Do You Have to Own Real Estate in the First Year to Start a REIT?
- 4 days ago
- 6 min read
Separating IRS Code From Internet Misinformation
In recent months, I have seen an increasing number of comments, messages, and posts circulating online claiming that a Real Estate Investment Trust (REIT) must immediately own real estate, have 100 shareholders, and meet every operational test in its very first year in order to be valid.
This is not only misleading — it reflects a misunderstanding of how REITs are structured under U.S. tax law and how sophisticated entities are built in practice.
This blog is written to bring clarity, protect against misinformation, and provide a fact-based understanding grounded in IRS code, timing rules, and real-world corporate structuring.
Let’s address this directly and professionally.
Understanding What a REIT Actually Is
A Real Estate Investment Trust (REIT) is not simply a company that owns property.
It is a tax election under Internal Revenue Code §856–§859 that allows a corporation or trust to be treated as a REIT if it meets certain requirements over time.
Notice the key phrase:
over time.
Many online discussions treat REIT qualification as if every requirement must be fully satisfied immediately upon formation.The Internal Revenue Code does not operate that way.
Like most corporate tax elections, REIT qualification includes timing rules and phased compliance requirements, especially during the first taxable year.
Myth #1: A REIT Must Own Real Estate Immediately
There is no IRS rule stating that a newly formed REIT must purchase real estate in its first year of existence in order to be properly structured.
What the IRS requires is that a REIT meet certain asset and income tests, but those tests are measured over a taxable year and across operational timing, not necessarily on day one of formation.
A newly formed entity may:
Establish its structure
Elect REIT status
Position itself operationally
Acquire assets strategically over time
This is not only permissible — it is common in sophisticated corporate structuring.
The idea that a REIT is invalid if property is not purchased immediately is a misunderstanding of how tax elections and corporate formation work.
Structure is established first.
Assets are acquired strategically.
Myth #2: A REIT Must Immediately Have 100 Shareholders to Exist
Another common misconception circulating online is that a Real Estate Investment Trust must immediately have 100 shareholders in order to be valid or properly structured.
This is not an accurate interpretation of IRS code.
While it is true that REITs must ultimately meet a 100-shareholder requirement, the Internal Revenue Code provides timing rules and compliance periods that allow a newly formed REIT to properly structure ownership before full testing applies.
Under Internal Revenue Code §856(a)(5), a REIT must have at least 100 shareholders.
However, this requirement is measured with respect to the REIT’s taxable year and is not intended to prevent the initial structuring and formation phase of a newly organized entity.
Timing and Compliance Considerations
A newly formed REIT is generally provided time to:
Establish its corporate structure
Properly issue shares
Capitalize the entity
Build out ownership in a compliant manner
REIT compliance is measured over taxable periods rather than assumed to be fully operational on the first day of formation.
This allows legitimate entities to organize, structure, and prepare for full operational compliance rather than forcing immediate shareholder distribution before the entity is properly positioned.
Source:
Internal Revenue Code §856(a)(5)
What If the 100-Shareholder Requirement Is Not Met Immediately?
The Internal Revenue Code recognizes that newly structured REITs may require time to fully align ownership and compliance requirements.
For this reason, the law provides relief provisions in situations where a requirement is not met due to reasonable cause rather than intentional disregard.
Under Internal Revenue Code §856(c)(7), a REIT may avoid disqualification if certain conditions are met and the entity is acting in good faith to achieve full compliance.
A REIT may preserve its status when:
The failure occurred due to reasonable cause and not willful neglect
Corrective action is taken within the allowable timeframe
Proper disclosure is made to the IRS regarding the failure and correction
Any applicable penalty is satisfied
In practical terms, this means an otherwise properly structured REIT is not automatically disqualified solely because ownership thresholds are still being finalized or adjusted
during its development and compliance phase.
Understanding “Reasonable Cause”
The IRS evaluates reasonable cause based on facts and circumstances. In the context of a newly formed REIT, examples may include:
Ownership structuring still in progress as shares are issued and capitalized
Administrative or recordkeeping adjustments being made during early formation
Reliance on professional legal or tax guidance during setup
Good-faith efforts to meet requirements within the required compliance period
When corrective steps are taken promptly and transparently, the IRS may allow the REIT to maintain its status while bringing the structure fully into compliance.
Why These Provisions Exist
These relief provisions exist because the IRS recognizes that legitimate corporate structures often require time to fully organize, capitalize, and align with technical requirements.
REIT compliance is measured over time and includes mechanisms that allow properly structured entities to correct issues rather than face immediate disqualification.
Understanding these provisions highlights an important distinction:
there is a difference between an entity ignoring compliance requirements and an entity actively working in good faith to meet them within the framework provided by law.
Source:
Internal Revenue Code §856(c)(7)
Can Shareholders Be Entities Instead of Individuals?
Yes.
REIT shareholders are not limited to individuals.
They may include:
C-Corporations
Trusts
Estates
Certain entities and institutional investors
This allows ownership to be structured across multiple entities, provided the REIT ultimately satisfies IRS ownership and closely-held requirements.
This is one of the reasons sophisticated structures often involve layered corporate ownership rather than relying solely on individual shareholders.
Why This Matters
Many online discussions present REIT qualification as an immediate pass-or-fail test.
In reality, REIT law includes timing rules, compliance periods, and correction provisions designed to allow legitimate entities to structure correctly and meet requirements over time.
Understanding the difference between:
reading IRS language
and
understanding how it is applied
is essential when discussing REIT structuring.
Proper structuring requires planning, compliance, and strategic execution — not assumptions based on isolated internet searches.
Source:Internal Revenue Code §856(a)(5)
Myth #3: The 5/50 Ownership Rule Applies Immediately
The “5/50 rule” states that no more than 50% of a REIT’s shares can be owned by five or fewer individuals.
This rule is outlined under IRC §856(h).
However, like the shareholder rule, it is applied with timing considerations and is not designed to prevent initial structuring phases of a newly formed REIT.
REIT compliance is measured over taxable periods — not assumed to be fully operational on day one.
Source:
Internal Revenue Code §856(h)
IRS Guidance on Newly Formed REITs
Recent IRS interpretive guidance has further clarified that newly formed REITs may take time to fully meet operational tests.
In IRS Private Letter Ruling PLR 202440007,
the IRS acknowledged that a newly formed REIT in its initial stages may not yet have fully operational assets or income and can still satisfy qualification requirements as it moves into operational status.
While private letter rulings apply to specific taxpayers, they provide insight into how the IRS interprets timing and startup conditions for REIT qualification.
IRS Written Determination Index:
(Search: PLR 202440007)
Structure First. Assets Strategically.
In corporate environments, structure is almost always established before full asset acquisition.
This is not unusual.
It is intentional.
Corporations across many industries:
Form entities first
Establish compliance structure
Build funding relationships
Acquire assets strategically
Scale operations after positioning
This approach allows for:
Proper capitalization
Liability separation
Funding readiness
Strategic acquisition timing
Long-term tax efficiency
This is how many entities and wealthy families build — not by rushing into asset purchases without structure, but by ensuring the structure is correct before scaling.
Information vs. Strategy
We live in an era where anyone can search a phrase online and believe they fully understand corporate law.
But reading isolated lines of IRS code without context often creates confusion rather than clarity.
Google provides information.
It does not provide strategy.
Understanding how rules apply in real-world structuring requires experience, interpretation, and execution — not just search results.
When people encounter strategies they do not yet understand, the first reaction is often to search for fragments of information that appear to contradict it.
That does not make the strategy incorrect.
It simply means the full context has not yet been understood.
Final Thoughts
A properly structured REIT:
Does not require immediate real estate acquisition on day one
Must meet IRS requirements over time
Follows timing rules within the Internal Revenue Code
Can be structured first and scaled strategically
Understanding the difference between legal requirements and strategic execution is essential.
There is a difference between forming an entity
and fully operating an entity.
There is a difference between reading rules
and knowing how to apply them.
And there is a difference between online opinions
and real-world execution.
Structure always comes before scale.
Sources & References
Internal Revenue Code §856
IRS REIT Qualification Overview
IRS Written Determinations (Private Letter Rulings)