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By Michael Hirschfeld, Esq., Bonnie A. Barsamian, Esq., Mark D. Grimm, Esq. Dechert LLP, New York, NY and Philadelphia, PA
The Internal Revenue Service (“IRS”) issued Rev. Proc. 2008-68 (the “Rev. Proc.”) on December 10, 2008, providing that a stock distribution by a publicly traded real estate investment trust (“REIT”) will be treated as a taxable dividend if certain requirements are met. The Rev. Proc. adopts a favorable rule that allows a REIT to meet mandatory distribution requirements with the use of non-cash consideration. The Rev. Proc. applies for REIT-taxable years ending on or before December 31, 2009.
As a result of the current economic environment, many REITs facing liquidity constraints have found it difficult to distribute 90% of their net taxable income in the form of dividends. If a REIT is unable to distribute 90% of its net taxable income, the REIT is subject to U.S. federal income tax at a 35% rate. Only taxable distributions of property may be counted toward the satisfaction of this distribution requirement.
The Internal Revenue Code (the “Code”) provides that a stock dividend will generally not be treated as a taxable distribution. However, the Code provides that distributions will become taxable if the shareholder is given the option to elect to receive either stock or cash. The IRS, through private letter rulings issued to certain REITs, has effectively treated distributions payable in stock or cash at the shareholder's election as a taxable distribution (including for purposes of the 90% distribution requirement) when the REIT limited the total amount of cash available to 20% of the aggregate distribution. These letter rulings, however, only benefited the named REIT.
The Rev. Proc. provides that a distribution of stock by any REIT will be treated as a taxable distribution (including for purposes of the 90% distribution requirement) equal to the value of the amount of money that could have been received instead, provided:
• the dividend is declared on or after January 1, 2008 with respect to a REIT's taxable year ending on or before December 31, 2009;
• the REIT's stock is publicly traded on an established securities market in the United States; and
• each shareholder is permitted to elect to receive the entire dividend in either (i) cash, or (ii) stock of the REIT of equivalent value, provided that the REIT does not limit the total amount of cash available (the “Cash Limitation”) to less than 10% of the aggregate distribution.
If too many shareholders elect to receive cash, the excess may be paid in stock, but each shareholder electing cash must receive a pro rata amount in cash (corresponding to such shareholder's respective distribution), but in no event may a shareholder who elects to receive cash receive less than 10% of the aggregate dividend in cash.
For the purpose of determining the amount of shares to be distributed, the REIT must calculate the value of its stock (as close as practicable to the dividend payment date), based on a formula utilizing market prices that is designed to equate the value of the shares received with the amount of cash that could have been received instead. With respect to shareholders participating in a REIT's dividend reinvestment plan (“DRIP”), the DRIP shall apply only to the amount of cash that the shareholder would have received absent the DRIP.
For taxable years ending on or before December 31, 2009, the IRS now provides REITs the ability to treat a distribution of stock as a taxable dividend when the Cash Limitation is not less than 10% of the aggregate distribution. With the issuance of the Rev. Proc., cash-conscious REITs are afforded a new opportunity to conserve their capital.
For more information, in the Tax Management Portfolios, see Carnevale, de Bree, Schneider, Temkin and Witt, 742 T.M., Real Estate Investment Trusts, and in Tax Practice Series, see ¶5180, Real Estate Investment Trusts (REITs).
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