IRS Provides Cash-Strapped REITs Relief by Liberalizing Certain
Taxable Stock Dividend Rules
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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