Tuesday, April 23, 2013

Creating New Tax Loop Holes: Stretching REITS

Creating New Tax Loop Holes

The tax code permits certain real estate companies to organize as investment trusts, known as REITs, in order to avoid paying corporate income tax.  Since the company does not engage in any business activity and merely exists to hold properties, it makes sense to exempt the property from double taxation.  The income and capital gains are taxable as personal income to the underlying owners of the trust.  For the better part of fifty years, REITs simply held portfolios of office buildings, shopping malls, or other real estate assets, and passed along income to their investors.

Scenarios for New Shares (1999)

In recent, years privately managed prisons, casinos, and cell phone tower companies have successfully applied to the IRS to place their assets in REITs.[1]  Apparently, a variety of other companies are looking into applying for this status in order to eliminate corporate tax liability.  When Congress created the REIT, I don’t think they expected operating businesses that relied on real estate to opt for this treatment.

Frankly, I am amazed that the IRS has issued letters supporting these schemes.  The Obama Administration talks fervently about closing tax loop holes in order to help reduce the budget deficit.  Yet by approving these structures, they are simultaneously sanctioning a brand new set of loopholes. 

Many of you may laud the lawyers and accountants who have provided this “innovative” advice to their corporate clients.  Reducing one’s tax bill through artful strategies is lauded even if it reduces the funds available to government.  The case of private prisons organizing in a REIT structure is especially ironic as its revenues (contracts to house prisoners) are entirely dependent on the government. 

There is a remarkable double standard in our country.  If someone were to stretch the purpose of a social welfare program in order to get more aid to poor families, there’d be an uproar.  We generally insist that those programs be narrowly construed.  However, when a company or wealthy individual creates a structure to reduce or avoid taxes, there are very few complaints, even though the tax burden rises for the rest of us.

[1] http://www.nytimes.com/2013/04/22/business/restyled-as-real-estate-trusts-varied-businesses-avoid-taxes.html?ref=business&_r=0

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