT can own and do are quieter: a 75% gross income test, a 95% gross income test, and a 75% asset test, codified at IRC Sections 856-859. Of these, the 75% income test is the operationally tightest, because it demands income from real estate specifically, not merely passive income. A REIT can drift out of qualification not through a single dramatic event but through a creeping change in its income mix, a new parking operation, a signage contract, a services arrangement with tenants, that nobody flagged as a tax problem until the year-end income test came up short.

The income tests are measured annually. The asset test is measured at the close of each quarter, with a 30-day cure window for inadvertent breaches. Failure on any of the three forces a binary choice between two bad outcomes: outright loss of pass-through status, which converts the REIT into a fully taxable C corporation, or a cure-and-penalty regime that preserves the status but extracts a meaningful penalty tax. This is why the REIT structure itself is built around the tests rather than the other way around: which assets the REIT holds directly, which businesses get pushed into a Taxable REIT Subsidiary, and which lease structures preserve qualifying income are all downstream of the calibration these tests demand.

The 75% test requires that at least 75% of a REIT's annual gross income come from real-estate-derived sources. The qualifying sources include:

75% Gross Income Test (REIT)

The REIT qualification requirement that at least 75% of annual gross income come from real-estate-derived sources, primarily rents from real property, mortgage interest on real property, dividends from other REITs, and gains from disposing of qualifying real estate. The test is one of two income tests (the other being the 95% test); both must be passed each year to maintain REIT tax status.

What "Rent from Real Property" Excludes

The term "rents from real property" is carefully defined and excludes several categories that look like rent but do not qualify:

The trickiest area is impermissible tenant service income (ITSI): income from services the REIT provides to tenants beyond customary services (basic property management, utilities pass-through, security). Services that go beyond customary (full-service concierge, gym operation by the REIT itself, restaurant operation, parking operation by the REIT) generate ITSI. If ITSI exceeds 1% of a property's gross income, all income from that property is treated as non-qualifying, which is the cliff that often catches sponsors who do not understand the threshold.

The ITSI workaround is the Taxable REIT Subsidiary: the REIT pushes the impermissible service business into a TRS, which pays full corporate tax on its income but isolates the contamination from the REIT parent's qualifying-income basket. The TRS is the pressure valve that lets a REIT capture income its tests would otherwise reject; the price is that the income inside the TRS is taxed like any C corporation's, which is where the broader tax mechanics of real estate (depreciation shields, gain deferral) re-enter the analysis. Lodging REITs use TRSs to hold hotel operating businesses; healthcare REITs use TRSs or RIDEA structures for skilled nursing and senior housing operations; data center REITs use TRSs for network services.

The 95% test requires that at least 95% of gross income come from all the sources qualifying under the 75% test plus other passive income sources: interest from any source (not just real-estate-secured), dividends from any corporation (not just REITs), and gains from the sale of securities. The 95% test is the broader of the two and is rarely the binding constraint for a normal REIT; the 75% test is almost always the operationally tighter one because the 75% test specifically requires real-estate-derived income, while the 95% test allows broader passive sources.

The asset test requires that at least 75% of the value of a REIT's total assets be represented by real estate assets, cash and cash items, and government securities. The test applies on the last day of each quarter and is the most operationally constraining of the three tests because asset composition can shift quickly with acquisitions, dispositions, and value changes in the underlying assets.

75% Asset Test (REIT)

The REIT qualification requirement that at least 75% of the value of a REIT's total assets, measured on a fair-market-value basis at the end of each quarter, consist of real estate assets, cash, cash items, and government securities. It applies quarterly rather than annually, with a 30-day cure window for breaches and a longer penalty-bearing procedure for failures not cured in that window.

Several additional asset-test limits apply:

The 25% TRS cap is the most operationally visible constraint. A lodging REIT with substantial hotel-operating-business income flowing through TRSs may push close to the 25% threshold and have to manage the cap actively as the operating business grows relative to the property portfolio.

These specific thresholds are creatures of the US Internal Revenue Code, but the architecture travels. The UK REIT regime imposes its own balance-of-business tests (at least 75% of profits and 75% of assets must come from the tax-exempt property rental business), and other jurisdictions that copied the US model, France's SIIC, Singapore's S-REITs, Japan's J-REITs, layer on analogous income and asset qualification rules. The numbers differ; the logic, that the tax exemption is conditioned on staying genuinely real-estate-focused, is the same everywhere.

Quarterly Compliance and the 30-Day Cure

The asset test is checked at the close of each quarter. A REIT that breaches the test has a 30-day cure window after the quarter-end, during which the REIT can dispose of non-qualifying assets to bring composition back into compliance. The 30-day cure protects against inadvertent breaches caused by a single acquisition that pushed the REIT over a threshold; the cure mechanism preserves REIT status if remediated within the window.

The penalty regime also applies to the 75% and 95% income test failures: a REIT that fails an income test can preserve REIT status by paying a penalty tax equal to the corporate-rate tax on the non-qualifying income amount that pushed it over the threshold, provided the failure was due to reasonable cause and the REIT files the required disclosures. The penalty is structurally less punitive than the asset test penalty because income shortfalls are typically remedied through prospective rebalancing rather than asset disposition.

The tests interact in ways that drive REIT structural decisions. A REIT that buys an operating business inside its tax-exempt REIT parent risks both the 75% income test (because operating income may be non-qualifying) and the 75% asset test (because the operating business's working capital and intangibles count as non-real-estate assets). The standard solution is to acquire the operating business inside a TRS structure that keeps the contamination isolated from the parent REIT.

Read the table top to bottom and a pattern emerges: nearly every qualification problem a REIT runs into is solved the same way, by relocating the offending activity into a TRS so the contamination stays out of the parent's qualifying baskets. The exceptions are the cash and TRS-cap rows, which are sizing problems rather than contamination problems and get solved by deployment timing and dividend management instead.