The compliance playbook for private lending funds just got a major rewrite, with REIT compliance becoming more critical than ever. With the passage of the One Big Beautiful Act (“OBBA”), key tax incentives including the 20% pass-through deduction under §199A of the Internal Revenue Code, have been made permanent. OBBA also increased the asset limit for Taxable REIT Subsidiaries (“TRS”) from 20% to 25% of a REIT’s total assets, giving REITs greater flexibility to hold non-qualifying assets without jeopardizing REIT status.
There’s a catch: most pass-through entities, including LLCs and LPs, are still subject to strict §199A income caps, which can reduce the deduction for high-income investors. For private lending funds using a REIT or SubREIT structure, however, the benefits are significant: REIT dividends remain fully exempt from the income cap, and the TRS flexibility allows funds to manage non-qualifying income strategically. SubREIT structures therefore offer not just tax efficiency but a compliance-backed path to deliver superior after-tax returns to high-net-worth investors.
For fund managers navigating these complex rules, working closely with knowledgeable securities counsel is essential, not only to ensure REIT compliance but also to structure your fund in a way that fully leverages new tax and operational advantages.
Here’s what you need to know in 2025 to stay compliant and optimize tax exposure.
Regulation D: The Foundation Still Matters
Private lending funds continue to rely on Rule 506(b) and 506(c) under Regulation D of the Securities Act of 1933 (17 C.F.R. § 230.506). That means compliance with both Form D filings and state Blue Sky laws remains essential for both your fund and your REIT, ensuring ongoing REIT compliance.
- Form D must be filed with the SEC within 15 days of the first securities sale. This form must be amended for material changes and renewed annually so long as the offering remains open.
- Blue Sky filings must be made in each state where an investor resides. Late or missing filings can trigger fee penalties, disqualification, or state bans on future offerings.
Verification of Accredited Investors Under 506(b) and 506(c)
Rule 506(b). Under the 506(b) exemption, investors may self-certify their accredited status. However, fund managers are limited to accepting no more than thirty-five (35) non-accredited investors over the life of the fund, and once those slots are used, they cannot be replaced. In addition, fund managers must establish and document a pre-existing, substantive relationship with each investor before accepting capital.
Rule 506(c). By contrast, 506(c) requires fund managers to take “reasonable steps” to verify accredited investor status, rather than relying on self-certification. Verification can be satisfied through third-party reviews, such as tax returns, CPA letters, or online verification platforms.
2025 SEC Guidance. This year, the SEC staff issued a no-action letter stating that if the following conditions are met, a fund manager may be deemed to have fulfilled the requirement of taking “reasonable steps” to verify that a prospective investor qualifies as an accredited investor under Rule 506(c):
- Minimum Investment Thresholds. Fund managers may now treat certain minimum investment amounts as a reasonable method of verification. This means an investment into the fund of at least $200,000 for natural persons or $1,000,000 for legal entities;
- Written Representations: Investors must represent in writing that (i) they are accredited and (ii) they did not finance their investment through a third party; and
- No Actual Knowledge: The fund manager must have no actual knowledge suggesting that an investor is unaccredited or financed the investment improperly.
Stay Within the Lines of Your Offering Documents
A common compliance pitfall for fund managers is operating outside the four corners of their offering documents. Your Private Placement Memorandum (“PPM”) sets the parameters for how investor capital may be used. If you start funding loans, acquiring assets, or pursuing strategies that fall outside of what the PPM contemplates, regulators may view this as securities fraud under Rule 10b-5 (17 C.F.R. § 240.10b-5).
This is more than a technicality. Offering documents are the foundation of your relationship with investors, and deviating from them undermines both compliance and trust. If your investment strategy evolves, as it often does in dynamic markets or on a funds scale, the appropriate steps are to amend your offering documents, provide updated disclosures, and communicate changes clearly to your investors.
By keeping your actions aligned with your offering documents, you not only avoid regulatory risk but also reinforce credibility with your investors, further supporting ongoing REIT compliance.
REIT Compliance: A Strategic Advantage in 2025
The Tax Cuts and Jobs Act of 2017 introduced the §199A deduction, allowing most pass-through entities to take a 20% qualified business income (QBI) deduction. While initially set to sunset in 2026, the OBBA has now made the deduction permanent.
However, the deduction is subject to income thresholds, and these thresholds increased in 2025 to approximately $394,600 for joint filers and $197,300 for single filers. Once income exceeds these thresholds, the deduction begins to phase out.
Crucially, REIT dividends are not subject to these caps, meaning both REIT structures allow your investors to retain the full 20% deduction regardless of income level, enhancing your REIT compliance strategy.
In practice, this makes REITs more than just a tax-efficient structure. It’s a compliance-backed strategy that enhances after-tax returns for all investors, but especially for those whose income levels would otherwise limit their ability to claim the deduction.
REIT Qualification Rules
The tax benefits of a REIT structure are powerful, but they come with strict qualification requirements. To maintain REIT status, funds must satisfy four ongoing tests:
- 75% Asset Test. At least 75% of total assets must consist of real estate, mortgages, or cash and cash equivalents.
- 75% Income Test. At least 75% of gross income must come from rents, mortgage interest, or other real estate–related sources.
- 95% Income Test. At least 95% of gross income must come from passive sources, including the 75% real estate income plus dividends and interest.
- 90% Distribution Requirement. At least 90% of taxable income (excluding net capital gains) must be distributed to shareholders each year.
Failure to meet these requirements is serious. In some cases, the IRS may allow a REIT to cure an inadvertent failure by paying a penalty tax, provided the lapse was not due to willful neglect. But intentional or significant violations can cause the REIT to lose its status altogether, exposing it to corporate-level taxation, potentially retroactive to the start of the year in which the failure occurred. Ongoing REIT compliance monitoring is key to avoid these outcomes.
Ownership and the “Penguin” Solution
REIT qualification depends not only on income and asset tests but also on strict ownership and governance requirements:
- 100-Shareholder Test. A REIT must be owned by at least 100 shareholders for at least 335 days of the taxable year.
- 5/50 Rule. No more than 50% of the REIT’s shares may be owned, directly or constructively, by five or fewer individuals during the last half of the taxable year.
Meeting these thresholds can be challenging for smaller or closely held REITs. Many REITs address this by bringing in so-called “penguin investors,” or small-dollar, passive shareholders recruited specifically to satisfy the shareholder count and diversification tests. These investors generally do not dilute fund control or materially affect economics.
Bad Income and Loan Sales in REITs
REITs are highly sensitive to income that falls outside the qualifying categories, or “bad income.” Examples include:
- Frequent foreclosures or loan sales,
- Operating income from commercial properties, such as hotels or resorts,
- Rent tied to a tenant’s net income rather than a fixed amount.
If such activities occur too frequently, the REIT could be treated as a dealer or engaged in prohibited transactions, potentially terminating REIT status and triggering corporate-level taxation.
To protect REIT status when it comes to bad income and loan sales, problematic assets can be structured outside the REIT, typically by transferring them to (i) a taxable REIT subsidiary (TRS), which can hold non-qualifying assets and generate active business income, or (ii) the parent fund, which is not subject to the same REIT income restrictions.
Fund managers should actively monitor income streams and loan activity, maintaining documentation and periodic reviews to ensure that non-qualifying income does not threaten REIT compliance status.
Operational Compliance: Separate Entities and Records
Once your fund and SubREIT structure are compliant on paper, operational discipline becomes critical to maintaining REIT status. A common compliance risk is blurring the lines between entities. When operating a SubREIT alongside a fund, it is essential to:
- Maintain separate bank accounts,
- Keep independent books and records, and
- Document all fund transfers between entities.
Failure to maintain these distinctions can attract IRS scrutiny, create compliance failures, and jeopardize REIT tax benefits. Clear operational boundaries demonstrate that each entity functions independently and in accordance with applicable rules, protecting both REIT status and investor trust.
Investor Communications Compliance: Marketing and Advertising
Even perfectly structured Funds and REITs can face enforcement risk if marketing and investor communications are mishandled. Fund managers must ensure that all materials adhere to securities laws and investor protection standards. Key requirements include:
- Clearly disclosing all investment risks,
- Avoiding guarantees or misleading return projections, and
- Refraining from offering investment advice unless properly licensed under the Investment Advisers Act of 1940.
Non-compliant marketing can trigger state enforcement actions, civil liability, and investor lawsuits. Careful review, documentation, and legal oversight of all communications are therefore essential to maintaining both RET compliance and investor confidence.
Compliance as a Core Business and Tax Strategy
The passage of OBBA has permanently secured the Section 199A Qualified Business Income (QBI) deduction, including the 20% deduction for qualified REIT dividends. REIT dividends remain fully exempt from the income cap that applies to other pass-through income, giving SubREIT structures a strategic advantage for funds targeting high-net-worth investors. OBBA also increased the asset limit for TRSs from 20% to 25% of a REIT’s total assets, allowing greater flexibility to hold non-qualifying income without jeopardizing REIT status.
At the same time, regulators are intensifying scrutiny on broker-dealer compliance, offering documents, and marketing practices. Fund managers can no longer afford to rely on assumptions or outdated procedures.
Key actions for 2025 and beyond (recommended best practices):
- Review and update offering documents to reflect current strategy,
- Track investor residency for accurate state filings,
- Monitor REIT compliance regularly
- Document all marketing and fundraising activities, and
- Maintain close coordination with knowledgeable securities counsel and CPA to ensure all strategies are properly implemented and compliant.
By integrating compliance into daily operations and partnering with experienced counsel, fund managers not only protect REIT status and minimize regulatory risk but also maximize structural and tax advantages, ultimately delivering superior after-tax returns to investors.
Need expert guidance on REIT compliance and fund structuring? The Fortra Law Corporate and Securities team works closely with private lending funds to navigate complex securities, tax, and regulatory rules, ensuring your fund operates efficiently and compliantly. Contact our team today to safeguard your fund, optimize tax benefits, and stay ahead in 2025.
