Mortgage REITs have gained significant traction among private lending fund managers over the past several years, and their popularity continues to grow in 2025. The appeal is straightforward: REIT dividends qualify for the 20% Qualified Business Income deduction under the Tax Cuts and Jobs Act, making the structure an increasingly attractive vehicle for mortgage fund operators seeking tax efficiency.
Despite their growing adoption, numerous misconceptions persist about how mortgage REITs operate within the private lending ecosystem. Below, we address the most prevalent myths and separate fact from fiction.
Myth: You Need Hundreds of Investors Before Considering a REIT
This is one of the most persistent misconceptions in the industry, and it is flatly incorrect. Two primary ownership requirements govern REITs — the 100 Investor Rule and the Closely Held Rule — but neither demands that a fund already have a massive investor base before pursuing REIT status.
Understanding the 100 Investor Requirement
The 100 Investor Rule does mandate that a REIT maintain at least 100 beneficial owners. However, the critical detail most people overlook is the timing. This requirement does not apply until the tax year following the REIT election, and only for a minimum of 335 days within that year.
In practical terms, a mortgage fund that elects REIT status on January 1 of a given year has until the end of the following calendar year to onboard its 100th investor. This built-in grace period provides substantial runway for compliance. Furthermore, when a fund utilizes a Subsidiary REIT (often called a “SUBREIT”), the 100 investor requirement applies exclusively to the subsidiary entity, not to the parent fund itself. Many REITs also leverage shareholder accommodation services to satisfy this threshold efficiently, making compliance straightforward in practice.
The Closely Held Rule and the 5/50 Test
The Closely Held Rule, also known as the 5/50 Test, prevents five or fewer individuals from holding 50% or more of a REIT’s outstanding equity. Ownership is calculated on a fully diluted basis, which means that for private lending mortgage funds employing a SUBREIT structure, the parent fund’s investor composition must be analyzed to confirm compliance.
Importantly, this rule does not require a large number of investors. It simply requires sufficient diversification so that no small group of five or fewer investors controls a majority stake. Additionally, the 5/50 Test only applies during the final six months of the taxable year following the REIT election, providing another timing buffer.
The IRS intentionally designed these transition windows to give newly formed REITs adequate time to achieve compliance. The myth that you need hundreds of investors before even exploring the REIT option is definitively busted.
Myth: Mortgage REITs Cannot Accommodate Carried Interest for Fund Managers
This one is technically true at the REIT entity level, but the practical reality for private lenders is far more nuanced. A REIT must distribute at least 90% of its taxable income to shareholders each year. Any undistributed income remains subject to corporate-level taxation, which undermines the tax-efficiency purpose of the REIT structure. This effectively precludes traditional carried interest arrangements within the REIT itself.
However, the SUBREIT strategy — widely used across the private lending industry — provides an elegant workaround. Under this approach, the SUBREIT entity complies with all REIT distribution requirements, paying out 100% of its taxable income as dividends to the parent fund. Those distributions then flow through the parent fund’s existing waterfall structure, which preserves the fund manager’s carried interest, profit splits, or preferred return mechanisms entirely intact.
The result is a best-of-both-worlds outcome: investors receive the favorable tax treatment associated with REIT dividends, while the fund manager retains its established compensation structure. The SUBREIT architecture has become the standard approach for mortgage fund managers who want REIT benefits without sacrificing their economics.
Myth: New Funds Cannot Launch as a REIT
This misconception follows directly from the first myth and is equally incorrect. New mortgage funds can absolutely be structured as REITs or incorporate a SUBREIT from inception. In fact, launching with a REIT structure from the outset often simplifies the process compared to converting an existing fund.
When a fund starts fresh with REIT architecture, there is no need to conduct due diligence on an existing loan portfolio, evaluate pending foreclosures, or analyze the current investor base for compliance with ownership tests. The timing buffers discussed above — which allow the REIT to meet the 100 Investor Rule and the 5/50 Test in subsequent tax years — apply equally to newly formed entities. Fund managers who are contemplating a new vehicle should seriously consider building in REIT or SUBREIT capabilities from the beginning.
Key Takeaways for Private Lending Fund Managers
The REIT structure remains one of the most compelling tax-planning tools available to mortgage fund operators in 2025. As interest rates stabilize and investor demand for tax-efficient yield vehicles intensifies, the strategic advantages of REITs and SUBREITs will only become more pronounced.
The legal and structural complexities of REIT formation, however, require experienced counsel. From ownership testing and distribution requirements to SUBREIT design and securities compliance, every element demands precision. The Corporate and Securities team at Geraci LLP has deep experience guiding private lending fund managers through REIT elections, SUBREIT formations, and ongoing compliance. Whether you are converting an existing fund or launching a new vehicle, our attorneys can help you navigate the process efficiently and confidently.
To discuss how a REIT or SUBREIT strategy could benefit your mortgage fund, contact Geraci LLP at (949) 403-3488 or visit our offices at 90 Discovery, Irvine, CA 92618.
