Tax Analysts Blog

How Much Do Converted and Nontraditional REITs Cost the U.S. Treasury?

Posted on Sep 8, 2014

Like inversions by U.S. corporations that move their legal domicile outside the United States, conversions by U.S. corporations to real estate investment trusts are fundamental restructurings that provide major tax benefits. Upon announcing these deals, stock prices pop -- so Wall Street is anxious for more. Investors try to guess who among likely candidates will be the next. Private equity firms pressure companies to be aggressive. Investment banks and law firms are making a fortune. But because they do not have the emotional wallop associated with corporations 'abandoning' America, REITs don’t get the same attention from the public or from Congress.

In plain English, a REIT is a widely held corporation that gets most of its income from real estate and is required to pay out most of its income directly to shareholders. These dividends are deductible so most REIT income is shielded from corporate tax. Congress created REITs in 1960 to provide small investors with the opportunity to invest in real estate when it enacted the Cigar Excise Tax Extension.

The two issues now generating a lot of attention are the growing number of corporations electing REIT status that are not engaged in traditional real estate business and the potential for a large increase in the number of C corporations choosing to spin off their real estate assets (both traditional and nontraditional) into independent entities that elect REIT status.

The table below presents my estimates of the long-term entity-level tax savings that 20 corporations gain from electing REIT status. The 20 REITs examined are those that have recently converted (or have announced their intention convert) to REIT status or that invest in nontraditional REIT assets, such as timber, data centers, prisons, cell towers, billboards, and document storage facilities. The estimates indicate that in total, these REITs in the long term will reduce corporate revenues by between $900 million and $2.2 billion annually (based on profits at estimated 2014 levels).



It is important to understand that these estimates are significantly larger than the total net cost to Treasury of REIT status for these 20 REITs. Offsetting the revenue losses estimated here are the tax increases not estimated, which include: (1) a permanent increase in individual tax revenues due to REIT distribution requirements and a higher rate of tax paid on REIT dividends than on typical corporate dividends; (2) a temporary increase in individual tax revenues due to the requirement that a corporation converting to REIT status distribute all of its accumulated earnings and profits; and (3) a temporary increase in corporate revenues resulting from a reassignment of REIT assets to asset classes with longer useful lives.

The Congressional Budget Office projects that federal corporate tax receipts will grow rapidly over the next few years--from $273 billion in 2013 to $452 billion in 2017. But working in the opposite direction of rising profits and expiring tax breaks is corporate tax planning. "Our projections of corporate tax receipts over the coming decade do incorporate some erosion of the corporate tax base through a variety of tax reduction strategies.” Congressional Budget Office Director Douglas Elmendorf told reporters on August 27. REIT conversions, along with inversions, and much less visible multinational supply chain restructurings -- in which companies push huge amounts of profits they attribute to risk-taking and intellectual property into tax havens -- are the types of tax reduction strategies Elmendorf is talking about.

For macroeconomists like Elmendorf, the one or two billion dollars of estimated corporate revenue losses due to expanding REIT activity are tiny dots in the overall budget picture. But the phenomenon is likely to grow. After showing some reluctance to preapprove REIT deals, the IRS has the REIT ruling machine up and running again. Because it isn't getting the same scrutiny as the emotionally charged issue of corporate inversions, Congress is unlikely to intervene except in the context of tax reform -- which means nothing will happen any time soon. REIT activity will continue to expand because many of the new nontraditional REITs are in fast-growing business lines, such as colocation services provided by data center REITs. And it will grow because REITs spun off from existing business -- such as Gaming and Leisure Properties and Windstream’s new REIT—are actively seeking to be the repository of REIT qualified assets for other C corporations within their industries.

At 8 a.m. on Monday, August 25, Minnesota-headquartered Life Time Fitness Inc. announced it was exploring a potential conversion of real estate assets into a REIT. The health club company’s share price, which had closed at $41.60 on Friday afternoon, jumped to $47.70 as trading began on Monday morning. That’s a 15 percent rise, increasing the firm’s market capitalization by nearly a quarter-billion dollars in a matter of minutes. Expect announcements like this to continue.

This post is based on an article in the September 8 issue of Tax Notes.

Read Comments (1)

Gareth LewisSep 11, 2014

interesting article. Also offsetting tax revenue losses to Treasury could be 1)
more liquidity in market increasing transaction taxes and 2) reduced tax
planning by corporates (I.e tax reduction strategies they would have done in
the absence of REIT legislation)

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