How REIT Spinoffs Will Further Erode the Corporate Tax Base

While Congress has been obsessing about tax inversions, it turns out another—potentially more important–tax avoidance technique is getting increased attention from the business community: Spinning off tangible assets into Real Estate Investment Trusts (REITs).

If these deals become widespread, they’d be another nail in the coffin of the corporate income tax. Multinational firms already slash their U.S. tax liability on income from intellectual property by shifting patents and goodwill to affiliates in low-tax countries. These latest transactions would allow them to slash their corporate tax by spinning off land and structures to tax-free REITs. That would significantly reduce the corporate tax base.

Shifting assets to a REIT effectively eliminates the corporate-level tax. As long as a REIT earns 75 percent of its income from rent or sale of real property and distributes 90 percent of its earnings to shareholders, it is generally exempt from corporate tax. The only tax is owed by shareholders, who pay ordinary income tax rates on those distributions.

The spin-off itself is tax-free.

REITs have been around for decades, mostly as investment vehicles for office and apartment buildings, shopping malls, and the like. In recent years, operators of casinos and for-profit prisons have spun off their land and structures into REITs.

But until recently, the shift has been slow, in part because the IRS had not written updated regulations for decades. Because the rules were so unclear, a firm needed to go through the cumbersome process of getting a private letter ruling from the agency to complete a spin-off.

However, in May, the Service released detailed guidance on what assets could be included in a REIT. Since then, firms have announced a small wave of spin-offs. Tom Gara of The Wall Street Journal did a nice piece on July 29 describing one of them—by the telecom firm Windstream Corp. It recently got IRS approval to spin off its fiber and copper network into a REIT. Here is a Powerpoint describing the deal.

The potential tax savings from these transactions is enormous. According to the Federal Reserve Board’s Flow of Funds report, of the $35 trillion in assets held by non-financial corporations, more than $10 trillion is in real estate alone.

Utilities, telecoms, pipeline companies, railroads, ports, and data centers are all prime candidates for REIT-hood.

Politically, these deals are far less controversial than inversions. For instance, firms that do them are not likely to have their patriotism questioned (though the consequences for the national fisc could well be more severe).

House Ways & Means Committee Chair Dave Camp’s tax reform would bar tax-free spinoffs into REITs but his plan is going nowhere, and Congress is in no rush to impose free-standing limits on these transactions. And, under siege in the wake of its treatment of political non-profits, it is hard to imagine the IRS unilaterally reversing its new regs.

It isn’t likely corporations will rush to shift all of their real property to REITs. For instance, bondholders may demand that borrowers continue to hold some tangible assets as security for debt. But faced with a 35 percent corporate tax rate plus a second tax on dividends of as much as 23.8 percent, companies never stop looking for ways to minimize taxes. And REITs seem like an unmistakable opportunity.


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