Spin-offs followed by REIT conversions are becoming increasingly popular
TAX ALERT |
Corporations are finding ways to increase tax efficiency and shareholder value utilizing tax-free spin-offs of real property into real estate investment trusts (REITs). To achieve the tax-free separation, the transaction is structured as a section 355 tax-free separation of the REIT assets from the business assets, followed by a subsequent REIT election by the REIT entity. Once REIT status is in place, income of the REIT effectively escapes corporate-level tax, as a REIT operates much like a pass-through entity, with its income generally taxed at the shareholder level. Where the REIT generates income via rental payments from the corporation, the result is income tax deductions at the corporate level for rents paid (albeit at the cost of foregone depreciation deductions received while holding the property) and income at the REIT level that avoids corporate-level tax. For a closer look at a REIT spin-off, please read our article, Section 355 and REITs opportunities for owner-occupied real estate.
Recently announced REIT spin-offs indicate that, barring a change to the rules and regulations covering REITs and section 355, it would be reasonable to expect an influx of such transactions by companies looking to reduce their overall tax burden and increase shareholder value. For example, CBS Corporation, a mass media company, and Penn National Gaming, Inc., a casino, both undertook REIT spin-offs and were granted favorable private letter rulings from the IRS. Most recently, Windstream Communications, a telecommunications company, announced it also plans to spin its real property into a REIT. It bears noting that each of these businesses operates in a different industry, which indicates the versatile nature of this transaction and potential applicability across industries.
Nevertheless, Congress is not blind to the tax benefits these corporations are receiving from spin-offs into a REIT. Some in Congress are seeking to stop what they view as an erosion of the corporate tax base by utilizing REITs for other than their intended purpose. Rep. David Camp (R-MI) has proposed tax reform that would limit or prevent such transactions, as well as narrow the ability for entities to claim REIT status. To learn more about Camp's tax reform proposals, see RSM's whitepaper, Chairman Dave Camp's tax plan: The end of the beginning?
Companies that are real property intensive (e.g., own rather than rent significant amounts of real property), may find a REIT spin-off an opportunity worth exploring. In addition, because non-traditional REIT transactions may face increased scrutiny in the future, now is as good a time as any to address the opportunity.