The IRS is working on proposed regulations about what qualifies as “real property” for REIT purposes.
REITs, or real estate investment trusts, are corporations or trusts that are not taxed at the entity level on the earnings they distribute to investors. There are both private REITs and publicly-traded REITs. The assets held in a REIT must be at least 75% “real property,” although a REIT can also hold some assets through a taxable subsidiary that do not qualify to be held by the REIT directly.
Several REITs have been formed to hold transmission and similar infrastructure assets after the IRS ruled privately that transmission lines and towers are real property for REIT purposes. There was a flurry of interest in REITs among solar and wind companies in 2012, but the interest diminished after the IRS rulings branches that handle REITs made clear they are not prepared to rule that solar panels and wind turbines are real property. Machines are not considered real property. Some solar advocates argue that solar panels are closer to transmission lines in that they are essentially a conduit for electricity.
Any new definition of “real property” that the IRS develops will have a prospective effective date.
It is possible any decision to expand what qualifies as real property for REITs could make European and other foreign companies invested in the US renewable energy sector more likely to pay US capital gains taxes when they exit US investments. The IRS uses the same definition of real property for taxing foreigners on capital gains from US investments. A foreign parent selling a US holding company for US investments is generally not taxed on the gain as long as less than 50% of the asset value in the holding company is in US real property.
The IRS had a hold on private letter rulings about REIT classification from May to November 2013 while it studied whether the rulings it has been issuing go too far. David Silber, a deputy IRS associate chief counsel, said in April that the agency decided it was comfortable with what it had done and is now working through a rulings backlog.
CBS, the US television company, said in April that it received a favorable tax ruling that will allow it to spin off its outdoor billboard advertising subsidiary into a REIT. The subsidiary, CBS Outdoor Americas Inc., raised $560 million in late March in an initial public offering of 19% of the shares. CBS plans to do a tax-free spinoff of the other 81% of the shares later this year and then convert the subsidiary into a REIT. One analyst estimated that the conversion would reduce the CBS tax bill by $145 million in 2014 if it had occurred at the start of the year.
Meanwhile, the IRS is under conflicting pressures on REITs. Some segments of the Obama administration have been keen to see REITs authorized for use in the renewable energy sector because they believe it will help bring down the cost of capital for the sector. At the same time, some in Congress are concerned about the erosion in the corporate tax base that has been occurring as billboard companies, cell phone and electric transmission companies, data centers, casinos and prisons get favorable private rulings from the IRS allowing them to convert to REITs.
The draft corporate tax reform bill that the House tax-writing committee chairman, Dave Camp (R-Michigan), released in February would define “real property” for REIT purposes to exclude assets with shorter depreciable lives than 27.5 years. That would rule out cell towers and billboards. It is not clear to what extent existing REITs or companies that are in the process of converting would be affected.
The Camp bill would also require any company converting into a REIT to pay tax on the untaxed appreciation in value in the company’s assets through the conversion date. The bill would also bar corporations from electing REIT status for 10 years after being spun off in a tax-free transaction after February 26, 2014.