[authors: Joseph A. Coco, Fred T. Goldberg, Jr., Evan R. Levy, John D. Rayis]
Penn National Gaming, Inc. (PNG) announced last evening the first-ever tax-free spin-off of a “PropCo” real estate investment trust (REIT) from a taxable C corporation. PNG intends to separate its real property gaming facilities in a new REIT and distribute the REIT stock to its public shareholders in a tax-free distribution. Following the distribution, the PNG REIT will lease the real property back to PNG, which will continue its gaming business. PNG announced that it has obtained a private letter ruling from the Internal Revenue Service (IRS) regarding this structure — the first ruling the IRS has issued addressing the tax-free spin out of a PropCo REIT.
The ruling highlights a tremendous opportunity for other companies with significant real estate holdings to similarly restructure their real estate and operations. Companies with substantial real estate may separate their real estate into a PropCo and their operations into an “OpCo,” then distribute out one of the two companies in a tax-free spin-off. After the distribution, PropCo would be a REIT and lease the real property to OpCo, while OpCo would operate the real property. A tax-free distribution of PropCo allows a company to distribute out its real property without triggering built-in gain inherent in the property, making the process of converting to a PropCo/OpCo structure much more attractive to companies with substantial amounts of built-in gain. Moreover, spinning the PropCo out in REIT form permits shareholders to enjoy the benefits afforded by holding real property through a REIT immediately.
With a potential path to conducting a PropCo/OpCo separation without gain recognition now reviewed and ruled upon by the IRS, the opportunities presented by a PropCo/OpCo structure are manifold for real estate intensive companies and their shareholders. REITs enjoy dramatically reduced costs of capital as compared to C corporations and provide shareholders with the potential for greatly enhanced share value. In addition, REITs attract a broad group of dedicated investors seeking the consistent yields provided by REITs, investors that would not have invested in a company absent the PropCo/OpCo separation. Existing shareholders in companies that have completed such a PropCo/OpCo division are able to enjoy both the potential for enhanced value with respect to the real estate assets of the company and continued exposure to the company’s operating business, while significant new investors (and their associated capital) are brought into the REIT.
The PNG transaction provides a model for real estate-intensive businesses to similarly employ a PropCo/OpCo structure and enjoy the benefits it affords.