United States - Tax Authorities (2024)

In response to the current economic crisis, the Internal RevenueService (IRS) last month issued Revenue Procedure2008-68¹ (Rev. Proc.), which provides temporary relief,applicable during 2009 only, to certain cash-strapped real estateinvestment trusts (REITs), while also highlighting a usefultechnique for all REITs to preserve cash — the use ofstock dividends.

Background

Today's economic environment has been referred to by many as"the worst economic crisis since the GreatDepression."² Even the most experienced investorsand economic analysts agree that the current state of the capitalmarkets is the worst that they have ever experienced. Despitepassage by the U.S. Congress in October 2008 of the $700-billionEmergency Economic Stabilization Act of 2008, and notwithstandingthe possible enactment of yet another massive stimulus package onthe order of $825 billion,³ most observers expect creditmarkets to remain sparse through 2009 and perhapsbeyond.⁴

All of this, in turn, has placed renewed emphasis on the abilityof companies to obtain and preserve cash. For companies thatcurrently pay dividends to stockholders, one obvious methodavailable to preserve cash is to cut their dividend, either inwhole or in part. However, as compared to most other types ofcompanies, entities that are structured as REITs⁵ are ata distinct disadvantage when it comes to employing this type ofcash-saving strategy. This is because the tax code effectivelyrequires the REIT to pay dividends each year equal to 100 percentof its taxable income for such year.⁶

Stock Dividends

Faced with these regulatory constraints, many REITs areexamining one cash-saving technique: declaring a dividend partly incash and partly in newly issued stock of the REIT. This strategy,however, must comply with another set of tax rules that providethat only certain types of stock dividends will qualify as"dividends" for tax purposes. For example, simplydeclaring and paying a dividend solely through the pro-rataissuance of new shares of common stock often times will not betreated as a dividend for tax purposes and, thus, while certainlyallowing the REIT to preserve cash, will not likely comply with thetax law requirements that REITs distribute dividends equal to 100percent of their taxable income each year.⁷

However, certain types of stock dividends do count as dividendsfor tax purposes and can be employed by cash-strapped REITs. Forexample, the Code and regulations generally provide that if anyshareholder has the "right to an election" with respectto whether a distribution shall be made in either cash or stock (orrights to acquire stock), then with respect to all shareholders,the distribution of stock can qualify as a dividend for taxpurposes.⁸

In several fairly recent private letter rulings,⁹ theIRS has permitted REITs to utilize this type of distribution, thatis, providing shareholders with the election to receive adistribution either in cash or stock of equivalent value, and evento set a limit on the aggregate amount of cash that shareholderswould receive in the distribution (irrespective of elections),provided that the aggregate amount of the cash limit was at leastequal to 20 percent of the total dividend.¹⁰ Thiseffectively permits a REIT to save cash by paying up to 80 percentof its dividend in the form of newly issued stock.

Given the severity and prospective length of the currenteconomic downturn, more and more REITs will undoubtedly continue toconsider stock dividends as a viable (and perhaps necessary)cash-saving strategy.¹¹ However, because private letterrulings can only be relied upon by the taxpayer requesting suchrulings, this has led the National Association of Real EstateInvestment Trusts (NAREIT) and other REIT interest groups to beginlobbying the IRS for more formal guidance. Last month, the IRSresponded with Revenue Procedure 2008-68, which provides temporaryand limited guidance applicable to all publicly traded REITs.

The Rev. Proc. generally provides that a distribution of stockby a REIT can be treated as a dividend for tax purposes if thefollowing safe harbor requirements are met:

The Rev. Proc. also states that the calculation of the number ofshares to be received by any shareholder must be determined, asclose as practicable to the payment date, based upon a formulautilizing market prices that is designed to equate in value thenumber of shares to be received with the amount of money that couldbe received instead.¹³

Summary

In short, where applicable, the Rev. Proc. is useful infacilitating stock dividend strategies for cash-strapped REITs inthat it eliminates the need for the REIT to obtain its own privateletter ruling and also expands upon the prior private letterrulings by permitting the cash portion of the dividend to be cappedat 10 percent (rather than 20 percent). However, the Rev. Proc. isonly temporary guidance in that by its terms it only applies todistributions declared on or after January 1, 2008 and with respectto taxable years ending on or before December 31, 2008. Also, since(as indicated above) it only applies to REITs whose stock ispublicly traded on an established securities market in the UnitedStates, it does not apply to "private" REITs, nor toso-called non-traded REITs.¹⁴ Private and/or non-tradedREITs undertaking stock dividend strategies will either need toobtain their own private letter rulings or proceed carefully underthe 20 percent limitation with advice from competent tax andsecurities counsel.

The foregoing is merely intended as a general summary of RevenueProcedure 2008-68 and necessarily does not address all issuesrelating to or arising in connection with the use of a stockdividend strategy. Other issues to be considered include, but arenot limited to, the following examples:

Consideration of other techniques for preserving cash inconnection with the REIT's required dividends (e.g., conductingrights offerings and/or timing issues in connection with thedeclaration or payment of dividends)

Footnotes

^{1 2008-52 IRB 1373 (December 10, 2009), amplified andsuperseded by Rev. Proc. 2009-15, 2009-4 IRB (January 7, 2009)(extending the principals of Rev. Proc. 2008-68 to regulatedinvestment companies, or RICs).}

^{2 See e.g., Sachs, "The Case for BiggerGovernment," Time Mag., Vol. 173, Issue 2 (Jan. 19,2009).}

^{3 See Bendavid, Williamson and Reddy, "StimulusPackage Unveiled," Wall St. J'nl., January 16, 2009, pageA-1.}

^{4 See e.g., Lyon, "ULI Panel: More Grim News,"GlobeSt.com (Jan. 19, 2009), available atwww.globest.com/news.}

^{5 The term "REIT" refers to entities that aretaxable as "real estate investment trusts" within themeaning of Section 856-859 of the Internal Revenue Code of 1986, asamended (IRC or the Code).}

^{6 Generally speaking, a REIT is required to distribute, asa dividend, at least 90 percent of the REIT's taxable income(excluding net capital gains) for each year to its shareholders.IRC § 857(a)(1). Failure to do so can cause the REIT to loseits preferential tax status under the Code, thereby subjecting theREIT to corporate-level income taxes imposed at federal rates of 35percent. In addition, even if a REIT distributes at least 90percent of its taxable income as a dividend during any particularyear, the failure to distribute 100 percent of its taxable income(including net capital gains) as a dividend will subject the REITto federal corporate income taxes to the extent of theundistributed amounts. IRC § 857(b)(2). Thus, in order tomaintain their "tax-exempt" status, REITs are effectivelyrequired to pay dividends each year to their shareholders equal to100 percent of the REIT's taxable income during suchyear.}

^{7 See Internal Revenue Code § 305(a).}

^{8 See Internal Revenue Code § 305(b)(1); Treas. Reg.§ 1.305-2.}

^{9 Private letter rulings are specific rulings issued totaxpayers on a specific set of facts and are permitted to be reliedupon only by the taxpayer receiving such ruling.}

^{10 See e.g., Private Letter Ruling 200817031(January 28, 2008); PLR 200618009 (May 5, 2006).}

^{11 See e.g., "Vornado Dividend to Include Stock,"Wall. St. J'nl, January 1, 2009, page C-3 (announcingVornado's intention to distribute 60 percent of its dividendsthis year in stock and 40 percent in cash, as "a way topreserve cash during difficult times for markets."); seealso, Pruitt, "UPDATE: REITs Offer Stock/Cash DividendCombo to Preserve Cash," WSJ.com, January 15, 2009 (reportingon both Vornado's and Sunstone Hotel's intentions to revisetheir dividend policies to include a large stockcomponent).}

^{12 Rev. Proc. 2008-68, supra, at §3.}

^{13 Id.}

^{14 The term "non-traded" REITs refers to anentity established as a REIT and whose shares are publicly offeredbut not publicly listed on any established securitiesexchange.}

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