REITs And The Corporate Tax Base

Author: James F. McDonough|August 12, 2014

As the U.S. public becomes more aware about corporate taxation issues, the topic of corporate inversions has become highly politicized.

REITs And The Corporate Tax Base

As the U.S. public becomes more aware about corporate taxation issues, the topic of corporate inversions has become highly politicized.

A number of politicians have gone as far as to call multinationals that perform the move “un-patriotic,” ahead of the November midterm elections.

Meanwhile, there are other, less controversial taxation issues that could potentially cause a larger problem. The rules regarding Real Estate Investment Trusts, or REITs, were recently clarified by the IRS.

While a little clarity is usually a good thing, this move opens the corporate tax base to a floodgate of REIT spinoffs, according to Forbes. This is an issue, because shifting assets into a REIT effectively eliminates corporate tax on them. As long as a REIT earns at least 75 percent of its income from rent or sale of real property and distributes 90 percent of its earnings to shareholders, it can usually be considered exempt from the 35 percent U.S. corporate income tax. Shareholders pay tax at the ordinary, considerably lower rate.

In the past, IRS rules on REITs were so unclear that firms needed to get a private letter from the agency ruling on each spinoff, the news source explained. After the recent IRS guidelines were published, a small but growing wave of spinoffs has been occurring. Any company that holds significant real assets, like oil companies, railroads, data centers and telecoms to name a few, can potentially take advantage of this type of tax strategy.

The potential for erosion of the corporate tax base is extremely large. The Federal Reserve Board’s Flow of Funds report shows that $10 trillion of the $35 trillion in assets held by non-financial corporations is in real estate, much of which could potentially be subject to REIT spinoff.

By contrast, the U.S. stands to lose less than $20 billion over the next ten years from corporate inversions, according to a nonpartisan congressional research panel quoted by The Wall Street Journal.

The issue of corporate inversions is a complex and loaded issue. To focus on it to the exclusion of all other potential problems, however, could have far-reaching consequences for the U.S. government.