Recent rulings by the Internal Revenue Service have led to a significant amount of publicity surrounding the conversion of C corporations to real estate investment trusts (REITs), particularly those in non-traditional asset classes. However, the tax implications of REIT conversions are often misunderstood in today’s rapidly evolving tax, business and regulatory landscape, as McRae Thompson, Managing Director with Alvarez & Marsal Taxand, recently examined in Business Entities.
Commentators and lawmakers have historically focused on corporate tax issues when publicly evaluating the implications of REIT conversions, but this concentration may miss the full picture, according to McRae. This viewpoint ignores factors such as tax revenues generated on the dividends derived by individual REIT investors, the acceleration of investor level taxation on both current and deferred corporate earnings, the generally higher tax rates paid by investors on REIT dividends and the retention of the C corporation tax taint on corporate built-in gain assets for an extended period of time.
While REIT conversions can be advantageous to a select group of C corporations, McRae emphasizes that they may not benefit the majority. A company considering a REIT conversion should consider the potential benefits of converting against other key business considerations such as:
- Strategic concerns (i.e. significant changes to the current business model and / or legal structure which may conflict with the company’s long-term growth strategy),
- Financial considerations involving liquidity and certain debt covenants, and
- Both initial and ongoing regulatory and compliance issues.
Companies can take steps to best determine whether the potential benefits of a REIT conversion are substantial enough to outweigh the adverse consequences, says McRae. A&M is well positioned to assist in this process which may include preparing financial models to quantify the potential cash benefits / detriments, as well as examining the most beneficial structure in which to convert. McRae has also helped clients identify and evaluate strategic alternatives that do not involve REIT conversions to ensure their objectives, as well as those of key stakeholders, are achieved in the most prudent and efficient manner. McRae also notes that after the deal has closed when many transaction advisors have long moved on, there is a significant need to manage the ongoing compliance and qualification process.