In Private Letter Ruling 201404005 (the “PLR”), the IRS provides additional confirmation and clarification regarding the treatment of a REIT special dividend made pursuant to the requirements of Section 857(a)(2)(B).1
The taxpayer in the PLR (“Taxpayer”) is the common parent of an affiliated group of corporations that files a consolidated Federal income tax return. Taxpayer has one class of common stock outstanding (“Taxpayer Stock”) and intends to elect to be treated as a real estate investment trust (“REIT”) under Section 856. In connection with the REIT election, Taxpayer intends to distribute to its shareholders with respect to their Taxpayer Stock all of its earnings and profits accumulated by Taxpayer for all taxable periods ending prior to the first REIT taxable year as required by Section 857(a)(2)(B) (the “Special Dividend”).
The Special Dividend
Taxpayer intends to provide each shareholder with an election to receive its share of the Special Dividend in the form of cash or Taxpayer Stock, or a combination of both. If a shareholder fails to make a valid election by the election deadline, that shareholder will be deemed to have made an election to receive only Taxpayer Stock. In addition, Taxpayer will limit the aggregate amount of cash to be distributed in payment of the Special Dividend so that cash will comprise at least 20% of the Special Dividend (the “Cash Limitation”).2
The facts in the PLR provide that the amount distributed in the aggregate would be 20% cash and 80% Taxpayer Stock and, further, provide a mechanism for increasing or decreasing the payment of cash or Taxpayer Stock, as the case may be, in order to achieve the intended 20/80 split in the event that in the aggregate the elections amount to more or less than the Cash Limitation. It appears that the Cash Limitation and the election adjustment mechanisms may be intended to allow for the cash / stock split in the Special Dividend to qualify for the minimum cash distribution that would be treated as a dividend of accumulated earnings and profits. If the elections to receive the Special Dividend would result in the payment of cash in an aggregate amount that is less than or equal to the Cash Limitation, then all such elections will receive the requested amount of cash. However, if all such elections would result in the payment of cash in an aggregate amount in excess of the Cash Limitation then: (i) each shareholder electing to receive the Special Dividend in cash on 20% or less of the total number of shares of Taxpayer
Stock held by such shareholder will receive the elected amount of cash; and (ii) each shareholder electing to receive the Special Dividend in cash on more than 20% of the total number of shares of Taxpayer Stock held by such shareholder will receive cash on the number of elected shares equal to 20% of its total number of shares of Taxpayer Stock plus cash on the number of elected shares exceeding 20% of the total number of shares of Taxpayer Stock it holds in a prorated amount based on a formula plus shares of Taxpayer Stock for the remaining amount of the elected shares for cash that were not paid in cash.
Taxpayer intends to distribute its stock and the cash in the Special Dividend during the first REIT taxable year and as soon as reasonably practicable following the date of the election deadline.
In order to qualify as a REIT, a corporation’s deduction for dividends paid must equal or exceed the sum of (i) 90% of the REIT taxable income for the taxable year and (ii) 90% of the excess of the net income from foreclosure property over the tax imposed on such income by Section 857(b)(4)(A), minus any excess noncash income.3 In general, a corporation is not eligible for REIT treatment for a tax year unless as of the close of the tax year the corporation has no earnings and profits accumulated in a non-REIT year.4 Thus, a C corporation which has accumulated earnings and profits must distribute its corporation accumulated earnings and profits before it can qualify to make an election to be treated as a REIT.5
Section 301 provides the rules with respect to a distribution of property made by a corporation to a shareholder with respect to its stock. The portion of the distribution which is a dividend is included in the shareholder’s gross income.6 In this context, the term “dividend” means any distribution of property made by a corporation to its shareholders out of its earnings and profits accumulated after February 28, 1913, or out of its earnings and profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made.7 In addition, the portion of the distribution which is not a dividend shall be applied against and reduce the adjusted basis of the stock.8 Finally, in general the portion of the distribution which is not a dividend, to the extent that it exceeds the adjusted basis of the stock, shall be treated as gain from the sale or exchange of property.9 However, the portion of the distribution which is not a dividend, to the extent that it exceeds the adjusted basis of the stock and to the extent that it is out of increase in value accrued before March 1, 1913, shall be exempt from tax.10
In general, Section 305 provides that gross income does not include the amount of any distribution of the stock of the corporation making the distribution.11 However, this general rule does not apply to a distribution by a corporation of its stock, and the distribution shall be treated as a taxable distribution of property to which Section 301 applies, if any of a number of exceptions apply. The exceptions include the following:
- If the distribution is, at the election of any of the shareholders (whether exercised before or after the declaration thereof), payable either in its stock or in property.12
- If the distribution (or a series of distributions of which such distribution is one) has the result of the receipt of property by some shareholders, and an increase in the proportionate interests of other shareholders in the assets or earnings and profits of the corporation.13
- If the distribution (or a series of distributions of which such distribution is one) has the result of the receipt of preferred stock by some common shareholders, and the receipt of common stock by other common shareholders.14
- If the distribution is with respect to preferred stock, other than an increase in the conversion ratio of convertible preferred stock made solely to take account of a stock dividend or stock split with respect to the stock into which such convertible stock is convertible.15
- If the distribution is of convertible preferred stock, unless it is established to the satisfaction of the Secretary that such distribution will not result in the receipt of property by some shareholders, and an increase in the proportionate interests of other shareholders in the assets or earnings and profits of the corporation.16
Application of Law
In the PLR, the IRS concluded that all of the cash and Taxpayer Stock to be distributed by Taxpayer in the Special Dividend will be treated as a distribution of property with respect to its stock, to which Section 301 and the taxable exceptions in Section 305(b) apply. In addition, with the caveats that (a) Taxpayer must elect to be taxed as (and actually qualify as) a REIT and (b) the Special Dividend must occur during the first REIT taxable year, the IRS additionally concluded that the amount of the distribution of stock shall be considered to equal the amount of cash that could have been received instead of such stock.17 Thus, when a REIT makes such a dividend as required pursuant to Section 857(a)(2)(B), this ruling confirms and clarifies that despite the fact that the corporation is making (at least partially) a distribution of its stock, such a distribution will nevertheless be excepted from the general rule of non-recognition and instead will fall within the familiar Section 301(c) analysis with respect to distributions of property.
While the applicable law in the PLR (i.e., the distributions of property / stock rules of Sections 301 and 305) is well settled and routinely seen and applied in practice, a ruling such as the PLR is a welcomed piece of guidance for practitioners seeking to apply everyday corporate tax rules to the perhaps less comfortable REIT rules. The PLR provides further confirmation and clarification that, at least with respect to the specific facts of the distribution at issue, a REIT special dividend of cash and stock by a REIT to holders of the REIT’s stock will be treated as a distribution of property with respect to the REIT’s stock to which Section 301 and the taxable exceptions in Section 305(b) apply.