Real Estate Contributions to REITs Tax, Legal and Securities Laws Considerations

Transcription

1 Real Estate Contributions to REITs Tax, Legal and Securities Laws Considerations Stephanie Smith, USDA, Washington DC Theodore Grannatt, McCarter English, Boston, MA Christopher Roman, Fried Frank, NY, NY Andrea M. Whiteway, EY, Washington, D.C RPTE Spring Symposia Boston, MA Andrea M. Whiteway. Copyright

2 Discussion Points Brief Overview of the Tax Consequences of Real Estate Dispositions Overview of the UpREIT Structure Tax Aspects of Real Estate Contributions to Partnerships / Tax Protection Agreements Legal Aspects of Real Estate Contributions to REITs Securities Laws Aspects of REIT Contributions Andrea M. Whiteway. Copyright

3 $ in billions # of REITs The Rise of the REITS REIT market capitalization $1, $900 $ $700 $ $500 $ $300 $ $100 $- 0 Market Capitalization ($ in bln) # of REITS Andrea M. Whiteway. Copyright

4 $ in millions # of Issuances The Rise of the REITS REIT issuance YTD REITs have become an important investment class Record breaking amounts of capital raised by REITs in 2012 and 2013 $90,000 $80,000 $70, Capital raised in 2014 saw a 17.3% decrease but was still far above all historical levels, excluding 2012 and is on track to be another record breaking year in January and February alone, there have been 35 offerings for a total amount of $15.8 bln That is far greater than the amount offered during the same period of 2013 (record high year), and greater than the amount offered in the entire first quarter of 2014 $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $- Capital Raised ($ in mm) # of Equity Offerings Andrea M. Whiteway. Copyright

5 What is a REIT? CORPORATION, TRUST OR ASSOCIATION OTHERWISE TAXABLE AS C CORPORATION MUST MEET REQUIREMENTS OF SECTION 856 AND ELECT REIT STATUS NOT SUBJECT TO CORPORATE TAX TO EXTENT INCOME IS DISTRIBUTED TO SHAREHOLDERS Andrea M. Whiteway. Copyright

6 What is an UPREIT? UMBRELLA PARTNERSHIP REIT SUBSTANTIALLY ALL ASSETS ARE OWNED THROUGH OPERATING PARTNERSHIP IN WHICH REIT IS GENERAL PARTNER OP UNITS HELD BY LIMITED PARTNERS ARE CONVERTIBLE INTO REIT STOCK Andrea M. Whiteway. Copyright

7 What is an UPREIT? SHAREHOLDERS 7 MILLION SHARES REIT CONTRIBUTING PARTNERS GP OP LP 3 MILLION UNITS CONVERTIBLE INTO 3 MILLION SHARES Andrea M. Whiteway. Copyright

8 Why an UPREIT? UPREIT STRUCTURE FIRST USED IN 1992 IN TAUBMAN REALTY CENTERS IPO OF THE 170 PUBLICLY TRADED REITS, 98 ARE UPREITS MOST EQUITY REITS ARE UPREITS Andrea M. Whiteway. Copyright

9 Transfer to REIT PUBLIC PROPERTY OWNERS CASH APPRECIATED REAL ESTATE REIT Andrea M. Whiteway. Copyright

10 Transfer to REIT EXCEPT AS SPECIFICALLY MODIFIED BY REIT RULES, SUBCHAPTER C APPLIES SECTION 351(a) GENERALLY PROVIDES FOR NONRECOGNITION TREATMENT ON TRANSFERS TO CORPORATION BUT SECTION 351(e) EXCEPTION FOR INVESTMENT COMPANIES Andrea M. Whiteway. Copyright

11 Transfer to REIT INVESTMENT COMPANY IF 80% OF ASSETS STOCKS AND SECURITIES AND TRANSFER RESULTS IN DIVERSIFICATION STOCKS AND SECURITIES BROADLY DEFINED UNDER 97 ACT REGULATIONS SAY REIT IS PER SE INVESTMENT COMPANY Andrea M. Whiteway. Copyright

12 Transfer to REIT DIVERSIFICATION RESULTS IF ONE PERSON TRANSFERS CASH AND ANOTHER TRANSFERS REAL ESTATE REGULATORY EXCEPTION FOR TRANSFERS OF DIVERSIFIED PORTFOLIOS OF SECURITIES Andrea M. Whiteway. Copyright

13 Transfer to REIT REGULATORY EXCEPTION DOES NOT APPLY TO DIVERSIFIED PORTFOLIOS OF REAL ESTATE BUT SEE PLR ; PLR ; PLR ; PLR Andrea M. Whiteway. Copyright

14 Transfer to REIT SECTIONS 351(a) AND 368(c) REQUIRE TRANSFERORS TO OWN 80% OF VOTING STOCK IMMEDIATELY AFTER TRANSFER NOT A PROBLEM FOR IPO TRANSACTION, BUT FOR SUBSEQUENT PROPERTY ACQUISITIONS Andrea M. Whiteway. Copyright

15 Transfer to REIT SECTION 357(c) REQUIRES GAIN RECOGNITION TO EXTENT OF DEBT IN EXCESS OF BASIS SECTION 856(h) PROHIBITS 5 OR FEWER INDIVIDUALS FROM OWNING 50% OR MORE OF REIT Andrea M. Whiteway. Copyright

16 UPREIT Structure PUBLIC CASH REIT CASH GP LP OP PROPERTY OWNERS APPRECIATED REAL ESTATE Andrea M. Whiteway. Copyright

17 UPREIT Structure MONEY RAISED IN IPO IS USED TO PAY DOWN DEBT AND/OR FOR ACQUISITIONS OP UNITS ARE CONVERTIBLE INTO STOCK OF PUBLICLY TRADED REIT OR CASH AT REIT S OPTION AVOIDS SECTION 351(e), 368(c), 357(c) AND 856(h) PROBLEMS Andrea M. Whiteway. Copyright

18 Partnership Anti-Abuse Regulation If a partnership is formed or availed of in connection with a transaction a principal purpose of which is to reduce substantially the present value of the partners aggregate federal tax liability in a manner that is inconsistent with the intent of Subchapter K, Then the Commissioner can recast the transaction as appropriate. Andrea M. Whiteway. Copyright

19 Partnership Anti-Abuse Regulation EXAMPLE 4 DESCRIBES AN UPREIT TRANSACTION AND BLESSES IT WHILE THERE ARE DIFFERENCES BETWEEN EXAMPLE 4 AND THE TYPICAL UPREIT STRUCTURE, GIVEN THE NUMBER OF DEALS, CHALLENGE IS UNLIKELY Andrea M. Whiteway. Copyright

20 Conversion Right OP UNITHOLDER IS PERMITTED TO EXCHANGE ONE OP UNIT FOR ONE SHARE OF REIT STOCK REIT MUST HAVE ELECTION TO PAY CASH TO AVOID OPTION ATTRIBUTION RECEIPT OF CONVERSION RIGHT AS BOOT? SEE REV. RUL Andrea M. Whiteway. Copyright

21 Conversion Right CONVERSION RIGHT PROVIDES LIQUIDITY EXERCISE OF CONVERSION RIGHT WITHIN 2 YEARS MAY TRIGGER DISGUISED SALE TREATMENT IF STOCK OR CASH COMES FROM OP Andrea M. Whiteway. Copyright

22 Conversion Right FORM OF CONVERSION IS CRITICAL CASH OR STOCK FROM OP = REDEMPTION (IF FORM IS RESPECTED) CASH OR STOCK FROM REIT = SALE (IF FORM IS RESPECTED) Andrea M. Whiteway. Copyright

23 Conversion Right BENEFITS OF REDEMPTION TREATMENT: REDEMPTION OF SOME BUT NOT ALL UNITS 15% CAPITAL GAINS RATE VS. 25% RATE FOR UNRECAPTURED SECTION 1250 GAIN Andrea M. Whiteway. Copyright

24 Section 704(c) SECTION 704(c) APPLIES TO PROPERTY CONTRIBUTED TO OP BUILT-IN GAIN ON PROPERTY WILL BE ALLOCATED BACK TO CONTRIBUTING PARTNER ON SALE DEPRECIATION WILL BE ALLOCATED AWAY FROM CONTRIBUTING PARTNER Andrea M. Whiteway. Copyright

25 Traditional Method CEILING RULE APPLIES CONVENTIONAL WISDOM: MAXIMIZES DEFERRAL OF INCOME TO CONTRIBUTING PARTNER BUT RUN THE NUMBERS Andrea M. Whiteway. Copyright

26 Curative Allocation Method NO CEILING RULE MINIMIZES DEFERRAL OF INCOME TO CONTRIBUTING PARTNER MAXIMIZES DEDUCTIONS TO REIT AND OTHER LPs Andrea M. Whiteway. Copyright

27 Remedial Allocation Method NO CEILING RULE INTERMEDIATE DEFERRAL OF INCOME TO CONTRIBUTING PARTNER (MORE THAN CURATIVE BUT LESS THAN TRADITIONAL) Andrea M. Whiteway. Copyright

28 Example CONTRIBUTED PROPERTY HAS $100 VALUE, $30 BASIS, 10-YEAR REMAINING LIFE, 39- YEAR NEW LIFE; GETS 1% OP INTEREST INCOME TO CONTRIBUTOR DEDUCTION TO REIT TRADITIONAL $0 ($3) CURATIVE $6.90 ($9.90) REMEDIAL $1.75 ($4.75) Andrea M. Whiteway. Copyright

29 Encumbered Property CASH DISTRIBUTIONS IN EXCESS OF BASIS IN PARTNERSHIP ARE TAXABLE REDUCTION IN SHARE OF LIABILITIES TREATED AS CASH DISTRIBUTION IF LIABILITIES IN EXCESS OF BASIS, MUST MAINTAIN SHARE OF LIABILITIES EQUAL TO NEGATIVE CAPITAL ACCOUNT Andrea M. Whiteway. Copyright

30 Encumbered Property EXAMPLE: CONTRIBUTE PROPERTY WITH BASIS OF $40, SUBJECT TO DEBT OF $100 BASIS IN PARTNERSHIP IS $40, REDUCED BY DEEMED DISTRIBUTION FROM DEBT SHIFT FOR DEEMED DISTRIBUTION NOT TO EXCEED $40, MUST KEEP AT LEAST $60 OF DEBT (= TO NEGATIVE CAPITAL ACCOUNT) Andrea M. Whiteway. Copyright

31 Recourse Debt PARTNER S SHARE OF RECOURSE DEBT BASED ON ECONOMIC RISK OF LOSS ECONOMIC RISK OF LOSS DETERMINED UNDER CONSTRUCTIVE LIQUIDATION ATOM BOMB TEST Andrea M. Whiteway. Copyright

32 Nonrecourse Debt THREE TIERS: PARTNERSHIP MINIMUM GAIN SECTION 704(c) MINIMUM GAIN EXCESS IN ACCORDANCE WITH PROFITS Andrea M. Whiteway. Copyright

33 Nonrecourse Debt IMPACT OF SECTION 704(c) METHOD ON SECOND TIER -- REV. RUL THIRD-TIER SEC. 704(c) FILL-UP ALLOCATION 10/30/2000 AMENDMENT Andrea M. Whiteway. Copyright

34 Nonrecourse Debt ON CONTRIBUTION OF PROPERTY SUBJECT TO NONRECOURSE DEBT, PARTNER WILL ALWAYS KEEP ENOUGH DEBT PROBLEM IS PAYDOWN, CROSS- COLLATERALIZATION, REFINANCING, ETC. Andrea M. Whiteway. Copyright

35 Preserving Share of Debt GUARANTEE OF NONRECOURSE LIABILITY CAUSES IT TO BE IN GUARANTEEING PARTNER S BASIS BOTTOM GUARANTEE MINIMIZES ECONOMIC EXPOSURE Andrea M. Whiteway. Copyright

36 Bottom Guarantee EXAMPLE: PROPERTY HAS VALUE OF $100, IS SUBJECT TO NONRECOURSE DEBT OF $60 TAXPAYER GUARANTEES THE BOTTOM $20 TAXPAYER ONLY LIABLE IF PROPERTY DECLINES IN VALUE TO LESS THAN $20 Andrea M. Whiteway. Copyright

37 DRO CAPITAL ACCOUNT DEFICIT RESTORATION OBLIGATION WILL NOT SHIFT NONRECOURSE DEBT IF ACCOMPANIED BY LOSS ALLOCATION, IT WILL SHIFT RECOURSE DEBT Andrea M. Whiteway. Copyright

38 Indemnity GUARANTEE OF RECOURSE DEBT WILL NOT SHIFT IT -- SEE REG. SEC (f) EXAMPLE 3 INDEMNITY OF GENERAL PARTNER (OR DRO AND LOSS ALLOCATION) IS REQUIRED TO SHIFT RECOURSE DEBT Andrea M. Whiteway. Copyright

39 Term of Guarantee/Indemnity TERMINATION UPON CONVERSION OF OP UNITS INTO STOCK MAY BE PROBLEMATIC TERM OF YEARS, WITH EXTENSION TERMS APPRAISAL OF PROPERTY AT EXPIRATION? Andrea M. Whiteway. Copyright

40 At-Risk Problems SEC. 465(a) LIMITS LOSSES OF INDIVIDUALS AND CLOSELY HELD C CORPS TO AMOUNT AT RISK AT RISK RULES EXTENDED TO REAL ESTATE IN MODIFIED FORM IN 1986 Andrea M. Whiteway. Copyright

41 At-Risk Problems UNDER SEC. 465(e), IF AMOUNT AT-RISK REDUCED BELOW $0 AT YEAR END, PRIOR LOSSES RECAPTURED GUARANTEE SHOULD CREATE AMOUNT AT RISK, BUT DOES IT? SEE PROP. REG. SEC (d); ABRAMSON, 86 T.C. 360 (1986) Andrea M. Whiteway. Copyright

42 At-Risk Problems DRO SHOULD CREATE AMOUNT AT RISK, BUT DOES IT? SEE HUBERT ENTERPRISES, 125 T.C. 72 (2005) Andrea M. Whiteway. Copyright

43 At-Risk Problems QUALIFIED NONRECOURSE FINANCING TREATED AS AT RISK FOR REAL ESTATE QNF MUST BE BORROWED FROM QUALIFIED PERSON OR GOVERNMENT, BE SECURED BY PROPERTY Andrea M. Whiteway. Copyright

44 At-Risk Problems QUALIFIED PERSON MUST BE ACTIVELY AND REGULARLY ENGAGED IN BUSINESS OF LENDING MONEY DOES PUBLICLY OFFERED DEBT QUALIFY? DOES EXCULPATORY (UNSECURED) DEBT QUALIFY? Andrea M. Whiteway. Copyright

45 At-Risk Problems FINAL QNF REGS ON LIMITED QUESTIONS ISSUED AUGUST 4, 1998 ALLOW EXCULPATORY DEBT; DISREGARD PERSONAL LIABILITY OF REAL ESTATE PARTNERSHIPS PLRS AND EXCULPATORY (UNSECURED) DEBT QUALIFIES; DISREGARD STEP-TRANSACTION DOCTRINE WHERE UNDERWRITER RE-SELLS DEBT Andrea M. Whiteway. Copyright

46 Marketable Securities UNDER SEC. 731(c), DISTRIBUTIONS OF MARKETABLE SECURITIES ARE TREATED LIKE CASH OP UNITS MAY CONSTITUTE MARKETABLE SECURITIES BECAUSE OF CONVERSION RIGHT Andrea M. Whiteway. Copyright

47 Marketable Securities IF PROPERTY PARTNERSHIP DISTRIBUTES OP UNITS PRO RATA, AND NO INSIDE/OUTSIDE BASIS DIFFERENCE, NO GAIN SHOULD BE RECOGNIZED EXCEPTION SHOULD ALSO APPLY TO NON PRO RATA DISTRIBUTION OF OP UNITS BY PROPERTY PARTNERSHIP WITHIN 5 YEARS OF RECEIPT Andrea M. Whiteway. Copyright

48 Protecting Deferral SALE OF CONTRIBUTED PROPERTY WILL TRIGGER GAIN UNDER SEC. 704(c) PAYDOWN OF DEBT, REFINANCING, CROSS- COLLATERALIZATION, ETC. CAN ALSO TRIGGER GAIN AS GP, THESE EVENTS ARE GENERALLY WITHIN REIT S CONTROL Andrea M. Whiteway. Copyright

49 Lock-outs REIT AND CONTRIBUTING PARTNER OFTEN AGREE TO A LOCK-OUT PERIOD DURING WHICH OP CANNOT SELL, REFINANCE, ETC. TYPICAL LOCK-OUT PERIOD IS 5 TO 15 YEARS LOCK-OUT UNTIL DEATH? Andrea M. Whiteway. Copyright

50 Make-Whole Payment UPON PROHIBITED EVENT PRIOR TO LOCK- OUT EXPIRATION, REIT GENERALLY MUST MAKE MAKE-WHOLE PAYMENT PAYMENT MAY BE 100% OF TAX, OR ONLY COMPENSATE FOR PRESENT VALUE HARM FORMULA ISSUES -- GROSS-UP, ACTUAL VS. HYPOTHETICAL TAX, DISCOUNT RATE, ETC. Andrea M. Whiteway. Copyright

51 Carve-Outs REIT MAY NEGOTIATE FOR CARVE-OUTS FOR INVOLUNTARY EVENTS -- FORECLOSURE, CONDEMNATION, ETC. CARVE-OUT FOR SEC EXCHANGES SHARE-THE-PAIN PROVISIONS; RATING AGENCY CONCERNS Andrea M. Whiteway. Copyright

52 Additional Protections SEC.1031 LIKE-KIND EXCHANGE AND SEC INVOLUNTARY CONVERSION BEST EFFORTS UNDERTAKINGS AFTER LOCK- OUT RIGHT OF FIRST OFFER USING OP UNITS AS CURRENCY AFTER LOCK-OUT Andrea M. Whiteway. Copyright

53 Going Private Issues 15 REIT GOING PRIVATE TRANSACTIONS ANNOUNCED IN FIRST QUARTER 2006 TYPICALLY STRUCTURED AS TAXABLE ASSET PURCHASE (FORWARD CASH MERGER) Andrea M. Whiteway. Copyright

54 Going Private Issues WILL OP UNIT HOLDERS BE FORCED TO ACCEPT CASH, TRIGGERING GAIN? IF NOT, HOW WILL LIQUIDITY BE ENSURED AFTER ENTITY IS NO LONGER PUBLICLY TRADED? WHAT DISTRIBUTIONS WILL OP UNIT HOLDERS GET GOING FORWARD NO LONGER TIED TO COMMON DIVIDEND Andrea M. Whiteway. Copyright

55 Going Private Issues OP UNITHOLDER WISH LIST: RIGHT TO RECEIVE SAME CASH AS SHAREHOLDERS RIGHT TO HOLD OP UNITS TO AVOID TRIGGERING GAIN RIGHT TO CONTINUED LOCK-OUT, DEBT AND INDEMNITY PROTECTION Andrea M. Whiteway. Copyright

56 Going Private Issues OP UNITHOLDER WISH LIST: RIGHT TO DISTRIBUTION PREFERENCE IF HOLD UNITS RIGHT TO PUT UNITS TO DEEP POCKET AT FORMULA PRICE Andrea M. Whiteway. Copyright

57 Extracting Cash WHERE TARGET PROPERTY IS OWNED BY PARTNERSHIP, SOME PARTNERS MAY WANT OP UNITS AND OTHERS CASH PARTNERS IN PROPERTY PARTNERSHIP WHO ARE NOT ACCREDITED MUST RECEIVE CASH UNDER SEC RULES Andrea M. Whiteway. Copyright

58 Extracting Cash TRANSFERRING THE PROPERTY TO THE OP FOR OP UNITS AND CASH WILL TRIGGER A PORTION OF THE TAXABLE GAIN PARTNERS WILL WANT TO SPECIALLY ALLOCATE TAXABLE GAIN TO PARTNERS RECEIVING CASH Andrea M. Whiteway. Copyright

59 Extracting Cash IF PROPERTY PARTNERSHIP IS LIQUIDATED OR THERE IS A BOOK-UP, THE ALLOCATION MAY FAIL SUBSTANTIALITY SALE OF PARTNERSHIP INTERESTS MAY BE RECAST UNDER MERGER RULES REG. SEC (c)(4) ALLOWS PARTNER WHO GETS THE CASH TO RECOGNIZE ALL THE GAIN Andrea M. Whiteway. Copyright

60 Extracting Cash GENERALLY, IF PROPERTY OWNER RECEIVES CASH AND OP UNITS, GAIN WILL BE TRIGGERED UNDER DISGUISED SALE RULES HOWEVER, TECHNIQUES EXIST TO AVOID DISGUISED SALE TREATMENT Andrea M. Whiteway. Copyright

61 Extracting Cash CHERRY PICKING -- SALE OF HIGH BASIS PROPERTY, CONTRIBUTION OF LOW BASIS PROPERTY PRECONTRIBUTION LEVERAGE AND GUARANTEE Andrea M. Whiteway. Copyright

62 Extracting Cash LEVERAGED DISTRIBUTION AND GUARANTEE REIMBURSEMENT OF PREFORMATION CAPITAL EXPENDITURES Andrea M. Whiteway. Copyright

63 Preferred Unit Deals POPULAR WHEN REIT COMMON STOCK PRICES NOT DOING WELL PREFERRED OP UNITS ENTITLED TO PRIORITY DISTRIBUTIONS FROM OPERATIONS AND ON LIQUIDATION Andrea M. Whiteway. Copyright

64 Preferred Unit Deals REIT MAY HAVE OVERRIDE TO GET DISTRIBUTIONS NEEDED TO RETAIN REIT STATUS MAY BE CONVERTIBLE INTO PREFERRED STOCK WITH SIMILAR RIGHTS OR INTO COMMON OP UNITS AND THEN COMMON STOCK Andrea M. Whiteway. Copyright

65 Preferred Unit Deals TO EXTENT NOT CONVERTED, MANDATORILY REDEEMABLE AFTER 5 TO 7 YEARS (TYPICALLY) CONVERTIBILITY INTO COMMON UNITS GIVES UPSIDE KICKER VALUABLE UNDER BLACK-SCHOLES MODEL Andrea M. Whiteway. Copyright

66 Preferred Unit Deals CONVERSION INTO COMMON UNITS SHOULD NOT TRIGGER ADVERSE TAX CONSEQUENCES SEE PROPOSED REGULATIONS ON NONCOMPENSATORY PARTNERSHIP OPTIONS PARTNERSHIP SWAP FUNDS ALSO BUYING NONCONVERTIBLE PREFERRED UNITS FOR CASH Andrea M. Whiteway. Copyright

67 Preferred Unit Deals DISGUISED SALE ISSUES 150% OF AFR SAFE HARBOR FOR PREFERRED RETURNS MANDATORY REDEMPTION FEATURE GROSS VS. NET INCOME ALLOCATIONS EFFECT OF CONVERTIBILITY Andrea M. Whiteway. Copyright

68 DOWNREIT Structure REIT GP ASSETS / PARTNERSHIPS CASH PROPERTY OWNERS LP APPRECIATED REAL ESTATE DOWNREIT PSHP. Andrea M. Whiteway. Copyright

69 DOWNREIT Terms LPs GET NUMBER OF UNITS EQUAL TO PROPERTY VALUE DIVIDED BY STOCK PRICE EACH UNIT GETS PREFERRED RETURN EQUAL TO DIVIDEND ON SHARE OF STOCK EACH UNIT CONVERTIBLE INTO ONE SHARE OF STOCK Andrea M. Whiteway. Copyright

70 DOWNREIT Issues SHOULD LPs BE TREATED AS RECEIVING REIT STOCK -- TAXABLE? IS RECEIPT OF CONVERSION RIGHT TAXABLE BOOT UNDER DISGUISED SALE RULES? Andrea M. Whiteway. Copyright

71 DOWNREIT Issues IF NO RESIDUAL INTEREST AFTER PREFERRED RETURN, DISGUISED SALE? IF GP FUNDS PREFERRED RETURN, DISGUISED SALE? Andrea M. Whiteway. Copyright

72 Other Legal and Securities Considerations Andrea M. Whiteway. Copyright