Why The IRS Shut Down REIT Spinoffs

A popular way for a business to utilize the value of its real estate has been with Real Estate Investment Trust (REIT) spin-offs. This enabled a company to separate their real estate holdings from their business operations. Doing this made it possible for a company to raise necessary capital at a favorable low cost. Businesses experienced nontax benefits associated with separating real-estate transactions from their core activities.

No Corporate-level Tax

An REIT spin-off does not pay corporate-level tax on the majority of their profits. This enables them to pass these profits to their shareholders. A corporation is usually responsible for paying an income tax on their profits. Their investors are then subject to another tax when provided with capital gains or dividends. An REIT spin-off was a benefit for companies who had a large amount of real estate holdings. This would normally involve companies in the hotel industry, telecommunications companies as well as retail companies and more. These corporations were able to divide themselves into two parts. One-half would be an REIT that was able to obtain valuable property free of tax on their gains. The REIT spin-off would then enter a leasing agreement with the other half of the company.

PATH Act

The desire by the US Congress to eliminate tax-free REIT spin-off transactions has been in the works since 2014. The Tax-Reform Act of 2014 had provisions that attempted to eliminate an REIT election by a C corporation who would use a spin-off for the next ten years after the transaction. This became law with the passage of the PATH Act of 2015. The regulations forced spun-off companies to obtain the status of REIT and be responsible for paying corporate taxes. The amount they are required to pay is equal to the selling of appreciated real estate. This eliminated much of the benefits associated with creating an REIT.

IRS Regulation

The IRS regulation does not eliminate a company’s ability to change into an REIT. A corporation must now qualify under existing IRS definitions. This means businesses that are not identified as real-estate firms can still become an REIT if they qualify under the new definitions. It is believed that diversified REITs could be used in the future to increase the value of internal assets. This will be a major factor when it comes to the Initial Public Offerings (IPO) of companies.

New REIT Requirements

Some of the requirements for an REIT are that distributing corporation must have been an REIT during the three years prior to any distribution. The REIT must have a minimum of 80 percent of the voting power in all classes of stock. Should a non-REIT distribute or control a corporation, it may not make a transaction as an REIT prior to the end of a 10-year period starting at the distribution date. These requirements took effect on December 7, 2015. They do not apply to requests for rulings given to the IRS on or before this date.

Reasons For REIT Regulations

The scrutiny now associated with REITs is based on the idea that these types of transactions are unfair and abusive. The belief is that it must be changed to preserve all possible tax revenues. The new IRS regulations have placed serious limitations on corporate taxpayers when it comes to maximizing their shareholder value. Many corporate leaders believe it is misguided politics.