Tax Analysts Blog

Red Hot REITs Fire-up Low Tech

Posted on Mar 4, 2013

Equipment vs. buildings. One of the long-standing debates in tax economics is whether or not investment incentives should be tilted in favor of equipment -- and, by implication, because of its disproportionate investment in equipment—manufacturing. The basic idea is that equipment investment is closely related to the development of new technology. This technology provides pro-growth benefits to the overall economy. In the absence of government policies to support technology, the private sector will invest less in technology than is optimal for the overall economy.

An old but highly influential paper by Bradford DeLong and former Treasury Secretary Larry Summers provides empirical evidence that equipment investment has a special role to play in economic growth. The overall debate is reviewed in detail in recent Senate testimony by Robert Atkinson of the Information Technology and Innovation Foundation. And of course now in Washington DC politicians on both sides of the aisle, including President Obama, are anxious to provide special tax benefits to manufacturing.

Meanwhile, Wall Street has fallen in love with REITs. As reported by my colleague Amy Elliott, the mere rumor that a company might convert from a taxable C corporation to a Real Estate Investment Trust, which are entirely exempt from corporation tax, is enough to send its stock price soaring. Several large firms--like Weyerhauser, American Tower, Corrections Corporation of America, Penn Gaming, and Ryman (owner of the Grand Ole Opry) -- have already taken the plunge. This is good for investors and for the companies, but Uncle Sam is going to lose some revenue.

In order to qualify for REIT status under federal tax rules most of the company's assets and income must be related to real estate (which the IRS in a series of rulings is struggling to define: “There is a trend toward relaxing REIT rules to include less traditional forms of real estate such as cell towers and infrastructure"). Obviously this will never be a possibility for companies like Microsoft or Caterpillar. But for companies in some businesses (e.g., hotels, casinos, nursing homes, restaurants, retailers, timber), becoming a tax-advanatged REIT is a real possibility.

There are several unattractive aspects to all this. Often companies that want to switch to REIT status must shed--purely for tax purposes--a lot of their business lines so a sufficient proportion of their business is real-estate related. They must incur large up-front and on-going costs to keep their business in compliance with the many complex tax rules. All this runs entirely counter to the idea that equipment investment should be favored. REITs move us exactly in the opposite direction. Tax rules urge Wall Street investors to favor companies that invest in real estate. And they provide incentives for businesses themselves to invest more heavily in real estate.

Gridlock in Washington will likely prevent any new tax breaks for equipment to ever see the light of day. But on Wall Street the lure of higher returns has already greased the skids for tax breaks on real estate.

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