Private Lending Capital Strategies: Do REITs still make sense in 2025?

Jennifer Young:

Welcome everybody to today's webinar, Private Lending Capital Strategies. Do REITs still make sense in 2025? I am Jennifer Young, partner at Geraci, LLP, joined by my partner Kevin Kim, and we're excited to dive into the world of REITs, especially in light of some tax changes coming down the pipeline. Before we begin, a couple of housekeeping items. Please use the q and a box for any questions that you have. Not the chat box, it's at the bottom. It has a little q and a symbol and that's where we will time permitted answer your questions. At the end of the webinar. The webinar and the slides will be emailed to all registrants. So enjoy and hopefully you guys will get a lot out of this webinar today. We'll be covering the REIT structure and compliance pros and cons of private debt fund REITs, how the sunset of the section 91 99 a deduction might impact investors and what the outlook looks like for 2025. So let's kick off things with a recap of the foundation for those less. Oh, let me show you guys the agenda. Sorry, this is the agenda and these are the items that we're going to be covering. To kick things off, I wanted to recap the foundation. So for those less familiar, let's level set. First of all, Kevin, what is a REIT and how does it apply specifically in the context of private debt funds?

Kevin Kim:

Yeah, hi everyone. So a REIT is an abbreviation stands for Real Estate Investment Trust. It's kind of a misnomer because it's an entity, it's an LLC or a corporation or an lp. It's not necessarily a trust. It can be, and in the world of debt funds, it is a conversion component. So what we would do is we would take existing debt fund or we set up a debt fund like you normally see LPGP structure, LLC manager structure offering units, and it would choose to become treated as a reit. And then there are all these different rules and testing obligations, but those come with pretty significant tax benefits. Namely for debt funds particularly, it allows the funds investors to take advantage of the section 1 99 A deduction that was established during the Trump administration part one. So that 20% pass their deduction, which is what everyone talks about and everyone wants for their investors. Second benefit it provides for your investors in a debt fund particularly is it blocks UBTI, unrelated business taxable income. It also eliminates the obligation for state withholding and state reporting. And then finally, it eliminates the concept of effective connected income, which in normal parlance is active trader business treatment, and that's less German main for what we're doing. But the idea here is all REITs in our world of private lending, let's consider all REITs are funds. Not all funds are REITs. It's kind of like a whiskey, right?

Jennifer Young:

Thank you. I like that analogy Quickly, the structural considerations, what are those for managers to keep in mind when they're setting up the re? What does that look like?

Kevin Kim:

Yeah, some structural considerations. So if you are operating a quote debt fund, but you're offering the phrase is used to loosely, but you're offering investor notes, right? The investor are lending to your company or they're buying or selling fractional interest in loans directly or you're offering some type of debt obligation. You are not a fund for my purposes, right? A fund is an LP GP structure, LLC manager structure equity based offering. Structurally speaking, the common methodology that we pursue is we drop a subsidiary underneath the fund and that will act as the reit. We call that a subsidiary REIT or sub reit, as many of you guys have seen in our content. That's one option, but the fund itself, you can convert that into a REIT as well.

Kevin Kim:

Key thing in all of this is that the REIT itself, the REIT entity, whether it's a subsidiary or the fund gets taxed as a C corporation. So you file a C corporation return. So there's some negative ramifications of doing that if you're not careful. And so for optimal conversion and flexibility, we strongly advocate the subsidiary REIT in the context of the mortgage fund world because it mitigates a lot of the need for disrupting your investors. You don't need go for a vote, you don't have any risk. You mitigate your risk significantly of having any kind of corporate tax being paid by the investor because remember, C corps have double taxation, right? So you don't want to risk that. And then also it's easier to qualify for the testing. So most of our clients will typically opt for the subsidiary reit. Many of our tenants today have already done their REIT and they have subsidiary REIT structure.

That's where we have the fund status quo, what you all used to seeing, we drop a subsidiary underneath the fund or maybe a layer below that and that holds the loans and that acts as the REIT that tells the IRS that it is the reit. It will dividend all of its income to the parent, which is the fund where your investors sit and the parent fund will then dividend distribute all of that dividend income to the investors in accordance with your existing waterfall. It is the preferred method, and we'll go over probably in more detail as to why it's the preferred method.

Jennifer Young:

Thank you. And I know you quickly touched on this, but how are REITs typically different from a standard private credit fund or debt fund or mortgage pool?

Kevin Kim:

The big difference is that structural component because the thing is now that you are a reit, if for example, were converting the fund into a reit, right? Then you are SC corporation tax wise, you also get all the tax benefits, right? We mentioned them earlier. The big moving driver of all of it is the 20% pass to deduction thanks to section 1 99 A. However, standard credit funds, standard debt funds actually are eligible for another component of section 1 99 A, but there's a cap out. So the way it works is section 9 1 99 a created a 20% deduction for all pass through companies that are eligible, debt funds are eligible, they're pass throughs, right? They're partnership taxation. The problem with that situation is in those circumstances, the investors are the ones that claim it. So if they're a taxable investor, they can go claim it on their tax return, but there's a cap, right?

So if you're in the top tax bracket, you're not eligible to claim that deduction in that circumstance. And so many investors in these funds are high net worth investors. They are in the top tax bracket, they are ineligible. However, in the context of REITs, there's a section of that same code section that says qualified REIT dividends have no tax bracket requirement. And so now everybody gets that benefit. And so that's the reason why REITs are different. REITs are better in that context of tax savings. Now, once you're a reit though, you are now submit to all the IRS rules. There's a lot of testing obligations.

Jennifer Young:

We'll get into

Kevin Kim:

That, we'll go over that to later today. There's also the cost of doing it and the enhanced operational costs. So it's not for the faint of heart, but it is quite common even at the smaller sizes because of those additional benefits to investors.

Jennifer Young:

Excellent. So that's the 10,000 foot view. Let's move from structure to the nuts and bolts of staying compliant. Once a read is set up and running, compliance becomes key obviously, especially with IRS rules that can trip up even seasoned managers. Kevin, what would you say are the key compliance requirements that private debt fund managers need to be aware of?

Kevin Kim:

There's two buckets of compliance. You got to think through, right? The first bucket is bad income. Bad income, as we call it. It's not a term of our, there's what's called prohibited transactions inside of REITs, right? And so this is namely within the realm of operating income or active trader business income REITs are supposed to be passive, and so REITs should not generate income that can be considered active trader business income. In the world of lending, there's kind of two big buckets. One, you have active trader business treatment because you sell loans on volume for profit. That's a big issue and that's a circumstantial case. It's not necessarily you sell one loan and all of a sudden the world is over circumstantial fact pattern and also that applies to real estate. So foreclosure real estate and the solution in that circumstance for foreclosure real estate is just the ear market as foreclosure property and just pay the taxes on it like you would in your fund anyway, and it's a lower tax rate in the context of bad income on the loan side, there's additional concerns if you're lending on commercial real estate or lending on short-term rentals.

There's a possibility that if you were to take back the property after the loan's in default and you retained operation of that property, and that property was one that created operating income. So for example, senior housing, hotels and hospitality, which includes short-term rentals that could theoretically create active trader business income. So you have to think about creating mitigating circumstances to block that, and that's really easily done through a master tenant relationship. Now, that's the bucket of what you shouldn't do to violate REIT status. There's also these testing obligations. There's a number of these testing obligations. There's so many of them, but there's a lot of the big ones revolve around the 90% test, the asset test, the a hundred investor test, and the closely held test. Those are the four big ones that are germane to us because the rest of them we're going to meet no matter what. So you are asking here about those two

Jennifer Young:

Tests here. Yeah, 90% income test and 75% asset test. How do the lenders typically navigate these?

Kevin Kim:

Yeah, so the income test REITs are required by law to dividend at minimum 90% of their taxable income. This is one of the reasons why we don't tend to convert existing funds into REITs because they will likely not meet this obligation in accordance with their waterfall. On top of that, the client may say, Hey, oh no, we distribute 90, we actually looked at it, it's 94%. Hold on there because 94% will meet the test. But from a tax standpoint, you'll have a taxable event because that 6% is not distributed, gets treated as, gets taxed the corporate tax rate, we don't want that, right, because double taxation. So ideally we want to dividend a hundred percent. This is one of the reasons why the subsidiary read is so helpful because it acts as subsidiary. It will always dividend all of its income up to the parent every single month, every single quarter, and the fund can retain its waterfall without adjusting anything for its investors. The asset test is less germane for what we're doing in our world because all of our clients have a portfolio full of loans. We very rarely have circumstances where it's not, it's loans and real estate. This test basically says that you have to have at least 75% of your portfolio in what's called real estate related assets, and it's a very broad definition. It includes cash, treasury, C-M-B-S-R-M-B-S, participations. So we've never run into a qualification issue on that test. It's a foregone conclusion for most clients.

Jennifer Young:

Excellent. What about some common compliance pitfalls that you've seen

Kevin Kim:

Not in this arena. The biggest arena where the screw ups happen have to do with the other tests, right? The big one, of course, five 50,

The closed the held test or the five and 50 test. So this test says that you have to make sure the REIT has enough diversification in ownership such that five or fewer individuals do not own 50% or more of the REIT on a fully diluted basis. And this test requires you to get to a warm body, get through all the vestings, get through all the different structures in place and figure out, okay, my warm bodies, what percent do they own of the fund? Do we have a concentration issue that's that five or fewer individuals own 50% or more of the reit? The IRS went one step further in this test to make it complicated because they define an individual in a weird way. An individual is me, my spouse, my parents, my grandparents, my children, my grandchildren, and my brother and my sister. This is very unique in the REIT world. It's not commonly seen throughout other I testing other IRS rules that complicates the conversation.

That's the number one thing that clients have tended to mess up on because what they don't realize is they have a timing. A clock starts ticking once they elect to be a reit, right? So the way you elect a REIT status is you either file a return or you file a form with the IRS saying, I'm a REIT now, right? What happens then is you have until the second half of the following fiscal year to meet that test. So basically June of the following fiscal year to December, you have to meet that obligation. This is where people have screwed up, is that they realize, oh, wait a minute, that deadline is sooner than we expected. And so it can be fatal, and it's if we find out that you violated this, then we would typically suggest unwinding the REIT and standing up a new one and they'll likely be penalties.

Jennifer Young:

So compliance always sounds dry, but as we know, missteps can be costly. Correct? I think it's helpful to weigh the strategic benefits and drawbacks. So let's go on to the next slide. Alright. So many private lender shops consider REITs for tax efficiency, but it's not always a clear win. I wanted to really quickly explore that. So let's talk about benefits. What are the main benefits for fund managers and investors when using a restructure?

Kevin Kim:

It's all tax related. So the first is that 20% pass the deduction. That's very meaningful. Simple math. If the distribution for the year is $10,000 to the investor, if they pay taxes on $8,000, it's straight line 20% deduction, and that applies to all taxable investors benefit from it. So if you're an ira, if you're a pension, whatever, you don't benefit from it.

Kevin Kim:

But on the flip side, the UBTI blocking is also very, very important to many clients that UBTI, if many, many funds today have leverage. Many, many funds want to have leverage. The downstream effect of having leverage is it creates U-B-T-I-A-K-A tax bill for your non-taxable guys, and they're unhappy about that. It'll block that. It'll eliminate the need to have for UBTI. Now what's fascinating is certain blue states, like New York City for example, has its own UBTI and this will block that as well, so it does open the doors in that circumstance. What a lot of clients don't realize is that there are actually a lot of non-taxable quasi institutional investors. For example, endowments and charities. They like these investments. They like fixed income investments, they like income producing investments, but they can't touch them because of UBTI. This eliminates that issue and it opens the door to them because they're allergic to it.

It'll blow up their mandate. So it's very, very lucrative when it comes to that aspect. The other main benefit is operational. That state withholding it's a lot of folks overlook this. If you lend in multiple states, right? You're supposed to file a tax return in those states. If you have investors in multiple states and they're in income tax states, you have to do withholding those income taxes and it creates a lot of burden on the operation. It's a very administrative lift, big administrative lift. So that for those reasons, it eliminates all that obligations. You just do one return. So that makes life a lot simpler for you, the operator and also for your tax return bill at the end of the year. The benefit aside from all of those, it's a question of what I would say competitiveness. In the world of private lending, all the biggest and brightest funds have done this already. And so it's kind of become table stakes if you want to scale, because if you're investors that look at these funds, they invest in multiples and they're going to ask, well, why don't you have a reit? Right?

Jennifer Young:

Yes. But on the flip side, what are the trade-offs or added burdens compared to using a more traditional LP or LLC structure?

Kevin Kim:

Primarily it's cost of operation and then the compliance with all the testing. So cost of operation, it's going to cost you more to do a REIT than it is to do a regular fund. Plain and simple, and we ran the numbers actually, and for your average fund that's within market returns, eight to 10% is kind of the market number right now, depending on the geography of the client, it's still 150 basis point savings. Even if you incorporate my bill and the common tax costs, like the return costs, you have to do another return, you have to file another return, you have to do all the testing obligations and all kind of stuff. Even then it's still 150 basis point increase to the investor, but still you have to figure out how to afford all that. And so

What we've been noticing is that emerging managers lately have been tightening the belt. I mean, in general, it seems like many private lands are kind of tightening their belts with the current climate we're in, and so it's understandable that they don't want to have this option. What I tell people is, listen, if it's something that you want to do, it's actually much more affordable to do it early because it's not as costly to set the stage as compared to doing it later and converting it. It's going to cost you a lot more to convert, but once again, it's a trade off. You have to choose, right?

Jennifer Young:

So for those thinking about converting an existing fund into a reit, what are their biggest challenges?

Kevin Kim:

I mean, there's the understanding of all the cost, right? It is a cost, right? It's like it's not like it's something that is done for free. We don't work for free and neither are the CPAs, and that's the primary two parties that have to do all this work. The second issue really is the testing obligations. And so the client will have to take an evaluation of their existing cap table, look out into the future and say, okay, can we meet that five and 50 test everything else? We're going to be fine on.

The last issue is really more along the lines of disruption to the fund. And so the summary strategy does mitigate that, but some clients have existing structures where for example, well, we didn't do the offering documents and this would require a vote. I've seen that a few times. Or they have a bank line and the bank is just so green to private lending that they're just scratching their head when it comes to this. That's been a hurdle we've run into is like, Hey, bank, this is how it's going to work. And they're like, we don't understand, and then their legal teams get involved. It's coming from a place of ignorance. It's not coming from a place of adversarial

Jennifer Young:

Posture. A lot of teaching and training goes into

Kevin Kim:

Correct, correct. And from the bank's perspective, they shouldn't matter. It's just another entity.

Jennifer Young:

Right. Excellent. So now let's talk about why we're here. The sun setting of the section 1 99 a deduction because this change might shake things up. So one of the main tax perks of REITs in recent years has been that section 1 99 a deduction, but that's set to expire at the end of 2025. What does that mean? Can you give us a quick overview of what the 1 99 a deduction is and why it's mattered to investors?

Kevin Kim:

Yeah, so 1 99 A is part of this larger tax bill. So the tax cuts and Jobs act from Trump 1.0 was passed in 17, and it has a subset provision this year, basically right December of this year. It all goes away. And for those of you who follow politics and follow the news, the big beautiful bill, we've all heard about that big beautiful bill, one major portion of it is to make the tax cut and jobs act, especially the 1 99 a deduction for today's purposes permanent. And so this bill is the tax cut and Jobs Act is a very important point to discuss because politically speaking, the Republicans have to have a gun to their head effectively. They have the house, they have the Senate narrow margins, they have the executive branch. If they can't pass this, this will result in the largest tax hike, not in my lifetime, but close to it. And so it will be devastating for from a investor perspective, they go back to status quo. So it's going to be they lose 20% deduction because unless they're below the top tax bracket,

Kevin Kim:

Actually no, it doesn't matter if 1 99 A dies, they go back to ordinary income, right? You have UBTI again, also, if you have leverage, you have to go back to do all the state filings. Well, hold on. Actually that's not true. Only the 1 99 A dies. So it's only the 20%. Only the 20%, the rest of it, stays in place. So UBTI blocking ECI blocking and state withholding blocking stays in place.

Yeah, we'll get to that too. Thus the 20% savings goes away out the door. So you're back to ordinary income if this goes away.

Now, granted, we have to watch this because it's very important to watch because the bill right now, as it stands, has passed the house. It narrowly passed the house by one vote, and now is in the Senate, and the Republicans now have, I think they've got an eight seat majority. They're using reconciliation, so they need a simple majority to pass this bill. But once again, the Republican party has got different segments to it, and so the fiscal hawks are fighting for their stuff. The blue state Republicans are fighting for their stuff, salt deductions. So they're going to negotiate and negotiate and negotiate. The likelihood is it passes, but it's still, I would say, hopeful.

Kevin Kim:

Anyone's game, who knows They could amend it. So it's an extension again, because it'll change the way the cost impact is, right? So this sunset is very meaningful for those of clients who adopted the REAP back in 17. You have to make a judgment call

Whether you keep it or you go back to status quo. Now, if you did a sub RET for you as the operator, it just means unwinding the sub ret, moving the loans back up to your parent fund, and you go back to status quo and you break the news to the investors, sorry guys, Trump didn't get his way and we're going back to ordinary income. But if you choose to keep the then, well no more 20%, but still no more UBTI and all the other stuff. So that's the question mark the client has to answer, right? Really weigh the options.

Jennifer Young:

So slight change to the value proposition, but there's still other advantages, right?

Kevin Kim:

I would call it pretty big, right? It's not a slight, because the thing is that this solves the age old question in our industry, how to get the taxes down on these interest payments. So that's kind of really, really meaningful. Now, granted, if I'm picking out my crystal ball, we're going to have bigger problems. If this bill doesn't pass, it is projected that this will lead to a pretty significant recession. So for those of you who are listening who are in the states where these fiscal hawks live, contact your senator because we need to get this thing passed.

Jennifer Young:

So that leads me to the next question, which is are there any legislative efforts to extend it or replace it with something similar?

Kevin Kim:

Yeah, so I think what we're facing right now, so the way it's happening is the mandate from the Trump administration was, I want a big beautiful bill. I want a giant bill that covers everything. It not only extends the TCJA, it also adds all the other things that he had in his campaign. So no tax on tips, adjustments to Medicaid spending, bill, all this other stuff. It's a big omnibus bill. It raises the debt ceiling. It does a lot of stuff. And so what's happening is that giant bill has passed the house by one vote and is now in the hands of the Senate this process called reconciliation. What happens is once the bill leaves the Senate, it leaves the house, goes to the Senate, it gets negotiated, gets modified, the house typically just okays. It goes to the president's desk and he will sign it.

The issue is now amongst the senators, right? There are two camps in the Senate right now. There's the fiscal hawks who are all about, Hey, debt ceiling crisis, our debt, government debts too high. Deficit spending is bad, it's going to lead us into financial ruin. And technically speaking, they're not wrong. We had to mark down a Moody's and all that kind of stuff. So there's that camp and they're trying to get their way, but remember that camp also existed in the house. So politically speaking, I'm not necessarily concerned about it because the margin inside of the Senate is actually bigger than that. In the house it's eight votes, and so there's that camp and they're the loudest they want. They want to reduce government spending, they want to reduce government, borrowing all that. Then you have the other camp that there are Republicans from blue states and they want salt state and local tax deductions, and they're going to fight for that.

There's a lot of pieces moving right now. There's other states. There are also senators from purple states where they're worried about Medicaid cuts and that kind of stuff. There's a lot of that going on politically right now. I'm watching this every single day and trying to figure out what the likelihood is. It looks almost identical to what we saw in the house. It's likely going to pass. Trump has the bully pulpit and he's going to use it. And Republicans also know, and I've been saying this for years now, if Republicans can't pass this, not only will it lead to a terrible recession in my opinion, but also politically, this is suicide, right? They will be responsible for the worst, greatest tax hike, as they say in a generation, and it's the Republicans that couldn't get it done, and so it's just political suicide. They will probably lose every election going forward from here till who knows?

So I would say right now, if you're a constituent of any of these states, Maine, Alaska, North Carolina, Florida, Wisconsin, Utah, Missouri, contact your senator and den to get this thing passed. Because we are all small business operators, the impact on small business will be detrimental. We need these tax savings, our clients with REITs, they definitely need these tax savings and these investors need these tax savings. And so this, we are directly responsible for creating housing. That is the position you should take with your senator. I urge you to reach out to them, and we're thinking about getting some paperwork out to you guys as well to help with that.

Jennifer Young:

Excellent. So with that potential change looming, it's fair to ask what is the road ahead, given everything we've discussed, structure, compliance, taxes, are REITs still worth considering in 2025? Kevin? I mean, do you think REITs are still a smart strategy for private lenders heading into

Kevin Kim:

Well, yeah. I mean it depends on what your own crystal ball says, right? We've had clients say, we're confident that this bill's going to pass, we're going to do it. We've had REITs get done at the end of last year and the beginning of this year, and so those clients have said, we're confident it's going to pass. We believe that it's going to happen, so we're going to do it. But at the same time, those clients said, you know what though? It also wouldn't be so bad because UBTI is a big problem for us, and so many clients have told me the 20% savings is the big reason why we did this. But at the same time, this UBTI thing has been really, really helpful.

So that's a really, really good thing for especially the non-taxable guys because leverage is very commonly used now and then some clients have said just not having to file a tax return in California is the best thing I've ever had to do. So there's that as well. But yeah, those three ancillary benefits are still worth considering. I think it's probably better if you are in the situation of someone that had a lot more leverage creating A-U-B-T-I problem. I think that's probably a big motivating factor. Or if you had, for example, endowments or nonprofits coming or charities coming into your fund, I think that would be a meaningful thing for them. But even for your larger non-taxable individuals, especially if they're from no income tax states like Texas, they'd be unhappy to see a tax bill suddenly. So I think that's a really big motivator. My advice to everyone lately is if you're on the fence about it, you're not sure what's going to happen with this bill.

The stated schedule is the July 4th holiday, maybe longer than that into the summer, and that's where we'll have concrete knowledge because it's a make or break situation for the Republicans because what is it? There's the government shutdown looming right around then. The debt ceiling is going to be met, hit right around summertime, I think at the end of July. So they have no choice. They have to get this thing passed because this bill also extends the debt ceiling. So it's going to solve the budgetary issues when it comes to extending the life of the government and the ability to borrow. And so if they don't solve this problem, they're going to be facing another problem. So I think they're going to have to prioritize it. It looks like the senate's on their way, but we're watching it very carefully, and so anyone who wants to know more can reach out to me on a daily basis. I'm happy to update you.

Jennifer Young:

So if the 1 99 a deduction does go away, are there alternatives or anything that's appealing?

Kevin Kim:

Right. I mean, technically speaking the answer is yes, but it would require some trade-offs. So you can structure your fund in a way that would hopefully require opinion from tax, hopefully create some kind of capital gain treatment, but it would require you not to make any actual distributions on a periodic basis because basically accrue, accrue, accrue, accrue, and then at the end of the fund you'd wind down and it's part of the liquidity plan. Excess distributions gets treated as capital gain. That's one option on the table, not ideal. The general answer to this question is no, there's no other meaningful, legitimate way to get the distributions and these funds down as meaningfully as 1 99 A does because the source income is interesting income. So we can't make the argument that it's capital gains. You just can't. There are some that say there are structures, but they require very complex bond issuances and I think it's speculative at best. I don't think it's worth pursuing, considering the complications that come with it.

Jennifer Young:

Yeah. Well, so with structuring, how should fund managers be thinking about structuring their capital vehicles over the next two years or so?

Kevin Kim:

Yeah, I think still if I'm a betting man, my position this in a personal opinion, it's a personal opinion that this bill's going to pass, I think it's going to pass. They have the votes, this would be a wasted opportunity. And they know it's political suicide, so they are under the gun. This is a different Republican party, they're going to get this thing done, in my opinion. So if that's the case and you believe that as well and you are of that mindset then having that optionality for the reit, it's a small premium comparatively speaking to converting do it right and yeah, sure it benefits us, but it also benefits me more for you to convert. So it's not about my interest, it's about yours. So have the ability to convert, have that light switch as I call it in your fund docs. Besides that, the other question is going to be how do you solve for the UBTI issue without it?

And there is no real solution unless you were to go debt-based, right? And that's just not ideal. It's not an ideal structure, so it actually kind of cuts you out the knees to get leverage. So from my perspective, it's kind of worth weighing the options from a political standpoint. If you're not political and you don't follow the news, then I would say build your fund now. Because the interesting part is there is a lot of capital on the sidelines. There is a lot of high net worth investor capital leaving Wall Street, leaving the bond market. They're looking for alternatives and if you're a strong performer, you are going to attract investors. So it is wise your funds set up as we head into kind of a new cycle.

Jennifer Young:

Excellent. Alright, well we've covered a lot today from structure and compliance, tax implications and future outlook. Kevin, can we get a few final takeaways for those weighing whether a REIT is still makes sense?

Kevin Kim:

So if you're an existing fund manager and your funds, let's say over 10 million ish, it's worth a consideration. Most of these funds out there have a large number of smaller ticket high net worth investors. It's worth a look at. I think it's worth considering because that tax savings is nothing to scoff at and most of our clients with funds don't really sell a lot of loans either, and they all are on the path to getting leveraged. So the formula is crystal clear that they should do. It boils back down to the legislation. And so I'll leave it to you individually to think about what your thoughts are and whether Trump can get this bill passed. Other things to think about in this world is just because this bill is in jeopardy doesn't mean that the fund structure is not something that's worth pursuing. From my perspective, and I am biased, I'll admit the bias, but the debt fund structure is still the most viable solution for building that balance sheet strategy as a private lender to fund your own loans at your own discretion, and it's part of the blueprint.

We published that recently. It's probably the best strategy because you can add on leverage, you can sell loans and benefit from those loan sales and share the benefits with your investors. You can do a lot of things with that. It's compared to a note based program and frankly, the market also proves a thesis. If you look at the vast majority of independent lenders, many of them have debt funds unless they have an institutional cap table. And so there's wisdom to the masses in that respect. So I think it's probably worth considering it either way. But yeah, we got some questions it looks like, so we should probably get to those.

Jennifer Young:

Yeah, we have some time for some questions. Let me open the box. Alright, so the first question is UBTI, the impact of UBTI on nonprofit status. Can you discuss that a little bit further? Provide clarity?

Kevin Kim:

Yeah, yeah. It is not actually just nonprofit. It's not nonprofit per se. It's actually for certain charitable organizations that need to invest to maintain, I guess you can call it some meaningful portfolio that they have to maintain. A lot of charities have an investment arm to them, but the mandates of those charities and their bylaws prohibit UBTI because they're nonprofits, right? So UBTI would mean that they have additional income sourced from capital that isn't theirs. That's what UBTI is, right? Unrelated business taxable income. In the circumstance of the debt fund world, it's generated from leverage, which is basically that arbitrage created from the fact that your deriving income from the borrowed money. And so that money is, that capital does not belong to the charity, the nonprofit, the ira. And so the profits derived from that should be taxable from the IRS perspective. And so that's the issue in most circumstances with charitable organizations that invest, it's fatal, it will violate their charter and typically result in forced wind down. So it's one of those table stakes issues for those organizations. Same thing with endowments, and I've noticed also some private organizations also have the same issue.

Jennifer Young:

Thank you. Second question. If we convert our LLC to a REIT, not using a sub REIT structure, what is a major issue with 90% income test? Is it the loan loss reserve or any other book or tax differences?

Kevin Kim:

Correct. The two concerns would be, well that too, but so the 90% test is the big one, right? Because does your waterfall actually satisfy the 90% income test? So loss reserve or now as we call it valuation allowance, which is the correct phraseology is a question mark, right? Because you're reserving income and the impact is very negative because C corp status on top of that, you also have a question of the carry. In most funds they have a carry, right? And so they have that incentive after the hurdle.

So that's a question as well. I am not a fan of converting funds to REITs and if you look at the market as a whole, I can only name one that actually converted their fund into a reit. The rest of them did subres and there's some wisdom to it because the other issue that's not discussed is the hundred ambassador test. Yeah, you're going to meet it yourself probably, and the person that asked the question, Maureen, we know who you are, you're going to meet it, but not everyone can. And so there's that issue and having a vendor do it in the subsidiary read, it's a lot easier than having to amend the fund documents to accommodate those guys to come in. But yeah, I mean the biggest issue is the 90% test because if you hold back any income, it's less than a hundred percent taxable income. It's taxed at the corporate tax rate. So we just want to make sure we're careful there. Most funds that do it, they rejigger their structure so that they don't have, they basically dividend everything out.

Jennifer Young:

Excellent. Alright, and a follow up question. If we do use a sub re, do we need to get a CFL license for the sub reit?

Kevin Kim:

I'll let you answer that question because you are our resident CFL master.

You guys didn't know that Jen is the master of CFL licenses.

Jennifer Young:

So to answer your question, yeah, I mean it is probably best practice and easiest if you're going to be originating from the sub REIT and you're going to be closing loans and funding those loans directly from that sub re. If that's the case and that's how you're operating, then yes, you definitely need to get that CFL for the sub reit. Alternatively, you can have the fund get the CFL and just transfer and assigned down to the sub reit, but those loans would have to close in the fund's name if the fund has a CFL and the sub REIT does not. So it really depends on how you're operating and in what entity fund or separate that you're closing the loans in. It's a practical consideration too, right? It takes so long nowadays to get a CFO and so 10 to 12 months it's fun. Alright, and the last question I see, does your recommendation structure, IE US fund hold US REIT change if a foreign REIT is the 100% owner of the US REIT structure?

Kevin Kim:

Okay, I've had this question asked before. It's a very nuanced issue. So foreign REITs are actually something that are not real in the context of, there may be countries that have their own version of REITs and that's possible. But in our world, the phrase the abbreviation, REIT is defined in the tax code. It's an IRS thing. So

If you are a foreign entity that came into the United States and chose to become a REIT under US law tax law, it doesn't make a difference to me. There are probably unique issues on the withholding side that we have to think about because it's a foreign entity and so that requires a conversation with tax. Typically speaking, we don't structure it that way. But if it were to be a foreign REIT that would own the fund or an investor or as an investor in the fund or in the reit, the issue is not related to the REIT issue. The issue is moral associated with the tax issues with dealing with a foreign investor. And I would refer everyone, including the question I asked, the question to our webinar about offshore tax questions, offshore structuring questions for funds. We did, I think about a year ago, I think it was two or three years ago, and we went over ad nauseum at length, the different options on the table. Fascinatingly enough though, in the past I would say two years, we've had a significant amount of requests for, we call it offshore feeder fund structure, feeder fund for both debt funds and for real estate funds. It seems there's a lot of interest overseas in these strategies. So if you're interested in layering that onto your structure, it's worth the look at. Now one thing to remember though is the foreign nationals or the foreign feeder fund, they don't get any of the benefits from IRC 1 99 A. They're not going to get that benefit, right, because they're not a US taxpayer, right? So worth some thought.

Jennifer Young:

Alright, I think that was the last question so we can wrap it up. Thanks again to my partner, Kevin for sharing your insights and thank you all for joining us. We'll follow up with the recording and the slides and feel free to reach out with any other questions you guys have. Hope you guys have a great rest of your day and week. Thank you.

Kevin Kim:

Bye everyone.

Jennifer Young:

Bye.