Adam N. Michel
Senate Finance Committee ranking member Ron Wyden (D‑OR) recently released draft legislation to raise taxes on data centers, following up on a white paper he posted in August.
The first part of the bill is a new excise tax on data center revenue. As I’ve explained, the “low single-digit rate,” which is still to be determined, could push total tax rates on data centers above 100 percent of profits in some parts of the country and near that in many others.
The second part of the bill denies data centers four widely available tax provisions: 100 percent bonus depreciation, Opportunity Zones, private real estate investment trust (REIT) status, and the research credit. Under current law, each is available to any business that meets criteria unrelated to AI or data centers.
The four provisions are not equally good policy. A direct subsidy pays a business to do something it would not otherwise do. Removing an investment penalty from the tax code is distinct from a direct subsidy.
The research credit is a subsidy, and Congress should repeal it for every firm. Opportunity Zones cut capital gains taxes only for investments in designated neighborhoods. The better policy is lower capital gains taxes for all investors. Denying either one to a single industry leaves the preference in place for everyone else.
Bonus depreciation and REITs both remove distortions caused by the normal income tax system. I’ve explained before why 100 percent bonus depreciation, or “full expensing,” is neutral tax treatment rather than a subsidy. Similarly, REITs are a partial fix for the double tax on business income. Calling these two provisions “unnecessary investment incentives” and repealing them for one industry conflates subsidies with neutral tax treatment. This piece focuses on REITs.
Data Center REITs and the Wyden Bill
The REIT structure was originally conceived as a way for “taxpayers of more modest means to invest in real estate,” according to the Congressional Research Service, a design modeled after the regulated investment company (RIC) rules governing mutual funds. Both RICs and REITs are allowed to deduct dividends paid to investors, allowing investors who pool their money in these structures to pay taxes similar to those of someone investing directly.
REITs began primarily as holders of mortgages, apartments, and commercial properties. They gradually expanded into nontraditional assets, such as prisons, timber, billboards, cell towers, and data centers. IRS regulations finalized in 2016 approved the shift. For data centers, the building shell, cooling plant, and power distribution are often qualifying real property.
The shorthand way to understand this distinction is: the REIT owns what is bolted down. The AI servers and chips are owned either by a taxable tenant or by a taxable subsidiary and get no REIT treatment.
The Wyden bill does not repeal REIT treatment for all data centers; it applies only to privately owned REITs. If less than 80 percent of a REIT’s stock trades on a public exchange, the bill reclassifies rent from a newly acquired data center with at least 25 megawatts of peak demand as nonqualifying income. Because at least 95 percent of a REIT’s gross income must come from qualifying sources, the change would bar private REITs from buying large data centers. This essentially reimposes the corporate income tax on data center rent earned through private REITs.
Publicly traded data center REITs could continue to own the same buildings, collect the same rent, and pass it through to shareholders under existing rules. If a dividend deduction for data center rent were an unnecessary subsidy, it would be one whether or not the shares are listed on a public exchange. The bill only objects to REIT treatment for data centers when ownership is not listed on a public exchange.
REITs Are an Imperfect Fix to a Broken Business Tax Code
Congress has spent decades fiddling with the distortion in how the tax code treats pass-through businesses and C corporations. REITs are one patch. A REIT deducts the dividends it pays, provided it distributes at least 90 percent of its taxable income each year, thereby shifting the tax from the entity to the investor. A dividend deduction is one form of corporate integration—taxing business income consistently regardless of legal form.
On their own, REIT dividends are taxed at the top 37 percent ordinary income rate plus the 3.8 percent net investment income tax, a combined 40.8 percent. That is slightly more than the combined 39.8 percent top rate on distributed C corporation profits.
The lower rate that REIT investors pay today comes from Section 199A, which allows investors to deduct 20 percent of qualified REIT dividends, reducing the top rate to 33.4 percent. The 20 percent deduction is also available to other pass-throughs. Rather than fixing the structural disparity between business forms, Congress’s 199A patch created a deduction that adds more complexity than neutrality.
Investors choose REITs partly for tax reasons, just as other businesses choose between partnerships, S corporations, and C corporations. But just because one business form has a lower tax burden relative to another, by itself, doesn’t make the tax rules an unnecessary subsidy. The right baseline is a neutral system that would tax business income once, at the same rate, for all legal forms.
REIT rules are certainly not neutral, but they are closer to a single layer of tax than the C corporation rules. They come with restrictions on assets, income, ownership, and distributions. They are a Band-Aid, but a step toward corporate integration.
Denying REIT treatment to data centers does not repeal a targeted subsidy. It would remove one imperfect mechanism for avoiding the corporate double tax. And the Wyden plan would deny REIT treatment only to owners whose shares don’t trade on a public exchange. The bill would make the effective tax rate for similar data center buildings dependent on legal form and listing status. Instead of targeting data centers, Congress should move toward only taxing business income once.
