A real estate investment trust is essentially a corporation that pools the capital of many investors to own and operate income-producing real estate assets. REITs enjoy a unique hybrid status for federal income tax purposes. From a shareholder's perspective, a REIT is a separate taxable entity. A REIT shareholder generally is taxed only on dividends paid by the REIT and on gains upon the disposition of REIT shares, and, unlike in a tax partnership, is not deemed to be conducting the entity's operations. A REIT is a corporation for U.S. tax purposes, but because it receives a dividends paid deduction, the REIT generally is not subject to corporate tax if it distributes to its shareholders substantially all of its taxable income for each year.1 As discussed below, REITs must satisfy numerous requirements to enjoy their special status.
This report focuses on REIT technical and policy issues, general tax policy concerns, and section 355 questions presented by REIT spinoffs.2 For purposes of this report, unless otherwise indicated, a REIT spinoff broadly means a transaction in which (1) a newly taxable C corporation parent (Parent or Distributing) contributes a portion of its assets to its newly formed wholly owned C corporation subsidiary (SpinCo or Controlled) in exchange for 100 percent of SpinCo's stock, and Parent distributes all the SpinCo stock to Parent shareholders in a transaction intended to qualify as a tax-free reorganization under sections 368(a)(1)(D) and 355;3 (2) SpinCo elects REIT status; and (3) Parent may lease back a substantial portion of its properties from SpinCo (an OpCo-PropCo lease).4
Depending on the nature of the assets involved, REIT spinoffs may raise the question whether the IRS has inappropriately broadened its interpretation of qualifying real property for purposes of the REIT rules.5 Some also have raised a more general concern about the activity level of REITs and their subsidiaries as compared with the expected scope of a REIT's operations when Congress enacted the original REIT legislation in 1960. These two issues are discussed in sections II.B. and II.C, respectively. REIT spinoffs also lead some to argue that these transactions inappropriately reduce federal tax revenue. That policy issue is discussed in Section II.D. Finally, REIT spinoffs raise the policy question whether SpinCo's distribution followed by its REIT conversion and entry into an OpCo-PropCo lease produces the type of bona fide separation that section 355 contemplates, as well as the technical question whether REIT spinoffs satisfy the requisite business purpose, active trade or business (ATOB), and device tests. These section 355 issues are discussed in Part 2, Section III.
This report argues that traditional REIT spinoffs are fairly well supported by current law and that the common criticisms of these transactions generally miss the mark.6 It concludes that (1) Treasury and the IRS over time have adopted a fairly comprehensive definition of real property for REIT purposes, and the current ruling practice reflects an application of this preexisting standard to contemporary circumstances; (2) although Congress has repeatedly expanded the scope of a REIT group's permitted activities, REITs remain largely restricted from running non-real-estate businesses; (3) based on available information, REIT spinoffs are not a tremendous drain on government revenues, may provide important benefits, and are likely worth their relatively small cost to the fisc; and (4) if properly structured, REIT spinoffs generally should satisfy section 355 and do not contravene the underlying policies of that section.
In November 2013, after receipt of a private letter ruling from the IRS, Penn National Gaming Inc. spun off its subsidiary, Gaming and Leisure Properties Inc. (GLPI), in a tax-free transaction under section 355. GLPI held Penn National's casino and gaming real estate, elected to be treated as a REIT, and entered into an OpCo-PropCo lease.7 Since some had argued that it would be difficult to observe both the tax-free spinoff rules, which require the conduct of an active business, and the REIT rules, which historically limited REITs to passive operations,8 the Penn National transaction attracted significant attention.9
After Penn National's REIT spinoff, the Ensign Group Inc. followed suit in June 2014, spinning off CareTrust REIT Inc., which holds...