Last Friday, President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 ("PATH Act"), a permanent extenders package. Several provisions of the PATH Act are of particular importance to REITs. The PATH Act largely implements the REIT proposals contained in the Tax Increase Prevention and Real Estate Investment Act of 2015 (introduced in the House of Representatives on December 8th), although there are some important differences.
The PATH Act implements the December 8th proposal disallowing tax-free spinoff treatment where either the distributing or distributee company is a REIT. This new rule prevents companies from spinning off tax-free their real estate in a newly formed REIT, although existing REITs are still allowed to do REIT spinoffs. There is one important difference from the December 8th proposal, though, as the PATH Act provides a transition rule. If the company had, prior to December 7th, submitted a private letter request to the Internal Revenue Service on the spinoff issue, the company will not be subject to this new rule. It is unclear how many companies will benefit from this transitional relief, however, as the Internal Revenue Service announced in September that it would no longer issue private letter rulings on this type of spinoff. The PATH Act also departs from the December 8th proposal in that it allows REIT's to spinoff taxable REIT subsidiaries that have been held for at least three years, even if a new corporation is formed to effectuate the spinoff.
Another important change for REITs is that the PATH Act negatively changes the REIT asset test. For taxable years beginning after December 31, 2017, the percentage of REIT assets that may consist of taxable REIT subsidiaries is reduced from 25 percent to 20 percent.
The PATH Act does provide some helpful provisions. With respect to the prohibited transactions safe harbors, the amount of property that a REIT can sell in any given year is increased from 10 percent of the adjusted basis or fair market value of the REIT assets to 20 percent, provided that the sales for the year do not exceed 10 percent of the three-year average adjusted basis or fair market value. The PATH Act also strikes from the prohibited transactions safe harbors the requirement that the property be described in section 1221(a)(1), opening the door for inventory property to qualify. The PATH Act also expands the prohibited transactions safe harbors to allow taxable REIT subsidiaries to engage in marketing and development expenses that previously had to be done by independent contractors. While the changes to the prohibited transactions provisions are generally positive, it should be noted that the PATH Act also added a new type of transaction to the list of prohibited transactions – transactions between a REIT and its taxable REIT subsidiary that are found to be on non-arm's length terms.
Other beneficial changes for REITs include the elimination of the preferential dividend rule for publicly offered REITs (effective for 2015 tax year) and the expansion of the beneficial treatment available for REITs under FIRPTA. This includes expanding the FIRPTA exception for publicly traded REIT stock for less than 5 percent shareholders to less than 10 percent shareholders.
It should also be noted that the PATH Act dropped the December 8th proposal to characterize as bad REIT income certain fixed percentage rent and interest income received from a single C corporation tenant. This proposal was highly criticized as it would negatively impact the OPCO/PROPCO arrangements typical in RIDEA structures.
The effective date of the PATH Act REIT provisions is generally for tax years starting after December 31, 2015, although as indicated above, special effective dates have been provided for many provisions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
