January 6, 2021 IRS rules that subsidiary REIT of a publicly traded REIT is exempt from preferential dividend rule In PLR 202051005, the IRS ruled that a real estate investment trust (REIT) that was a subsidiary of a publicly traded REIT, and whose operations were consolidated under generally accepted accounting principles (GAAP) with the publicly traded REIT, qualified as a "publicly offered REIT" under IRC Section 562(c)(2). Accordingly, the subsidiary REIT was exempt from the preferential dividend rule of IRC Section 562(c)(1) and thus, an apparent preferential dividend paid by the subsidiary REIT during the tax year was 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 conducts its operations through Operating Partnership. Operating Partnership owns substantially all its assets through Partnership X and Partnership Y, which own interests in Partnership Z. Partnership Z owns all the stock of Taxpayer, except for certain preferred shares. Parent REIT has a controlling interest in Taxpayer, which has been 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. Taxpayer, Operating Partnership, Partnership X, Partnership Y and Partnership Z are included in the consolidated financial statements that Parent REIT files with the SEC. For purposes of the consolidated financial statements, the assets, income, loss and other activities of Taxpayer are included with those of Parent REIT and the other consolidated entities. Taxpayer made a distribution (Distribution) on its common stock. At that time, Partnership X and Partnership Y owned their interests in Taxpayer directly rather than through Partnership Z. Although the Distribution was intended to be pro rata, Taxpayer paid an overdistribution to Partnership Y due to the rounding of the ownership percentages shown in the Operating Partnership's organizational charts. The overdistribution was returned to Taxpayer and distributed to Partnership X after the error was discovered. Law and analysis Under IRC Section 857(b)(2)(B), a REIT may claim a dividends-paid deduction (DPD), as defined in IRC Section 561, in computing its taxable income. Under IRC Section 561(a), the DPD generally 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] is required to file annual and periodic reports with the SEC under the Securities and Exchange Act of 1934." In its analysis, the IRS stated that the Securities and Exchange Act of 1934 required Taxpayer's accounting information to be consolidated with Parent REIT's periodic and annual reports submitted to the SEC. Consolidating the reports, however, does not alter the information in the annual and periodic reporting furnished to the SEC. Because Taxpayer's assets, income, loss and other activities are reported to the SEC as part of Parent REIT's consolidated reports, the IRS reasoned, "annual and periodic reporting to the SEC is required of Taxpayer"; accordingly, Taxpayer qualifies as a "publicly offered REIT" under IRC Section 562(c)(2). As the IRS ruled that Taxpayer is a publicly offered REIT as defined in IRC Section 562(c)(2), the Distribution is not a preferential dividend under IRC Section 562(c)(1). Implications PLR 202051005 is the second private letter ruling in which the IRS has concluded that a subsidiary REIT that is consolidated under GAAP with a parent "publicly offered REIT" for SEC reporting will itself constitute a "publicly offered REIT." See PLR 201924003 (Tax Alert 2019-1230). Publicly offered REITs and their advisors should be pleased with the issuance of this second private letter ruling, 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). ———————————————
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