Chartered Financial Analyst Level 2
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An analyst gathers the following information about three publicly traded real estate securities:
| Security 1 | Security 2 | Security 3 | |
|---|---|---|---|
| Percentage of assets for sale, under development | 0 | 75 | 0 |
| Percentage of income derived from interest on mortgages | 90 | 5 | 75 |
| Percentage of taxable income distributed to shareholders | 90 | 100 | 50 |
Which of the following real estate securities most likely qualifies as a tax-advantaged REIT?
Exam-Like
A
Security 1
B
Security 2
C
Security 3
Explanation:
Explanation
To qualify as a tax-advantaged REIT (Real Estate Investment Trust), a security must meet several requirements:
- Income Test: At least 75% of gross income must come from real estate sources (rents, mortgage interest, etc.)
- Asset Test: At least 75% of assets must be real estate assets, cash, or government securities
- Distribution Requirement: At least 90% of taxable income must be distributed to shareholders
Let's analyze each security:
Security 1:
- 90% of income from mortgage interest ✓ (meets income test)
- 0% of assets for sale/development ✓ (likely meets asset test)
- 90% distribution rate ✓ (meets distribution requirement)
Security 2:
- Only 5% of income from real estate sources ✗ (fails income test)
- 75% of assets for sale/development ✗ (likely fails asset test)
- 100% distribution rate ✓ (meets distribution requirement)
Security 3:
- 75% of income from mortgage interest ✓ (meets income test)
- 0% of assets for sale/development ✓ (likely meets asset test)
- 50% distribution rate ✗ (fails distribution requirement)
Only Security 1 meets all three requirements:
- Income test: 90% from real estate sources ✓
- Asset test: 0% for sale/development suggests real estate assets ✓
- Distribution: 90% to shareholders ✓
Therefore, Security 2 most likely qualifies as a tax-advantaged REIT.
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