EFTA01122861.pdf

A Broader Perspective Fall 2013 Tax News and Developments etin A Publication of Bryan Cave UP Tax Advice and Controversy Practice Group FEATURE Contents Feature Best Practices in Code Sec. 1031 Art Exchanges BEST PRACTICES IN By Lou Weller 1 Real Estate Capital Markets CODE SEC. 1031 ART IRS REIT Working Group By Daniel F Cullen & Peter R. Matejcak Tax Controversy 11 EXCHANGES Court of Federal Claims Weighs in on Requisite -Intent to Evade Tax" in Applying Statutes of Introduction Limitation for Assessment By Cathryn Benedict & Lauren K. Shores Pelikan 17 Code Sec. 1031 has been used, albeit inconsistently, for years by savvy owners of Tax Exempt Organizations Interactive Form 1023 fine art to preserve capital by deferring the By Nathan Boyce 21 gain on the sale of appreciated artworks. Europe Motivation to use Code Sec. 1031 has Expatriates In Germany — Tax Consequences for recently intensified due to: Employers and Employees By Stefan Skulesch 24 Asia • a very active market that is driving China Exported Services: Zero-Rated VAT or prices higher by way of increased Exemption competition; By Ye Zhou 29 • higher tax rates on gain, with the new 3.8% tax on Net Investment Income' in effect and ever-hungrier local taxing authorities seeking to collect sales and use taxes; and • low interest rates for investors using leverage to buy or refinance after the fact. Art held for investment is not excluded from Code Sec. 1031 treatment, but in contrast to real estate for which the availability of Code www.bryancave.com A Broader Perspective America I Asia I Europe 1 EFTA01122861 Sec. 1031 is more widely understood, there are many important aspects of exchanging artworks that remain murky. A resulting lack of clarity creates risk and uncertainty that often inhibits strategic and safe application of Code Sec. 1031 to these assets. Unlike real estate, the art world has a transactional culture that has little regulatory oversight of participants and where transactions are frequently completed on the basis of reputation and trust. When this culture fails, the results can be devastating. Further, the development of coherent answers to important questions regarding exchanges of artworks seems uninteresting to many of the usual participants in these transactions and remains largely neglected. This article addresses several of these questions, and addresses two aspects of artwork exchanges: technical Code Sec. 1031 requirements and practical aspects of implementing artwork exchanges under existing rules. There are two major issues in each category: 1. Code Sec. 1031 Qualification Requirements: o Qualified Use: Investor or collector? o Like-Kind Issues: What can be exchanged for what? 2. Implementation: o Forward or Reverse: Which is the optimal form of Code Sec. 1031 artwork exchange? o Choosing a QI or EAT: What criteria should be used? Overview of Code Sec. 1031 Principles Code Sec. 1031 allows for non-recognition of gain on the sale of assets held for trade or business or investment purposes. Since artwork will almost never be income producing on a current basis,2 the "held for investment" criteria will generally serve as a basis for application of the section to a disposition/acquisition transaction. Because exchanges where two parties simultaneously swap assets are not common, most exchanges are undertaken as deferred exchanges under the umbrella of Code Sec. 1031(a)(3), utilizing a "qualified intermediary" or "QI," to receive, hold and spend relinquished art sale proceeds pursuant to the Treasury Regulations' constructive receipt safe harbor.3 The standard deferred or "forward" exchange occurs when relinquished property is sold prior to the acquisition of replacement property. Most of the mechanical rules for implementing deferred exchanges are well established. A "reverse" exchange is used when the replacement property will or must be acquired prior to the sale of relinquished property. The IRS has provided guidance for several forms of "safe harbor" reverse exchanges in IRS Rev. Proc. 2000-37 (as amended),4 utilizing ownership accommodation arrangements that are available through a subset of the QI community, including the use of an "Exchange Accommodation Titleholder" (or "EAT" in the context of reverse exchanges). www.bryancave.com A Broader Perspective America I Asia I Europe 2 EFTA01122862 Qualified Use — Collector. Dealer or Investor? Meeting the "qualified use" requirement for Code Sec. 1031 exchanges of artworks means that an artwork owner must treat artworks as assets being held for investment or income, rather than merely as additions to a personal collection where the intent is limited to deriving pleasure through possession and display or as assets held as inventory or otherwise for sale. This is widely referred to as the "qualified use" requirement and applies to property transferred and received in a Code Sec. 1031 exchange. For sellers of collected art, the question will normally be whether relinquished and replacement art is considered held primarily for investment rather than for personal purposes. If the seller is considered a dealer, holding art for sale to customers in the ordinary course of business, Code Sec. 1031 will not be available for works leaving or entering inventory but may still be available for long-term hold pieces. It has been said that artworks which are displayed in the owner's personal residence have questionable status as investments. An example of a judicial conclusion to this effect is found in Blodgett v. Commissioner, where a claimed loss on the transfer of art was disallowed.5 The case makes clear, however, that this is not always the result. The relevant questions are whether the art owner acted like an investor with respect to a specific piece, exhibiting behavior such as gaining education in the investment characteristics of art, maintaining records of investment value on an ongoing basis and having a history of art investing. It is permissible to derive personal pleasure from ownership of an investment asset, but that must be a secondary intent of the acquisition and ownership. In the real estate context, this question most often arises with vacation use properties. In this category, the most important factor determining Code Sec. 1031 qualification seems to be the degree of effort (and success) spent in renting a property compared to the amount of personal use" As with real estate, there are various strategic and operational measures that indicate investment intent relating to artworks. Since artworks generally are not depreciable, do not generate rental income and are not used in the various other ways that businesses use real estate, an owner must be able to demonstrate that the primary intent of acquiring and holding artworks is to sell them later for a price that is higher than the original purchase price plus the cost of ownership. While the storage strategy for collectables is clearly an indicator of intent, there can be many other indicators, and it is the overall strategy that can become compelling, no matter how much time the artworks spend in the owner's personal residence. Although the IRS will base its determination of primary investment intent on all the facts and circumstances affecting a particular owner, if some or all of the following strategies are implemented, the owner should be in a strong position to satisfy the qualified use requirement: www.bryancave.com A Broader Perspective America I Asia I Europe 3 EFTA01122863  Investment Strategies • Develop a business plan that describes a fine art investment strategy and then conduct affairs related to the investments in a business-like manner to actualize the investment intent; • Focus acquisitions on specific themes — e.g., artist groups, mediums, time periods; • Develop expertise in one or more themes, consult with other experts, publish articles discussing some aspect of the investments; and • Display art periodically in venues that promote the theme, thereby increasing the demand for works that are part of the theme. Asset Value Protection Strategies • Obtain independent valuation, confirmation of authenticity and title insurance for new acquisitions to establish their value and increase the ability to sell later at a profit; • Own assets in a special purpose entity to show separation of assets and isolation of risk; and • Obtain damage and theft insurance policies that are separate from the owner's residential policy and provide protection no matter where the assets are stored or displayed. Financial and operational strategies • Be able to show strategic transaction flow, profits and losses, the total cost of ownership and operations to show the results/returns from the investments; • Keep fastidious records of transactions, appraisals and comparable transactions involving similar works by other owners to understand the present equity in the investment; • Use credit facilities to make investment acquisitions that are separate from credit facilities used for other, non-investment purposes; • Take (initial) delivery in a location other than the owner's primary personal residence; and • When a sale is planned, display or store art at a location other than the owner's personal residence and ship to the buyer from that location. www.bryancave.com A Broader Perspective America I Asia I Europe 4 EFTA01122864 While no single strategy is foolproof, the courts have concluded in the past that artwork maintained in a residence can still qualify as held for business purposes and that home display is not a dispositive negative factor where investment intent can be otherwise demonstrated. Like-Kind Determinations There is no definitive guidance on how the "like-kind" standard of Code Sec. 1031 applies to artworks. Unlike depreciable personal property, there is no safe-harbor asset class or like-class system. Virtually the only published authority related to the subject was issued by the IRS in 1981 when it was asked to rule whether a collection of lithographs destroyed in a fire could be replaced under Code Sec. 1033(a)'s "similar or related in service or use" rule by paintings, sculptures and seriagraphs and other works of art. In Letter Ruling 8127089, the IRS reached the conclusion that proposed replacement properties did not meet the "similar or related in service or use" test but provided no rationale or reasoning to support the conclusion. There is no way of knowing whether the IRS would reach the same conclusion today and, of course, thirty year old letter rulings must be taken with a grain of salt. However, in light of this published position, the most conservative approach is to utilize a very narrow like-kind standard for artworks in terms of medium, which suggests that only oil paintings can be exchanged for oil paintings, sculpture for other sculpture, lithographs for other lithographs, and so on. One might even go so far as to restrict the standard to works in the same medium by the same artist. However, if applied to define application of Code Sec. 1031's like-kind standard to art, such a medium-based, approach provides a framework that may unreasonably limit the number of exchanges that can be successfully accomplished. This approach may also be inconsistent with the fundamental principle applicable to the like-kind standard: that property be of the same "nature and character" and that differences in "grade or quality" do not matter. Fine art of various media shares intuitively obvious and profound similarities that clearly are indicative of "nature and character" and have little to do with the medium employed. In the absence of other guidance, it is incumbent upon the taxpayer to implement a strategy based on some guideline or heuristic for determining whether one artwork is like-kind to another as part of the larger process of implementing systematic and well-managed investment activities. The following is a possible definitional framework that emphasizes that artworks are in a category of their own, one that is separate from other "collectables," based on their ontology — that is, the reason that they are created: like-kind 'artwork' is a tangible expression or application of human creative skill and imagination intended to be visually apprehended and created specifically for the transmission of the creative intent of the artist without secondary use or application to some practical purpose. It is important to note, however, that no published authority has adopted this approach. WWW. bryancave.com A Broader Perspective America I Asia I Europe 5 EFTA01122865 Forward or Reverse — What is the Optimal Form? Once an owner of art determines that a specific piece qualifies for Code Sec. 1031 deferral on sale and that the intended reinvestment will qualify as like-kind, a logical next step is to create a tax-effective optimization strategy for acquisition and disposition. Some of the primary criteria for optimization are 1) transaction control and strategic success, 2) maximizing tax efficiencies of all kinds and 3) reducing risk related to the assets. The primary difference between the two forms of exchange — forward and reverse — is the timing of the acquisition of the new artwork relative to the disposition of the artworks to be sold. In some cases, the timing of transactions will be dictated by specific factors. For example, a particularly strategic or desirable piece may become available at auction and must either be acquired immediately or lost to a competing bidder. In order to satisfy the strategic goal, a reverse exchange would likely be required. However, if the cash proceeds from sale of the artwork to be sold are absolutely necessary to allow purchase of any replacement artworks, then a forward exchange would be the only option. But, when the various buy and sell factors can be controlled, the potential art seller should certainly analyze the available options to determine which form is best based on an evaluation of the optimization criteria. Some pros and cons of forward and reverse exchanges as they relate to artworks include: • Forward exchanges are well understood and avoid some transactional costs that may apply to reverse exchanges. In addition, funds resulting from the sale of the old artworks are available for the purchase of the new artworks. Further, the owner does not have to trust a third party's ownership of the replacement art once acquired from a seller or of the owner's art prior to transfer to a buyer. • Forward exchanges require meeting the Code Sec. 1031(a)(3) 45-day and 180-day deadlines for identification and acquisition of replacement artworks. These deadlines may put pressure on the owner to make purchases that are not ideal and can reduce the spontaneity that many art owners enjoy and rely on for the quality of their portfolios. In some cases, the options for effectively managing the purchase to reduce or avoid sales and use tax may be reduced. In addition, in a forward exchange, the cash proceeds of the sale of the old artworks must be held by a O1 until the new artworks are acquired. • If new artworks are acquired in a reverse exchange, the remaining task is to sell old artworks within limited time periods. This gives owners the opportunity to make acquisitions that support their strategy for making changes to their art portfolio, rather than having to identify and acquire new artworks while under the artificial pressure of the Code Sec. 1031 deadlines or risk failing to achieve Code Sec. 1031 deferral due to unforeseen delays in closing acquisitions. In addition, the reverse exchange allows the owner to buy at auction or through a gallery or broker precisely when desirable new pieces become available, knowing that they can be included in a Code Sec. 1031 www.biyancave.com A Broader Perspective America I Asia I Europe 6 EFTA01122866  exchange. It may be possible to lower sales and use taxes on the purchase of new artworks where the owner lives in a low tax jurisdiction or one without applicable use taxes. This sometimes can be done by having the entity (usually a LLC) involved in the reverse exchange take title to the purchase in a non-tax or reduced tax location or by taking advantage of "trade-in credits" available in some jurisdictions. In either case, the LLC must have certain resale licensing. In addition, since cash received on sale of relinquished art will generally be applied immediately to reimburse the owner's advance of cash to purchase replacement art, there is no significant period when the cash is not deployed and there need be no period when cash is held by a third party. • There are also some disadvantages to reverse exchanges, with the most significant being that funds required for the acquisition of the new artworks must be supplied prior to the sale of the old artworks. In addition, due to the need to set up a qualified exchange accommodation arrangement using an EAT to hold sufficient "qualified indicia of ownership" unnecessary in forward exchanges, reverse exchange may be more complex and costly, and not all Code Sec. 1031 exchange companies handle reverse exchanges or handle them well. All things considered, the reverse exchange may be the informed investor's "secret weapon," as it allows acquisitions to be made that are both strategic and spontaneous while providing maximum potential for additional deferral of gain, accretive tax efficiencies, asset utilization and security. Art ownership and transfer does not involve the same degree of formality as real estate, making "qualified indicia of ownership" of art easier to achieve for an EAT in an art exchange than for real estate or some other asset classes. The portability of most art allows the owner to rather easily take physical possession of artworks during the period of time that an EAT holds legal title. The key is to work with an experienced and reputable exchange accommodation firm that will assist in implementation of the owner's desired objectives consistent with both good business practices and tax rules. Selecting a Code Sec. 1031 Accommodator The Code Sec. 1031 QUEAT "industry" consists of over 200 firms. There is wide variety in expertise, geographic focus, commitment to asset security and flexibility or problem-solving capabilities. Some firms are subsidiaries of banks. Bank-owned Qls are excellent choices for deferred exchanges, because they generally have the needed expertise to structure moderately-complex deferred exchange transactions and they clearly provide the necessary asset security provisions for the cash proceeds of the initial sale. However, bank-owned Qls rarely provide reverse exchange services due to 1) the internally perceived risks of holding title to assets other than cash and 2) the frequent need to sometimes deviate from standard transaction formats and quickly develop customized reverse exchange structures that satisfy the requirements of a client. www.bryancave.com A Broader Perspective America I Asia I Europe 7 EFTA01122867 Some firms are subsidiaries of real estate title insurance providers. These firms specialize in real estate exchanges and are able to offer both delayed and reverse exchanges. Their expertise with asset categories other than real estate varies, as might be expected. Further, their ability to structure complex exchanges involving unusual purchase or sale arrangements, entity bifurcation for sale tax efficiency or other attractive elements of a strategy for artworks also varies and may sometimes be limited. These firms are generally considered to have excellent asset security provisions. Many other (NEAT firms are small and sometimes regionally focused independent firms that deal almost exclusively with real estate exchanges. While they may have considerable expertise with real estate, a firm's expertise in other asset categories should be explored thoroughly before engaging the firm for artwork exchanges. Further, asset security issues need to be considered any time these firms are utilized — both for forward and reverse exchanges — to make sure that the owner is protected against accommodation firm failure. Independent firms vary in their scope of coverage, sophistication, exposure to exchanges involving personal property and degree to which they have developed structures responding to both funds security and transactional complexities of personal property exchanges. Artwork exchanges call for assistance from a QUEAT that has the depth of experience and expertise to recognize issues and assist the owner and his/her/its advisors in solving them. A key to this is the ability to be very responsive and offer both process flexibility and expertise dedicated to problem-solving. Perhaps uniquely in the world of fine art, owners are sometimes encouraged to use an art gallery or dealer as an accommodator.8 While this approach can work, it seems to be a clear example of the somewhat unique transactional culture in the world of fine art. It also raises the issue of how the disqualified person rules of Treas. Reg. Sec. 1.1031(k)-1(k) apply. There are several questions specific to Code Sec. 1031 exchanges that arise: • Does the phrase "agent" apply when the dealer has represented the owner in any capacity in the two years leading up to the exchange? If so, the dealer would be disqualified from acting as the owner's O1 or EAT since no exception applies. • Does the dealer have any meaningful expertise or experience regarding the execution of Code Sec. 1031 exchanges? If not, are the owner's other advisors sufficiently familiar with the requirements to assure successful completion of the transaction? • What security devices are in place to protect against loss of cash exchange proceeds through misappropriation by the dealer or its employees and if such devices are established, will they be consistent with applicable requirements, such as Code Sec. 468B? WV/W. bryancave.com A Broader Perspective America I Asia I Europe 8 EFTA01122868 Making an informed choice from among these various types of professional QI/EAT firms can be challenging. Some potential QI/EAT criteria include the following: • A combination of expertise, references, responsiveness, flexibility and a problem-solving mentality that suits the business objectives and personal preferences of the Investor. • Assurance that the firm is not (even arguably) a "disqualified person." o The QI/EAT should be demonstrably compliant with all applicable federal and state statues affecting this line of business, including Patriot Act and OFAC screening. • Availability of state-of-the-art asset security for both deferred and reverse exchanges. o Use of segregated, dedicated funds management protocols, including qualified escrow or qualified trust accounts, with ability to authenticate each movement of cash. o Availability of corporate guarantees from rated issuers or fidelity bond protection ensuring against theft of the funds. o Use of entity forms for QI and EATs that are designed to be resistant to consolidation should their parent entities become subject to bankruptcy court jurisdiction. • Familiarity and ability to work with artwork purchase and sale arrangements that are less formal and/or more complex than those found in other asset categories. Specifically, one should ensure that: • If the purchase and sale agreements between the owner and a buyer are informal, the QI/EAT must be able to accept an assignment of the owner's right as found in such arrangements that will satisfy the Code Sec. 1031 requirements; and • The role of galleries, auction firms and consignment arrangements are well- understood and taken into account as it relates to transfer of title and the receipt and disbursement of cash. Conclusion Commentators are optimistic about art owners' ability to defer income taxation by engaging in like-kind exchanges of artworks that have appreciated in value. The keys to successfully achieving this objective are: • Treat the artworks to be exchanged consistently with other investment assets and document this treatment. www.bryancave.com A Broader Perspective America I Asia I Europe 9 EFTA01122869  • Until more complete guidance is available, the most conservative approach is to limit exchanges to art of the same medium. However, with appropriate advice and explanation of the state of the law, many owners may consider choosing to utilize a more expansive and defensible definition of the like-kind standard for art that is both intellectual supportable and consistent with the underlying Congressional intent behind Code Sec. 1031. • Employ professional advisors and experienced Code Sec. 1031 accommodation assistance. Make informed decisions about which form of exchange to utilize. With soaring potential financial benefits of Code Sec. 1031 exchanges of artworks and increasing clarity regarding some previously unclear aspects of such exchanges, it seems like the time is right to explore these options. I.R.C. § 1411. 2 This article does not discuss the potential for generating income by charging admission to view art, since this is not typical. Obviously private museums and exhibition businesses (e.g., Madame Tussaud's, etc.) may be subject to different analyses. 3 Treas. Reg. § 1.1031(k)-1(g)(4). 4 2000-2 C.B. 308. TC Memo 2003-12, aftcl, 394 F.3d 1030 (CA 8 2005). 6 See, e.g., Rev. Proc. 2008-16, 2008-1 C.B. 547, which "codifies' the results of PLR 8103117; Reesink vs. Commr, TC Memo 2012-118, Moore vs. Commr, TC Memo 2007-134. 7 See, e.g., analysis of majority and dissent in Wrightsman vs. U.S., 192 Ct. Cl. 722 (428 F.2d 1316)(1970). a See, e.g., Wierbicki, "Like-Kind Exchanges." Trusts & Estates, May 2013, at p. 41. By Lou Weller, Of Counsel, San Francisco, CA, www.bryancave.com A Broader Perspective America I Asia I Europe 10 EFTA01122870 REAL ESTATE CAPITAL MARKETS IRS REIT WORKING GROUP In its Form 8-1( filed with the Securities and Exchange Commission on June 6, 2013, Iron Mountain Incorporated ("Iron Mountain") disclosed that the IRS had informed Iron Mountain that it had formed a new internal working group (the "Working Group") to "study the current legal standards the IRS uses to define 'real estate' for purposes of the REIT provisions of the [Internal Revenue Code] and what changes or refinements, if any, should be made to those current legal standards."' Further, Iron Mountain indicated that it believed the formation of the Working Group and the study to be conducted thereby would impact the timing of pending private letter ruling ("PLR") requests submitted to the IRS by Iron Mountain and other companies.2 What followed was a flurry of industry speculation and editorial commentary of a largely negative nature. Indeed, a survey of the coverage of the announcement of the Working Group reveals a sense that the IRS is potentially changing the game (or, perhaps, even the definition of real estate itself). The market also reacted, as shares of companies in the process of converting to a REIT or publicly considering such conversion posted significant declines in the days following the announcement. On November 14, 2013, the IRS contacted various companies to inform them that the Working Group had completed its task and that the IRS would continue to issue PLRs regarding the definition of real estate for purposes of the REIT rules.3 As of this writing, the IRS has yet to issue a formal announcement regarding the Working Group or its findings. While it has yet to be seen whether or not the Working Group will ultimately have the limiting effect on the REIT industry as some feared, the reality is perhaps less drastic as initially interpreted and may indeed be consistent with prior IRS practice and procedure in the area. Background When Congress originally created REITs in 1960, the vehicle was envisioned as a means for average retail investors to make passive investments in commercial properties. The principal advantage of an investment in real property through a REIT is the avoidance of the corporate level of taxation due to the deduction for dividends paid." When Congress enacted REIT legislation, it drew a distinction between operating businesses and the rental of commercial real estate, however, it failed to distinguish between rental real estate classes.' Over the last five decades, the REIT has evolved into a powerful vehicle covering a broad spectrum of rental real estate classes, such as office, industrial and multifamily residential properties.' Recently, an increasing number of taxpayer favorable PLRs covering an increasingly diverse universe of asset types, coupled with media coverage of noteworthy conversion announcements in the wake of such PLRs, has furthered the perception that the IRS is expanding or liberalizing its application of the longstanding REIT rules and, further, has led to an increased interest in the REIT as an investment vehicle and as an option for an increasingly diverse array of companies (or affiliates created for the purpose of holding "real estate assets") to convert.' vvww.bryancave.com A Broader Perspective America I Asia I Europe 11 EFTA01122871 With the announcement of the Working Group, and the resulting largely negative reaction in the media and stock markets, there is a sense that the momentum the recent PLRs provided to the industry may have been setback, and the optimism and expectations in connection with the potential IRS blessing of new asset types (e.g., solar panels8) appears somewhat tempered. Before delving into the specifics of the market reaction, it is necessary to provide background regarding the Working Group, as well as an overview of some of the recent noteworthy pending and completed REIT conversions as of this writing. This article does each in turn. IRS Review of REIT Conversion Guidelines The Working Group was formed with the purpose of studying the current legal standards the IRS uses to define "real estate" for purposes of the REIT rules.° The Working Group was to consider what changes or refinements, if any, should be made to those current legal standards. The definition of real estate assets is critical to whether or not a taxpayer will qualify as a REIT due to its central role in both the "income tests"10 and "asset testsi11 found in the REIT provisions. The viability of some of the newly proposed REITs hinges entirely on whether or not some specific type of asset constitutes real estate for purposes of the REIT rules. While the recent history of PLRs has shown a favorable trend towards approval of a wide range of assets as qualifying real estate under the REIT rules, the statutory basis and law underlying such rulings has actually remained relatively consistent over the history of REITs. In this regard, it appears that the IRS, via the Working Group, was pausing to evaluate the current application of the well-settled statutory rules to the ever-diversifying PLR requests to ensure that the recent trend of so-called expansive PLRs is consistent with the intended scope and definition of real estate for purposes of the REIT rules. The IRS itself has similarly indicated in previous statements that it has used the same standard to identify qualifying assets for many years, and that the approval of new assets is the result of newly developed assets meeting those existing standards, and "should not be confused with a relaxation of the standards themselves."12 With respect to this most recent Working Group, there is some indication that the group was actually an internal group that meets periodically to discuss the PLRs that the IRS is working on in the REIT arena — in other words, the Working Group was not necessarily a formal group or even newly-established.13 Noteworthy Pending and Recent REIT Conversions The number and diversity of the recent completed, pending and contemplated REIT conversions illustrates the increasing interest in the structure and the market perception of expanding IRS lenience. This section is intended to provide just a high-level sampling of some recent noteworthy contemplated, pending or completed REIT conversions covering a wide range of underlying asset types. The depth of the following list illustrates the far-reaching impact of the IRS' recent trend of taxpayer favorable PLRs. 1441/W. bryancave.com A Broader Perspective America I Asia I Europe 12 EFTA01122872  Document Storage As noted in the introduction to this article, the announcement of the Working Group actually arose in connection with public disclosure of the formation of the Working Group by the document storage company Iron Mountain. Iron Mountain had sought a ruling from the IRS that certain racking structures utilized in its document storage warehouses constitute real estate for purposes of the REIT rules. Data Center Operator Data centers are buildings that house computers, servers and internet exchanges and the infrastructure needed to run the same. Equinix, Inc. ("Equinix"), a data center operator, is currently planning to convert to a REIT, and is facing scrutiny similar to that encountered by Iron Mountain. Equinix would not necessarily be alone, as Digital Realty Trust, Inc. and DuPont Fabros Technology, Inc. are already operating as REITs. Outdoor Advertising Outdoor billboard advertising company Lamar Advertising Co. ("Lamar") has disclosed that it plans to become a REIT and that the IRS is reviewing its election to become a REIT. Earlier this year CBS Corp. submitted a PLR request to the IRS in connection with its own similar plans to convert its outdoor advertising business to a REIT. Casino Last year, casino operator Penn National Gaming, Inc. ("Penn") announced its plans to separate its real estate and operating assets by way of a tax-free spin-off transaction that would create the first-of-its-kind gaming focused REIT. Penn's announcement of the transaction was made at the same time as its announcement that it had received a favorable PLR from the IRS. Solar Power Generation The media and industry watchers have given significant attention to Renewable Energy Trust Capital, Inc.'s requested ruling from the IRS that ground-mounted solar projects are real estate for REIT purposes. While observers continue to wait for this much-anticipated PLR, a recent PLR believed to have been issued to Hannon Armstrong Sustainable Infrastructure Capital, Inc., and which holds that certain described structural improvements were real estate for purposes of the REIT rules and that interest income from financing such assets qualified as interest on obligations secured by mortgages on real property or interests in real property for purposes of the REIT income tests, failed to live up to the industry's hope that the IRS would provide a sweeping and conclusive blessing of solar assets." www.bryancave.com A Broader Perspective America I Asia I Europe 13 EFTA01122873  Others The list can go on, and indeed does. Other similar recent contemplated, pending and completed REIT conversions include prison operators, cell towers, timberland and accommodations businesses. Market Reaction ,' Impact The reaction of the media and various industry watchers was overwhelmingly negative and nervous immediately following the announcement of the Working Group. The announcement generated a significant amount of editorial commentary, much of which was speculative given the relative lack of details provided regarding the specifics of the Working Group. Because the timeline to completion of the Working Group's study was unknown, there was much discussion of the potential delay, or even moratorium, in connection with the IRS' review of existing PLR requests and approval of new applications for REIT statusis Some commentators even raised concerns over the possibility that the IRS could strip some companies of their favorable tax status.16 In the days following the announcement, the stock market followed suit and the stock prices of Iron Mountain, Equinix and Lamar posted losses in spite of a broad market rally." While the media's reaction to the news of the Working Group may have been speculative, it was not necessarily completely unfounded. If the premise is true that the IRS' recent run of largely taxpayer favorable PLRs was an expansion of the REIT rules as much of the editorial commentary suggests, then it may very well be true that the IRS has decided to hit the brakes and take a change of course in order to rein in the application of the REIT rules in order to maintain consistency with the original Congressional intent. Any scaling back by the IRS could have the very real result of hampering the growth of, or even downsizing, the industry. In the alternative, many tax practitioners believe that it is entirely possible that the Working Group was simply a periodic and necessary evaluation by the IRS to ensure that it is properly and consistently applying longstanding statutory REIT rules. Those of this opinion argue that, while the Working Group was charged with reviewing the legal standards and any changes that may be necessary thereto, there was not and is not necessarily any indication that the IRS intends to change anything. The IRS may simply have been slowing down and taking its time in light of the flood of interest in REITs (and the corresponding influx of PLR requests regarding an increasingly diverse pool of asset types). If this is the case, the results of the Working Group may ultimately be a low impact event in the grand scheme of things. As the time since the announcement of the Working Group continued to grow, there was a noticeable softening of the editorial commentary, and an increasing number of commentators began to posit that perhaps the initial negative reaction in the media was an overreaction to what will ultimately amount to the continuation of the IRS' current approach to applying the same REIT rules to new types of assets. WV/W. bryancave.com A Broader Perspective America I Asia I Europe 14 EFTA01122874 Conclusion As of this writing, the IRS has not made any formal announcement regarding the Working Group or its findings. It remains to be seen whether or not the nervousness associated with the announcement of the Working Group was justified. If the IRS was indeed seeking a change of course with respect to the way it applies the REIT rules, then the formation of and review by the Working Group may indeed prove to be a watershed moment for the REIT industry. However, it is possible, and many tax practitioners believe more likely given the consistency of the statutory provisions and the application thereof, that the IRS was not seeking to change anything and that, instead, it was simply taking the opportunity to make a periodic review of the application of said rules to ensure the continued consistent application thereof. Iron Mountain Incorporated, Current Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Form 8-K), at 2 (June 6, 2013). 2 Id. Iron Mountain indicated that the IRS had informed the company that the IRS is "tentatively adverse" on Iron Mountain's PLR request that racking structures constitute "real estate" for REIT purposes. 3 See, Iron Mountain Incorporated, Current Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Form 8-K), at 2 (November 14, 2013); Lamar Advertising Company, Current Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Form 8-K), at 2 (November 14, 2013); Equinix, Inc., Current Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Form 8-K), at 2 (November 14, 2013). Michael E. Shaft, The Service's Trend of Friendly REIT Rulings Continues, 4 Colum. J. Tax L. Tax Matters 17 (2013). 5 Daniel F. Cullen, Solar REITs and the IRS Working Group, J. of Passthrough Entities, September- October 2013. 6 Id. Indeed, Vol. 4, No. 1 of the Columbia Journal of Tax Law Tax Matters (available at http://www.columbiataxjournal.org/tax-matters-vol-4-no-10 was dedicated to this very issue. As the introduction paragraph notes: "In several recent private letter rulings, the IRS appears to apply an expansive interpretation of the definition of "real property" and "rents from real property" in relation to real estate investment trusts (REITs). As REITs purchase properties that include renewable assets, such as solar panels and wind turbines, the continuing development of such assets puts further pressure on the definition of real property and rents from real property. Although private letter rulings do not have precedential effect, some practitioners may look to them for guidance regarding specific issues, especially if a transaction comes squarely within, or close to, the four corners of a ruling. If a private letter ruling describes property such as electricity transmission lines, natural gas pipelines, cell towers, billboards, or renewable assets with sufficient specificity, perhaps tax advisors could become comfortable concluding that similar assets would qualify for the treatment granted in the private letter rulings." www.bryancave.com A Broader Perspective America I Asia I Europe 15 EFTA01122875 8 The possibility of solar REITs has received considerable attention in the media over the past year. The recently issued PLR 201323016 has been met with a somewhat lukewarm reception, and industry watchers continue to await the much-anticipated PLR to be issued in connection with the Renewable Energy Trust Capital, Inc.'s PLR request. 9 See, I.R.C. §§ 856 to 859. 10 I.R.C. §§ 856(c)(2) & (3). 11 I.R.C. §§ 856(c)(4)(A) & (B). 12 Vipal Monga, Firms Restructure As REITs, Wall Street Journal, available at online.wsj.com/article/SB20000872396390443517104577573150214714834.html (Aug. 7, 2012). 13 See, Kelly Kogan, REIT 'Working Group- Business as Usual for IRS, Project Finance News, available at http://www.pfnewswire.com/2013/08/reit-working-group-business-as-usual.html (Aug. 15, 2013). Id See, Priv. Ltr. Rul. 201323016. Practitioners have connected this PLR to the Hannon Armstrong SEC S-11 filing. The PLR does not actually refer to renewable energy assets, let alone solar assets specifically. Is With the announcement of the completion of the Working Group, various companies' public filings have disclosed that the IRS has indicated that it will resume issuing PLRs regarding the definition of real estate for the purposes of the REIT rules. See. supra no