REITS: IRS RULING OPENS DOOR FOR MIDSTREAM ASSETS · 12/02/2020 · •REITs are also subject to a...

Energy Series / REIT Series

REITS: IRS RULING OPENS DOOR FOR MIDSTREAM ASSETS

FEBRUARY 12, 2020

velaw.com

Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 2

DISCUSSION TOPICS

MLP Backdrop 4

What is a REIT? 9

REIT Advantages & Disadvantages 19

REIT Structures 22

REIT Governance & SEC Reporting 28

Real Property, Rents from Real Property, and PLR 201907001 34


TODAY’S PANELISTS

RYAN CARNEY

PARTNER, TAX

HOUSTON

PAIGE ANDERSON

SENIOR ASSOCIATE, REIT-TAX

RICHMOND

CHRIS MANGIN

PARTNER, REIT-TAX

WASHINGTON, D.C.

DAVE OELMAN

PARTNER, CAPITAL MARKETS &

MERGERS & ACQUISITIONS

HOUSTON

DANIEL LEBEY

PARTNER, REIT-CAPITAL MARKETS &

MERGERS & ACQUISITIONS

RICHMOND


BCU HWY

Years

Exploration and Production

Refining

Midstream

Wholesale Distribution

Shipping

Other

Fertilizer

Coal

Propane

Timber

General Partner/Holding Co.

† Corporate IPO

EPR PDE LHP ENP NBP

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

EOT

12 13 14

VLP

MAR

LPG

SFL KPP TPP

APU GEL TIMBZ EPD

PAA

TCP

ARLP

APL MMP

UDL

PVR

MMLP DMLP CPNO

HEP

KSP

USS

STON

XTXI

†

BWP

DPM

GLP

HLND

TLP

WPZ

TGP

NRP

NRGP

QRE LREATN

BBEP

CEP

EVEP

LINE

CLMT

EROC

UCLP

RGNC

ENP

LGCY

QELP

VNR

SGLP

CEQP

KGS

DEP

EPB

PSE

WES

WMZ

CHKM

NKA

PNG

OXF

RNO

MCEP

MEMP

AMID

CCLP

NRGM

OILT

RRMS

TLLP

GMLP

†

RNF

UAN

NGL

PDH

ALDW

NTI

DKL

EQM

MPLX

SMLP

SXE

CAPL

SUSP

SDLP

†

HCLP

WGP

NSLP

CVRR

ARCX

FISH

MEP

PSXP

QEPM

SRLP

TEP

VLP

WNRL

WPT

DLNG

†

KNOP

†

EMES

OCIP

OCIR

USAC

SXCP

CQH

†

VNOM

WLKP

ENBL

PBFX

VTTI

†

CONE

JPEP

USDP

Primary Industry at IPO:

15

BSM

CPPL

GPP

PTXP

EVA

CNXC

TEGP

†

EQGP

16

NBLX

17

KRP

HESM

OMP

BPMP

AMGP

†

AMC UAN LEV TNH

FGP

CRO

SGU CNO

HOLP

NPL

SPH

NRGY

MWE

PPX

SXL

ENLK

EPE TOO

†

AHD

AHGP

BGH

ETE

HPGP

NGLS

SEP

CQP

CPLP

†

NMM

†

OSP

MGG

NSH

PVG

PAGP

†

DM

SHLX

AM

RMP

GLOP

†

HMLP

†

RIGP

†

NAP

†

CELP

LMRK

FELP

PCL

MLP IPOS

MLP BACKDROP


UAN

Years

Exploration and Production

Refining

Midstream

Wholesale Distribution

Shipping

Other

Fertilizer

Coal

Propane

Timber

General Partner/Holding Co.

† Corporate IPO

GEL

SPH

EPD

PAA

TCP

ARLP

MMP

NS

MMLP DMLP

HEP DCP

GLP

TGP

SNMP

CLMT

TOO

†

ET

RHNO

MCEP

CCLP

GMLP

†

NGL

DKL

EQM

MPLX

SMLP

SXE

CAPL

SUN

SDLP

†

WES

PSXP

SRLP

DLNG

†

KNOP

†

CINR

USAC

WLKP

ENBL

PBFX

CNXM

USDP

SHLX

GLOP

†

HMLP

†

CELP

LMRK

FELP

Primary Industry at IPO:

BSM

GPP

EVA

CCR

TGE

†

NBLX

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

BKEP

OMP

BPMP

CQP

CPLP

†

NMM

†

CEQP

PAGP

†

NRP

CURRENTLY TRADED MLPS

MLP BACKDROP


• Simplification Transactions – GP and LP trading entities combined into single

traded entity

• C-Corp Conversions

• C-Corp Roll Ups

• Take Privates

WHERE DID THEY GO?


• MLPs that converted to REITs in late 1990s:

➢Plum Creek Timber

➢Southwest Realty Limited

• Traditional MLP vs. REIT Choice – Rent from Real Property is Clear

• More Recent Examples:

➢Landmark Infrastructure (MLP/REIT Combination)

➢CorEnergy Infrastructure Trust, Inc.

• Today’s Topic: Increased Flexibility for Midstream Assets to Qualify for REIT

Structure

WHAT’S OLD IS NEW AGAIN

WHAT IS A REIT?


• A REIT, or real estate investment trust, is a company that owns, and in most cases, operates income-producing

properties such as apartments, office buildings, shopping centers, hotels, malls and warehouses. Some REITs

(mortgage REITs) engage in financing real estate or invest in mortgage loans and other mortgage-related assets and

therefore do not have ownership of the underlying real estate.

• Congress created REITs in 1960 to allow the investing public access to investments in large-scale, income-producing

real estate through the purchase of equity. REITs are estimated to own $1.8 trillion in real estate today.

• REITs offer investors access to commercial property returns without the barriers to entry associated with traditional

property ownership (i.e. large price tags and illiquidity). REITs allow investors to own a “piece” of a commercial real

estate property or portfolio by simply owning shares of REIT stock.

• To qualify as a REIT, a company must, among other things, have most of its assets and income tied to real estate

investment and must distribute at least 90% of its “REIT taxable income” annually. A REIT is permitted to deduct

dividends paid to its shareholders from its corporate taxable income. As a result, most REITs distribute at least 100%

of their taxable income to their shareholders and pay no corporate tax. Taxes are paid by shareholders on the

dividends received and any capital gains. Most states honor this federal treatment and do not require REITs to pay

state income tax. A REIT is not a pass-through entity like a partnership, and thus cannot pass any tax losses through

to its investors.

• Due to their distribution requirement and cash flow oriented business model, REITS typically offer higher yields than

other companies but REIT stocks are not generally regarded as “growth stocks” (e.g., investors often buy them for

the yield more than for stock price appreciation).

WHAT IS A REIT?


• In order to qualify as a REIT under the Internal Revenue Code, a company must:

➢ Be structured as a domestic entity taxable as a corporation

➢ Be managed by a board of directors or a board of trustees that functions like a board of directors

➢ Have shares or certificates that are freely transferable, subject to any applicable securities law restrictions and

compliance with certain REIT ownership tests

➢ Distribute at least 90% of its taxable net income as dividends to shareholders

➢ Have at least 75% of its assets in real estate (real property or loans secured by real property)

➢ Derive at least 75% of its gross income from real estate income (rents or interest from mortgages), and at least

95% of its gross income from real estate income and other passive sources

➢ Have a minimum of 100 shareholders

➢ Have no more than 50% of its shares held by 5 or fewer individuals

➢ Have no more than 20% of its assets invested in the securities of taxable REIT subsidiaries (TRSs)

WHAT IS A REIT?


• A REIT calculates its taxable income in a manner similar to other domestic corporations, the major

difference being that a REIT is entitled to a deduction for dividends paid.

• A REIT is not a pass-through entity like a partnership or S corporation, but rather avoids taxation at the

entity level only by distributing its income as dividends.

• A REIT’s taxable income (after deducting dividends paid and making other adjustments) is taxed in the

manner prescribed in Section 11 of the Code for corporations.

• If a REIT has recognized any net capital gain during a taxable year, the REIT is taxable on the amount

of such gain unless it elects to pay a capital gain dividend.

• A REIT must distribute at least 85% of its ordinary income and 95% of its net capital gains within the

calendar year. Any shortfall is subject to a 4% excise tax.

• To the extent property of a C corporation becomes property of a REIT in a tax-free transaction or in a

conversion to REIT status, the REIT is subject to a corporate level tax on the subsequent recognition of

the built-in gains within a five year period.

• REITs are also subject to a 100% tax on any gain recognized from the sale of “dealer property,” which is

a “prohibited transaction” under the REIT rules. Certain safe harbor provisions provide that sales of real

property meeting specific requirements will not be treated as prohibited transactions and will not be

subject to the 100% tax.

TAXATION OF REITS


• Distributions received by a U.S. shareholder from a REIT are generally treated as income to the extent

of the REIT’s current or accumulated earnings and profits.

• Individuals, trusts, and estates generally may deduct 20% of the ordinary REIT dividends they receive,

resulting in a maximum 29.6% federal income tax rate on ordinary REIT dividends.

• The deduction for qualified REIT dividends is not subject to the wage and property basis limitations that

apply to other types of qualified business income.

• A REIT may designate a portion of its dividends as distributions of the REIT’s capital gains (to the extent

it has capital gains), in which case such portion will be taxed as capital gain to the U.S. shareholders.

• The sale of REIT stock by U.S. shareholders generally gives rise to capital gain.

• Because distributions from a REIT are generally taxable as dividends or are treated as a return of

capital (or capital gains), they do not result in unrelated business taxable income (“UBTI”) to tax-exempt

persons such as pension or profit sharing plans, 501(c)(3) organizations or individual retirement

accounts (“IRAs”). Special UBTI rules apply to “pension held REITs” predominately owned by qualified

trusts with significant interests.

• Income from the ownership of REIT shares is qualified income to a regulated investment company

(“mutual fund”) for federal income purposes.

TAXATION OF U.S. SHAREHOLDERS


• The taxation of distributions by a REIT to foreign shareholders depends on whether the distributions are

attributable to gains from the disposition of United States Real Property Interests (“USRPIs” and such

distributions, “USRPI Distributions”) or other types of income or gain.

• REIT distributions other than USRPI Distributions are treated as dividend income to foreign

shareholders (so long as such distributions do not exceed the REIT’s earnings and profits (“E&P”)), and

are subject to tax at a rate of 30% (unless a lower rate applies under an applicable tax treaty).

• REIT distributions in excess of the REIT’s E&P are treated as (i) a non-taxable return of capital to the

extent of the shareholder’s basis in its REIT shares, and (ii) as amounts received in exchange for the

foreign shareholder’s interest in the REIT to the extent such excess distributions exceed the

shareholder’s basis in its REIT shares.

TAXATION OF FOREIGN SHAREHOLDERS


• USRPI Distributions are taxable to foreign shareholders under the Foreign Investment in Real Property

Tax Act of 1980 (“FIRPTA”).

• For both foreign individuals and corporations, the actual tax due on USRPI Distributions is imposed at

graduated rates applicable to U.S. taxpayers.

• In addition, corporate foreign shareholders are subject to an additional 30% branch profits tax on the

amount of any USRPI Distributions, reduced by the income tax incurred thereon.

• However, if a REIT is publicly traded on a U.S. exchange and the foreign shareholder has not owned

more than 10% of the REIT shares at any time during the one-year period ending on the date of the

USRPI Distribution, the USRPI Distribution will be treated as an ordinary distribution with respect to that

foreign shareholder.

• Finally, the sale of REIT shares by a foreign shareholder are generally exempt from tax, provided that

either (i) the REIT is not a U.S. Real Property Holding Company(1) (“USRPHC”), (ii) less than 50% of

the value of the REIT’s shares are held by foreign persons for the five years preceding the sale (a

“domestically controlled REIT”), or (iii) the REIT shares are publicly traded and the selling foreign

shareholder did not own more than 10% of the REIT shares at any time during the five-year period

ending on the date of the sale.(1) Generally a corporation at least 50% of whose assets consist of interests in real property.



REIT Dividends Other Than USRPI Distributions


Foreign Persons Obligated

to Pay Tax Type of Tax: Rate: Applicable Withholdings:

All Shareholders U.S. income tax 30% (or lower treaty

rate)

30% of gross distributions (or a

lower rate under any treaty)


USRPI Distributions from REITs


Foreign Persons Obligated

to Pay Tax: Type of Tax: Maximum Rate:

Applicable Withholdings:

Qualified Foreign Pension

Fund, Qualified Shareholder

U.S. income tax 0% None

Individual Shareholders (other

than a shareholder of ≤ 10%

of a Public REIT)

U.S. income tax 20% 21% withholding on

distributions (may be

reduced by regulations)

Corporate Shareholders (other

than a shareholder of ≤ 10%

of a Public REIT)

• U.S. income tax

• Branch Profits Tax (on

the net gain after the

allowance of a

deduction for the 21%

U.S. income tax)

• 21%

• 30%

• 21% withholding on

distributions

• None

Shareholders with ≤ 10% of a

Public REIT

U.S. income tax 30% (or lower treaty rate) 30% withholding on

distributions (or lower treaty

rate)


Sale of REIT Shares


Persons Obligated to Pay

Tax:Type of Tax: Maximum Rate: Applicable Withholdings

Qualified Foreign Pension

Fund, Qualified Shareholder


Non-USRPHC REIT U.S. income tax 0% None

Domestically Controlled REIT U.S. income tax 0% None

Shareholder of ≤ 10% of a

Public REIT


Foreign Controlled/USRPHC/Non-Public REIT Shareholders

Individuals U.S. income tax (if shares

held for more than one year)

20% 15% withholding on gross

proceeds

Corporations U.S. income tax 21% 15% withholding on gross

proceeds

REIT ADVANTAGES

& DISADVANTAGES


• Like an MLP, a REIT is generally not subject to entity-level tax to the extent the REIT distributes its

income to its shareholders.

• REIT acts as a “blocker” of unrelated business taxable income (“UBTI”) for tax-exempt investors.

• REIT acts as a “blocker” of effectively connected income (“ECI”) for foreign investors.

• Simplified reporting: An MLP owner receives a tax reporting form (K-1) which is relatively complex

compared to the simple Form 1099 issued by a REIT.

➢ In addition, an MLP owner will generally be required to file a tax return and pay taxes in every state in which the

MLP engages in business or owns assets and which imposes an income tax (which is most states) – a

requirement that is more difficult for a large holder (such as an institution) with significant income (and visibility) to

ignore (as it is believed many small, individual investors do).

• Ordinary REIT dividends, including dividends from private REITs, received by taxpayers taxed at

individual rates are eligible for favorable 29.6% net tax rates on a dollar for dollar basis due to 20%

deduction on dividends received.

REIT ADVANTAGES


• REIT has to meet more tests than an MLP in order to qualify for its status and, as a consequence,

cannot engage in a number of activities in which an MLP can engage.

• A REIT must distribute at least 90% of its income to retain its status as a REIT and all of its taxable

income to avoid being taxed. In contrast, no distribution requirement applies to an MLP in order to

retain its tax treatment.

• Ordinary REIT dividends are subject to 30% outbound withholding for most foreign investors (subject to

reduction by treaty).

➢ Qualified Foreign Pension Funds (“QFPFs”) and section 892 investors in treaty jurisdiction may be able to avoid

U.S. withholding tax.

• Certain REIT distributions and sales of REIT stock may be subject to FIRPTA taxation for foreign

investors.

➢ But see myriad exceptions from prior slides.

REIT DISADVANTAGES

REIT STRUCTURES


TYPICAL REIT ORGANIZATIONAL STRUCTURE (UPREIT)

OPERATING

PARTNERSHIP

Property

Contributors

Properties

ASSET OWNING

SUBS

REIT(corporation)

LP

GP & LP

TRS


• In the typical REIT IPO, a sponsor creates a new umbrella partnership REIT (UPREIT) structure

whereby the partners of existing property owning partnerships and a REIT become partners in a new

partnership – the operating partnership (OP). In exchange for interests in the operating partnership (OP

units), the partners contribute the properties from the existing partnerships (or their partnership interest

in the existing partnerships) to the operating partnership on a tax-deferred basis and the REIT

contributes the cash proceeds from its IPO to the operating partnership. The OP is the subsidiary

through which the REIT will own substantially all of its assets and conduct all of its business.

• The REIT is typically the general partner of the OP and the owner of a majority of the limited partner

interests. The property contributors are typically limited partners of the OP (Unitholders).

• After a period of time (usually one year), the Unitholders are permitted to redeem some or all of their OP

units for either cash based on then-current market value of the REIT’s shares or (at the option of the

REIT) REIT shares on a one share for one unit basis.

• The exchange of OP units for REIT shares is a taxable transaction in which gain or loss (subject to

certain limitations) is recognized by the Unitholder.

• Although this exchange is taxable, Unitholders typically sell the shares they receive and use a portion of

the proceeds to pay taxes.

UPREITS


• A redemption of OP units in exchange for cash paid by the OP may have the same or a similar

consequence, depending on the facts.

• Assuming the REIT is not permitted to own material assets outside of its interest in the OP, the

economic fungibility between a REIT share and an OP unit will continue indefinitely. As a result,

subsequent contributions by property owners to the OP may be made in exchange for OP units based

on the then market value of the REIT’s shares.

• Distributions by the OP are generally made proportionately to its Unitholders, including the REIT.

• If the OP distributes $1/unit to its partners, the REIT would use its share of the distribution to pay a

dividend of $1/share to its shareholders.

• As a result, REIT shares and OP units are typically entitled to identical distributions.

• For these reasons, OP units are generally regarded as common stock equivalents. However, OP units

do not have voting rights on matters that are subject to a REIT shareholder vote.

• Partners contributing property to the OP typically negotiate a Tax Protection Agreement with the OP to

prevent or minimize the risk of a gain recognition event that would accelerate taxation to the contributing

partners. The parties often negotiate a lock-out period for selling the contributed property and paying

down the OP’s debt, as well as covenants allowing contributors to guarantee portions of the OP’s debt.

UPREITS


DOWNREIT STRUCTURE

DownREIT

Partnership

Property

ContributorsExisting

Properties

New Properties

REIT(corporation)

GP & LP

LP


• If the REIT did not adopt the UPREIT structure and subsequently wants to acquire properties on a tax-deferred

basis, it may adopt the DownREIT structure.

• Unlike an UPREIT, where all activities are performed at the operating partnership level, the DownREIT is a joint

venture between the REIT and the property owner. Only the property owner’s assets are held at the DownREIT

partnership level. Most of the REIT’s real estate investments are held directly by it or through other partnerships

that have no relationship to the DownREIT partnership.

• In exchange for contributing property to the DownREIT partnership, the property owner typically receives a number

of units in the DownREIT partnership entitled to a distribution equal to the dividend paid on REIT shares and a put

right for REIT shares or an equivalent cash payment.

• The DownREIT partnership’s performance does not mirror the performance of the REIT. Consequently, the put option

is often based on the value of the DownREIT partnership’s assets at the time of conversion. A DownREIT structure

probably is most appropriate when the owner of the property being contributed to the DownREIT partnership believes

that his property will outperform the rest of the REIT’s portfolio.

• DownREITs are also used to avoid transfer taxes in jurisdictions where transfer taxes are high, like New York City.

• In most cases, no tax liability is triggered when the property owner contributes property to the DownREIT

partnership. Not until the units are redeemed for REIT shares or cash or the partnership assets are sold will there be

a taxable event.

DOWNREIT STRUCTURE

REIT GOVERNANCEAND SEC REPORTING


• Most REITs are Maryland corporations or trusts; Maryland has a favorable REIT statute and has long

been the preferred jurisdiction for REITs.

• Listed REITs are subject to the same NYSE and NASDAQ rules regarding governance as other listed

companies; there are no special exemptions for REITs other than the “controlled company” exemptions.

Thus, REITs are required to maintain a majority of independent directors (or trustees) on their boards

and have audit, compensation and nominating and corporate governance committees comprised

entirely of independent directors (or trustees), among other things, unless they qualify as controlled

companies.

• Public REITs are subject to the same SEC reporting requirements as other public reporting companies

and file form 10-K’s, Form 10-Q’s, Form 8-K’s and proxy statements. REITs hold annual meetings to

elect their directors or trustees. Unlike MLPs, REITs can be subject to proxy contests and shareholder

activism.

• REITs can be internally managed or externally managed.

• In order to satisfy the tax requirement that no more than 50% of its shares be held by 5 or fewer

individuals, most REITs have a 9.8% limitation on share ownership in their charters. Waivers of the

9.8% ownership limit can be granted by the Board for holders that are widely held (such as

corporations, partnerships and pension funds).

REIT GOVERNANCE AND SEC REPORTING


• REIT IPOs are filed on Form S-11 instead of Form S-1. Form S-11 requires the same information as

Form S-1, plus certain additional disclosure regarding the registrant, including:

➢ investment and borrowing policies

➢ descriptions of the real estate

➢ property operating data

➢ disclosure about the prior experience of sponsors and their affiliates in accordance with SEC Industry Guide 5,

when applicable

• Many REIT IPO registration statements, similar to those of MLPs, contain a “Magic Page” where the

REIT discloses its dividend policy and distribution plans using a forecast and/or pro forma presentation

showing anticipated dividend payouts relative to cash available for distribution.

• Acquisition financial statements required to be filed by a REIT typically take one of 2 forms— Regulation

S-X Rule 3-05 financial statements or Regulation S-X Rule 3-14 financial statements. Rule 3-14

financial statements, which are net operating income statements, are required with respect to

acquisitions of properties with historical operations when the acquisition is at the 10% or greater

significance level. For single-tenant net leased properties that are significant, tenant financial

statements may be required in lieu of Rule 3-14 financial statements.

REIT GOVERNANCE AND SEC REPORTING


• Over 200 publicly-listed REITs

• Over $1 trillion in total market capitalization vs. ~$250 million for MLPs

• ~$2 trillion in total assets vs. ~$300 billion for Midstream C corps.

REIT INDUSTRY SNAPSHOT


• GAAP Net Income usually not a meaningful operating performance metric for REITs.

• Most REITs report Funds from Operations (“FFO”) and often report different versions of Adjusted FFO.

For example, CorEnergy reports the following:

➢ Nareit FFO: Net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from sales of

depreciable operating property, impairment losses of depreciable properties, real estate-related depreciation and

amortization (excluding amortization of deferred financing costs or loan origination costs) and other adjustments

for unconsolidated partnerships and non-controlling interests. Adjustments for non-controlling interests are

calculated on the same basis.

➢ FFO Adjusted for Securities Investments: Nareit FFO adjusted for distributions received from investment

securities, income tax expense (benefit) from investment securities, net distributions and other income and net

realized and unrealized gain or loss on other equity securities.

➢ AFFO: FFO Adjusted for Securities Investments plus (gain) loss on extinguishment of debt, provision for loan

(gain) loss, net of tax, transaction costs, amortization of debt issuance costs, amortization of deferred lease

costs, accretion of asset retirement obligation, non-cash costs associated with derivative instruments, and certain

costs of a nonrecurring nature, less maintenance, capital expenditures (if any), income tax (expense) benefit

unrelated to securities investments, amortization of debt premium, and other adjustments as deemed appropriate

by Management.

REIT OPERATING PERFORMANCE METRICS


• Common equity

➢ Public and private offerings of common stock

➢ Issuances of OP units to property contributors

• Preferred equity

➢ Perpetual

➢ Rated and unrated

➢ Convertible

• Corporate debt

➢ Secured

➢ Unsecured

REIT FINANCING

REAL PROPERTY, RENTS FROM REAL PROPERTY, ANDPLR 201907001


• Real Property

➢ Land—includes fee, leaseholds, easements/rights of way

➢ Inherently Permanent Structures (IPSs)

➢ Structural Components of IPSs (but only if included with IPS)

• Passive Nature

➢ Must serve a passive function and not active function

• Qualifying Non-Real Property

➢ Associated Personal Property

• Use of TRS for Non-Qualifying Assets and Income

➢ Investment in TRSs cannot exceed 20% of gross assets

WHAT QUALIFIES AS “REAL PROPERTY” UNDER THE REIT RULES?REAL PROPERTY


Treas. Reg. §1.856-10 (2016) Illustrative Examples

REAL PROPERTY

Qualify as Real Property

• Water and air space superjacent to land • Natural products (including crops and deposits (including ores and

minerals) that are unsevered from land

• Microwave transmission, cell, broadcast and electrical

transmission towers

• Transmission lines, pipelines and offshore drilling platforms

• Storage structures (including silos and oil and gas storage tanks) • Stationary wharves and docks (e.g., marinas)

• Outdoor advertising displays for which an election has been made

under Internal Revenue Code Section 1033(g) (e.g., billboards)

• Central refrigeration systems, integrated security systems and

humidity control systems

• Goodwill attributable to real property • Licenses, permits and other rights for the use of real property

• Permanently affixed sculptures • Conventional partition systems

• Solar mounts for photovoltaic (“PV”) modules; buried exit wire for a

solar energy site; integrated solar energy systems providing

electricity to the tenants of a building where the building and the

solar energy system are owned by the same REIT

• Valves in a pipeline transmission system

• Electrical and telecommunications infrastructure systems in data

centers


Treas. Reg. §1.856-10 (2016) Illustrative Examples

REAL PROPERTY

Do Not Qualify as Real Property

• Bus shelters • Modular partition systems

• PV modules in solar energy sites that sell electricity to

third parties

• Meters and compressors in a pipeline transmission

system

• Casino licenses


• Operating Lease

➢ Lease must qualify as an operating lease and not a capital lease under tax rules

• Related Party Tenant Prohibition

➢ Tenant cannot be materially related to REIT (no overlapping 10% or greater owners)

• Prohibition on Rents based on Net Income

➢ Rent can be based on gross income

• Enter PLR 201907001

WHAT QUALIFIES AS RENTS FROM REAL PROPERTY?RENTS FROM REAL PROPERTY


• A 2019 private letter ruling (PLR) finds that service fees collected by a REIT from the end-user for the

right to use platforms, pipelines and storage tank facilities may be considered “rents from real property”

for purposes of the REIT rules under certain conditions.

• Previously, it was assumed that REITs could only lease these facilities to third-party operators and

collect rent.

• Now, based on the conclusions reached in the PLR, it appears that with the proper conditions in place,

a REIT (or one of its subsidiaries) can operate the midstream assets itself and charge service fees to

the end-user, giving rise to qualifying rents from real property.

• Critically, the PLR concludes that a REIT can charge the customer a single fee, allowing midstream

asset owners to utilize the REIT structure without restructuring customer agreements.

• Additionally, unlike MLPs, the storage or movement through pipelines of products that are not “natural

resources” for MLP purposes may nevertheless give rise to qualifying rents from real property under the

REIT rules.

• PLR may be properly viewed as a “gross income test” ruling, as the asset test side of the house is fairly

clearly dealt with in the 2016 real property regulations.

• PLR also contained a ruling on offshore oil and gas platform that didn’t break new ground from a REIT

gross income test perspective.

PLR 201907001IMPLICATIONS


• Contracts entered into with third party users for multi-year terms

• REIT agreed not to oversell capacity on the pipeline

• Taxable REIT subsidiary (TRS) required to own, monitor, maintain, and operate all compressors and

pumps in the pipeline.

• In some cases, the pipeline user fee is a fixed monthly amount for fixed portion of pipeline capacity,

which the user pays regardless of whether it uses the reserved capacity.

➢ In some cases, user has the right to exceed capacity reserved for it, and in such cases the fee includes an

additional mount for excess capacity based on a fixed dollar amount multiplied by the volume of product that

exits the pipeline.

• In other cases, the fee is computed solely based on a fixed dollar amount set forth in the user

agreement multiplied by the volume of product that exits the pipeline.

➢ In such cases, the user agrees to use the pipeline for all of the product it extracts from a particular area or field,

and REIT agrees to accept and reserve capacity for that product.

• User fee includes both amounts for use of the pipeline and also related services.

RULING DETAILS: PIPELINESPLR 201907001


• Contracts entered into with third party users for multi-year terms

• REIT agreed not to oversell capacity in the tanks and is obligated to ensure that the capacity specified

in the storage agreement is reserved for the user.

• In some cases, the storage agreement specifies the tank or tanks in which the user’s product will be

stored.

• In other cases, the storage agreement provides the user with a right to a fixed portion of storage

capacity at the particular facility, but does not specify the particular tank or tanks.

• The storage fee is computed based solely on a fixed dollar amount set forth in the storage agreement

based on a prescribed amount of reserved storage capacity.

➢ In some cases, a storage user will have the right to exceed its reserved capacity; in these cases the storage fee

includes an additional amount for the excess capacity computed based on a fixed dollar amount multiplied by the

volume of product stored or the volume of product that exits the pipeline.

• Storage fee includes both amounts for storage and also related services.

RULING DETAILS: STORAGE TANKSPLR 201907001


• REIT could directly perform only services consistent with owning the real estate, such as construction,

security, inspections, and repairs and maintenance.

• TRS would perform all other services, including:

➢ Scheduling the use of the pipeline

➢ Loading and unloading product from the pipeline

➢ Monitoring all compressors and pumps on the pipeline

• TRS is paid an arm’s length fee from the REIT (out of the user fee) for these services.

➢ 150% of cost safe harbor/transfer pricing study

• IRS required REIT to represent that all services, even those deemed to be provided by the TRS, are

customarily provided to tenants of similar properties in the geographic market in which the pipeline is

located, in order for the entire user fee from the customer to be treated as qualifying rents from real

property for REIT purposes.

RULING DETAILS: PIPELINES—SERVICESPLR 201907001


• REIT could directly perform only services consistent with owning the real estate, such as construction,

security, inspections, repairs and maintenance, testing product in the tanks for environmental safety.

• TRS would perform all other services, including:

➢ Taking samples of product in the tank for the benefit of the user

➢ Measuring or weighing product for the benefit of the user

➢ Heating and circulating the product

➢ Blending products and maintaining the blended state of the products

➢ Operating, maintain and repairing all equipment used to heat, circulate and blend the products.

• TRS is paid an arm’s length fee from the REIT (out of the storage fee) for these services.

➢ 150% of cost safe harbor/transfer pricing study

• IRS required REIT to represent that all services, even those deemed to be provided by the TRS, are

customarily provided to tenants of similar properties in the geographic market in which the storage

facility is located, in order for the entire storage fee from the customer to be treated as qualifying rents

from real property for REIT purposes.

RULING DETAILS: STORAGE—SERVICESPLR 201907001


• Owners of pipelines, storage facilities, gathering pipes whose contracts are not based on spot volumes

• Single asset owners

• Owners interested in attracting foreign private capital

POTENTIAL USERS OF A REIT STRUCTUREPLR 201907001


• Owners of pipelines, storage facilities, gathering pipes whose contracts are based on spot volumes

• Midstream asset owners who oversubscribe pipe capacity

• Midstream asset owners who buy and sell significant amounts of commodities

• Owners of processing, fractionation, cracking, and processing assets

• Owners of midstream assets who chiefly serve related parties such as sponsors or parents

THOSE WHO WOULD HAVE DIFFICULTY USING A REIT STRUCTUREPLR 201907001


• PLRs may be relied upon only by the taxpayer to whom they were issued.

• Unless/until a larger body of similar PLRs are issued, it is recommended that those seeking to replicate

the PLR seek their own ruling from the IRS.

• IRS still relatively unsettled on the revenue side on non-traditional REIT assets

➢ Requirement that personal property be owned (not merely operated) by TRS

➢ Customary services representation

➢ Potential turnover

RELIANCE ON PLRPLR 201907001


PANELIST BIOGRAPHIES

Ryan’s practice focuses on the tax aspects of domestic and international business transactions,

primarily within the energy sector. He has extensive experience with the taxation of publicly traded

partnerships, MLPs, private equity transactions and structures, mergers and acquisitions,

reorganizations, and capital markets transactions.

Over the last ten years, Ryan has represented issuers and underwriters in more than 45 MLP initial

public offerings and more than 140 follow-on offerings, as well as multiple mergers, acquisitions, and

financing transactions. He has particular experience in advising MLPs and prospective MLPs in

connection with qualifying income matters and seeking private letter rulings and other guidance from the

Internal Revenue Service.

RYAN CARNEY

PARTNER, TAX

HOUSTON

Dave co-heads V&E’s Mergers & Acquisitions and Capital Markets practice group .

Dave is one of the country’s preeminent IPO practitioners, having worked on more IPOs in the last three

decades than all but a small handful of lawyers practicing in the U.S. across all industries. He represents

issuers and underwriters on capital markets transactions involving oil exploration and production companies,

midstream companies, OFC companies and other energy, power and infrastructure-related businesses.

Over the course of his thirty-year career, Dave has participated in more than one energy industry

transformation. In the 1990s and early 2000s, he advised on the IPOs of numerous midstream businesses.

Dave has been fortunate to represent a number of the pioneers of the “Shale Revolution” and over the past

decade has worked with numerous upstream, downstream, LNG and OFS businesses launched in its wake.

David continues to counsel clients after completing their IPOs on corporate governance matters, follow-on

public offerings, private placements of equity and debt, mergers and acquisitions, dispositions, joint ventures,

and private equity investments.

David is a member of the board of directors of the Energy Infrastructure Council (formerly MLPA).

DAVE OELMAN

PARTNER, CAPITAL MARKETS & MERGERS & ACQUISITIONS

HOUSTON

+1.713.758.4720

[email protected]

+1.713.758.3708

[email protected]



Chris is a nationally-recognized authority on REIT taxation, real estate funds, and real estate

partnerships.

Chris works with REITs, real estate companies, and private equity sponsors on IPOs, mergers and

acquisitions, real estate fund formation, qualified opportunity zone funds, joint ventures, take-private

transactions, spin-offs, financings, dispositions, recapitalizations, and issues relating to foreign

investment in U.S. real estate under FIRPTA.

Chris partners with his clients to provide practical and commercial solutions to tax issues while

achieving their business goals. His work has earned him recognition in Chambers USA, where

reviewers praised Chris as “a very impressive lawyer" with a "strong understanding of REIT tax

consequences” (2019). He is also recognized by Legal 500 (US) in US Real Estate-REITs (2019).

Prior to attending law school, Chris spent three years working as a certified public accountant at Big

Four accounting firms.

CHRIS MANGIN

PARTNER, REIT-TAX

WASHINGTON, D.C.

Paige focuses her practice on the federal income tax aspects associated with real estate capital markets

transactions and real estate companies. She advises partnerships, corporations and other businesses in a

variety of tax matters, including tax planning associated with REITs, mergers and acquisitions, joint ventures,

reorganizations, and financings.

PAIGE ANDERSON

SENIOR ASSOCIATE, REIT-TAX

RICHMOND

+1.202.639.6534

[email protected]

+1.804.327.6326

[email protected]



Daniel’s principal areas of practice are capital markets and securities law, private equity and fund

formation, mergers and acquisitions, and corporate governance matters. He has a particular focus on

transactions involving REITs.

He advises REITs and their sponsors through the entire life cycle of a REIT from formation through the

IPO process, and thereafter with respect to equity and debt capital markets transactions, SEC reporting

and compliance, mergers, acquisitions and other strategic transactions, and corporate governance.

Daniel also regularly serves as counsel for the underwriters in capital markets transactions.

Daniel also advises boards of directors and special committees on strategic transactions and other

governance matters.

In addition to REITs, Daniel advises clients in a variety of other industries ranging from technology to

manufacturing to infrastructure. Clients in particular appreciate his "thoroughness and attention to

detail," according to Chambers USA, where a reviewer also praised him as "extremely intelligent" and

"very efficient." (2019)

DANIEL LEBEY

PARTNER, REIT-CAPITAL MARKETS & MERGERS & ACQUISITIONS

RICHMOND

+1.202.639.6534

[email protected]

Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com

Austin

T +1.512.542.8400

Beijing

T +86.10.6414.5500

Dallas

T +1.214.220.7700

Dubai

T +971.4.330.1800

Hong Kong

T +852.3658.6400

Houston

T +1.713.758.2222

London

T +44.20.7065.6000

New York

T +1.212.237.0000

Richmond

T +1.804.327.6300

Riyadh

T +966.11.250.0800

San Francisco

T +1.415.979.6900

Tokyo

T +81.3.3282.0450

Washington

T +1.202.639.6500

THIS CONTENT IS INTENDED FOR EDUCATIONAL AND INFORMATIONAL PURPOSES ONLY AND DOES

NOT CONSTITUTE THE PROVISION OF LEGAL ADVICE OR SERVICES BY ANY OF THE SPEAKERS OR

BY VINSON & ELKINS LLP.

REITS: IRS RULING OPENS DOOR FOR MIDSTREAM ASSETS · 12/02/2020 · •REITs are also subject to a...

Documents

Transcript of REITS: IRS RULING OPENS DOOR FOR MIDSTREAM ASSETS · 12/02/2020 · •REITs are also subject to a...