The latest in REIT M&A activity ► ► ►
Cristina Arumi, Principal, Ernst & Young LLP Rick Solway, Partner, Ernst & Young LLP Lawrence M. Garrett, Principal, Ernst & Young LLP
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2015 REIT CFO and Tax Director Roundtables
Update on tax-free spin-offs
Update on REIT-related spin-offs ►
Continuing very active market ►
Corporate “Opco-Propco” trend continues ► ► ►
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Darden tax-free spin-off (restaurants) Gaming & Leisure Properties’ (known as “GLPI”) acquisition of Pinnacle Entertainment’s real estate through a taxable spin-off/merger structure (gaming) Sears Holdings’ rights offering to create/distribute Seritage (not a spin-off)
Listed REIT tax-free spin-offs of “non-core” business (e.g., Ventas’ spin-off of Care Capital Properties)
IRS concerns regarding REIT-related tax-free spin-offs ► ► ►
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Rev. Proc. 2015-43 adds three new “no rule” areas, one of which involves spin-offs by a C corporation in which the “Remainco” or “Spinco” elects to be a REIT Notice 2015-59 discusses the technical/policy concerns that the Government has with REITrelated tax-free spin-offs Implications for tax opinions on REIT-related spin-offs 2015 REIT CFO and Tax Director Roundtables
Rev. Proc. 2015-43 ►
Adds three new, distinct no-rule policies:
► IRS “ordinarily” will not rule under section 355 on any spin-off by C corporation involving a REIT or RIC election by either Remainco or Spinco (but not both) ► IRS “ordinarily” will not rule under section 355 on any spin-off in which the FMV of the active trade or business (ATB) assets of Remainco or Spinco is less than 5% of its total assets ► IRS will not rule under section 355 on any spin-off in which all three of the following conditions are met with respect to Remainco or Spinco:
► the FMV of investment assets (generally does not include real estate) is at least 2/3 of the FMV of the total assets, ► the FMV of ATB assets is less than 10% of the FMV of the investment assets, and ► the ratio of ATB/non-ATB assets is at least 3 times greater than the ratio for the other corporation
► EFFECTIVE DATE: “This revenue procedure applies to all ruling requests that are postmarked or, if not mailed, received on or after September 14, 2015, and relate to distributions that occur after such date.” Page 3
2015 REIT CFO and Tax Director Roundtables
Notice 2015-59 ►
Expresses the government’s concerns regarding spin-offs involving a corporation that, prior to the distribution, does not meet the requirement to be a REIT and intends to separate REIT-qualifying assets from non-qualifying assets so that the distributing corporation or the controlled corporation can meet the requirements to be a REIT ►
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In some situations, a REIT election may be made or become effective within a short period of time before the distribution; these transactions may involve relatively small “active trade or businesses” (ATBs) and retention of control over or use of the REIT’s assets through long-term leases or other arrangements These transactions involve significant concerns relating to the device prohibition, and the business purpose and active trade or business requirements under section 355, as well as the Code provisions intended to repeal the General Utilities decision
Comments by the Associated Chief Counsel (Corporate) have provided further insight into the government’s concerns
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2015 REIT CFO and Tax Director Roundtables
REIT going private transactions
REIT going private transactions Recent market developments ► ►
Driven by readily available debt and equity financing, activist investors, and relatively high (but still potentially reasonable) valuations Four major recent transactions ► ► ► ►
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Blackstone/Excel Trust (retail) Brookfield/Associated Estates (multifamily) Lone Star/Home Properties (multifamily) Blackstone/Strategic Hotel Capital (lodging)
More going private activity likely as long as debt financing remains available Step-up acquisition structures are playing a prominent role Social issues remain important but provide advantages to private equity buyers over listed REIT buyers
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2015 REIT CFO and Tax Director Roundtables
REIT going private transactions Key tax issues ► ► ►
Does the transaction create REIT qualification issues for a REIT target (assuming the REIT target is otherwise a “good REIT”)? Is the transaction taxable or tax-free (in whole or in part) to the target and its shareholders? Will the acquiror receive a “step up” or “step down” in the tax basis of the assets of the target? ► ►
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How are these transactions structured? Why might a buyer execute a reverse cash merger rather than a forward cash merger structure?
Do post-closing divestitures or liquidations create prohibited transactions risks? Does the transaction result in adverse tax consequences to limited partners in UpREIT or DownREIT structures?
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2015 REIT CFO and Tax Director Roundtables
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Going private structure option 1: forward cash merger of Target into Purchaser’s Merger Sub Step 1: Taxable Merger
Step 2: The End Result Common Shares
Purchaser REIT
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The forward merger is treated as an asset sale by the Target REIT ►
Purchaser OP
LP/Promote Partner
See Rev. Rul. 69-6, 1969-1 C.B. 104
Target Shareholders
Cancellation of Target Shares
Cash
Merger Sub (LLC)
Purchaser REIT
Merger, with Merger Sub as Surviving Entity
Purchaser OP
Merger Sub Target REIT Stepped-up Target Assets
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2015 REIT CFO and Tax Director Roundtables
Going private structure option 2: reverse cash merger of Target with Purchaser’s Merger Sub Step 1: Reverse Merger
Step 2: The End Result Common Shares
Purchaser REIT
Purchaser OP
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The reverse merger is treated as a stock sale by the Target REIT shareholders
Target Shareholders
Cancellation of Target Shares
Cash
Merger Sub (LLC)
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Merger, with Target REIT as Surviving Entity
Purchaser REIT LP/Promote Partner
Purchaser OP
Target REIT Target REIT
2015 REIT CFO and Tax Director Roundtables
Target Assets, with historic basis
Going private structure option 2 (cont.): Post-acquisition liquidation of Target into OP Alternative 1: Taxable Liquidation (UpREIT)
Purchaser REIT
Purchaser REIT
LPs
Purchaser OP
Alternative 2: Tax free-liquidation (No UpREIT)
Purchaser REIT
Purchaser REIT
LPs
Purchaser OP
Target REIT Target Assets, with historic basis
Target REIT
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Stepped-up Target Assets
Target Assets, with historic basis
2015 REIT CFO and Tax Director Roundtables
REIT going private transactions – summary of key tax consequences ►
The transaction is taxable to the REIT target ► ►
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The transaction is also taxable to the target shareholders ► ►
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If the target has been a REIT since formation or for 10 years, it may not be subject to a REIT-level tax on the sale of the assets followed by a liquidation The liquidating distribution may provide a dividends paid deduction for the REIT-level taxable gain As taxable mergers, both the forward and reverse cash mergers are taxable to the selling shareholders Management of the target may “rollover” its equity in the Target in a tax-free manner
In a forward cash merger, and in a reverse cash merger followed by a liquidation, the acquiror will receive a new tax basis in the Target’s assets equal to the consideration paid in the transaction and thus may receive a “step up” or “step down” in the basis of the assets
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2015 REIT CFO and Tax Director Roundtables
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Additional tax consequences to consider in going private transactions ►
Target OP tax protection agreements ► ►
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Deductibility of executive compensation ► ► ►
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Potential effects on going private transaction Potential substitution of a separate UpREIT buyer to assume the tax protection risks 280G Section 162(m) Allocation of expenses among Target entities (REIT, OP, TRS entities)
Shareholder loans and deductibility of interest expense FIRPTA ► ► ►
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Domestic control issues Interplay with buyer’s ability to obtain tax basis step-up in Target’s assets FIRPTA withholding certificate 2015 REIT CFO and Tax Director Roundtables
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