IRS Seeks to Prevent Tax Avoidance in REIT Spinoffs

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By Laura Davison

June 7 — Corporations that move property to a real estate investment trust within 10 years of a spinoff will be taxed as though they sold the assets at fair market value, the Internal Revenue Service said.

The agency is seeking to address transactions not already addressed in the 2015 Protecting Americans from Tax Hikes Act that avoid gain recognition in a real estate investment trust (REIT) and regulated investment company (RIC) conversion in temporary rules (T.D. 9770, RIN:1545-BN39).

The law, passed in December, restricted C corporations from spinning off real estate assets tax-free into a REIT, a move that had become popular to reduce taxes and increase shareholder value (242 DTR GG-4, 12/17/15).

This is the most recent in a long line of guidance trying to police the “General Utilities” doctrine repeal—the 1986 law change that locked in an entity-level tax on appreciation in C corporations—in the REIT context, Steven Schneider, a partner at Baker & McKenzie, told Bloomberg BNA. The rules seek to tighten one tool, tax code Section 1374, that has been used to enforce the GU repeal.

“The IRS is still sticking with the general ‘Section 1374 approach' of using the same built-in gain rules that police S corporation conversions, but they note a concern that in the context of a tax-free Section 355 spinoff that the general Section 1374 approach is not always enough, even after the PATH Act changes,” Schneider said.

Escape Hatch Locked

Under Section 1374, if the property is sold during a set time period—which used to be 10 years and is now five—a corporate-level tax is applied. After that time is up, the assets can escape the tax. The temporary rules again raise the waiting period to 10 years for REITs and RICs.

Because C corporations are no longer able to spinoff real estate under Section 355, taxpayers aren't able to do a tax-free separation of assets that do and don’t qualify to be held in a REIT into separate corporations, Schneider said.

Spinoffs have been used by companies in the hospitality, restaurant and retail industries as a move to save taxes on real estate assets, because REITs aren't taxed at the entity level and pass the liability onto shareholders. Companies, including Hilton Worldwide Holdings Inc. and Darden Restaurants Inc., were some of the final companies to use the strategy as the law went into effect (39 DTR G-4, 2/29/16).

“The temporary 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 IRS said in the rules. “The temporary regulations provide an appropriate increase to the basis of the converted property held by the REIT.”

Definition Revision

The IRS also proposed rules (REG-126452-15, RIN:1545-BN06) June 7 that would modify the definition of converted property. This revision would treat converted property as any property that is partially or wholly owned by a C corporation that becomes property of a REIT or regulated investment company.

The temporary and proposed rules are scheduled to be published in the Federal Register June 8. Comments on the proposed rules are due Aug. 8.

To contact the reporter on this story: Laura Davison in Washington at

To contact the editor responsible for this story: Brett Ferguson at

For More Information

Texts of T.D. 9770 and REG-126452-15 are in TaxCore.