IRS Limits Ability of REITs to Obtain Private Letter Rulings on Tax-Free Spin-Off Transactions

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In the recently released Revenue Procedure 2015-43, the Internal Revenue Service (“IRS”) announced that it no longer will issue private letter rulings with respect to certain tax-free spin-offs where, immediately after the spin-off, there is a newly-formed real estate investment trust (“REIT”).  Given the frequency with which such REITs are formed as Maryland corporations and real estate investment trusts under Title 8 of the Corporations and Associations Article of the Maryland Code, this development will not only be of interests to taxpayers contemplating such a spin-off, but also to Maryland corporate law practitioners and investors.

Generally, taxpayers can write to the IRS requesting guidance on the tax treatment with respect to a particular set of facts.  These private letter rulings, or “PLRs”, are binding on the IRS only with respect to the taxpayer who requested the ruling.  If a taxpayer requests and receives a PLR prior to engaging in a transaction, the taxpayer can engage in the transaction and be certain that the IRS will follow the tax treatment set forth in the PLR.  In addition, the IRS makes all PLRs available to the public, which, although not binding on other taxpayers, provide insight into the IRS’s thought process on particular issues.  In certain instances, the IRS determines that it will not issue PLRs with respect to a particular type of transaction or set of facts.  

The IRS recently announced that it ordinarily will no longer issue PLRs where the facts involve a tax-free spin-off under section 355 of the Internal Revenue Code (the “Code”) and a REIT.  Section 355 allows a corporation to spin-off a line of business into another corporation in a tax-free transaction; it often is used in corporate restructurings.  To qualify for tax-free treatment, the transaction must satisfy certain requirements, including the requirement that the distributing corporation (i.e., the transferor) and the controlled corporation (i.e., the transferee) both conduct an active trade or business immediately after the spin-off.

Per Rev. Proc. 2015-43, the IRS ordinarily will not issue a private letter ruling regarding whether a distribution qualifies under section 355 of the Code if the fair market value of the gross assets used to meet the active trade or business requirement is less than 5% of the fair market value of all of the gross assets of either the distributing or the controlled corporation.  In addition, the IRS ordinarily will not issue a ruling if the distribution at issue involves a transfer of property from a C corporation to a REIT.  The IRS will issue rulings on these facts only in “unique and compelling circumstances.”

Further, the IRS indicated that the IRS is conducting a study of certain tax issues and, for the time being, will not issue any private letter rulings if, immediately following the distribution, either corporation has a significant amount of investment assets and the fair market value of the active trade or business of either corporation is less than 10% of such corporation’s investment assets.

Although the Revenue Procedure is important in that it outlines when the IRS will not issue a private letter ruling, of more importance is the notification to taxpayers that the IRS is applying increased scrutiny to section 355 spin-off transactions involving REITs, particularly where the active trade or business conducted by the distributing or controlled corporation is minimal compared to the corporation’s overall assets.  REIT managers should be sure to consult their tax advisors before engaging in any section 355 transactions to ensure the proposed transaction conforms with IRS requirements.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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