What Happens to MLPs, REITs in a Tax Overhaul?

By Laura Davison

Tax-preferred passthroughs, such as real estate investment trusts and master limited partnerships, could lose some of their relative advantage in an overhaul of the tax code, but investors are still likely to benefit as entities are able to choose whatever structure produces the most tax benefit.

“To the extent that both REITs and MLPs are viewed as tax-efficient forms of investments, a little bit of the bloom will come off the rose with lower tax rates,” Robert Willens, an independent tax consultant in New York, told Bloomberg BNA.

Neither REITs nor MLPs are expressly addressed in the tax plans put out by House Republicans or President-elect Donald Trump, but House GOP aides say the tax-preferred treatment of those entities isn’t expected to change during any tax code rewrite next year.

Big-scale changes to the tax code, however—a 20 percent corporate rate, a 25 percent passthrough rate and elimination of interest deductibility, for example—would cause these entities to take a second look at their business models and examine how to improve value for investors. Some might even ponder becoming a corporation.

MLPs and REITs probably would consider converting to C corporations, because it isn’t particularly difficult to collapse a partnership and the conversion would expand the investor base, Nomura Holdings analyst Steven Chubak said in a note to investors.

Both entity types will see some upsides and downsides from the tax overhaul plans lawmakers are discussing. Neither, with the exception of refining MLPs, import much from overseas, meaning they wouldn’t be subject to the border adjustment taxes. However, both take on debt, meaning they would be subject to the loss of interest expense deductions.

Corporate Conversion

House Republicans are pushing a 20 percent rate for corporations and 25 percent for passthrough entities, down from the current 35 percent corporate rate. MLP and REIT income now is passed onto investors and taxed through the individual side of the tax code, which tops out at 39.6 percent.

“If the rate for MLPs ends up being 25 percent I don’t think that’s so much of a gap that MLPs wouldn’t be valuable,” said Mary Lyman, executive director of the Master Limited Partnership Association. “Our main concern is that MLPs be preserved intact.”

But lower rates make incorporating less objectionable, Willens said. Some could see an opportunity to have income taxed at a lower rate and increase the number of potential investors.

Many tax-exempt institutions, such as pension funds, don’t invest in MLPs because they give rise to unrelated-business taxable income, which the institution has to pay tax on.

“That is something that institutions really despise,” Willens said. “To avoid this problem, they simply don’t invest in MLPs.”

REIT Reality

While MLPs might explore the possibility of converting to C corporations, REITs aren’t likely to go through the arduous process of “de-REITing,” said Jeffrey Langbaum, a senior REIT analyst at Bloomberg Intelligence.

“The biggest impact might be for the addition of new REITs who are not currently REITs,” Langbaum said, because the tax changes could cause a slowdown in the number of entities that elect to be REITs rather than C corporations.

REITs will likely both benefit and suffer from the proposed changes to the tax laws, making it difficult to foresee how the industry might change as a result of legislative changes.

“The House plan would permit the immediate write-off of the cost of investments, including, amazingly enough, real property,” Willens said, so when a REIT calculates its taxable income, it gets to expense the cost of any property placed into service that year.

One of the largest items on REITs’ balance sheets tends to be interest expense, so they are likely to be hurt by elimination of interest deductibility, Langbaum said. But that would only penalize property REITs, not mortgage REITs, because mortgage REITs have net interest income, as opposed to net interest expense.

Congress restricted some REIT provisions in the Protecting Americans from Tax Hikes (PATH) Act in 2015—preventing C corporations from spinning off REITs, for example. But REITs have been likely to stay off the chopping block since former Ways and Means Chairman Dave Camp (R-Mich.) proposed to scale back many of the REIT rules in 2014.

“The lobbying bodies for commercial real estate world have effectively put the scare out there,” Langbaum said. “If you take away this financing model, you’re going to see bad effects.”

To contact the reporter on this story: Laura Davison in Washington at lDavison@bna.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bna.com

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