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IRS Issues Final Regulations On REIT Spin-Offs

Tuesday, January 24, 2017

On January 18, the US Internal Revenue Service (IRS) issued its final regulations regarding the measures included in the Protecting Americans from Tax Hikes (PATH) Act to restrict the tax-free spin-offs involving publicly traded real estate investment trusts (REITs).

US REITs do not pay corporate tax as long as at least 75 percent of their total assets are real estate assets and/or cash; at least 75 percent of gross income comes from real estate-related sources; and at least 90 percent of their taxable income is distributed to shareholders annually in the form of dividends.

Prior to the PATH Act, more American corporations were encouraged to consider spinning-off assets into REITs, when the IRS began to accept that non-traditional real estate assets (such as warehouses, shopping centers, health care facilities, and telecommunication assets) could be held in a REIT.

Such spin-offs are capital gains tax-free for both the distributing corporations and their shareholders and enables them to limit their exposure to the US's 35 percent corporate tax rate. Subsequently, REITs normally lease the property back to the distributing corporations, to be utilized in the latter's operations.

However, the PATH Act laid down that a spin-off involving a REIT will qualify as tax-free only if, immediately after the distribution, both the distributing and controlled corporation are REITs.

The only change that the IRS has made in its final regulations was to relax the "recognition period" – the length of time during which a REIT could still be subject to capital gains and corporate tax on certain dispositions of property – to five years from the 10 years it had originally imposed.

On October 18, 2016, the Chairmen and Ranking Members of the House of Representatives Ways and Means Committee and the Senate Finance Committee had written to the Treasury Secretary that the 10-year recognition period introduced unilaterally by the IRS in its temporary regulations "was inconsistent with congressional intent and the longstanding practice of treating REITs as having the same built-in gain recognition period as S corporations, currently five years."