Compendium Memorandum 2009-27

On December 23, 2009, the IRS issued an advance copy of Rev. Proc. 2010-12, extending for two years Rev. Proc. 2009-15, relating to elective stock dividends. Rev. Proc. 2010-12 extends the IRS guidance for REITs first issued in Rev. Proc. 2008-68 and expanded to mutual funds in Rev. Proc. 2009-15 so that, for dividends declared on or after January 1, 2008 and on or before December 31, 2012 (for taxable years ending on or before December 31, 2011) by publicly traded REITs, the IRS will treat the entire value of the declared amount (including the stock portion) as a dividend, and thereby eligible for the dividends paid deduction so long as the specific calculation formula in Rev. Proc. 2010-12 is met, including that the total amount of cash available for the distribution is not less than 10%.

NAREIT is pleased that the Treasury Department and IRS responded favorably not only to its request to extend Rev. Proc. 2009-15, but also that they clarified that the calculation of the number of shares and the value of the stock portion of the elective stock dividend may be made pursuant to a formula calculated over up to a two-week period. NAREIT is also pleased that Rev. Proc. 2010-12 clarifies that an elective stock dividend within its scope will not be treated as a preferential dividend.

BACKGROUND

Before 2009, the IRS issued a number of private letter rulings regarding the tax treatment of a distribution that allows shareholders to elect to receive cash or stock. See PLRs 200852020; 200850022; 200832009; 200817031; 200618009; 200615024; 200406031; 200348020; and 200122001.

In these rulings, the IRS held that any and all of the cash and stock distributed would be treated as a dividend. Furthermore, the amount of the distribution of the stock received by any shareholder electing to receive stock would be considered to equal the amount of money that could have been received instead. Thus, the full amount of the declared dividend would be available to satisfy the REIT's 90% distribution requirement. Other than where redacted, all of these rulings set a minimum threshold on the amount of cash that must be distributed equal to 20% of the total distribution.

Rev. Proc. 2008-68 was issued following NAREIT's submission of an October 31, 2008 request to codify the above-mentioned rulings and temporarily reduce the minimum cash threshold to 5% of the total value of the distribution. Rev. Proc. 2008-68 treats a publicly traded REIT's entire distribution to shareholders pursuant to which shareholders can elect either cash or stock (an elective stock distribution) as a dividend equal to the amount of cash that could have been received provided that at least 10% of the distribution is in cash, and the dividend is declared on or after January 1, 2008 with respect to taxable years ending on or before December 31, 2009. Unfortunately, the revenue procedure did not address the circumstances under which the elective stock dividend would or would not be considered a preferential (and therefore, non-deductible) dividend although requested to do so by NAREIT. However, the absence of precedential guidance on this issue was not a surprise since only one of seven private rulings had addressed the issue. Rev. Proc. 2009-15 expanded the guidance in Rev. Proc. 2008-68 to mutual funds and superseded Rev. Proc. 2008-68.

Following the issuance of Rev. Proc. 2008-68, the IRS issued the following additional private rulings with holdings similar to the above-mentioned rulings: PLRs 200946023 (20% cash threshold; listed REIT); 200942030 (20% cash threshold; non-listed REIT); 200917020 (10% cash threshold; listed REIT); and 200906040 (20% cash threshold; listed REIT).

On July 10, 2009, and in response to the continuing liquidity crisis facing the commercial real estate industry, NAREIT submitted a letter to the Treasury Department and IRS requesting that the current guidance be: 1) extended for two years; 2) clarified to state that such dividends are not preferential in nature merely because they are calculated by reference to a multi-day trading period; 3) made available to non-listed as well as to listed REITs; and, 4) amplified to ensure that such distributions of REIT stock to limited partners in the operating partnership of an UPREIT are not deemed to be disguised sales.

PROCEDURE

Under Rev. Proc. 2010-12, effective for all distributions declared on or after January 1, 2008, the IRS will treat a distribution of stock by a corporation that qualifies as a REIT as a distribution of property to which § 301 applies by reason of § 305(b), and the amount of such distribution of stock will be considered to equal the amount of the money which could have been received instead, if:

1) The distribution is made by the corporation to its shareholders with respect to its stock;

2) Stock of the corporation is publicly traded on an established securities market in the United States;

3) The distribution is declared on or before December 31, 2012, with respect to a taxable year ending on or before December 31, 2011, whether declared and distributed prior to the close of the taxable year or whether declared and distributed pursuant to the provisions of § 855, § 852(b)(7), § 858, § 857(b)(9), or § 860 (and thus the distribution includes "spillover dividends" declared with respect to the 2010 and 2011 tax years and/or deficiency dividends declared with respect to the relevant tax years and not declared until December 31, 2012);

4) Pursuant to such declaration, each shareholder may elect to receive its entire entitlement in either money or stock of the distributing corporation of equivalent value subject to a limitation on the amount of money to be distributed in the aggregate to all shareholders (the Cash Limitation), provided that: a) the Cash Limitation is a minimum of 10% of the aggregate declared distribution; and, b) if too many shareholders elect to receive money, each shareholder electing to receive money will receive a pro rata amount of money corresponding to their respective entitlement under the declaration not less than 10% of their entire entitlement under the declaration in money;

5) The calculation of the number and value of shares to be received by any shareholder will be determined, over a period of up to two weeks ending as close as practicable to the payment date, based upon a formula utilizing market prices that is designed to equate in value the number of shares to be received with the amount of money that could be received instead; and,

6) With respect to any shareholder participating in a dividend reinvestment plan (DRIP), the DRIP applies only to the extent that, in the absence of the DRIP, the shareholder would have received the distribution in money under subsection (4).

OBSERVATIONS

NAREIT appreciates that the Treasury Department and IRS responded to its request to issue Rev. Proc. 2010-12 prior to the end of 2009, and confirmed that the calculation of the stock dividend may be determined by reference to a formula calculated over a two-week period.The minimum cash threshold in Rev. Proc. 2010-12 remains at 10%.

Of particular note with respect to the Treasury Department and IRS' agreement to permit the calculation of the number of shares of distributed stock to be determined in advance through a calculation based on a multi-day trading average over up to a two-week period is Rev. Proc. 2010-12's specific statement that an elective stock dividend within its scope will not be a preferential dividend "if some shareholders receive a combination of stock and money that differs from the combination received by other shareholders and if the fair market value of the stock on the date of distribution differs from the amount of money which could have been received instead." (Emphasis added.)

This conclusion provides additional clarification to the requirement in Rev. Proc. 2008-68 and Rev. Proc. 2009-15 that the "calculation of the number of shares to be received by any shareholder be determined, as close as practicable to the payment date, based upon a formula utilizing market prices that is designed to equate in value the number of shares to be received with the amount of money that could be received instead." Unfortunately, the IRS apparently continues to believe that the per share trading price of stock on the particular date of distribution (although it is not clear which trading price at which time during that day) represents the "fair market value" of the stock notwithstanding an agreed-upon formula in advance for calculating the "fair market value" of the stock.

Finally, NAREIT is disappointed that Rev. Proc. 2010-12 did not address NAREIT's requests that the Treasury Department and IRS: 1) not apply the "disguised sale" rules of § 707(a)(2)(B) to elective stock dividends distributed by those REITs that own and operate their properties through the UPREIT structure and that an operating partnership (OP) which receives REIT stock from its REIT, whether purchased by the OP from the REIT for cash (which the REIT reinvests in OP units), or contributed by the REIT for OP units obtains a fair market value basis in the stock so that the other limited partners who receive REIT stock from the OP will have a fair market value basis in the stock; and, 2) extend the guidance to non-traded REITs. While there are methods through which to mitigate any adverse tax consequences resulting from the issuance of REIT stock to OP partners in connection with an elective stock dividend, the ideal resolution of any questions would have been through an explicit declaration in Rev. Proc. 2010-12. Further, although the IRS has issued a private letter ruling extending the guidance to non-traded REITs, PLR 200942030, it would have been preferable for the new revenue procedure to extend its terms to non-traded REITs so that they need not have to go through the time and expense of obtaining a private ruling.

With that said, NAREIT is very appreciative of the Treasury Department and IRS' efforts in extending and expanding Rev. Proc. 2009-15 by issuing Rev. Proc. 2010-12.