The bill from Rep. Kevin Brady (R., Texas), the chairman of the House Ways and Means Committee, would prevent companies that aren’t REITs from spinning off REITs. It would also prevent spun-off companies from converting into REITs for 10 years.
Unfortunately, it seems to have made it into the final package so this could be the end for the transaction as the ban would be retroactively effective to December 7th with some limited exceptions. Companies which have sought IRS Private Letter Rulings beforehand will be allowed to proceed.
Spinning off real estate has been a popular suggestion by activist investors and a number of these types of spinoffs have occurred over the past few years. In a low yield environment, REITs were attractive for their dividends and often garnered premium multiples. A recent example would be Darden’s (DRI) spinoff of Four Corners Property Trust (FCPT), a deal which actually received a Private Letter Ruling or blessing of the transaction from the IRS (probably to protect it from a bill like this). Other industries such as gaming (Penn National), telecom (Windstream(WIN,CSAL) and outdoor advertising (CBS/CBS Outdoor) have also pursued this strategy, while other companies, such as McDonald’s (MCD) and Macy’s (M), considered the idea but passed. Quite the mix of companies and industries!
Not surprisingly, some tax specialists were opposed to the idea:
Robert Willens, a New York-based tax adviser, said in an email that he understood concerns about whether REIT spinoffs truly separate real estate from the rest of the business, because they are so interrelated even after the transaction.
But, he added, “I think it’s dangerous, and totally unwarranted, to deny tax-free status to a spinoff based purely on the ‘identity’ of the parties to the spinoff. I’m not a fan of this proposal and would hope that ‘cooler heads’ prevail here and the proposal never gets enacted.”
While I tend to agree, I think the issue is similar to the one which derailed Yahoo’s (YHOO) planned Alibaba (BABA) stake spinoff. Loophole abuse tends to get noticed and unfortunately, draws a strong response. Yahoo tried driving a truck through a loophole in order to save billions in taxes and despite the confidence in their lawyer’s tax opinion, the deal got killed. No one really cares as long as the damage remains small, but it’s tough for loopholes to remain that way. The proliferation of REIT proposals, including in some non-traditional areas, set off concerns about lost revenues and this is the response.
The bill hasn’t been passed yet and the final language is yet to be determined, so there is still a slight possibility that something could get changed. There might also be some loopholes in there allowing these types of transactions to continue to proliferate. If you have some insight on this, please share in the comments. Even if it somehow survives or allows for some more exceptions though, it’s future would be bleak.
Either way, it seems REIT to REIT spinoffs are still ok and carve-outs via IPO would still work. It’s unclear if any of the currently proposed transactions (like Pinnacle’s) will be effected though due to the Private Letter Ruling exception. It seems Hilton’s(HLT) recently reported REIT spinoff got their request in on time and would be good to go. The future pipeline just went dry though. Activists will just have to find a new loophole to exploit…
Disclosure: Author holds no position in any stock mentioned.
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