IRS’ New Rules Slam Door On REIT Spinoff Loophole

Given their increased popularity and media coverage, spinoffs have recently received a lot of attention from regulatory bodies such as the IRS. In fact, one of the under reported items coming out of last year’s budget battle was Congress taking a stand against non-real estate companies spinning off REITs. Essentially, the bill requires a spinoff to wait 10 years before electing to become a REIT, effectively neutering the tax efficiency of the transaction. The REIT spinoff pipeline isn’t totally dry though as the bill did ‘grandfather’ in companies already in the process of spinning off their real estate, such as Hilton’s (HLT) in-progress spin, and allows for REITs to spin off REITs.

Not surprisingly, the new legislation didn’t cover all of the possible contingencies and numerous quick witted parties quickly discovered a bit of wiggle room within the new law. Surprisingly, the IRS also noted many of these loopholes and moved quickly to shut them down by issuing new rules on the topic. According to the WSJ, one loophole that could have been exploited was the law ‘didn’t prevent spun-off companies from merging into an existing REIT’. Clever. Here is how the WSJ describes the new rules:

They take effect immediately and “are necessary to prevent abuse,” the government said. The rules would require spun-off companies that later get REIT status to pay corporate taxes as if they sold their appreciated real estate, a tax that would undermine much of the purpose of putting it in a REIT.

“This should effectively shut down REIT spins,” said Lisa Zarlenga, a former Treasury official who is now co-chair of the tax practice at Steptoe & Johnson LLP in Washington.

It remains to be seen if some other workarounds can be found, but even if they do exist, it’s unlikely those spins would be looked at favorably by the IRS. We recently noted that the IRS is working on developing guidance for spinoffs and overall, it will likely be a positive if the dust finally settles with clear rules for moving ahead with spinoffs. Of course, it depends how heavy a hand the agency adopts…

Disclosure: Author holds no position in any stock mentioned.