In PLR 201109003 (3/04/2011) the Service ruled, under the facts set forth in the request, that the proposed issuance of two classes of stock by a corporation which intended to meet the requirements of a real estate investment trust (REIT) would not cause distributions to stockholders to be treated as “preferential dividends” under Section 562(c) or otherwise jeopardize the corporation’s qualification as a REIT.
A REIT and its shareholders are taxed in accordance with Sections 856-859 provided certain requirements are met. A REIT, generally organized as a corporation, trust or association, generally results in federal income taxes being imposed on a current basis to its members through the form of dividend distributions.
The general requirements of a REIT per Section 856(a) are: (i) the organization must be managed by one or more trustees or directors; (ii) beneficial ownership in the organization must be represented by transferable shares or certificates; (iii) the organization generally must be taxable as a domestic corporation ; (iv) the organization must be neither a financial institution per Section 582(c)(5) nor an insurance company subject to the provisions of Subchapter L; (v) the organization must be beneficially owned by at least 100 persons during a minimum of 335 days in a taxable year of twelve months (or during a proportionate part of a taxable year of less than twelve months); and (vi) the organization must not be closely held per Section 542(a)(2). Substantial amendments were made to the REIT provisions in 2004 which expanded the types of securities which will constitute “straight debt” for purposes of apply the 10% single issuer limitation in Section 856(m) as well as adding safe harbor rules for determining whether rents from a taxable REIT subsidiary are comparable to unrelated party rents. See Section 856(d)(8)(A).
Back to the ruling. Under Section 857(a)(1) , a REIT's dividends-paid deduction must equal or exceed 90% of its REIT taxable income. For purposes of Section 561(a) , the deduction for dividends paid includes dividends paid during the tax year. A distribution is not qualified dividend if it is “preferential” in nature. Thus, under Section 562(c), a dividend for REIT deductibility purposes can not: (i) prefer any shares of stock in a class over other shares of stock within the same class; or (ii) prefer one class of stock over another (except to the extent that such a class is entitled to a preference).
In Rev Proc 99-40, 1999-2 CB 565 , the Service rule that in certain instances distributions made by a regulated investment company (RIC) to its shareholders in varying amounts may still be deductible as dividends under Section 562. Where the varying distributions to different groups of shareholders differ on account of expense allocations relating to shareholder services, the distribution of shares, allocation of the benefit of a waiver or reimbursement of a fee, or variations resulting from the allocation of performance-based advisory fees, will not be treated as nondeductible preferential dividends so long as such expenses are allocated to the group of shares for which the expenses were incurred and certain other requirements are met.
Under the facts of PLR 201109003 the taxpayer-corporation (intending to qualify as a REIT) . intends, through its operating partnership, to invest primarily in a diversified portfolio of commercial real estate properties located in major metropolitan markets and other real estate-related assets. Taxpayer's shares of common stock will not be publicly traded but liquidity for shares would be realized under a redemption plan. The plan would generally allow stockholders to request on a daily basis that Taxpayer redeem their shares at the net asset value (“NAV”) per share. Taxpayer's shares will be distributed a broker-dealer that will form a syndicate of participating broker-dealers to offer and sell the shares to the public.
Ttraditional non-listed REITs have been criticized for up front costs which will be avoided in this case through a reduced commission at closing but will pay dealer manager fees based on net asset value and a distribution fee. In preliminary discussions with potential broker-dealers, Taxpayer was informed that its shares will not be attractive to investors with wrap accounts or registered investment advisors (RIAs) where investors pay their financial advisors an asset-based fee as an alternative to paying additional transaction fees. Specifically, although Taxpayer's selling commission could be waived for such investors, they would still bear a second level of distribution charges if Taxpayer charges a distribution fee with respect to such investors. So, to attract investors the Taxpayer proposed to issue: (i) one class of common stock that will be subject to the selling commission and annual distribution fee; and (ii) for investors with wrap accounts or RIAs, a class of common stock that will not be subject to any selling commission or allocation of the distribution fee. After shares are purchased, Taxpayer will pay certain quarterly and annual fees which are accrued on a daily basis for purposes of NAV calculation.
Taxpayer filed its registration statement on Form S-11 to register its shares of common stock to be offered to the public. Taxpayer now intends to amend its registration statement before its public offering to provide for two classes of common stock. The various fees Taxpayer proposes to charge for each class are as follows: (i) an advisory fee payable by Taxpayer to advisor for implementing Taxpayer's investment strategy and managing its day-to-day operations which will be charged at the same rate for each class of stock; (ii) a dealer manager fee, charged at the same rate for each class, paid in consideration of the distribution, marketing and stockholder services the Dealer Manager provides to Taxpayer in connection with the continuous offerings; (iii) a distribution fee, charged only to one class of stockholders, that will be entirely reallowed to participating broker-dealers selling such shares. This fee compensates those broker-dealers for their distribution services related to the shares.
The PLR concluded that under the facts involved the issuance of the two classes of shares won't: (i) cause the dividends paid by Taxpayer with respect to those shares to be preferential dividends under Section 562(c) ; or (ii) cause Taxpayer to fail to qualify as a REIT.
The Service determined that, although Taxpayer didn't technically fall within the scope of Rev Proc 99-40 , sufficient common ground exists between REITs and RICs warranting similar treatment. Thus, the dual class structure the Service found was consistent with RIC requirements under Rev. Proc. 99-40 and therefore qualified for favorable treatment. The Service found significant the provision that the Taxpayer is subject to a continuous “merit review” process intended to ensure that the stockholders are treated fairly, in addition to many SEC, state, and other restrictions and regulations with respect to its stock offerings, its operations, and the rights of its stockholders.