The Internal Revenue Service has issued final and temporary regulations to curb the use of spinoffs of corporate assets into real estate investment trusts, or REITs, to reduce taxes.
The Protecting Americans from Tax Hikes Act of 2015, also known as the PATH Act, included provisions to discourage companies with extensive real estate holdings, such as restaurant and hotel chains, from avoiding corporate taxes. The PATH Act prohibited companies from opting for REIT status for 10 years after doing a tax-free spinoff. However, there were still some loopholes, including merging into an existing REIT, according to The Wall Street Journal.
The new IRS regulations impose corporate-level tax on certain transactions in which property of a C corporation becomes the property of a REIT. The temporary regulations affect regulated investment companies (RICs), REITs, C corporations the property of which becomes the property of a RIC or a REIT, and their shareholders.
The regulations provide that a C corporation engaging in a conversion transaction involving a REIT within the 10-year period following a related section 355 distribution is treated as making an election to recognize gain and loss as if it had sold all of the converted property to an unrelated party at fair market value on the deemed sale date. Section 1374 treatment is thus not available in these cases as an alternative to recognizing any gain with respect to the converted property on the deemed sale date. The regulations also provide that a REIT that is a party to a section 355 distribution occurring within the 10-year period following a conversion transaction for which a deemed sale election has not been made recognizes any remaining unrecognized built-in gains and losses resulting from the conversion transaction.
For the taxable year in which the related section 355 distribution occurs, the REIT’s net recognized built-in gain is the amount of its net unrealized built-in gain limitation for that taxable year. The regulations cause the REIT to recognize any built-in gains or losses attributable to time periods in which the REIT was a C corporation while ensuring that gains and losses recognized in previous taxable years during the recognition period on which taxes have been paid are accounted for appropriately. The regulations provide an increase to the basis of the converted property held by the REIT.
However, consistent with section 311 of the PATH Act, the temporary regulations contain two exceptions. First, the regulations do not apply if both the distributing corporation and the controlled corporation are REITs immediately after the date of the section 355 distribution and at all times during the following two years.
Second, the temporary regulations also do not apply to certain section 355 distributions in which the distributing corporation is a REIT and the controlled corporation is a taxable REIT subsidiary.
In addition, and consistent with the effective date in section 311(c) of the PATH Act, the temporary regulations do not apply to distributions pursuant to a transaction described in a ruling request initially submitted to the IRS on or before Dec. 7, 2015 that has not been withdrawn and for which a ruling has not been issued or denied in its entirety as of that date.
To prevent avoidance, the regulations apply to predecessors and successors of the distributing corporation or the controlled corporation and to all members of the separate affiliated group, of which the distributing corporation or the controlled corporation are members.
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