Wednesday, June 19, 2013

IRS Could Put a Halt to REIT Conversions

By Tim Dulaney, PhD and Tim Husson, PhD

We've talked a lot about real estate investment trusts (REITs) before.  In the US, REITs are companies that invest at least 75% of their assets in real estate, pay out almost all of their annual income in dividends, but also pay little or no corporate income tax.  As we've discussed before, many companies have tried to qualify for the REIT designation to reduce their tax liabilities, even if their business is only peripherally related to real estate.1  This  'REIT conversion boom' has been controversial, and according to a recent Law360 article, might be drawing scrutiny from the IRS.

Most REITs own properties such as apartment, office, industrial, or hotel buildings.  Some own less traditional real estate properties; for example, Public Storage (PSA) is a publicly traded REIT that owns and operates self-storage facilities.  Some REIT applications, however, have stretched the definition of real estate even further:  prison operators, telecom companies, data centers, and even landfills have applied for REIT status with some success.  There is some concern that companies are abusing the REIT designation to avoid corporate taxes.

According to the Law360 article, the IRS is reviewing its rules regarding REIT qualifications, which might affect the REIT market even before its results are released:
Many attorneys are bracing for the IRS review to result in narrower class definitions, and several expect the uncertainty before an IRS opinion comes down to dampen the recent fervor for REIT proposals. But, in the longer run, the results of the IRS review could end up bolstering the asset classes that are given a clear thumbs-up and will shave down the time it takes for the IRS to handle REIT applications, some experts told Law360.
The article notes that even Congress might get involved, and may clarify whether the REIT designation should only apply to traditional (or 'core') real estate properties, or if it can also be extended to non-traditional properties as well.

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1A recent example that made headlines involves Iron Mountain (IRM), which is basically a document-storage company.

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