Vornado Sees Potential Tax Upside to Toys “R” Us Bankruptcy

For over 50 years, Bloomberg Tax’s renowned flagship daily news service, Daily Tax Report® has helped leading practitioners and policymakers stay on the cutting edge of taxation and...

By Allyson Versprille

Vornado Realty Trust stands to benefit from capital losses it is likely to sustain as a result of its investment in Toys “R” Us Inc.—a silver lining to the big-box toy retailer’s recent bankruptcy filing.

“Vornado had previously fully reserved for its 32.5% investment in Toys, and carries this investment on its balance sheet at zero,” the company said Sept. 19 in a news release. “For income tax purposes, it carries this investment at approximately $420 million which could result in a tax deduction in future periods.”

Because Vornado, a real estate investment trust, has already written down its investment to zero on its financial statements, no further “book” loss will be recorded if and when the investment becomes worthless, said Robert Willens, president of tax and consulting firm Robert Willens LLC in New York. “Write downs” aren’t permitted for tax purposes, but “if the stock does become worthless, which seems like a virtual certainty, the REIT will sustain a capital loss” in an amount equal to its basis in Toys “R” Us stock, Willens said in an email. The company won’t sustain an ordinary loss because it doesn’t own at least 80 percent of the toy retailer, he said.

“The capital loss will be helpful to Vornado since it will enable the corporation to generate capital gains, from sales of real property, which, due to the offsetting capital loss, will not give rise to taxable income to Vornado’s shareholders when those gains are distributed to them,” Willens said. And even though the company didn’t set out to sustain a capital loss when it invested in Toys “R” Us, the loss will “allow the corporation to restructure its portfolio (through sales of certain properties) without tax consequences,” he said.

Toys “R” Us, which has about 1,600 stores in 38 countries, filed for voluntary Chapter 11 bankruptcy protection late Sept. 18.

Don’t Cry Over Spilled Milk

Vornado, Bain Capital, and KKR & Co. acquired Toys “R” Us in a $7.5 billion leveraged buyout in 2005. The three companies and their co-investors put $1.3 billion of equity into the purchase and financed the rest with debt. Vornado said in the news release that it doesn’t “hold any debt of Toys and does not guarantee any of Toys debt and has no further liability.”

Vornado is communicating to investors that there’s a potential upside to the Toys “R” Us bankruptcy, said Alexander D. Goldfarb, a managing director and the senior REIT analyst in the Research Department of Sandler O’Neill and Partners LP.

The company is saying that it has no financial obligations, already wrote down the investment to zero on its financial statements, and could sustain losses that can be used to offset taxable gains, Goldfarb said. “No one goes into an investment seeking to lose money, so obviously they had the highest and best hopes when they took over Toys “R” Us with Bain and KKR back in ’05, but this is the lemonade, if you will.”

The negatives have already occurred, Goldfarb said. “Let’s just say the milk was spilled seven years ago,” he said, referring to the toy retailer’s failed initial public offering. The company filed for an IPO with the Securities and Exchange Commission in 2010, but withdrew the filing in 2013. “It’s a little late to cry about it,” Goldfarb said.

Sandler O’Neill disclosed that it provides investment banking services to Vornado and has other business ties to the trust separate from the Toys “R” Us matter.

Bain Capital, a private equity company, declined to comment about tax matters involving the company. KKR said its investment in Toys “R” Us is held in a fund characterized as a partnership for tax purposes. The company didn’t immediately respond to additional questions on its tax position.

To contact the reporter on this story: Allyson Versprille in Washington at aversprille@bna.com

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

For More Information

Text of the Vornado news release is at http://src.bna.com/sHt.

Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.

Request Daily Tax Report