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Rev. Rul. 2012-17: Investment in Money Market is Cash or Equivalent Under REIT Testing Rules

IRS issued Rev. Rul. 2012-17 on June 15, 2012, ruling that a REIT’s investment in a money market fund is investment in cash or cash equivalents under the REIT testing rules.  The failure of a REIT to meet the tests under these rules can lead to penalties and, in some cases, the loss of REIT status for tax purposes.

A REIT must satisfy a number of tests to achieve and maintain its classification as a REIT.  Section 856(c)(4)(A) provides that at the close of each quarter of its taxable year, at least 75% of the value of a REIT's total assets must be represented by real estate assets, cash and cash items and Government securities (the “75% value test”). In addition to the asset test, the Code requires that at the end of each quarter of a taxable year, with certain exceptions, not more than 25% of the value of a REIT's total assets may be represented by securities and that REITs must further ensure that not more than 5% of their total assets may be represented by securities of any one issuer.

Investments in money market funds, even funds traded for $1 a share, are technically investments in regulated investment company (“RIC”) stock.  Prior to this ruling, there was uncertainty as to whether or not investment in money markets would be treated as cash or cash equivalents or as investments in a RIC.  Notably, the term “cash and cash items” is not defined in the Code.   Section 856(c)(5)(F) provides that all terms that are not defined in § 856(c)(5) shall have the same meaning as when used in the Investment Company Act of 1940. The term “cash item” is not defined in either the 1940 Act or the regulations under the 1940 Act.   However, with respect to the issue addressed by this revenue ruling, the staff of the Division of Investment Management at the Securities and Exchange Commission (SEC) has issued a no-action letter that is directly on point. The SEC No-Action Letter concluded that the SEC Division of Investment Management would not object if an issuer calculated the amount of its investment securities without including the money market fund shares. The conclusion reached in the SEC No-Action Letter is not inconsistent with the language of section § 856(c)(4)(A) or its underlying legislative history.  While the SEC No-Action letter was issued many years ago, the service had not formally adopted the position that money market accounts are cash or cash equivalents until the issuance of this ruling.

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