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In private letter ruling 201924003, the IRS has ruled that a real estate investment trust (REIT) that was a subsidiary of a publicly traded REIT, and whose operations are consolidated under generally accepted accounting principles (GAAP) with the publicly traded REIT, qualified as a "publicly offered REIT" under IRC Section 562(c)(2) and thus is exempt from the preferential dividend rule of IRC Section 562(c)(1). Accordingly, an apparent preferential dividend paid by the subsidiary REIT during the tax year is not a nondeductible dividend under IRC Section 562(c).

Facts

Taxpayer is a corporation that has elected to be taxed as a REIT.

Parent REIT is a publicly traded REIT that, through its Operating Partnership, owns a controlling interest in Taxpayer. More specifically, Taxpayer is an indirect subsidiary of the Operating Partnership.

Taxpayer is consolidated with Parent REIT under GAAP for purposes of the annual and periodic reports that Parent REIT must file with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934. As such, Taxpayer, its immediate parent and Operating Partnership are included in the consolidated financial statements that Parent REIT files with the SEC. For purposes of the consolidated financial statements, Taxpayer is disregarded as a separate entity, and Taxpayer's assets, income, loss and other activities are included with those of Parent REIT.

On Date 1, Taxpayer made a pro rata distribution (Distribution) of its common stock. At that time, Taxpayer's new management team believed the common stock was Taxpayer's only outstanding stock. Subsequently, it learned that Taxpayer also had outstanding shares of Series A Preferred Stock at the time of the Distribution. The Series A Preferred Stock accrued dividends at a stated percent per annum and all accrued but unpaid dividends on the Series A Preferred Stock were to be paid first, or simultaneously, with any other dividends that Taxpayer declared or distributed. On Date 2, Taxpayer declared and paid a dividend to the owner of the Series A Preferred Stock.

Law and analysis

Under IRC Section 857(b)(2)(B), a REIT is entitled to a dividends-paid deduction (DPD), as defined in IRC Section 561, in computing its taxable income. IRC Section 561(a) provides the general rule that the DPD equals the sum of dividends paid during the tax year, and the IRC Section 565 consent dividends for the tax year.

Except for a publicly offered REIT, IRC Section 562(c)(1) specifies that a distribution will not qualify for the DPD unless the distribution is "pro rata, with no preference to any share of stock as compared with other shares of the same class, and with no preference to one class of stock as compared with another class except to the extent that the former is entitled (without reference to waivers of their rights by shareholders) to such preference."

IRC Section 562(c)(2) defines a publicly offered REIT as a REIT that must file annual and periodic reports with the SEC under the Securities and Exchange Act of 1934.

In its analysis, the IRS first described that, under the Securities and Exchange Act of 1934, Taxpayer's accounting information must be consolidated with Parent REIT's periodic and annual reports that are submitted to the SEC. Thus, Taxpayer's assets, income, loss and other activities are reported to the SEC as part of Parent REIT's consolidated reports. The consolidation of the reports does not alter the information reported to the SEC in the annual and periodic reporting required under the Securities and Exchange Act of 1934. The IRS then reasoned that "annual and periodic reporting to the SEC is required of Taxpayer" and thus, Taxpayer meets the definitional requirements to be a "publicly offered REIT" under IRC Section 562(c)(2).

The IRS ruled that Taxpayer is a publicly offered REIT as defined in IRC Section 562(c)(2), so the Distribution is not a preferential dividend under IRC Section 562(c)(1).

Implications

PLR 201924003 is the first private letter ruling to conclude that a subsidiary REIT that is consolidated under GAAP with a parent "publicly offered REIT" will itself constitute a "publicly offered REIT." Publicly offered REITs sometimes use subsidiary REITs as co-investment vehicles with institutional investors. Publicly offered REITs and their advisors should be pleased with this conclusion, especially given the severe consequences that can result if a subsidiary REIT were otherwise found to have violated the preferential dividend rule of IRC Section 562(c).

The PATH Act of 2015 amended IRC Section 562(c) to provide the exemption from the preferential dividend rules for publicly offered REITs and amended IRC Section 562(e) to give the IRS authority to provide "remedies" for REITs (not otherwise exempt from the preferential dividend rule) to cure a violation of the preferential dividend rule that was determined to be inadvertent or due to reasonable cause. PLR 201924003 is the first guidance of any type addressing these amendments. Previously, NAREIT (an advocacy group for REITs) asked the IRS to provide formal guidance on the matter addressed in PLR 201924003, as well as guidance on "remedies" for curing violations of the preferential dividend rule.

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