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FEBRUARY 12, 2020 REITS: IRS RULING OPENS DOOR FOR MIDSTREAM ASSETS Energy Series / REIT Series velaw.com
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
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 2
TODAY’S PANELISTS
RYAN CARNEY PAIGE ANDERSON CHRIS MANGIN
PARTNER, TAX SENIOR ASSOCIATE, REIT-TAX PARTNER, REIT-TAX
HOUSTON RICHMOND WASHINGTON, D.C.
DAVE OELMAN DANIEL LEBEY
PARTNER, CAPITAL MARKETS & PARTNER, REIT-CAPITAL MARKETS &
MERGERS & ACQUISITIONS MERGERS & ACQUISITIONS
HOUSTON RICHMOND
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 3
MLP BACKDROP
MLP IPOS
PAGP
Primary Industry at IPO: †
CQH
Exploration and Production †
Fertilizer
SXCP FELP
Refining Coal USAC LMRK
PVG
NSH OCIR CELP
Midstream Propane NAP
OCIP
MGG †
RIGP
EMES
Wholesale Distribution Timber HPGP OSP †
KNOP HMLP
NMM
ETE † † †
Shipping General Partner/Holding Co. CPLP DLNG GLOP
NGL WGP
BGH † † †
CQP UAN HCLP WPT RMP
AHGP
Other † Corporate IPO SDLP
SEP RNF WNRL AM
AHD †
TOO GMLP
EPE NGLS SUSP VLP SHLX
† †
NRGP RGNC EPB TLLP CAPL TEP DM
NRP UCLP DEP RRMS SXE SRLP USDP EQGP
TGP EROC KGS OILT SMLP QEPM JPEP TEGP
†
XTXI WPZ CLMT CEQP RNO NRGM MPLX PSXP CONE CNXC
†
VTTI AMGP
SPH ENLK STON TLP LINE SGLP OXF CCLP EQM MEP EVA †
†
LPG NRGY BPMP
CRO NPL SXL USS HLND EVEP VNR PNG AMID DKL FISH PBFX PTXP
MAR PCL FGP HOLP PVR PPX KSP GLP CEP QELP WMZ NKA MEMP NTI ARCX ENBL GPP OMP
VLP SFL KPP TPP AMC UAN LEV TNH SGU CNO PAA ARLP UDL MWE HEP DPM BBEP LGCY WES CHKM MCEP ALDW CVRR WLKP CPPL HESM
BCU HWY EPR PDE LHP ENP NBP EOT APU GEL TIMBZ EPD TCP APL MMP MMLP DMLP CPNO BWP ATN ENP PSE QRE LRE PDH NSLP VNOM BSM NBLX KRP
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
Years
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 4
MLP BACKDROP
CURRENTLY TRADED MLPS
Primary Industry at IPO: PAGP
†
Exploration and Production Fertilizer
FELP
Refining Coal
USAC LMRK
CINR CELP
Midstream Propane
Wholesale Distribution Timber
NMM KNOP HMLP
ET
† † †
Shipping General Partner/Holding Co. CPLP DLNG GLOP
NGL WES
† † †
CQP UAN
Other † Corporate IPO
SDLP
†
GMLP
SUN SHLX
†
CAPL
NRP SXE SRLP USDP
TOO TGE
TGP SMLP
† †
CLMT RHNO MPLX PSXP CNXM CCR
BPMP
SPH BKEP CCLP EQM EVA
CEQP DKL PBFX OMP
GLP SNMP ENBL GPP
PAA ARLP NS HEP DCP MCEP WLKP
GEL EPD TCP MMP MMLP DMLP BSM 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
Years
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 5
WHERE DID THEY GO?
• Simplification Transactions – GP and LP trading entities combined into single
traded entity
• C-Corp Conversions
• C-Corp Roll Ups
• Take Privates
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 6
WHAT’S OLD IS NEW AGAIN
• 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
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 7
WHAT IS A REIT?
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).
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 9
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)
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 10TAXATION OF REITS
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 11TAXATION OF U.S. SHAREHOLDERS
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 12TAXATION OF FOREIGN 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 13TAXATION 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 14TAXATION OF FOREIGN SHAREHOLDERS
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 30% of gross distributions (or a
rate) lower rate under any treaty)
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 15TAXATION OF FOREIGN SHAREHOLDERS
USRPI Distributions from REITs
Foreign Persons Obligated Applicable Withholdings:
to Pay Tax: Type of Tax: Maximum Rate:
Qualified Foreign Pension U.S. income tax 0% None
Fund, Qualified Shareholder
Individual Shareholders (other U.S. income tax 20% 21% withholding on
than a shareholder of ≤ 10% distributions (may be
of a Public REIT) reduced by regulations)
Corporate Shareholders (other • U.S. income tax • 21% • 21% withholding on
than a shareholder of ≤ 10% distributions
of a Public REIT) • Branch Profits Tax (on • 30% • None
the net gain after the
allowance of a
deduction for the 21%
U.S. income tax)
Shareholders with ≤ 10% of a U.S. income tax 30% (or lower treaty rate) 30% withholding on
Public REIT distributions (or lower treaty
rate)
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 16TAXATION OF FOREIGN SHAREHOLDERS
Sale of REIT Shares
Persons Obligated to Pay
Type of Tax: Maximum Rate: Applicable Withholdings
Tax:
Qualified Foreign Pension U.S. income tax 0% None
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 U.S. income tax 0% None
Public REIT
Foreign Controlled/USRPHC/Non-Public REIT Shareholders
Individuals U.S. income tax (if shares 20% 15% withholding on gross
held for more than one year) proceeds
Corporations U.S. income tax 21% 15% withholding on gross
proceeds
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 17REIT ADVANTAGES & DISADVANTAGES
REIT ADVANTAGES
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 19REIT DISADVANTAGES
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 20REIT STRUCTURES
TYPICAL REIT ORGANIZATIONAL STRUCTURE (UPREIT)
REIT
(corporation)
GP & LP Property
Contributors
LP
OPERATING
PARTNERSHIP
ASSET OWNING
SUBS
TRS
Properties
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 22UPREITS
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 23UPREITS
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 24DOWNREIT STRUCTURE
REIT
(corporation)
Property
Existing Contributors
Properties GP & LP
LP
DownREIT
Partnership
New Properties
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 25DOWNREIT STRUCTURE
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 26REIT GOVERNANCE AND SEC REPORTING
REIT GOVERNANCE AND 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).
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 28REIT 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 29REIT INDUSTRY SNAPSHOT
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 30REIT OPERATING PERFORMANCE METRICS
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 31REIT FINANCING
• 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
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 32REAL PROPERTY, RENTS FROM REAL PROPERTY, AND PLR 201907001
REAL PROPERTY
WHAT QUALIFIES AS “REAL PROPERTY” UNDER THE REIT RULES?
• 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
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 34REAL PROPERTY
Treas. Reg. §1.856-10 (2016) Illustrative Examples
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 lines, pipelines and offshore drilling platforms
transmission towers
• 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 • Central refrigeration systems, integrated security systems and
under Internal Revenue Code Section 1033(g) (e.g., billboards) 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 • Valves in a pipeline transmission system
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
• Electrical and telecommunications infrastructure systems in data
centers
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 35REAL PROPERTY
Treas. Reg. §1.856-10 (2016) Illustrative Examples
Do Not Qualify as Real Property
• Bus shelters • Modular partition systems
• PV modules in solar energy sites that sell electricity to • Meters and compressors in a pipeline transmission
third parties system
• Casino licenses
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 36RENTS FROM REAL PROPERTY
WHAT QUALIFIES AS RENTS FROM REAL PROPERTY?
• 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
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 37PLR 201907001
IMPLICATIONS
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 38PLR 201907001
RULING DETAILS: PIPELINES
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 39PLR 201907001
RULING DETAILS: STORAGE TANKS
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 40PLR 201907001
RULING DETAILS: PIPELINES—SERVICES
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 41PLR 201907001
RULING DETAILS: STORAGE—SERVICES
• 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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 42PLR 201907001
POTENTIAL USERS OF A REIT STRUCTURE
• 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
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 43PLR 201907001
THOSE WHO WOULD HAVE DIFFICULTY USING A REIT STRUCTURE
• 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
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 44PLR 201907001
RELIANCE ON PLR
• 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
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 45PANELIST BIOGRAPHIES
RYAN CARNEY DAVE OELMAN
PARTNER, TAX PARTNER, CAPITAL MARKETS & MERGERS & ACQUISITIONS
HOUSTON HOUSTON
+1.713.758.4720 +1.713.758.3708
rcarney@velaw.com doelman@velaw.com
Ryan’s practice focuses on the tax aspects of domestic and international business transactions, Dave co-heads V&E’s Mergers & Acquisitions and Capital Markets practice group .
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, Dave is one of the country’s preeminent IPO practitioners, having worked on more IPOs in the last three
reorganizations, and capital markets transactions. 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,
Over the last ten years, Ryan has represented issuers and underwriters in more than 45 MLP initial midstream companies, OFC companies and other energy, power and infrastructure-related businesses.
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 Over the course of his thirty-year career, Dave has participated in more than one energy industry
connection with qualifying income matters and seeking private letter rulings and other guidance from the transformation. In the 1990s and early 2000s, he advised on the IPOs of numerous midstream businesses.
Internal Revenue Service. 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).
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 46PANELIST BIOGRAPHIES
CHRIS MANGIN PAIGE ANDERSON
PARTNER, REIT-TAX SENIOR ASSOCIATE, REIT-TAX
WASHINGTON, D.C. RICHMOND
+1.202.639.6534 +1.804.327.6326
cmangin@velaw.com panderson@velaw.com
Chris is a nationally-recognized authority on REIT taxation, real estate funds, and real estate Paige focuses her practice on the federal income tax aspects associated with real estate capital markets
partnerships. 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,
Chris works with REITs, real estate companies, and private equity sponsors on IPOs, mergers and reorganizations, and financings.
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.
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 47PANELIST BIOGRAPHIES
DANIEL LEBEY
PARTNER, REIT-CAPITAL MARKETS & MERGERS & ACQUISITIONS
RICHMOND
+1.202.639.6534
cmangin@velaw.com
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)
Confidential and Proprietary ©2020 Vinson & Elkins LLP velaw.com 48THIS 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.
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