Tax Technicalities Trip BRT Realty Trust

Includes: ANH, BRT, EPR
by: Patrick Harden

Apparently, there is a reason while REITs include this risk factor in their SEC filing boilerplate:

The U.S. federal income tax laws governing REITs are complex.

BRT Realty Trust (NYSE:BRT) learned this lesson the hard way. The mortgage REIT, which bills itself as a hard money lender specializing in bridge loans and short-term commercial real estate loans, has been unable to collect from its economically-sensitive borrowers and unable to continue originating new loans.

This development is obviously not surprising news; the Company itself suspended its cash dividend in December 2008, noting that BRT "will likely report a tax loss for the tax year ended December 31, 2008" due to the negative effect of the credit crisis on revenues and earnings.

Even as recently as August, BRT reported in its 10-Q that

[S]ince we will report a taxable loss for the year ended December 31, 2008, no distributions will be required in 2009 in order for us to retain our REIT status.

Oops. Today's hastily-released press release (coming at the awkward time of 3:56 p.m., instead of after the market close) suddenly announced that BRT would be paying a special dividend on BRT's common shares of $1.15 per share.

Only mortgage REIT nerds like me would care about the sudden about-face, but the special dividend was declared at the latest possible moment -- mere hours before BRT is required to file its 2008 federal income tax return.

Of course, to avoid taxes at the corporate level, BRT had to distribute 90% of its 2008 taxable income before filing its 2008 tax return, so the date of the dividend is not coincidental.

As noted in the release, BRT's taxable income came as a result of selling its highly-appreciated stake in Entertainment Properties Trust (NYSE:EPR), which generated quite a bit of precious cash for a company who has suffered a ($0.70) per share cash operating loss for the nine months ended June 30, 2009.

One can only assume that BRT expected to fully offset the taxable income from the sale of the EPR shares with bad debt deductions from worthless portfolio loans -- a position that must not have materialized upon final review of the tax return.

A similar situation was disclosed by fellow mortgage REIT Anworth Mortgage (NYSE:ANH) two weeks ago, although its tax reversal did not require any additional distribution by Anworth.

Regardless of what technical tax interpretations caused the snafu, liquidity-strapped BRT is having to dish out $1.3 million in cash and issue 2.4 million shares to satisfy the distribution requirements and maintain REIT status.

Just another reason why investing in REITs isn't that straightforward -- and why investors should be careful before investing in the five new mortgage REITs coming public in the next two weeks.

Disclosure: No position in any stocks mentioned.