Old Bill Gates Had a Farm
In early 2021, a news report identified Gates as America’s Top Farmland Owner. Gates owns 242,000 acres of farmland, 25,750 acres of transitional land, and 1,234 acres of recreational land — a total of 268,984 acres (~420 square miles). That’s a landmass larger than Malta, Singapore, and quite a few other sovereign states.
That being said, this doesn’t make Gates America’s largest private landowner. That honor goes to John Malone, who owns 2.2 million acres of land (3,438 sq. miles). In fact, on Land Report's Top 100 list, Bill and Melinda Gates appear at number 49.
Gates’ extensive portfolio of land holdings is managed by Michael Larson through a limited liability company — Cascade Investment, LLC — whose single member is Gates himself. Cascade’s General Counsel has described the entity as Gates’ personal investment entity.
This may seem a bit strange. A limited liability company (LLC) is formed under state law, and most states prohibit an LLC from being formed to operate a financial entity, such as a banking or insurance company. However, an investment company can be set up as an LLC. By doing so, members of the LLC can elect to be taxed as a partnership. The LLC becomes a pass-through entity and is not liable to income tax.
The Investment Company Act of 1940 defines an investment company as an issuer which “is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities…” Securities are stocks and bonds, but also any “certificate of interest or participation in any profit-sharing agreement,” or any “investment contract.”
In Real Estate We Trust
Even better, an LLC focused on investments in land can become a real estate investment trust (REIT), a status that conveys many benefits. For property owners who may incur significant tax liabilities if appreciated property with a low tax basis is sold, partnering with a REIT may avoid or defer taxes. Risk is reduced. A property owner surrenders title to specific properties and receives interests in a diversified portfolio of assets. Liquidity increases. It will generally be easier to sell shares in a REIT than to sell real property. Property management responsibilities can be relinquished.
After transfer, the REIT operates the asset. Moreover, this turns over management of the property to professionals who are likely to have broader real estate experience and expertise in the capital markets. The risk of negative cash flow is avoided. A vacant property earns no income but still incurs expenses. This list is not exhaustive. These are not the only benefits of a REIT. So what is this magic bullet for real estate management difficulties?
What’s a REIT?
A REIT is a tax-advantaged investment pool that focuses on real estate. Created by the Real Estate Investment Trust Act of 1960, REITs are meant to allow individual investors to invest in large-scale, income-producing real estate. By purchasing shares in a REIT, a retail investor will be able to partake in the commercial real estate property market, which he would not otherwise have access to.
Two basic types exist. Equity REITs invest in properties that produce rental income, such as apartments, hotels, office buildings, resorts, self-storage facilities, shopping malls, and warehouses. Mortgage REITs invest in real estate debt, such as mortgages and mezzanine financing.
Forming a REIT is subject to a number of restrictions on ownership structure, distributions, and operations. The REIT must have at least 100 shareholders and have shares that are transferable. It must also satisfy a number of tests relating to its income and assets. An additional requirement makes it possible for a REIT to be an LLC. A REIT must be either a domestic corporation or an entity, like an LLC, that can elect to be treated for federal tax purposes as a corporation.
There’s a further requirement that makes it difficult for Cascade Investment, LLC to be a REIT. In order to qualify as a REIT, an entity must not be “closely held.” This means that five or fewer individuals together must not own more than 50% of the value of its outstanding stock.
The income test requires that most of a REIT’s income be derived from real property. The asset test demands that at least 75% of total assets, by value, be in real estate assets, cash, cash items (including receivables), and Government securities. Additionally, there must be at least 100 shareholders, and a REIT must distribute most of its income. The required distribution is 85% of ordinary income, plus 95% of capital gains net income. This is usually done quarterly by way of dividends. Nonetheless, these restrictions may be a small price to pay for the substantial benefits, including tax savings, that a REIT brings.
REITs enjoy a peculiar tax status. They are required to be corporations; nevertheless, if they comply with the restrictions on ownership, structure, distributions, income, and assets, they are allowed to deduct dividends paid from taxable income. This is an exception to the way dividends are usually treated. Dividends are an appropriation of profits, not a charge against profits (i.e., an expense). In other words, dividends are not a deduction from revenue to determine income. They are paid out of profits (income) and can only be paid if there are profits.
A REIT will be liable for a 4% excise tax on the amount of undistributed income that exceeds the “required distribution.” However, most REITs avoid paying income tax at the entity level by paying out all their taxable income to shareholders. This avoidance of corporate tax on income makes them appear to be pass-through entities, but they aren’t. True pass-through entities transfer income and losses to owners. REITs cannot pass through their losses to shareholders. Neither are they really passing through income.
REIT shareholders are taxed on the dividends they receive. One drawback is that such dividends are taxed as ordinary income rather than qualified dividends.
UPREIT, DownREIT, Paper Clips and Staples
A further advantage of REITs is that they can be structured in a variety of ways. There are UPREITs, DownREITS, paired-share REITs or stapled REITs, and paper clip REITs.
UPREITs are the most common types. A UPREIT — or umbrella partnership real estate investment trust — allows a proprietor to convert their ownership of property into an interest that can be transformed into a security.
In general, when property is contributed to a REIT, the capital gain (i.e., the excess of fair market value over tax basis) must be recognized. A UPREIT avoids this recognition of capital gains. It does that by setting up a partnership — an umbrella partnership — to acquire the properties from contributors. Accordingly, the REIT does not directly own any real estate properties in the UPREIT structure; rather, it owns interests in the partnership. The properties are managed by the partnership, known as the “operating partnership,” which collects the rental income they generate. When a partner contributes property to a partnership, no gain or loss is recognized.
Cascade the Closely Held
The “closely held” requirement — that five or fewer individuals together must not own more than 50% in value of outstanding stock — means that Cascade, most likely, cannot qualify as a REIT. Washington State records show the LLC as having one governor (i.e., the state’s term for an LLC manager or member) — Michael Larson. Larson has been Gates’ personal money manager since the early nineties. Gates’ name does not appear on the LLC filing.
But Cascade’s incapacity to be a REIT does not prevent the LLC from investing in REITs. And it has done so extensively. In fact, Cascade’s single largest acquisition of land was of the Agricultural Company of America (“AgCoA”), a private US farmland REIT. The purchase, which took place in 2017, had a price tag of around $520 million. The deal increased Gates’ land portfolio by over 100,000 acres. In 2008, Cascade had also purchased an interest in Strategic Hotels and Resorts Inc., a REIT that owns and manages luxury hotels in North America and Europe.
Gates’ foray into agriculture stems from his interest in seed science and biofuel development. He is hoping to increase farm output in third-world countries with more productive seeds and reduce carbon emissions by substituting fossil fuels with biofuels. There’s another motive. The Microsoft co-founder’s vast wealth mostly consists of shares in Microsoft. These real estate acquisitions bring a welcome diversification to that portfolio.
About the Author
Anthony is the owner of Kip Art Gifts, an ecommerce store that specializes in art-inspired jewelry, fashion accessories, and other objects. Previously, he worked as an accountant and financial analyst. He enjoys writing on small business, financial intermediation, and economics. Anthony was educated at Wilson’s School and the London School of Economics and Political Science.