FAQ Real Estate Investment Trust Morrison Foerster | 23 How are REIT stockholders taxed on REIT distributions? ▪ Distributions of E&P – Distributions to the extent of a REIT’s earnings and profits (“E&P”) generally will be taxable income to taxable U.S. stockholders (as ordinary income, except to the extent attributable to capital gains that the REIT elects to distribute as capital gains dividends, which generally will be taxable as long-term capital gains). Additionally, non-corporate shareholders generally will be entitled to a 20% deduction against the amount of ordinary dividends received from a REIT. ▪ Distributions in Excess of E&P – To the extent REIT distributions exceed its E&P, they will be treated as a non-taxable return of capital to the stockholders, to the extent of their basis in their REIT stock, and as capital gain to the extent such non-E&P distributions exceed their basis in their REIT stock. What are the tax benefits of contributing property to an Operating Partnership of an UPREIT? The contribution of property directly to a REIT generally will be entitled to tax-free treatment only if: (i) the contributor(s) are in “control” of the REIT (generally 80% of both vote and value of all REIT stock) immediately after the contribution transaction; and (ii) the contributions do not result in the diversification of the contributors’ interests (which, subject to certain potential exceptions, generally would result upon a contribution by one contributor of non-identical assets to those already in the REIT, or upon a contribution by two or more contributors of non-identical assets to each other and/or to existing assets in the REIT). See “What are the primary benefits of the UPREIT structure and OP unit transactions?” above and our publication entitled “Frequently Asked Questions about UPREITs and OP Unit Transactions.” In contrast, a contribution of property to a partnership (including an UPREIT Operating Partnership) generally can be contributed in a tax-free transaction, regardless of the percentage interest in the partnership received in return by the contributors (i.e., no “control” requirement), and, unless the partnership holds mostly stocks and securities, regardless of whether the contributor’s interest becomes diversified as a result of the contribution. What are the primary tax considerations for Operating Partnership contributors? The primary tax considerations relevant to a contributor of built-in gain property (and/or property encumbered by liabilities in excess of the tax basis in the property) to an UPREIT Operating Partnership relate to the potential recognition of some or all of that built-in gain either in connection with the contribution transaction itself, or upon a subsequent disposition of the contributed property by the Operating Partnership. ▪ Gain Recognition on Contribution – Recognition of gain on the contribution may result from a number of factors, including (i) the reduction in the contributor’s share of liabilities secured by the contributed property, or of its share of all liabilities of the Operating Partnership relative to its share of liabilities prior to the contribution (since, subject to certain exceptions, such reductions are treated as distributions of money to the contributing partner), and (ii) the distribution of cash or other property by the Operating Partnership that is treated as being part of a “disguised sale” of the contributed property and does not fall within certain exceptions. ▪ Gain Recognition on Disposition of Contributed Property – Upon a taxable disposition of a contributed property by the Operating Partnership, gain will be allocated to the contributing partner up to the amount of the built-in gain of the property at the time of the contribution, as adjusted to the date of the disposition (including for the disproportionate allocation of items relating to such property, including depreciation, as required to reduce, over time, the amount of built-in gain). What is the purpose of a tax protection agreement? The main purpose of a tax protection agreement (“TPA”) is to protect a contributor of built-in gain property (and/or property encumbered by liabilities in excess of tax basis in the property)
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