The IRS has issued final, temporary and proposed regulations that impose corporate level tax on certain transactions in which property of a C corporation becomes the property of a REIT or a RIC. The regulations are intended to prevent abuses of Code Secs. 355(h) and 856(c)(8), both added by the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) (P.L. 114-113), and to further the purposes of the repeal of General Utilities.
Current Reg. §1.337(d)-7 addresses conversion transactions in which property of a C corporation becomes the property of a REIT or a RIC (converted property) by a transfer of the converted property from the C corporation to the RIC or a REIT or by the qualification of the C corporation as a RIC or a REIT. The RIC or the REIT owning the property after the conversion transaction is generally subject to Code Sec. 1374 treatment unless the C corporation engaging in the conversion transaction elects deemed sale treatment with respect to the converted property.
Prior to the PATH Act, the IRS issued Notice 2015-59, I.R.B. 2015-40, 467, and Rev. Proc. 2015-43, I.R.B. 2015-40, 495, in part to respond to transactions in which a C corporation that does not qualify as a REIT distributes the stock of a controlled corporation in a transaction intended to qualify under Code Sec. 355 so that either the distributing corporation or the controlled corporation can qualify as a REIT.
The PATH Act added Code Ses. 355(h) to exclude from the Code Sec. 355 nonrecognition regime a distribution if either the distributing corporation or the controlled corporation is a REIT. However, a REIT can distribute the stock of another REIT or of a taxable REIT subsidiary under certain conditions. Under Code Sec. 856(c)(8), a corporation may not elect REIT status during the ten-year period following a Code Sec. 355 distribution if the corporation was the distributing corporation or the controlled corporation in that distribution.
Although the PATH Act addressed some of the concerns, certain variations of the above transactions may continue to be used to circumvent the purposes of the PATH Act, such as the use of corporations affiliated with the distributing or controlled corporation.
Temporary Regulations under Code Sec. 337(d)
The temporary regulations generally provide that a C corporation engaging in a conversion transaction involving a REIT within the ten-year period following a related Code Sec. 355 distribution is treated as making an election to recognize gain and loss as if it had sold all of the converted property to an unrelated party at fair market value on the deemed sale date. Thus, Code Sec. 1374 treatment is not available in these cases as an alternative to recognizing any gain with respect to the converted property on the deemed sale date.
A REIT that is a party to a Code Sec. 355 distribution occurring within the ten-year period following a conversion transaction for which a deemed sale election has not been made recognizes any remaining unrecognized built-in gains and losses resulting from the conversion transaction (after taking into account the impact of Code Sec. 1374 in the interim period, as described below).
For the tax year in which the related Code Sec. 355 distribution occurs, the REIT’s net recognized built-in gain is the amount of its net unrealized built-in gain limitation (as defined in Reg. §1.1374-2(a)(3)) for such tax year. For this purpose, the limitations in Reg. §1.1374-2(a)(1) and (2) do not apply because the net unrealized built-in gain limitation generally achieves the effect of a deemed sale election, adjusted for prior recognized built-in gains and recognized built-in losses.
As a result, the temporary rules cause the REIT to recognize any built-in gains or losses attributable to time periods in which the REIT was a C corporation while ensuring that gains and losses recognized in previous tax years during the recognition period on which taxes have been paid are accounted for appropriately. An appropriate increase is made to the basis of the converted property held by the REIT.
The temporary regulations do not apply if both the distributing corporation and the controlled corporation are REITs immediately after the date of the Code Sec. 355 distribution and at all times during the two years thereafter. They also do not apply to certain Code Sec. 355 distributions in which the distributing corporation is a REIT and the controlled corporation is a taxable REIT subsidiary. To prevent avoidance, the temporary regulations apply to predecessors and successors of the distributing corporation or the controlled corporation and to all members of the separate affiliated group of which the distributing corporation or the controlled corporation are members.
Clarifying amendments are also made to the generally applicable rules of Reg. §1.337(d)-7 in response to amendments to Code Sec. 1374(d)(7) by the PATH Act to provide that the term “recognition period” means the five-year period beginning with the first day of the first tax year for which a corporation was an S corporation. The temporary regulations replace the term “10-year recognition period” with “recognition period” and clarify that the recognition period is no longer determined by reference to Code Sec. 1374(d)(7), but is the ten-year period beginning on the first day of the RIC or the REIT’s first tax year or on the date the property is acquired by the RIC or the REIT.
The temporary regulations apply generally to conversion transactions occurring on or after June 7, 2016, and to conversion transactions and related Code Sec. 355 distributions for which the conversion transaction occurs before, and the related Code Sec. 355 distribution occurs on or after, June 7, 2016.
Proposed Regulations under Code Sec. 337(d)
The text of the temporary regulations also serves as the text of the proposed regulations. However, the proposed regulations also include a modification to the definition of converted property that is not addressed in the temporary regulations. This modification treats as converted property any property the basis of which is determined, directly or indirectly, in whole or in part, by reference to the basis of property owned by a C corporation that becomes the property of a RIC or a REIT.
Comments and requests for a public hearing must be received by August 8, 2016. Submissions may be mailed to: CC:PA:LPD:PR (REG-126452-15), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044. Submissions may also be hand-delivered Monday through Friday between the hours of 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR (REG-126452-15), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, D.C., 20224, or sent electronically via the Federal eRulemaking Portal at http://www.regulations.gov (IRS REG-126452-15).
T.D. 9770, 2016FED ¶47,029
Proposed Regulations, NPRM REG-126452-15, 2016FED ¶49,700
Code Sec. 337
CCH Reference – 2016FED ¶16,241H
CCH Reference – 2016FED ¶16,241HC
CCH Reference – 2016FED ¶16,241HK
Tax Research Consultant
CCH Reference – TRC RIC: 3,550
CCH Reference – TRC RIC: 6,124