IMPACT OF THE TAX REFORM ACT OF 1986
ON CORPORATE REAL ESTATE ASSET MANAGEMENT
By
BRUCE A. EIDELSON
B.A., Economics and Geography
University of California, Los Angeles
(1977)
Finance
M.B.A.,
University of California, Los Angeles
(1980)
SUBMITTED IN PARTIAL FULFILLMENT
OF THE REQUIREMENTS OF THE
DEGREE OF
MASTER OF SCIENCE
IN REAL ESTATE DEVELOPMENT
at the
MASSACHUSETTS INSTITUTE OF TECHNOLOGY
July 1987
Q
Bruce A.
Eidelson
The author hereby grants to M.I.T. permission to reproduce and
or in
thesis document in whole
copies of this
to distribute
part.
Signature of Author
Department of Urban Studies and Planning
July 15, 1987
Certified b y
Marc A. Louargand
Visiting Associate Professor
Department of Urban Studies and Planning
Accepted by
Michael Wheeler
Chairman
Interdepartmental Degree Program in Real Estate Development
1
MASSACHUSETTS INSTITUTE
OF TECHNOLOGY
JUL 2 9 1987
LIBRARIES
IMPACT OF THE TAX REFORM ACT OF 1986
ON CORPORATE REAL ESTATE ASSET MANAGEMENT
by
BRUCE A.
EIDELSON
Submitted to the Department of Urban Studies and Planning
on July 15, 1987, in partial fulfillment of the
requirements for the Degree of Master of Science in
Real Estate Development at the
Massachusetts Institute of Technology
ABSTRACT
the potential
is to evaluate
of this paper
The purpose
Act) on the
(Tax
of
1986
Reform
Act
Tax
of the
impacts
The focus of the
assets.
management of corporate real estate
is on corporations which have substantial real
analysis
property holdings used in operations, but are not primarily in
the real estate business.
review of recent
based on an extensive
The analysis was
Act
and corporate
Tax
on
the
literature
periodical
studies and
were also
Interviews
general.
in
management
asset
estate
real
conducted with: tax accounting experts, investment bankers and
corporate
clients; and
corporate
serving major
consultants
variety of
officers in a
real estate
managers and financial
industries.
on
Tax
Act
of
the
impact
of
potential
Four
areas
corporate
real estate
asset
management
were examined:
(1)
(2)
estate facilities;
of
new real
lease
versus ownership
(3) frequency and
facilities;
for existing
sale-leasebacks
and
(4)
ventures;
joint
of
developer/corporate
structure
securitization
of corporate
real estate
assets with
master
real estate investment trusts
limited partnerships (MLPs) and
(REITs).
study are as
and conclusions of this
The major findings
follows:
on
indirect impacts
has both direct and
- The Tax Act
leasing and ownership costs.
When taken in combination,
these impacts are indeterminate with respect to potential
changes in corporate facility occupancy decisions.
- The cost
from
of sale-leaseback
the corporation's
financing will
perspective due
to:
be increased
(1)
higher
economic rents required to compensate
investors for
reductions
in tax benefits; and
(2) increased capital
gains tax
liability incurred
time of sale.
2
by the corporation
at the
imposition of
- Due to changes in marginal tax rates and
individual investors, the Tax Act
passive loss rules for
tax
allocations of
special
opportunities for
presents
partner in a developer/corporate
benefits to a corporate
joint venture.
Tax Act were generally
- Although provisions of the
favorable with respect to MLPs and REITs, it is unlikely
toward
trend
widespread
be a
will
there
that
securitization of corporate
either investment vehicle.
Thesis Supervisor:
Visiting
Title:
Planning
Marc A.
Associate
real estate assets utilizing
Louargand
Professor of
3
Urban
Studies
and
IMPACT OF THE TAX REFORM ACT OF 1986
ON CORPORATE REAL ESTATE ASSET MANAGEMENT
ABSTRACT.
. . . . . . . . . . . . . . . . . . . . . . . . . 2
LIST OF TABLES.
CHAPTER ONE -
. . . . . . . . . . . . . . . . . . . . . . 6
INTRODUCTION.
.
.
.7
.
. . . . . . . . . . . . . . 7
A. Background and Purpose.
B. Research Methodology. . . . . . . . . . . . . . . . 8
.
C. Organization of the Thesis.
.
.
.
.
.
.
.
CHAPTER TWO - PROVISIONS OF THE TAX ACT AFFECTING
CORPORATIONS AND REAL ESTATE. . . . . . . . .
.
.
.
.
.
.
. 9
.
11
A. Tax Rates. . . . . . . . . . . . . . . . . . . . . 12
1. Ordinary Income. . . . . . . . . . . . . . . .12
2. Capital Gains. . . . . . . . . . . . . . . . .13
B. Depreciation. . . . . . . . . . . . . . . . . . . .13
1. Real Property. . . . . . . . . . . . . . . . .13
2. Personal Property. . . . . . . . . . . . . . .14
3. Leasehold Improvements. . . . . . . . . . . . 15
.
.
.
.
.
.
.
.
.
.
.
.
.
. 15
D. Alternative Minimum Tax.
.
.
.
.
.
.
.
.
.
.
.
.
.
C.
Investment Tax Credit.
E. Passive Loss Limitations.
.
F. Master Limited Partnerships.
G. Real
1.
2.
3.
4.
5.
H.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
16
.17
. 18
Estate Investment Trusts. . . . . . . . . . . 19
Shareholder Qualifications. . . . . . . . . . 19
Qualified Asset and Income Tests. . . . . . . 19
REIT Subsidiaries. . . . . . . . . . . . . . .20
Independent Contractor Requirement. . . . . . 20
Pass-Through of Sublease Income. . . . . . . .20
.
Summary and Implications of Tax Act Changes.
CHAPTER THREE - ANALYSIS OF THE TAX ACT IMPACTS ON
CORPORATE REAL ESTATE ASSET MANAGEMENT. . . .
A. Lease Versus Ownership of New Facilities.
4
.
.
.
.
.
.
.
.21
.
.
24
.24
1.
2.
3.
4.
Direct Impacts. . . . . . . . . . . . . . . . 25
Indirect Impacts. . . . . . . . . . . . . . . 27
Comparative Lease Versus Ownership Analysis. .30
Summary of Lease Versus Ownership Impacts. . .38
B. Sale-Leasebacks for Existing Buildings. . . . . . .39
1. Individual Investors. . . . . . . . . . . . . 40
2. Corporate Investors. . . . . . . . . . . . . .46
3. Summary of Sale-Leaseback Impacts. . . . . . .50
.
.
.
.50
Impact of the Tax Act on Joint Ventures.
Hypothetical Example of an Equity Lease.
.
.
.
.
.51
.52
C. Developer/Corporate Joint Ventures. .
1.
2.
.
.
.
D. Master Limited Partnerships and Real Estate
. .. .. .
Investment Trusts . . . . . . . . . *
1.
2.
3.
4.
Asset, Income and Ownership Restrictions.
Control by the Sponsor. . . . . . . . . .
Treatment of Income and Losses. . . . . .
. . . . . . . . . .
Tax-Exempt Investors.
5. Administration and Accounting. .
6. Tax Risk.
.
.
.
.
CHAPTER FOUR - INTERVIEWS OF CORPORATE REAL ESTATE
EXECUTIVES. . . . . . . . . . . . . . . . -. .
.
A. Lease Versus Ownership of New Facilities.
.
.
B. Sale-Leasebacks for Existing Buildings. .
.
.
C.
Developer/Corporate Joint Ventures.
.
.
.
.
.
.
.
.
.
.
.
60
60
61
61
.61
.
-. .
. . . . . . . . . . . . ..
59
.
62
..
63
.
.
.65
.
.
.
.67
.
.
.
.68
D. Master Limited Partnerships and Real Estate
Investment Trusts.. . . . . . . . . . . . . . . . 68
.
.
.
.
.69
SUMMARY OF FINDINGS AND CONCLUSIONS.
.
.
.
.71
E. Summary of Corporate Policy Implications.
CHAPTER FIVE -
REFERENCES.
. . . . . . . . . . . . . . . . . . . . .. .
PERSONS INTERVIEWED.
.76
. . . . . . . . . . . . . . . . . . . 81
5
LIST OF TABLES
Table 1
Lease Versus Ownership Analysis Under
Prior Law. .
.
.
.
.
.
.
.
.
.
-. .
.
.
.
31
-.
Table 2
Lease Versus Ownership Analysis Under Tax Act,
Including Direct Impacts Only. . . . . . . . .32
3
Lease Versus Ownership Analysis Under Tax Act,
Including Direct Impacts and Indirect Impacts
.33
on Rents and Property Value. . . . . . .. .
Table
Table 4
Lease Versus Ownership Analysis Under Tax Act,
Including Direct Impacts and Indirect Impacts
on Rents, Property Value and Interest Rates. .34
Table 5
Sale-Leaseback Analysis for Individual
Investor, Under Prior Tax Law. .
Table 6
.
.
.
.
.
.
.41
Individual
Sale-Leaseback Analysis for
Investor, Under Tax Act - No Indirect Impact
on
Table 7
Table 8
Table
Table
9
10
Interest Rates Assumed.
.
.
.
.
.
.
.
.
.
Sale-Leaseback Analysis for Individual
Investor, Under Tax Act - Includes Indirect
Impact on Interest Rates. . . . . . . . . .
Sale-Leaseback Analysis for Corporate
Investor, Under Prior Tax Law. . . . .
.
Table 12
.47
Sale-Leaseback Analysis for Corporate
Investor, Under Tax Act - No Indirect Impact
on Interest Rates Assumed. . . . . . . . . .
.48
.
Sale-Leaseback Analysis for Corporate
13
Projected Partnership Taxable Income
14
.53
for
.
.
.55
.
.
.56
Projected After-Tax Cash Benefits for
Corporate Tenant for Joint Venture Office
Building. . . . . . . . . . . . . . . . .. .
57
.
.
.
.
.
Projected Partnership Sources and Uses of
Funds For Joint Venture Office Building.
Table
. 49
First-Year Pro Forma Operating Statement for
Joint Venture Office Building. . . . . . . .
Joint Venture Office Building.
Table
43
.
.
Investor, Under Tax Act - Includes Indirect
Impact on Interest Rates. . . . . . . . . .
Table 11
.42
6
CHAPTER ONE
INTRODUCTION
A.
Background and Purpose
This paper provides an analysis
1986
as
(Tax Act)
of the Tax Reform Act of
it pertains to the
management of corporate
is on Fortune
The focus of the analysis
real estate assets.
500 corporations which have substantial real property holdings
impacts of
potential
extent to which these
assets, and the
corporate real
impacts
estate
will or should
estate
real
toward
policy
corporate
influence
Act on
the Tax
the
evaluate
to
is
the paper
of
purpose
The
business.
the real estate
but are not primarily in
used in operations,
asset
management.
A major objective of the Tax Act was to reduce individual
income taxes in exchange for
tax rates
While corporate
increasing taxes
have been
on corporations.
reduced, a
broader tax
base coupled with the elimination of credits and establishment
of
in
result
the Tax Act contains many
estate
assets,
schedules, elimination
gains, and repeal
context
of a
to
billion
in
At the same time,
five years.
negative provisions with respect to
including lengthening
of
depreciation
of preferential tax rates
for capital
credit.
Within this
it is
increasingly
of the investment tax
changing
is expected
$120
more than
paying
corporations
additional taxes over the next
real
minimum tax
corporate alternative
a new
tax environment,
7
important for corporations to understand the financial impacts
of their decisions regarding real estate assets.
Specific questions to be addressed in this thesis include
the following:
Act affect corporations'
the Tax
1. How will
decisions to
lease or own new real estate facilities?
2. What impact will the Tax Act have on corporations' use of
sale-leaseback financing for existing facilities?
the
3. Will
frequency
between corporations
structure
and
and developers
of
ventures
joint
be affected
by the
Tax Act?
4. How
will
the
securitization
the
use of
estate
B.
Tax
the
Act affect
real estate
of corporate
master limited
investment trusts
potential
partnerships
for
the
assets through
(MLPs)
or real
(REITs)?
Research Methodology
The
derived
upon which
information
from the
Tax Act
investment
thesis
is based
was
following major sources:
- Secondary research, including:
on the
this
prepared by
banks;
academic journal
and
(2)
articles on
(1) studies and brochures
major accounting
business
the Tax Act
real estate asset management in general.
8
firms and
periodical
and
and corporate
- Primary research
corporate real
(3)
and
clients;
corporate real
serving
and consultants
bankers
investment
(2)
taxation;
corporate
and
estate
with experts,
in the fields of
(1) accountants specializing
including:
real
consisting of interviews
estate
and
managers
estate
financial officers in a variety of industries.
C. Organization of the Thesis
Chapter Two presents a summary of the major provisions of
the Tax Act which affect the tax treatment of corporations and
Act
passive loss
credit, alternative minimum tax,
investment tax
the
depreciation,
rates,
including tax
compared,
are
before and after the Tax
Provisions both
real estate assets.
and real estate investment
rules, master limited partnerships
trusts.
potential major
Chapter Three presents an analysis of the
Tax
the
of
impacts
management, based
This
versus
ownership
at the
decision,
asset
estate
findings and the
investment banking and consulting
chapter analyzes the
questions posed
the key
real
on the secondary research
interviews with accounting,
experts.
corporate
on
Act
use
Tax Act with
respect to
outset, including
of
the lease
joint
sale-leasebacks,
venture structures, and securitization with MLPs or REITs.
Chapter
corporate
respect to
Four
presents
real estate
the major
the findings
managers and
interviews
financial officers
areas of analysis.
9
of
The focus
of
with
of this
chapter
is on the current awareness of the Tax Act on the part
of these managers and
their corresponding attitudes regarding
management of their real estate assets.
Finally,
Chapter
each question
synthesis
of
interview
findings.
assessment of
constraints
Five
The
future trends
or unrealized
contains
in
a
terms
product
of
brief
of the
this
and
analysis
and
summary
and identification
opportunities
summary
an
of potential
for corporate
estate asset management resulting from the Tax Act.
10
is
real
CHAPTER TWO
PROVISIONS OF THE TAX ACT AFFECTING
CORPORATIONS AND REAL ESTATE
This chapter provides an overview of the major provisions
in the
Tax Act
which relate to
estate
assets.
The
asset
major changes
outlined in
for the analysis
a basis
serve as
this chapter
real estate
of corporate
and constraints
management opportunities
their real
corporations and
presented in
Chapter Three.
The provisions outlined in this chapter were derived from
business
in
articles
journals,
tax
and
brochures prepared by major accounting
Co.[1];
Andersen &
[15);
Leventhal
(37];
Co.
&
and Touche Ross
[10];
Peat,
& Whinney
Ernst
Horwath [36];
Laventhol &
Thornton (24];
Grant
and
firms, including Arthur
& Lybrand
Coopers
studies
and
Marwick, Mitchell &
Kenneth
[45];
Co.
[58].
Each of the provisions which affect corporate real estate
directly
following
or
indirectly
sections.
are
These
depreciation, investment tax
passive
estate
loss
rules,
investment
examined
provisions
in
separately
include:
tax
the
rates,
credit, alternative minimum tax,
master limited
trusts.
11
partnerships
and
real
A.
Tax Rates
1.
Ordinary Income
corporation's taxable income was taxed
Under prior law a
at rates
ranging from 15 percent
to 46 percent, as
shown in
the schedule below:
Tax Rate
Taxable Income
$25,000 or less
25,000 - 50,000
50,000 - 75,000
75,000 - 100,000
Over $100,000
15%
18%
30%
40%
46%
up
to $20,250
percent tax
additional 5
An
corporate taxable income
this surcharge
in
was imposed
excess of $1,000,000.
on
In effect,
than $1,405,000
caused corporations with more
in taxable income to pay a flat rate of 46 percent.
Act reduces marginal tax
The Tax
to a
range of
15 to
to three.
brackets from five
are shown
34 percent, and
number of
brackets and rates
in the following schedule:
Tax Rate
15%
25%
34%
$50,000 or less
50,000 - 75,000
Over $75,000
additional
for corporations
changes the
The new tax
Taxable Income
As under
rates
prior law,
tax,
up
a 5 percent
to
surcharge is
$11,750, is
taxable income over $100,000.
The
12
assessed
applied.
on
The
corporate
effect is to impose a flat
taxable income over
rate on corporations with
34 percent tax
$335,000.
The
rates
new tax
ordinary income
for corporate
were
effective for tax years beginning after June 30, 1987.
2.
Capital Gains
Under prior
law, an alternative
tax rate of
28 percent
corporation's net
capital gain
unless the
to a
was applied
corporation's regular tax rate was lower.
Capital losses were
deductible only against capital gains.
The Tax
gain
Act repeals
beginning after
capital
all
rate for
tax
the corporate
gains
recognized in
December 31, 1986.
gains are
taxed at
preferential capital
taxable
Therefore,
regular corporate
maximum tax rate of 34 percent.
years
corporate net
rates with
a
As before, capital losses are
deductible only against capital gains.
B. Depreciation
1.
Real Property
The Accelerated
feature of
Tax Act
real
Cost Recovery System (ACRS)
the Reagan Administration's Economic
Recovery and
Under the
ACRS system,
(ERTA) implemented in
property
was
originally
recovery period of 15 years.
extended by
was a major
1981.
depreciated
over
a
minimum
The minimum recovery period was
subsequent legislation to 18
years (effective in
1984) and 19 years (effective in 1985).
The Tax Act increases the minimum recovery period to 31.5
13
a
with
method
straight-line
for
an end
purchase to
year
of
purchase a
investor cannot
one-half
property in
i.e.,
month;
December and
take a
Personal Property
Under
connection
most
law,
prior
real
with
estate
personal
in connection with real estate
Year 1 -
15 percent; Year 2
21 percent
The
to
Personal
one
of
The most
recovery classes.
property used
following schedule:
- 22 percent; and Years 3 through
ACRS system to provide six cost
common forms of personal property
Office
fall into either the 5-year class or the 7-year class.
furniture, fixtures
falling within the
7-year
declining
two
each year.
Tax Act modifies the
rather than the
in
into the 5-year
generally fell
class and was depreciated according to the
used
property
was assigned
3-year and 5-year.
recovery classes:
and
an
in service after December 31, 1986.
2.
-
the depreciation
were effective for assets
The extended depreciation schedules
5
(i.e.,
substantial portion of the year.
depreciation deduction for a
placed
the
service in the middle of the
effectively limits
This provision
to
convention
mid-month
property is treated as placed in
month).
years for
limited
is
Depreciation
property.
residential
and 27.5
real property
for non-residential
years
and equipment
(except for
5-year class) are in
the seven-year class
5-year class as under prior
classes are
balance
depreciated
method,
under
switching to
14
limited types
law.
The 5-year
the 200
percent
straight-line
when
depreciation under the straight-line method exceeds the amount
computed under the accelerated method.
A half-year convention
applies to first-year and last-year allowances for depreciable
to property placed
These new rules apply
personal property.
in service after December 31, 1986.
3.
Leasehold Improvements
Under prior
could
either
law, a tenant making
depreciate
depreciation period
the
cost
or amortize
lease term,
whichever was
tenant must
recover the cost of
the
general depreciation
term.
If
and
improvements, the
over
shorter.
Under
tenant may
applicable
the remaining
the Tax
Act, the
leasehold improvements under
rules without
the tenant
the
the cost over
the lease terminates
depreciated
leasehold improvements
regard to
the lease
before the property
does
not
retain the
is fully
leasehold
deduct any unrecovered
cost at
the end of the lease term.
C. Investment Tax Credit
Under
prior
law,
the
investment
tax
credit
(ITC)
permitted companies to reduce their tax by up to 10 percent of
an asset's cost.
effective for
1985.
The Tax
Act has repealed the ITC, generally
property placed
Transition rules
in service after
December 31,
are provided that allow
the ITC with
respect to property placed in service after this date.
As a result
of the repeal of
the ITC, capital-intensive
corporations may pay more tax than previously,
15
even though tax
rates have been
on
D.
The repeal will
reduced.
not
are
that
corporations
have little effect
capital-intensive.
Alternative Minimum Tax
minimum tax was an add-on
Under prior law, the corporate
amount by which the sum of the
tax equal to 15 percent of the
items exceeded the
tax preference
or the
greater of $10,000
regular tax deductions for the year.
after December 31, 1986, the
For taxable years beginning
Tax Act
add-on minimum tax and replaces
repeals the corporate
it with a 20 percent alternative minimum tax (AMT).
A corporation's alternative minimum taxable income
is
equal to
items
taxpayer's tax preference
20
percent
exemption
$150,000.
of
income,
regular taxable
its
in
AMTI
of
The AMT rate
The
$40,000.
The exemption is eliminated
for AMTI
of
is
$40,000
of the excess of AMTI
is reduced by 25 percent
the
increased by
for the year.
excess
(AMTI)
over
$310,000 or
more.
AMT
Significant
preference
investments in real estate
- For real
January 1,
include the
items
to
following:
and personal property placed
1987, the amount of
applicable
in service before
accelerated depreciation
depreciation is recognized as
in excess of straight-line
a tax preference.
- For
property
preference
is
placed
defined
service after
in
as
16
the excess
the
tax
regular
tax
1986,
of
the
over
depreciation
under
calculated
amount
the
alternative depreciation system (the straight-line method
straight-line for
method switching to
declining balance
percent
the 150
and
real property
for
40 years
over
personal property).
- Tax-exempt interest on most private activity bonds issued
after August 7, 1986 is treated as a tax preference item.
E. Passive Loss Limitations
passive
loss limitations
of individuals,
holdings
trusts
this
real estate
effect on the
estates,
to the
Tax Act,
in the
established
have a substantial
provision will
not subject
corporations are
widely held
While
and closely
held
corporations.
Under
Tax Act,
the
most
including
activities;
(2)
other income;
income
noncorporate
loss for
and
be divided into three
taxpayers will
income,
income
categories:
from
real
estate-related
active income, including salaries,
and (3) portfolio income,
interest and gain
(1) passive
wages and
including dividends,
or loss from the sale of
stocks and bonds.
In general, passive losses can only offset passive income, and
therefore
cannot be
deducted
salaries,
interest
and
effectively eliminate
against other
dividends.
the use
This
of tax shelter
income such
provision
as
will
structures for
noncorporate taxpayers which have been widely used by the real
estate industry since passage of ERTA in 1981.
17
F. Master Limited Partnerships
Master limited partnerships (MLPs) are subject to changes
affected
general,
partnerships in
affecting
by
partnerships
Tax
the
MLPs
Act.
publicly
are
registered
receipts)
(or depository
interests
whose
otherwise
were not
but
are
MLPs therefore offer liquidity not available
publicly traded.
to standard public partnerships.
When the Tax Act was
of
a
that
special rule
being drafted, there was discussion
treat
would
MLPs
income from
MLPs as passive losses.
portfolio income and losses from
as
The
Tax Act, however, did not specifically address the application
of the passive
have been
structured in real
estate and other
industries to
income
generators or
passive
(i.e.,
income
generate passive
PIGs) for
result, several MLPs
loss rules to MLPs. As a
are no longer
investors who
offset their
able to
investments against active and
passive losses from tax shelter
portfolio income.
While MLP activity has
availability of MLPs
the
fall
summer and
hearings to
possibility
that
IRS
in question.
Congress
MLPs should no
should instead
the attendant
income of MLPs
long-term is
of 1987,
determine if
partnerships and
status and
in the
accelerated in recent months, the
will be
as portfolio income.
will
reclassify
Either
also a
taxable
of these changes
would effectively restrict MLP activity in the future.
18
taxed as
corporate tax
There is
double taxation.
regulations
conducting
longer be
be subject to
During
G. Real Estate Investment Trusts
(REITs).
of
operations
the
govern
makes several
Tax Act
The
Effective
for tax
general requirements
restrictions
estate
real
investment
are
trusts
REIT and
to qualify as a
While
liberalized.
which
1986, the
years beginning after
for an entity
on operations
the rules
changes in
several
technical changes have been provided by the Tax Act, the major
features are summarized in the following paragraphs.
1.
Shareholder Qualifications
a minimum of 100 shareholders.
and must have
the
Tax Act
for a
this standard
difficulty in meeting
this requirement
eliminates
closely held
from being
generally prohibited
REITs are
Because of the
newly formed REIT,
during the
REIT's
first tax year.
2.
Qualified Asset and Income Tests
REITs are required
to have at least 75
estate assets and to earn
value represented by qualified real
at
least
75
investments.
percent
their
income
from
real
estate
In order to provide flexibility in meeting these
income and asset
debt
of
percent of their
tests, the Tax Act treats
securities and
their
these tests for a period of
associated
one year.
19
certain stock and
income as
satisfying
3.
REIT Subsidiaries
Under prior
law, REITs were effectively
forming subsidiaries
estate operations.
to limit
liability among
Under the Tax
have subsidiaries, provided
prohibited from
separate real
Act, REITs are permitted to
the REIT owns 100
percent of the
stock.
4.
Independent Contractor Requirement
Under prior law, a REIT
qualifying
if
the REIT
directly
tenant or actively managed
required to
could not treat rental income as
provided
services to
the
the property; these functions were
be performed
by an independent
contractor.
The
Tax Act relaxes this rule and allows REITs to directly provide
certain services.
5.
Pass-Through of Sublease
Under prior
Income
law, REITs were prohibited
from engaging in
an active trade or business, or sharing in the net
business.
relaxed.
Under
If the
the
tenant
income from rent on that
would be qualified
REIT,
the payments
Tax
Act, this
prohibition
receives substantially
income of a
has
all of
been
its
particular property, and if the rent
rental income if received
can be
based on
tenant.
20
the net
directly by the
income of
the
H. Summary and Implications of Tax Act Changes
briefly summarizes
This section
tax law
implications
the corresponding
the Tax Act, and
brought about by
tax
for corporate
changes in
the salient
A more
planning.
detailed
discussion of the implications of several of the provisions is
provided in Chapter Three.
the
in
following modifications
the
sections suggest
the preceding
outlined in
The changes
tax environment
facing
corporations:
-
For
for
the
tax
to
and
period.
must
Freeman
Tax
the
also foresees
percent).
likely to
many
closely-held
with
flow-through
Act,
Subchapter
S
year
accounting
widely-held corporations
level of
the corporate
(34
S
of MLPs as a means
turning increasingly to the formation
of avoiding
the
Subchapter
the calendar
adopt
than
or
partnerships
as
Under
corporations.
corporations
of
replacement
their
less
this situation is
disincorporation
such
entities
corporations
Freeman [21],
the
corporations
will be
percent)
for
rate
According to
lead
(28
individuals
maximum
in over 70 years, the maximum tax rate
first time
taxation for certain
elements of their business.
-
While corporate
tax rates for ordinary
reduced, tax rates on
The
income have been
capital gains have been increased.
significant benefit
of
21
conversion of
depreciation
deductions at
gain taxed at
ordinary rates into capital
lower rates is therefore eliminated.
this change are examined
The implications of
in the analysis
of the corporate
lease versus ownership decision in Chapter Three.
-
commercial real property has
The depreciation period for
nearly two-thirds, from
by 12.5 years or
been increased
19 years under prior law to 31.5 years under the Tax Act.
The
depreciation
used in
property
period
connection with
from five
increased
property, corporations
real
has been
(effectively
will face
as opposed
to
real property
favored
vis-a-vis
property
an incentive
to
as personal
opportunities to classify assets
search for
property
real estate
the continued
of personal
treatment
depreciation
personal
half-year convention)
with the
Because of
Act.
the Tax
of
types
seven years
years to
seven-and-one-half years
under
most
for
the time
at
of
construction or acquisition of new facilities.
-
The development
of real
estate requiring
is less attractive after
investment in personal property
repeal
the
of
affected
by
exisiting
investment
this change
properties
may
rather
a substantial
tax
be
Corporations
credit.
inclined to
than construct
purchase
their
own
facilities.
-
The
alternative minimum
with real
tax preference
item associated
and personal property depreciation
22
may impact
the
estate
real
decisions of
the alternative
subject to
This
minimum tax.
are
issue is
versus ownership
connection with the lease
discussed in
which
corporations
analysis in Chapter Three.
-
and REITs
Both MLPs
Act.
Although
favorably by
were treated
presently under scrutiny by
the Tax
Congress and
the IRS, MLPs have emerged as a liquid investment vehicle
which provides
to
offset
investments.
individual taxpayers with
passive
losses
from
previous
reduced
and
tax
shelter
Restrictions for establishing and operating
REITs were substantially liberalized
REITs have
passive income
become more attractive to
emphasis on
REIT vehicles
by the Tax Act, and
investors with the
tax-oriented investments.
are
compared in
The MLP
Chapter Three
with
respect to their applicability to a spin-off of corporate
real estate assets.
23
CHAPTER THREE
ANALYSIS OF THE TAX ACT IMPACTS ON
CORPORATE REAL ESTATE ASSET MANAGEMENT
This chapter
corporate real estate asset
Act on
of impact which
major areas
the Tax
potential impacts of
analyzes the
versus ownership
decisions for new corporate
sale-leasebacks
for
(2)
facilities;
(3)
facilities;
corporate
(4) MLP
partnerships; and
corporation/developer joint venture
lease
(1)
are examined include:
existing
The
management policies.
and REIT securitization vehicles.
A. Lease Versus Ownership of New Facilities
Act
The Tax
Direct
leasing
on
impacts
is likely
and
Indirect
difficult
impacts, on
to
indirect
real
estate.
which are inherent
in the
rates and depreciation schedules.
These
identify and quantify.
are relatively easy to
direct impacts
for
ownership costs
impacts result from features
Tax Act, such as tax
and
to have both direct
the
quantify.
are
other hand,
These
impacts
more subtle
and
short-
and
include
long-term market responses to the Tax Act with respect to rent
levels, property
values, equity returns, interest
The two following
interrelationships between these variables.
sections present
indirect impacts of the Tax
the
lease/ownership
hypothetical
of the major
a brief discussion
direct and
Act on the variables which affect
comparison.
example which
rates, and
This
compares
24
is
followed
lease versus
by
a
ownership
costs
occupancy
under
prior
under
law and
the
Tax
Act,
isolating direct and indirect impacts.
1.
Direct
Impacts
have the
Act are likely to
in the Tax
Four provisions
greatest effect on the lease versus ownership decision:
-
reducing tax
a
for
deductions
in
maximum-bracket
of leasing
increase the effective cost
corporation will
by
for
rates
tax
marginal
corporate
reduction
The
rates.
tax
corporate
in
Change
Similarly,
rent.
the
lower rates will increase the effective after-tax cost of
depreciation
in depreciable
the change
(independent of
and
The elimination of the preferential capital gain
lives).
rate
tax
for interest
tax deductions
by reducing
ownership
will
ownership by
also
the
increase
reducing net
sales
effective
cost
of
for corporate
proceeds
facilities.
-
Extension
depreciable
will
lives for
both real
increase the effective
The effect will
ratio
The
extended
and personal
property
schedules.
depreciation
of
after-tax cost of ownership.
be greatest for real estate
of building
value to
land value
with a high
such as
office
buildings, and least for less intensive developments such
as
warehouses.
schedules
less
The
for leasehold
attractive
than
implementation
improvements
under
25
prior
of
depreciation
may make
leasing
for
certain
law
corporations which
However,
require highly
because
tenants
unrecovered costs
may
are
allowed
at the conclusion of
be
opportunities
for
between
landlords and
tenants
reduced rent,
customized facilties.
more
the tenant can provide
deduct
the lease, there
creative
(e.g.,
to
in
arrangements
return for
a
improvements which
are depreciated, with the remaining balance deducted when
they revert
to the
landlord at
the termination
of the
lease).
-
Repeal
of the
increase the
ITC.
costs
The elimination
for
of
the
corporations which
lease their facilities.
Repeal
will result
in a corresponding
demountable
partitions,
ITC
will
construct or
of the 10 percent credit
increase
in the
office furnishings
cost of
and
office
equipment.
-
Establishment
of the
subject
AMT,
to
AMT.
tax
For
corporations that
preferences
resulting
are
from
depreciation on real and personal property could increase
their tax liability.
therefore
find
it
Corporations in an AMT position may
financially
rather than own certain facilities
own,
to
elect
the
40-year
advantageous
to
or, if they prefer to
alternative
depreciation
schedule for real property in order to minimize AMT.
26
lease
2.
Indirect Impacts
levels,
property values
and
Hendershott
Brueggeman
and
[18]
perhaps
studies by
Recent
decisions.
Ling
are of
rent
for corporations
direct impacts
magnitude of
analyzed the
[7] have
Thibodeau
on equilibrium
Act
interest rates
their occupancy
contemplating
Follain,
and
than the
greater importance
Tax
of the
impacts
Indirect
and
these impacts
under varying assumptions.
In
prepared for
study
their
a
Institution
Brookings
National Issues Forum, Follain, Hendershott and Ling arrive at
following major conclusions:
the
-
lives and elimination
demand
for
rates
interest
than
this
is
decline
thereby
to
difficult
quantify
lower
without
occurred
While the
Act.
to
leading
have
would
the Tax
implementation of
expected to reduce
of the ITC are
assets,
capital
of depreciable
lengthening
The
rate decline.
Interest
magnitude of
to
due
the
complexity of the capital markets, the authors assume a 1
percent
decline
in
mortgage
interest
rates
in
their
analysis.
- Long-term
increase in
equilibrium
assuming
occurs.
by 6 to 10
that the
If
1
The
authors
rents on commercial properties
conclude that equilibrium
should increase
rents.
percent due to the
percent
the interest rate
27
interest rate
impact
Tax Act,
adjustment
is excluded, their
analysis reveals that equilibrium rents would
14
to
18
percent.
The
adjustment of markets to
require
authors
increase by
conclude
that
the
the new equilibrium levels will
approximately four
to ten
vacancy rates and growth in demand.
years, depending
on
The adjustment would
be most rapid in fast-growing markets with relatively low
vacancy
-
rates.
Short-term
decrease
conclude
that,
instantaneously,
short-term.
investors'
increase
in
property values.
because
property
rents
values
The magnitude
of
perceptions of the
to
their
The
will
authors
not
will decline
the
rise
in
the
decline depends
time required
new equilibrium
on
for rents to
level.
The
value
declines are shown to be significantly higher for markets
with higher vacancy
rates than for markets
which are
in
equilibrium.
Brueggeman
regarding the
estimated
and
Thibodeau
reach
indirect impacts of
magnitude of
these
similar
the Tax Act,
impacts
differ.
conclusions
although the
Their
major
conclusions are summarized as follows:
-
Mortgage rate decline.
Act
will probably
interest
rates.
place downward
This
reduction in the maximum
after-tax cost
The authors conclude that the Tax
of debt.
pressure
attributed, in
is
on
mortgage
part, to
the
tax bracket which increases the
For purposes
28
of analysis, they
mortgage interest rates
1.5 percent decline in
assume a
resulting from the Tax Act.
- Long-run rent
rates occurs,
interest
period.
for
time required
the
They do not
range from
provide an estimate
equilibrium
to reach
rents
the
on the length
to 18 percent, depending
approximately 11
of
conclude that
authors
in commercial rents should
long-run increase
of the holding
the
decline in
that the
Assuming
increases.
levels.
- Short-run
that
investor
returns
commercial
will
property
probably
values
in the
after-tax
in
reduction
cumulative
the
conclude
authors
The
values.
property
in
decline
significantly
reduce
short-run,
because
owners will be able to shift losses in tax benefits on to
tenants only over time.
they
estimate
that
Depending on market conditions,
declines
short-run
in
commercial
property values could range from 13 to 17 percent.
- Increase
in equity
equity investors may demand
as
equity
rent
increases
because
investment caused
of
that
authors suggest
a higher after-tax return on
take
to
place
offset
the
They indicate that this will
reduction in tax benefits.
occur
The
returns.
additional
risk
in
by relatively uncertain
replacing relatively certain tax
returns.
29
real
estate
rental income
benefits as a source of
- Moderating effect
conclude
that
of tax-exempt investors.
tax-exempt
entities
The authors
(including
pension
funds and REITs) may have greater interest in real estate
investment,
given
the
taxable investors.
increase demand
reduction
of
tax
They suggest that as
for real estate, the
benefits
to
such investors
short-term decline
in property values will be moderated.
3. Comparative Lease Versus Ownership Analysis
In order to
indirect
demonstrate the magnitude of
impacts
occupancy costs,
of
the
of
the
depreciation,
Act
on
corporate
this section analyzes a
building with respect to
Several
Tax
the direct and
facility
hypothetical office
the lease versus ownership decision.
variables
tax rates,
in
the
analysis,
rent increases,
including
acquisition price,
and interest rates are adjusted to determine the separate cost
effects of the
comprised of
-
Table
direct and indirect impacts.
The analysis is
four tables:
1 is
based on prior
tax law.
- Table 2 incorporates the direct impacts of the Tax Act.
-
Table 3 includes the direct impacts in Table 2 as well as
indirect impacts on rents and property value.
- Table
4 includes
analyzed in
both the
Table 3
direct and
as well as
interest rates.
30
indirect impacts
the indirect
impact on
TABLE 1
LEASE VERSUS OWNERSHIP ANALYSIS UNDER PRIOR LAW
(In 000s)
8
9
10
$1,947
569
$1,947
$1,947
$1,947
592
616
640
2,494
2,516
2,539
2,563
2,587
1,148
713
4,266
1,347
760
5,026
1,359
697
5,723
1,371
640
6,363
1,384
587
6,950
1,397
539
$7,488
1,600
583
1,600
635
1,600
692
1,600
755
1,600
823
1,600
897
1,600
977
787
428
1,600
535
787
428
1,600
787
428
1,600
787
0
1,600
787
0
787
787
583
635
787
0
1,600
823
1,600
897
1,600
977
3,327
(1,530)
3,350
(1,541)
3,399
(1,563)
3,210
(1,477)
3,284
(1,511)
560
463
5,012
593
446
5,458
619
3,365
(1,548)
(4,836)*
(3,806)
(1,467)
$6,636
1
2
3
4
5
6
$1,600
450
$1,600
468
$1,600
487
$1,600
506
$1,600
526
$1,947
547
Total Expenses
2,050
2,068
2,087
2,106
2,126
After-tax Rental Cost
Present Value @ 10%
Cumulative Present Value
1,107
1,006
1,006
1,117
923
1,929
1,127
847
2,776
1,137
777
3,553
1,600
450
1,600
491
1,600
535
787
306
1,600
450
787
449
1,600
491
3,143
(1,446)
604
549
4,549
0
YEAR:
7
LEASE ALTERNATIVE
Total Rent
Operating Expenses
OWNERSHIP ALTERNATIVE
Purchase Net of Debt
uJ
$4,000
Interest Expense
Operating Expenses
Tax Shelter
Real Property Depreciation
Personal Property Depreciation
Interest Expense
Operating Expenses
Total
Tax Shelter Benefits @46%
After Tax Sales Proceeds
Total Costs (Benefits)
Present Value @10%
Cumulative Present Value
4,000
4,000
4,000
3,451
(1,587)
$26,315
Net Sales Proceeds
Less: Adjusted Basis
25,526
(10,086)
(789)
Capital Gain
Recapture of Personal Property Dep
15,440
(2,040)
Gain Subject to Capital Gain Rates
13,400
3,080
(1,417)
648
402
876
423
5,881
6,283
6,778
* After-tax Sales Proceeds Calculation
Gross Sales Proceeds
Less: Sales Expense
692
Summary of Tax on Sale
*
46.00%
2,040
*
28.00%
13, 400
938
3,752
4,690
Summary of After-tax Proceeds
25,526
Net Sales Proceeds
(4,690)
Less: Tax on Sale
(16,000)
Less: Debt Repayment
Net After-tax Proceeds
$4,836
494
1,600
755
3,142
(1,445)
909
467
7,244
946
441
7,686
0
986
418
8,104
0
TABLE 2
LEASE VERSUS OWNERSHIP ANALYSIS UNDER TAX ACT
INCLUDING DIRECT IMPACTS ONLY
(In 000s)
YEAR:
0
1
2
3
4
5
6
7
8
9
10
$1,600
450
$1,600
468
$1,600
487
$1,600
506
$1,600
$1,947
547
$1,947
569
$1,947
526
592
$1,947
616
$1,947
640
Total Expenses
2,050
2,068
2,087
2,106
2,126
2,494
2,516
2,539
2,563
2,587
After-tax Rental Cost
Present Value @ 10%
Cumulative Present Value
1,353
1,230
1,230
1,365
1,128
2,358
1,377
1,035
3,393
1,390
949
4,342
1,403
871
5,214
1,646
929
6,143
1,661
852
6,995
1,676
782
7,777
1,691
717
8,494
1,708
658
$9,152
1,600
450
1,600
491
1,600
535
1,600
583
1,600
635
1,600
692
1,600
755
1,600
823
1,600
897
1,600
977
475
291
1,600
450
475
500
1,600
491
475
357
1,600
535
475
255
1,600
583
475
182
1,600
635
475
182
1,600
692
475
182
1,600
755
475
91
1,600
823
475
0
1,600
897
475
0
1,600
977
2,816
(958)
3,065
(1,042)
2,966
(1,009)
2,913
(990)
2,892
(983)
2,949
(1,003)
3,012
(1,024)
2,989
(1,016)
2,972
(1,010)
1,048
866
5,860
1,126
846
6,706
1,192
814
7,520
1,252
777
8,297
1,290
728
9,025
1,331
683
9,708
1,407
656
10,364
1,486
630
10,995
3,052
(1,038)
(5,339)*
(3,799)
(1,465)
$9,530
LEASE ALTERNATIVE
Total Rent
Operating Expenses
OWNERSHIP ALTERNATIVE
LO
K)i
Purchase Net of Debt
Interest Expense
Operating Expenses
Tax Shelter
Real Property Depreciation
Personal Property Depreciation
Interest Expense
Operating Expenses
Total
Tax Shelter Benefits @34%
After Tax Sales Proceeds
Total Costs (Benefits)
Present Value @10%
Cumulative Present Value
$4,000
4,000
4,000
4,000
1,092
993
4,993
* After-tax Sales Proceeds Calculation
Gross Sales Proceeds
Less: Sales Expense
$26,315
(789)
Summary of Tax on Sale
12,315
*
34.00%
Net Sales Proceeds
Less: Adjusted Basis
25,526
(13,211)
Summary of After-tax Proceeds
Net Sales Proceeds
25,526
Less: Tax on Sale
(4,187)
Less: Debt Repayment
(16,000)
Capital Gain
12,315
Net After-tax Proceeds
4,187
$5,339
TABLE 3
LEASE VERSUS OWNERSHIP ANALYSIS UNDER TAX ACT
INCLUDING DIRECT IMPACTS AND INDIRECT IMPACTS ON RENTS AND PROPERTY VALUE
(In 000s)
1
2
3
4
5
6
7
8
9
$1,600
450
$1,600
468
$1,600
487
$1,600
506
$1,600
526
$2,141
547
$2,141
569
$2,141
592
$2,141
616
$2,141
640
Total Expenses
2,050
2,068
2,087
2,106
2,126
2,689
2,711
2,733
2,757
2,782
After-tax Rental Cost
1,353
1,365
1,377
1,390
1,403
1,775
1,789
1,804
1,820
1,836
Present Value @ 10%
Cumulative Present Value
1,230
1,230
1,128
2,358
1,035
3,393
949
4,342
871
5,214
1,002
6,215
918
7,133
842
7,975
772
8,747
708
$9,454
1,520
450
1,520
491
1,520
535
1,520
583
1,520
635
1,520
692
1,520
755
1,520
823
1,520
897
1,520
977
451
277
1,520
450
451
475
1,520
491
451
339
1,520
535
451
242
1,520
583
451
173
1,520
635
451
173
1,520
692
451
173
1,520
755
451
86
1,520
823
451
0
1,520
897
451
0
1,520
977
2,698
(917)
2,936
(998)
2,845
(967)
2,796
(951)
2,779
(945)
2,837
(964)
2,899
(986)
2,880
(979)
2,868
(975)
1,053
957
4,757
1,012
836
5,593
1,087
817
6,410
1,152
787
7,197
1,210
751
7,949
1,248
704
8,653
1,289
662
9,315
1,363
636
9,951
2,949
(1,002)
(7,598)*
(6,103)
(2,353)
$8,209
YEAR:
0
10
LEASE ALTERNATIVE
Total Rent
Operating Expenses
OWNERSHIP ALTERNATIVE
w
Lo
Purchase Net of Debt
Interest Expense
Operating Expenses
Tax Shelter
Real Property Depreciation
Personal Property Depreciation
Interest Expense
Operating Expenses
Total
Tax Shelter Benefits @34%
After Tax Sales Proceeds
Total Costs (Benefits)
Present Value @10%
Cumulative Present Value
$3,800
3,800
3,800
3,800
* After-tax Sales Proceeds Calculation
Gross Sales Proceeds
Less: Sales Expense
$28,945
(868)
Summary of Tax on Sale
15,526
*
34.00%
Net Sales Proceeds
Less: Adjusted Basis
28,077
(12,550)
Summary of After-tax Proceeds
Net Sales Proceeds
28,077
Less: Tax on Sale
(5,279)
Less: Debt Repayment
15,200)
Capital Gain
15,526
Net After-tax Proceeds
5,279
$7,598
1,442
611
10,562
TABLE 4
LEASE VERSUS OWNERSHIP ANALYSIS UNDER TAX ACT
INCLUDING DIRECT IMPACTS AND INDIRECT IMPACTS ON RENTS, PROPERTY VALUE AND INTEREST RATES
(In 000s)
1
2
3
4
5
6
7
8
9
10
$1,600
450
$1,600
468
$1,600
487
$1,600
506
$1,600
526
$2,042
547
$2,042
569
$2,042
592
$2,042
616
$2,042
640
Total Expenses
2,050
2,068
2,087
2,106
2,126
2,590
2,611
2,634
2,658
2,683
After-tax Rental Cost
1,353
1,365
1,377
1,390
1,403
1,709
1,724
1,739
1,754
1,770
Present Value @ 10%
Cumulative Present Value
1,230
1,230
1,128
2,358
1,035
3,393
949
4,342
871
5,214
965
6,178
884
7,063
811
7,874
744
8,618
683
$9,300
1,368
450
1,368
491
1,368
535
1,368
583
1,368
635
1,368
692
1,368
755
1,368
823
1,368
897
1,368
977
451
277
1,368
450
451
475
1,368
491
451
339
1,368
535
451
242
1,368
583
451
173
451
451
451
451
1,368
635
173
1,368
692
173
1,368
755
86
1,368
823
0
1,368
897
451
0
1,368
977
2,546
(866)
2,784
(947)
2,693
(916)
2,644
(899)
2,627
(893)
2,685
(913)
2,747
(934)
2,728
(928)
2,716
(923)
952
866
4,666
912
754
5,419
987
1,052
1,148
648
8,216
1,189
610
8,826
1,341
718
6,879
1,110
689
7,569
1,263
742
6,161
589
9,416
9,984
0
YEAR:
LEASE ALTERNATIVE
Total Rent
Operating Expenses
OWNERSHIP ALTERNATIVE
w
Purchase Net of Debt
Interest Expense
operating Expenses
Tax Shelter
Real Property Depreciation
Personal Property Depreciation
Interest Expense
Operating Expenses
Total
Tax Shelter Benefits @34%
After Tax Sales Proceeds
Total Costs (Benefits)
Present Value @10%
Cumulative Present Value
$3,800
3,800
3,800
3,800
* After-tax Sales Proceeds Calculation
Gross Sales Proceeds
Less: Sales Expense
$28,945
(868)
Summary of Tax on Sale
34.00%
*
15,526
Net Sales Proceeds
Less: Adjusted Basis
28,077
(12,550)
Summary of After-tax Proceeds
28,077
Net Sales Proceeds
(5,279)
Less: Tax on Sale
15,200)
Less: Debt Repayment
Capital Gain
15,526
Net After-tax Proceeds
5,279
$7,598
569
2,797
(951)
(7,598)*
(6,203)
(2,392)
$7,593
The major
assumptions upon
which the analysis
is based
are summarized below:
- The
facility is
a 100,000
suburban office
square foot
building.
period are concurrent at 10
- The lease term and ownership
years.
- The initial rent is set at $16 per square foot triple-net
for a period
and remains constant
The rents in
Rent is adjusted
of five years.
the lease term.
for the balance of
Years 6 through 10 under
in Year 6
each scenario are
adjusted from the level in Years 1 through 5 as follows:
. Table 1 (prior
Tax Act
law) and Table 2
only) - 4
(direct impacts of
percent per year
cumulative for
five years.
. Table 3 (holding interest
rates constant at pre-Tax
Act levels) - 6 percent per year cumulative for five
years.
. Table 4
the Tax
(decreasing interest rates with
Act) -
5 percent
per year
passage of
cumulative for
five years.
The real annual rent adjustments in Tables 3 and 4, 2 and
1 percent respectively, are
conservative estimates based
on the findings of Follain, Hendershott and Ling.
- Operating expenses are borne by
35
the occupant in both the
lease and ownership alternatives.
set
at $4.50
per square
foot
Operating expenses are
or $450,000
in Year
1,
increasing at a rate of 4 percent per year.
-
The acquisition price is assumed to be as follows:
.
Table 1
(prior
law) and Table
Tax Act only) -
$200
2
(direct impacts of
per square foot or $20,000,000
total.
. Tables 3
on
and 4 (both including
property
value)
-
$190
the indirect impact
per
square
foot
or
$19,000,000 total, a 5 percent decline in value from
the base case.
-
Eighty percent of the acquisition
price is assumed to be
financed with an interest-only loan due and payable in 10
years at
scenario
the time
is
. Table
Act
of sale.
assumed
interest rate
and
Table
Table 3
2
(direct impacts of Tax
(holding
constant at pre-Tax Act levels) . Table
4
-
For purposes
interest
rates
10 percent.
(decreasing interest rates with
the Tax Act) -
in each
to be as follows:
1 (prior law),
only),
The
passage of
9 percent.
of calculating depreciation, 15
percent of
the acquisition price is allocated to land and 85 percent
to building
improvements.
For
the improvements,
it is
assumed that 88 percent of the value is comprised of real
property
and
the
remaining
36
12
percent
consists
of
periods
property depreciation
Real
property.
personal
are set at 19 years in Table 1 (prior law) and 31.5 years
in
and
2, 3
Tables
4
5-year ACRS
schedules are
depreciation
property
Personal
(Tax Act).
in Table
1 and
convention in Tables 2, 3
7-year ACRS with the half-year
and 4.
- Ordinary
income tax
Act).
percent in
and 34
(prior law)
percent.
projected by
capitalizing
and
income
A sales cost of
4 (Tax
3 and
in Table 1
under the ownership
price in Year 10
lease alternative
under the
1
3 and 4.
and 34 percent in Tables 2,
alternative is
Tables 2,
tax rates are 28 percent
Capital gain
- The building sales
in Table
percent
are 46
rates
10 rent
inflating the Year
11 rental
to estimate Year
resulting
the
amount
at
9
3 percent of gross sales price
is used in calculating net sales proceeds.
As shown in Table 1,
present
value
of
under prior tax law, the cumulative
ownership
costs based
on
a
10
percent
discount rate over a period of 10 years ($6.6 million) is less
than
the
cumulative present
value
leasing costs
of
($7.5
million).
When only the direct impacts
in
Table
2,
substantially.
leasing
However,
leasing costs ($9.2
and
the
of the Tax Act are included
ownership
costs
cumulative
million) is now less
37
both
present
increase
value
of
than the cumulative
present value of ownership costs
the results of
costs
of the
this
enlarges
less than the
($8.2 million) is now
disparity --
ownership
in the
million
$7.6
further
Table 4
in
rate effect
interest
million).
costs ($9.5
leasing
of
present value
Inclusion
the cumulative present
In this case
Table 2.
value of ownership
value reverses
on rents and property
the Tax Act
cumulative
of the indirect
demonstrates that the inclusion
Table 3
impacts of
($9.5 million).
alternative and $9.3 million in the lease alternative.
Summary of Lease Versus Ownership Impacts
4.
that the combination of
The preceding analysis indicates
direct
and
indeterminate
Consideration of the direct
corporations.
However, consideration of the
opposite
direction
event that the
or
of
an
costs.
indirect impacts on
rates may continue to make
less expensive alternative
In the
has
leasing over ownership in many
rents, property value and interest
ownership a
Act
depreciation and tax rate impacts
of the Tax Act only would favor
situations.
Tax
versus ownership
lease
on
net effect
the
of
impacts
indirect
lesser
leasing
than
indirect
magnitude
for most
impacts are of
than
those
anticipated, the ownership alternative would become relatively
less attractive.
In assessing these impacts, it is important for corporate
real estate managers
the Tax
Act can be
to recognize that the
direct impacts of
forecast with relative
certainty (unless
the tax law is significantly revised in the near future) while
38
the
indirect impacts
uncertain.
speculative and
are highly
for the risks inherent in
Corporations must therefore account
basing their lease versus ownership decisions on the uncertain
indirect impacts of the Tax Act.
B. Sale-Leasebacks for Existing Buildings
been
a
common
method
bolster
and
earnings.
of a sale-leaseback was
past, one
of the advantages
enabled a
corporation to transfer depreciation
investors
(i.e. the
them more highly than
to
corporations
by
used
sheet financing
off-balance
facilities has
of existing corporate
The sale-leaseback
purchaser/lessor)
the corporation.
provide
In
the
that it
deductions to
who generally
valued
The corporation could
be compensated in the form of a higher purchase price or lower
rent than would have occurred without consideration of the tax
implications.
According
in
interviewed
sale-leaseback
to
investment
the
course
to
investors
maintain
order
in
study,
this
of
accountants
and
bankers
for
investment
after-tax
yields comparable to pre-Tax Act levels, an increased economic
rent
is
now
required
compensate
to
capital
at the
corporation
cost
of
tax
gains
time of
sale-leaseback
the
significant
This higher rent, coupled with the
reduction in tax benefits.
increased
for
liability
incurred
by
the
sale, effectively
increases the
the
corporation's
financing
from
perspective.
This
section attempts
to
quantify
39
the increased
rent
sale-leaseback of a corporate facility
required for a typical
in order to
benefits.
reduction of tax
compensate the investor for the
who
Investors
individual
to
subject
are
and
corporate taxation are examined separately.
1.
Individual
Investors
Tables 5, 6 and 7 present an analysis of a sale-leaseback
for
a
an individual
perspective of
physical
corporate
hypothetical
examined
investor.
characteristics and
building are assumed to be
in the
office
from
building
For
depreciation
the
convenience, the
schedules
of
the
identical to those of the building
preceding lease
analysis.
versus ownership
The major assumptions which differ in this case are summarized
below:
- The
lease
of the
term
every five years
on a
the investor
The rent
years.
is 20
corporation
between
level is
and
the
adjusted
cumulative basis given a 4 percent
annual inflation rate.
- Seventy-five percent of the $20,000,000 purchase price is
financed
amortized
balance is
with a
on
a
long-term
mortgage.
is
the
outstanding
at the time the
property is
30-year schedule
due and payable
The mortgage
and
sold after 20 years.
- The
tax rate
for
the individual
income is 50 percent in Table
percent in Tables
investor on
5 (under prior law) and 28
6 and 7 (under the Tax
40
ordinary
Act).
The tax
LL9'1
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100
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111
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199
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(18S')
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(T6s'!) (16s'!)
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(o0'ss)
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TABLE 6
SALE-LEASEBACK ANALYSIS FORINDIVIDUAL INVESTOR
UNDER TAX ACT NO INDIRECT IMPACT ON INTEREST RATES ASSUMED
RENT ADJUSTED TO ACHIEVE 10\IRR
(InOOOs)
YEAR:
Purchase NetofDebt
1
8
3
2
7
4
9
10
11
12
13
14
15
16
17
18
19
20
($5,000)
$18.25$18.25 $22.20$22.20$22.20$22.20 $22.20 $27.81$27.01$27.01 $27.01 $27.01$32.87 $32.87 $32.87$32.87$32.87
== = = = :: :
--:=:7ZZ-:-::::::::z=::=:-------------------------------------:----=--=:--:----:--=--=--=------------
RentPerSquare Foot
$18.25$18.25$18.25
NetRental Income
Less:
DebtService
1,825 1,825 1,825 1,825 1,825 2,220 2,228 2,220 2,220 2,220 2,701 2,701 2,701 2,701 2,781 3,287 3,287 3,287 3,287 3,287
(1,591) (1,591)
11,591)1
11,591)1
(1,5911
(1,591) (1,591) (1,591) 11,5911
11,591)
(1,591)
(1,5911
(1,5911
(1,591)
11,591)
(1,5911
11,591)
11,591)
11,591)
(1,591)
Before-tax Cash Flow
Less:
Dep. RealProperty
Less:
Dep.- Personal Property
Plus:
Amortization of Principal
1,110 1,696 1,696 1,696 1,696 1,696
629 629 629 1,110 1,118 1,110 1,110
629 629
234 234 234 234 234
1475)
(475)
(475) (475) (475) (475) (475) (475) (475) (475) (475) (475) (435) 1475) (475) 1475) (475) 1475) (475) (475)
8
8
O
O
(5O) (357) (255) (182) (182) (182) (91)
(291)
587 558
461
419
346
381
315
215 2373 260 286
121 134 147 162 178 195
100 110
91
Taxable Income
(441) (640) (488) (375) (290) 119
Tax Liability @ 28%
0
0
0
0
0
134
241
350
369
872
896
922
958
982 1,602
1,640
1,682
1,728 1,778
(33) (37) (67) (98) (103) (244) (251) (258) (266) (275) (448) (459) (471) (484) (498)
2,995
After Tax Sales
Proceeds
After-tax CashFlow
Internal Rate of Return
0
(5,000) 234
234
596
Summary of Tax on Sale
28.801
2,885 t
808
234
234
234
10.0%
After-tax Sales Proceeds Calculation
Gross Sales Proceeds
Less:
Sales Expense
14,000
1420)
13,580
NetSales Proceeds
(8,462)
Adjusted Basis
Less:
Less:
Accumulated Passive Losses (2,234)
Capital Gain
Summary of After-tax Proceeds
13,580
Proceeds
NetSales
(808)
Less:
Taxon Sale
Less:DebtRepayment (9,777)
2,885
NetAfter-tax Proceeds $2,995
592
562
531
526
866
860
852
844
835 1,247
1,236 1,225
1,212
0
4,193
TABLE 7
SALE-LEASEBACK ANALYSIS FORINDIVIDUAL INVESTOR
UNDER TAI ACT - INCLUDES INDIRECT IMPACT ONIN.EREST RATES
RENT ADJUSTED TOACHIEVE 101IRR
(In OOs)
YEAR:
0
Purchase Net of Debt
XA
1
2
3
4
5
6
7
8
$17.10 $20.80
$20.80
$20.80
9
10
11
12
13
14
15
16
17
18
19
20
($5,000)
Rent PerSquare Foot
$17.10
Net Rental Income
Less: Debt Service
1,710 1,710 1,710 1,710 1,710 2,080 2,080 2,080 2,080 2,080 2,531 2,531 2,531 2,531 2,531 3,080 3,080 3,080 3,080 3,080
(1,460) (1,460) (1,460) (1,460) (1,460) (1,460) (1,460) (1,460)
(1,460)
(1,460)
(1,460)
(1,460) (1,460) (1,460) (1,460) 11,460)
(1,460) (1,460) (1,460) (1,460)
$17.10$17.10$17.10
Before-tax Cash Flow
Less: Dep. - RealProperty
Less:Dep. - Personal Property
Plus: Amortization of Principal
250
250 250
620
250 250
(415) (475) (475) (475) (475) (475)
(291)
(500)
(255)
(357)
(182) (182)
110
120
131
143
155
169
Taxable Income
(406)
Tax Liability
8281
0
(605) (451) (337) (252) 133
0
0
0
0
$20.80 $20.80 $25.31
620
620
620
(475) (475) (475)
0
(182)
(91)
201
185
219
140
256
365
$25.31$25.31
$25.31 $25.31 $30.80 $30.80$30.80
620
1,071 1,071 1,071 1,071
(475) (475) (475)
(475) (475)
0
0
0
284 310
337
239
261
385
857
880
906
934
1,071 1,620
(475)
(475)
0
0
368 401
964 1,545
$30.80
1,620 1,620 1,620
1,620
(475)
(475) (475) (475)
0
0
0
0
566
519
437 476
1,582
1,621
1,664
Internal Rate of Return
3,351
(5,000) 250
250
250
250
250
583
10.0%
t After-tax Sales Proceeds Calculation
Gross Sales Proceeds
Less:Sales Expense
14,000
(420)
Summary of Tax onSale
3,067
t
28.001
NetSales
13,580
(8,462)
(2,051)
Summary ofAfter-tax Proceeds
Net Sales Proceeds
13,580
Less:
Tax on Sale
(859)
Less:
Debt Repayment (9,370)
Proceeds
Less: Adjusted Basis
Less:Accumulated Passive Losses
Capital Gain
1,710
(37) (41) (72) (102) (108) (240) (246) (254) (261) (270) (433) (443) (454) (466) (479)
After Tax Sales Proceeds
After-tax Cash Flow
$30.80
859
3,067
Net
After-tax Proceeds $3,351
579
549
518
513
831
825
818
810
801 1,187
1,177
1,166
1,154
4,492
rate on
capital gains is
percent in
Tables 6 and
20 percent
7.
in Table 5
Under the Tax
and 28
Act, passive
losses are not assumed to be currently deductible against
other income and instead
are accumulated and deducted at
the time of sale.
-
Due
to the
length of the lease
on the part of
and general conservatism
sale-leaseback investors, the residual or
gross sales proceeds at the end of Year 20 are assumed to
be 70 percent of the original purchase price.
As shown in
$16
per
percent,
Table 5, based on an initial
square foot
and
an individual
a
investor would
internal rate of return of
prior tax
direct
law.
Holding
impacts of
mortgage
The
receive an
constant all other
the Tax Act
initial rent has
foot to maintain
interest rate
of
10
after-tax
10 percent on the investment under
extended depreciation schedules
6.
annual rent of
the change
--
--
in tax rates and
are accounted for in Table
been adjusted to $18.25
the same 10 percent
of return as achieved under
assumptions, the
after-tax
prior law.
per square
internal rate
The required increase
in rent in this example is approximately 14 percent.
Reflecting the potential indirect interest rate impact of
the Tax Act noted previously, Table 7 modifies the analysis in
Table 6 by reducing the mortgage interest rate from 10 percent
to
9
percent.
increased from $16
In
this
case, the
to $17.10, or by
44
initial
rent
must
be
approximately 7 percent,
in order to maintain the same after-tax yield.
To analyze
corporation's point
If the
in the property.
property were
from the
(i.e. the seller/lessee),
of view
make an assumption regarding
necessary to
the
these rent increases
the effect of
it is
its adjusted basis
adjusted basis were $10,000,000, and
be unencumbered
assumed to
by debt,
the
corporation's first year financing cost for the sale-leaseback
under
be calculated
law could
prior tax
at 9.3
percent as
detailed below:
Sales Price
Less: Capital
(10,000,000)
Basis
Capital Gain
$20,000,000
Sales Price
$20,000,000
Less: Adjusted
$10,000,000
Net Sales Proceeds
First Yr. Rent
Capital Gain
Tax @ 28%
(2,800,000)
Gain Tax
$2,800,000
$17,200,000
$1,600,000
------------------
Net Sales Proceeds
$17,200,000
9.3%
Under the Tax Act,
percent
if the
percent if
it is
the first year financing cost would be 10.3
interest
rate effect
is
included and
illustrated on
excluded, as
page:
45
11.0
the following
Sales Price
$20,000,000
Less: Adjusted
Basis
(10,000,000)
Sales Price
Capital Gain
$10,000,000
Net Sales Proceeds
Capital Gain
Tax @ 34%
$3,400,000
$20,000,000
Capital
Less:
(3,400,000)
Gain Tax
$16,600,000
Including Interest Rate Effect:
$1,710,000
First Yr. Rent
Net Sales Proceeds
$16,600,000
=
10.3%
Excluding Interest Rate Effect:
$1,825,000
First Yr. Rent
Net Sales Proceeds
$16,600,000
=
2.
Corporate Investors
8, 9
Tables
and 10
present a
similar analysis
potential corporate investor's perspective.
that the
11.0%
investor's
sale-leaseback
after-tax
from a
Table 8 indicates
internal rate of
return on the
investment would be 9.4 percent under prior tax
law.
As shown in Table 9, if the direct impacts of the Tax Act
are included
order
annual rent must
$17.70 per square foot, or by
from $16 to
in
in the analysis,
to
maintain
indirect interest
Table 10, the
the same
rate impact is
after-tax
nearly 11 percent,
yield.
also included, as
required increase in rent is
46
be increased
If
the
shown in
minimal, from $16
TABLE I
SALE-LEASEBACK ANALYSIS FOR CORPORATE INVESTOR
UNDER PRIOR TAT LAV
(In000s)
YEAR:
Purchase Net of Debt
3
2
1
0
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
($5,000)
$23.68
$21.82
$28.82
$28.82
$28.82
$28.82
Rent Per Square Foot
$16.00
Net
$1,600$1,600$1,600 $1,600 $1,600 $1,947 $1,947$1,947 $1,947 $1,947 $2,360$2,368 $2,368 $2,368 $2,368 $2,882 $2,002 $2,882 $2,882 $2,882
(1,591) (1,591) (1,591) (1,591) (1,591)
(1,591) (1,591) (1,591) (1,591) (1,591)
(1,591) (1,591)
(1,591)
(1,591)
(1,591)
(1,591)
(1,591)
(1,591)
(1,591)
(1,591)
Rental Income
Less:DebtService
$16.00
$16.00
$16.00 $16.00 $19.47$19.47 $19.47
9
(717) (787)
(306)
(449)
91
100
Taxable Income
(1,127) (1,097) (1,086) (1,073)
(993)
Tax Shelter (Liability) 046%
457
518
(787)
(428)
110
504
499
494
$19.47 $23.68
$23.68
777
155
(787)
(787)
0)
0
215
237
777
(787)
0
260
(285) (270) (254) (236) (217) 226
250
355
355
355
(787) (787)
(787) (787) (787)
0
(428) (428) 0
162
121
147
178
134
Before-tax Cash Flow
Less: Dep. - Real Property
Less:
Dep. - Personal Property
Plus: Amortization ofPrincipal
$19.47
131
124
117
355
(787)
0
195
109
100
$23.61 $23.68
777 1,290 1,290 1,290 1,290 1,290
777
777
(787) (707)
(787) (717) (787) (787) (787)
(717)
0
0
0
0
0
0
0
507 558
461
346
381 419
286
315
276
305
336
884
922
964 1,010
(104) (115) (127) (140) (155) (407) (424) (443) (465) (400)
253t
After Tax Sales Proceeds
After-tax Cash Flow
Internal Rate ofReturn
1,061
(5,000)
466
527
513
508
503
487
9.4%
t After-tax Sales Proceeds Calculation
Gross Sales Proceeds
Less:
Sales Expense
14,000
(420)
Net
13,580
(2,213)
Sales Proceeds
Less: Adjusted Basis
Capital Gain
11,367
Recapture ofPersonal Property Dep. (2,040)
Gain Subject toCapital Gain Rates
9,327
Summary
of TaxonSale
2,040 t
938
46.00%
t
9,327
28.001 2,617
3,550
Summary of After-tax Proceeds
Net Sales Proceeds
13,580
(3,550)
Less:
Tax on Sale
Debt Repayment (9,777)
Less:
Net
After-tax Proceeds
$253
480
472
464
455
673
662
650
637
623
804
866
847
826 1,055
TABLE 9
SALE-LEASEBACI ANALYSIS FORCORPORATE INVESTOR
UNDER TAXACT - NO INDIRECT IMPACT ON INTEREST RATES ASSUMED
RENT ADJUSTED TO ACHIEVE 9.4%IRR
(InOO0s)
YEAR:
Purchase NetofDebt
0
3
2
1
4
5
6
8
9
10
11
12
13
14
15
16
17
15
19
20
($5,000)
$17.70
$17.70
$17.70 $17.70
$21.53
$21.53$21.53$21.53
$21.53
$26.20
$26.20$26.20
$26.20 $26.20
$31.88
$31.88
$31.88$31.88$31.88
RentPerSquare Foot
$17.70
NetRental Income
Less:DebtService
1,770 1,770 1,770 1,770 1,770 2,153 2,153 2,153 2,153 2,153 2,620 2,620 2,620 2,620 2,620 3,188 3,188 3,188 3,188 3,188
(1,591)
(1,591) (1,591)
(1,591) (1,591)
(1,591) (1,591)
(1,591)
(1,591)
(1,591)
(1,591)
(1,591)
(1,591)
(1,591)
(1,591)
(1,591) (1,591) (1,591)
(1,591)
(1,591)
179
(475)
(357)
110
Before-tax Cash Flow
Less:Dep. - RealProperty
Less:Dep.- Personal Property
Plus: Amortization of Principal
179
179
(475)
(475)
(291) (500)
91
100
Taxable Income
(496)
(648) (488)
Tax Shelter (Liability) ( 34%
169
218
166
179
(475)
(255)
121
179
(475)
(182)
134
(375)
(290)
127
98
562 562 562 1,029 1,029 1,029 1,029 1,029 1,596 1,596 1,596 1,596 1,596
562 562
(475)
(475)
(475)
(475)
(475) (475)
(475) (475) (475) (475) (475) (475) (475) (475) (475)
0
0
0
8
0
0
(182) (182) (91)
507 558
381
461
346
419
286 315
237 260
147
162 178 195 215
119
134
241
350
369
872
896
922
950
982
1,602
1,640
1,682
Internal Rate of Return
2,063
348
(5,000)
397
345
306
277
522
9.4%
t After-tax Sales Proceeds Calculation
Gross Sales Proceeds
Less:Sales Expense
14,000
(420)
Summary
of Tax on Sale
5,118
t
34.001 1,740
NetSales
13,580
(8,462)
Summary of After-tax Proceeds
13,580
NetSales Proceeds
(1,740)
Tax on Sale
Less:
Debt Repayment (9,777)
Less:
Proceeds
Less:Adjusted Basis
Capital Gain
1,778
(40) (45) (82) (119) (126) (296) (304) (313) (323) (334) (545) (557) (572) (587) (605)
After Tax Sales Proceeds
After-tax Cash Flow
1,728
5,118
NetAfter-tax Proceeds $2,063
517
480
443
437
732
724
716
706
695 1,052
1,039
1,025
1,009 3,054
TABLE
10
SALE-LEASEBACK ANALYSIS FORCORPORATE INVESTOR
UNDER TAXACT - INCLUDES INDIRECT IMPACT ON INTEREST RATES
RENT ADJUSTED TO ACRIEVE 9.4%IRR
(In000s)
YEAR:
1
0
Purchase Netof Debt
3
2
4
10
11
12
13
14
15
17
18
$29.54 $29.54
$29.54
16
19
8
9
$16.40 $19.95 $19.95
$19.95
$19.95
1,995
1,995
535
($475)
($91)
$201
968 1,494 1,494 1,494 1,494 1,494
968 968 968 968
535
535
($475) ($415)($475) ($475) ($475)($475)($475) ($475) ($475) ($475) ($475) ($475)
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$8
$401 $437
$476 $519 $566
$284
$368
$219
$239
$261
$310 $337
($5,000)
Rent PerSquare Foot
Net Rental Income
Less: Debt Service
$16.40 $16.40
$16.40
$16.40
1,640 1,640
468))(
($1,
1,640
1,640
10
10
($475)
($500)
$110 $120
($475)
($357)
$131
(476) (675)
(521)
180
($475)
($291)
Before-tax Cash Flow
Less:Dep. - Real Property
Less: Dep. - Personal Property
Pls: Amortization of Principal
Taxable Income
Tax Shelter (Liability) $ 34%
162
229
177
1,640
1,995
1,995
180 180 535
535
($475) ($475)($475) ($475)
($255) ($182) ($182)($182)
$143
$185
$155 $169
(407)
138
(322)
109
48
63
170
280
$19.95 $24.28
1,995
299
2,428
753
$24.28
$24.28
2,428
2,428
777
802
$24.28 $24.28
2,428
830
2,428
$29.54
Internal
Rate
ofReturn
860 1,419
1,455
1,495
1,538
2,470
(5,000)
342
409
357
318
289
519
9.4%
Gross Sales Proceeds
Less:
Sales Expense
14,000
(420)
Summary of Tax on Sale
5,118
0
34.00% 1,740
Net
13,580
(8,462)
Summary of After-tax Proceeds
NetSales Proceeds
13,580
(1,740)
Less:
Tax on Sale
Debt Repayment (9,370)
Less:
Capital Gain
1,584
(16) (21) (58) (95) (102) (256) (264) (273) (282) (293) (483) (495) (508) (523) (539)
t After-tax Sales Proceeds Calculation
Sales Proceeds
Less:
Adjusted Basis
$29.54
2,954 2,954 2,954
2,954 2,954
460)
($1,
460)($1, 460)($1,460($,460) ($1,
After Tax Sales Proceeds
After-tax Cash Flow
20
7
6
5
5,118
NetAfter-tax Proceeds
$2,470
514
477
440
433
711
704
695
685
675
1,011
999
985
971
3,424
t
to $16.40 per square foot or less than 3 percent.
3.
Summary of Sale-Leaseback Impacts
The
major
results
of
the preceding
analysis
can
be
respect
to
summarized as follows:
- The
provisions
of
the
sale-leasebacks are
investors than
Tax
Act
with
clearly more onerous
for individual
for corporate investors due,
in part, to
the differing treatment of passive losses.
- Because
rents
on
sale-leasebacks
pre-Tax Act levels to
of sale-leaseback
must
increase
maintain investor yields, the cost
financing can be expected
for corporations.
This increase
the Tax Act has the
over
could be
to increase
moderated if
indirect effect of reducing interest
rates.
- The disadvantaged treatment
the
higher required
suggests
that
the
pre-tax yields
tax-exempt
investors, along
be
for individual investors and
for sale-leasebacks
institutional
with high taxpaying
primary
source
of
and
foreign
corporations, will
investment
capital
for
sale-leasebacks in the new tax environment.
C. Developer/Corporate Joint Ventures
Joint
venture
corporations have
as each
partnerships
between
developers
become increasingly common in
party has recognized
the benefits to be
50
and
recent years
gained from
this
type
include:
of arrangement.
(1)
the
The
corporation
benefits
may provide
substantial credit tenant generally
obtain;
and
(3) a
advantages
corporate
in securing
corporation
appreciation
and
tax
it
tenant
capital;
can provide
(2) a
and
marketing
The benefits
can participate
benefits;
developer
makes financing easier to
other tenants.
include: (1)
to the
(2)
to the
in cash
it
can
flow,
maintain
long-term control over the cost and use of its space.
1.
Impact of the Tax Act on Joint Ventures
Under
prior
structured
tax law,
to allocate
benefits to
joint
ventures
a disproportionate
the developer
partner in
were most
share of
exchange for
often
the tax
a larger
share of cash flow and potential appreciation to the corporate
partner.
Under
relatively
credits.
low
In
ERTA,
after
effective corporate
accounting
contrast,
taxpayers, including many
percent.
little
In this
value from
valued these
for
marginal tax
all
rates
tax
rates
deductions
were
and
for
individual
developers, could be as
high as 50
context, corporations
tax benefits,
benefits highly.
received relatively
while individual
Under these
was therefore most efficient to
taxpayers
circumstances, it
allocate the largest share of
tax benefits to the developer partner.
Under the Tax Act,
individual taxpayers
for
most
taxpayers.
the relationship beween corporate and
has been reversed.
corporations
are
higher
In addition, individual
51
Effective
than
for
tax rates
individual
taxpayers are affected by
the
passive loss
limitations while
from these provisions.
to
structure
a
corporations are
exempt
In most cases it is now more efficient
joint
disproportionate share
venture
of the
which
allocates
tax benefits to
a
the corporate
partner.
2.
Hypothetical Example of an Equity Lease
This example
of an
equity lease,
prepared by Rosenberg [47],
is
the effectiveness
both parties.
has
of a
to a corporate partner can
joint venture
Several of the the
the hypothetical
project have
been modified
to reflect
a model
a useful illustration of how a
special allocation of tax benefits
enhance
adapted from
structure for
underlying assumptions for
been changed and
changes
in the
the analysis
Tax Act
with
regard to depreciation and marginal tax rates.
The project is assumed to be a
building.
be
$5
The developer's land acquisition cost is assumed to
million.
calculated at
rent
200,000 square foot office
for the
Hard
$130 per
and
soft
construction
square foot
or $26
costs
million.
are
Market
office space is assumed to be $16 per square foot
per year, triple-net.
Table
statement
corporation
11
for
as
presents
the
project
a joint
proceeds independently,
million and his
a
first-year
both
venture
pro
with
tenant.
forma
and
operating
without
If the
developer
his equity requirement would
initial cash return on investment
be $5.9
based on a
$533,000 cash flow after debt service would be 9.1 percent.
52
the
TABLE 11
FIRST-YEAR PRO FORMA OPERATING STATEMENT
FOR JOINT VENTURE OFFICE BUILDING
(In 000s)
DEVELOPER WITHOUT CORPORATION AS JOINT VENTURE
TENANT
Income:
200,000 sq. ft. @ $16 per sq. ft. NNN
Debt Coverage Ratio
1.20
Supportable Annual Debt Service
Cash Flow After Debt Service
$2,667
$533
Supportable Loan Amount
(10% interest; 30-year amortization)
Developer's
$3,200
Equity Requirement
$25,138
$5,862
DEVELOPER WITH CORPORATION AS JOINT VENTURE TENANT
Net Operating Income:
100,000 sq. ft. @ $19 per sq. ft. NNN
100,000 sq. ft. @ $16 per sq. ft. NNN
Total Net Operating Income
Debt Coverage Ratio
$1,900
1,600
$3,500
1.15
Supportable Annual Debt Service
Cash Flow After Debt Service
$3,043
$457
Supportable Loan Amount
(10%
interest; 30-year amortization)
Total Equity Requirement
Developer's Share of Equity (90%)
Corporate Tenant's Share of Equity (10%)
53
$28,691
$2,309
$2,078
$231
In order
his
equity
to obtain an
requirement,
increased loan amount
the
long-term lease with a credit
the
corporate tenant
developer
can
enter
corporate tenant.
pays an
and reduce
into
a
In this case
above-market rent
of $19
per
square foot per year and contributes 10 percent of the initial
equity.
In
percent
annual priority
return, the
tenant is entitled
return
on its
to receive
a 10
investment, plus
25
percent of the cash flow remaining after the priority payment.
The corporate tenant also receives
a special allocation of 75
percent of the depreciation deductions
remaining taxable
are
allocated
investments;
percent
income or loss.
to
each
the remaining
between
the
partner
plus 25 percent of the
The
initial sale proceeds
to
return
their
cash is divided 25
corporate
tenant
equity
percent and 75
and
developer,
respectively.
As shown
in the
bottom half of
Table 11,
the analysis
assumes that the corporate tenant occupies 100,000 square feet
of space at an annual rent of
The debt
coverage ratio
$19 per square foot, triple-net.
is assumed to
decline from
1.20 to
1.15, reflecting the creditworthiness of the corporate tenant.
Under
these
reduced to
assumptions
the
total
$2.3 million, including
equity
requirement
$2.1 million paid
is
by the
developer and $0.2 million paid by the corporate tenant.
Table 12 projects taxable
income for the partnership and
Table 13 projects the partership's
including cash flow distributions
developer.
Table
14
sources and uses of funds,
to the corporate tenant and
summarizes the
54
total
after-tax
cash
TABLE 12
PROJECTED PARTNERSHIP TAXABLE INCOME
FOR JOINT VENTURE OFFICE BUILDING
(In 000s)
YEAR:
U,
U,
1
2
3
4
5
Net Operating Income
Less: Interest Expense
Less: Depreciation
Real Property
Personal Property
$3,500
(2,869)
(726)
(446)
(726)
(764)
(726)
(546)
(726)
(390)
(726)
(278)
Taxable Income (Loss)
($541)
($842)
($605)
($428)
Special Allocation of 75% of
Depreciation to Corp. Tenant
($879)
($954)
25% Taxable Income (Loss)
Allocable to Corporate Tenant
$84
Corporate Tenant's Total Share of
Taxable Income (Loss)
Developer's Share of Taxable
Income (Loss)
($795)
$253
$3,500
(2,852)
($1,118)
$69
($1,049)
$207
$3,500
(2,832)
$87
($867)
$262
$3,500
(2,811)
$3,500
(2,788)
6
7
8
$4,258
(2,763)
$4,258
(2,734)
$4,258
(2,704)
9
$4,258
(2,670)
10
$4,258
(2,632)
(726)
(278)
(726)
(278)
(726)
(139)
(726)
0
(726)
0
($293)
$491
$519
$689
$862
$900
($837)
($754)
($754)
($754)
($649)
($545)
($545)
$102
$115
$311
$318
$335
$352
$361
($735)
($638)
($442)
($435)
($315)
($193)
($184)
$346
$933
$954
$307
$1,004
$1,055
$1,083
TABLE 13
PROJECTED PARTNERSHIP SOURCES AND USES OF FUNDS
FOR JOINT VENTURE OFFICE BUILDING
(In 000s)
YEAR:
1
2
3
4
($541)
1,172
($842)
1,490
($605)
1,272
($428)
1,116
($293)
1,005
$491
1,005
$519
1,005
648
668
689
712
1,496
31,631
648
668
689
712
31,000
174
192
211
232
31,174
192
211
$457
$457
Preferred Distribution (10% of
Corporation's Equity Inv.)
$23
Excess Distribution (25%)
5
6
7
8
9
10
$689
866
$862
726
$900
726
1,524
1,555
1,589
1,626
1,496
1,524
1,555
1,589
1,626
255
281
309
340
374
411
232
255
281
309
340
374
411
$457
$457
$457
$1,215
$1,215
$1,215
$1,215
$1,215
$23
$23
$23
$23
$23
$23
$23
$23
$23
108
108
108
108
108
298
298
298
298
298
$131
$131
$131
$131
$131
$321
$321
$321
$321
$321
$325
$325
$325
$325
$325
$894
$894
$894
$894
$894
Sources of Funds:
Taxable Income (Loss)
Depreciation
Provided by Operations
Investment by Partners
Proceeds from Permanent
Financing
Total Sources of Funds
631
2,309
28,691
Uses of Funds:
Ln
Acquisition of Property
Mortgage Principal Payments
Total Uses of Funds
Cash Available for Distribution
Cash Distributed to Corporate
Tenant:
Total Distribution to Corporate
Tenant
Distribution to Developer
TABLE 14
PROJECTED AFTER-TAX CASH BENEFITS FOR CORPORATE TENANT
FOR JOINT VENTURE OFFICE BUILDING
(In 000s)
YEAR:
Corporate Tenant's Share of
Taxable Income (Loss)
($1,049)
3
4
5
6
7
8
($867)
($735)
($638)
($442)
($435)
($315)
9
($193)
10
($184)
270
357
295
250
217
150
148
107
66
62
Corporate Tenant's Share of
Cash Flow
131
131
131
131
131
321
321
321
321
321
$402
$488
$426
$381
$349
$471
$469
$428
$387
$383
$4.02
$4.88
$4.26
$3.81
$3.49
$4.71
$4.69
$4.28
$3.87
$3.83
After-tax Benefits per Sq. Ft.
-a
($795)
2
Tax Benefit (Liability) @ 34%
of Taxable Loss (Income)
Total After-tax Benefits
(.J1
1
benefits for the corporate
tenant, including tax benefits and
cash flow.
From the
developer's perspective, the advantages
of the
joint venture arrangement include the following:
- The
developer's
equity
requirement is
reduced
percent, from $5.9 million to $2.1 million.
developer
maintains a
value of the property
majority of
by
65
However, the
the future
economic
because of the favorable financing
and the
fact that he traded
some of
the corporate tenant's economic
depreciation deductions for
benefits in the
property.
-
The
developer's
first-year
pre-tax
cash
return
on
investment is increased from 9.1 percent to 15.6 percent,
based on the developer's
first-year cash distribution of
$325,000 and his initial
investment of $2.1 million.
the developer has passive losses
to or
greater than his
from other
share of taxable
If
sources equal
income,
no tax
will be incurred.
From
the
corporate
tenant's
perspective,
the
joint
venture also provides substantial advantages:
-
In the first year, the
savings of
for
its
calculated
corporation receives a net rental
approximately $1 per square
entire
by
space.
This
subtracting the
after-tax benefits
(Table 14)
58
net
$4
foot or $100,000
rental
per
from the
savings
is
square foot
in
contract rent of
$19 per
less
square foot, leaving
than
market
the
$100,000 net
$15 per square foot
rent.
The
tenant's
corporate
rental savings corresponds to
or $1
a 43 percent
return on its $231,000 initial equity investment.
- In
addition to
tenant
the
will build
long-term
net rental
equity in
up
through
savings, the
corporate
project over
the
mortgage amoritization
and
the
property
appreciation.
D. Master
Trusts
Limited
Parnerships and
The provisions of
were
emerged
toward master
a
taxpayers with
liquid investment
passive income
of
tax-oriented
interest
returns
in
investments
REITs which
while
establishing
also
(REITs).
which
provides
resulted
structured
a
individual
losses from
REIT
in
to yield
providing liquidity.
and operating
MLPs have
The disadvantaged treatment
has also
are
in Chapter Two,
to offset passive
previous tax shelter investments.
Investment
limited partnerships
real estate investment trusts
as
Estate
the Tax Act, outlined
generally favorable
(MLPs) and
Real
renewed
economic
Restrictions
were also
for
substantially
liberalized.
MLPs and REITs can potentially be used by corporations as
a means of removing undervalued
balance sheets
for
and generating earnings.
the corporation
directly to
real estate assets from their
to
raise
an MLP or REIT.
cash is
The
to
simplest method
sell the
If the assets are
59
assets
required for
continued use, they can be leased back to the corporation.
an
alternative
to
a
direct
sale,
corporation can transfer the assets
in
a
roll-out,
As
the
to an MLP in exchange for
partnership interests in the MLP which in turn are distributed
to shareholders.
This section
compares the major characteristics
investment vehicle after
the Tax Act from
of each
the perspective of
both a potential corporate sponsor and potential investors.
1.
Asset, Income and Ownership Restrictions
As
noted
in Chapter
restrictive asset,
Two,
income and
REITs
MLP
is
much
more
relatively
ownership tests, although these
restrictions are relaxed during
An
must meet
the first year of operations.
flexible
in
terms
of
its
asset
sponsor, a
major
composition, sources of income and operations.
2.
Control by the Sponsor
From
the perspective
difference between
the
to
in
general partner, can
an advisory firm
generally
have
maintain
Because investors
participate
importance
REIT is the degree
control over
in an
the
maintain control.
corporate
A REIT
under the direction of the
control.
to corporations
the sponsor,
This
the real
to which
estate
MLP have very limited rights
management,
independent of
ultimate
a corporate
an MLP and a
corporation can
assets.
of
which
over their real estate assets.
60
as
is managed by
trustees who are
and the
distinction
sponsor,
is
shareholders
of
require long-term
critical
control
3.
Treatment of Income and Losses
A REIT generates portfolio
passive income.
offset
income while an MLP generates
Only the latter type of income can be used to
passive losses
for individual
taxpayers.
A
REIT is
also unable to pass through losses to investors.
4.
Tax-Exempt Investors
Pension
funds
generally not
and
other
interested in
tax-exempt
investors
investing in an
MLP due
are
to the
risk that a portion of the income will be treated as unrelated
business income and will
therefore be taxable.
A corporation
that has a large number of tax-exempt shareholders may find it
difficult to
hand,
sell
tax-exempt
5.
implement a
a
roll-out MLP.
significant
percentage
REITs, on
of
their
the other
shares
to
investors.
Administration and Accounting
An MLP is
administration
much more complex than a REIT
with respect to
and accounting
The
requirements.
accounting
experts interviewed during this study estimated that a minimum
of approximately
$1 million in
normally required to set up a
several
hundred partners
accounting and legal
fees is
registered MLP. An MLP may have
for whom
separate records
maintained by the sponsor on an ongoing basis.
61
must be
6.
Tax Risk
Congress
efforts to
and the
may be
successful in
reclassify MLPs as corporations
This would eliminate
the
Treasury
absence
of
for tax purposes.
two of the investor benefits
double-taxation
of
their
of an MLP:
income
and
the
classification of income as passive rather than portfolio.
To date, corporations have been much more inclined to use
MLPs than
REITs as
a source of
off-balance-sheet financing,
although neither technique is yet widespread among Fortune 500
corporations.
According
to
the
accounting
experts
and
investment bankers interviewed during this study, investors in
MLPs
are
most
attracted
requiring current
this
returns of
investor requirement,
structured
around
fast
outlets,
food
hotels.
by
high
10 to
cash
12 percent.
real estate
intensively
operated
restaurants, retail
Recent investor interest
yields,
MLPs are
generally
Because of
most often
properties, such
establishments
as
and
in MLPs, however, has waned
pending the outcome of the Congressional hearings on their tax
status.
62
CHAPTER FOUR
INTERVIEWS OF CORPORATE REAL ESTATE EXECUTIVES
This chapter presents the results of telephone interviews
of
selected
officers.
corporate
These
real estate
interviews were
managers
and
conducted to
financial
determine the
impacts, if any, of the Tax Act on corporate real estate asset
management policies.
The corporate real estate
survey were
identified from
executives interviewed in this
two sources:
(1)
the membership
directory of the National Association of Corporate Real Estate
Executives
(NACORE);
and
Managers section of the
Directory.
manager
(2)
the
each
policy-making
Real
Estate
1986/87 National Real Estate Investor
Whenever possible,
in
Corporate
the most
corporation
with
resonsibility was
senior real
overall
estate
planning
identified and
and
interviewed.
In some cases, the individual in this position indicated that,
given the subject
to
interview
corporation.
conducted
a
of the study, it would
financial
officer
or
Approximately two-thirds
with
senior
one-third with
be more appropriate
tax
of the
corporate real
expert
in
the
interviews were
estate
managers
financial and tax specialists.
and
The names and
positions of interviewees along with the date of the interview
are provided at the conclusion of this paper.
In order
based
on
to ascertain
the
characteristics,
type
the 24
of
if differences in
industry
or
firms examined
63
policies exist
building
in this
occupancy
survey were
derived from four major categories.
The corporations included
in each category are presented below:
I. Heavy Industrial/Manufacturing/Distribution
1.
2.
3.
4.
American Cyanamid Company
Boise Cascade Corporation
Colgate/Palmolive Company
Dow Chemical Company
5. Mead Corporation
6. United Parcel Service,
II.
Inc.
High Technology/Research & Development/Office
1. GTE Corporation
2. Hewlett Packard
3. International Business Machines (IBM)
4. Raytheon Company
5. Teradyne, Inc.
6. Wang Laboratories,
Inc.
III. Financial Services/Office
1. American Express
2. Bank of America
3.
4.
5.
6.
Chemical Bank
Citicorp
Commerce Bancshares, Inc.
Manufacturers Hanover Trust Co.
IV. Retail
1. Dayton Hudson Corporation
2. Federated Department Stores,
3. K Mart Corporation
4. May Department Stores
5. McDonald's Corporation
6. Southland Corporation
64
Inc.
A.
Lease Versus Ownership of New Facilities
The
interviews of
financial officers
decision
is
corporate real
revealed that
based on
several
These
factors
implications.
estate managers
the lease
factors
versus ownership
in addition
include
and
the
to
tax
corporation's
operational considerations, cash position, debt capacity, cost
of capital and financial statement impacts.
the
Tax
Act
in
influencing
the
The importance of
occupancy decision
varies
significantly between different industries and corporations.
Corporations with highly
heavy
industrial,
specialized facilities used for
manufacturing
generally prefer to own these
or
distribution
facilities
purposes
in order to maintain
long-term control and flexibility in operations.
Based on the
interviews of real estate managers in these firms, the Tax Act
has had relatively little impact
these corporations,
on the occupancy policies of
as operating
factors are
more important than financial considerations.
consistent
with
the
executives conducted
and Associates
The
base
This finding is
survey
for Cushman & Wakefield
of
corporate
by Louis Harris
lease
versus
purpose office
occupancy are
ownership
Several of these
lease-versus-own
financial services and high
use general
or intermediate-term
the
a
far
[11].
firms that
considerations.
flow
of
interviews revealed that
technology
short-
results
considered
analysis
65
space for
more inclined
decision
on
to
financial
firms use a discounted cash
in
which
tax
factors
are
included; they
heavily
report that
dependent on
residual
value
the results
the discount
assumptions.
Some
of
reported that they
due to the
the
these
firms
are
or indirect effects of the
corporations
in
are now more prone to
these
categories
expense real estate
capital gains tax rate change,
the ITC and, in some
period and
of action, primarily based on
their differing emphasis on direct
Act.
analysis are
rate, holding
Managers in
divided over the optimal course
Tax
of the
the elimination of
cases, the imposition of the alternative
minimum tax.
Real estate managers in other corporations share
the
perception
general
against
and
overbuilding, and
increase rents
several
that
of these
constructing
the Tax
Act
therefore reduce
over
time.
corporations
buildings, or
Based
are
should
mitigate
office vacancies
on this
expectation,
currently purchasing
are negotiating
or
long-term leases
that fix current lease rates.
Corporate
real estate managers
reported that
these firms
their facilities
are
not
category,
four
possible and
indicated
generally choose
to own
based on longstanding corporate
affected
considerations.
in the retailing category
by
Of the
prefer
short-term
six
to
two prefer to
that their
own
lease.
their
changed as a result of the Tax Act.
66
or
tax
surveyed in
this
facilities
The real
firms' occupancy
policy, and
financial
corporations
or lease
whenever
estate managers
preferences have
not
B.
Sale-Leasebacks for Existing Buildings
The
interviews
industrial,
manufacturing
generally not
noted in
most
revealed
that corporations
or
interested in
distribution
the use of
the preceding lease versus
cases
these firms
desire
with
heavy
facilities
are
sale-leasebacks.
As
ownership discussion, in
long-term
control of
their
facilities.
Other corporations typically
one
of
several potential
perception among
consider sale-leasebacks as
sources
of
representatives of
financing.
A
these firms is
common
that the
effective cost of sale-leasebacks has increased in the form of
higher required
same time, the
to the
consensus of
the
Tax
net proceeds from sale are
increase
Act,
in the
those
generally less due
capital gains tax rate.
interviewed
sale-leasebacks
The general
tha t, with the
is
At the
o f the Tax Act.
rents since passage
have
become
passage of
more
expensive
relative to conventional forms of debt and equity financing.
While the level of sale-leaseback activity is expected to
decline over
pre-Tax Act
levels,
they will still be
used in
cases where firms are trying to remove undervalued real estate
assets
from
their balance
sheets.
Because
of
the
higher
pre-tax returns, tax-exempt and foreign investors are expected
to
replace tax-oriented
investors as
captital for sale-leasebacks.
67
the primary
source of
C. Developer/Corporate Joint Ventures
While joint ventures
are
becoming
buildings,
between developers and corporations
increasingly
there
are
no
common, particularly
consistent
patterns
for
for
office
special
allocations of depreciation benefits between the two partners.
Some
of
the corporate
real
estate
officers interviewed indicated that
managers and
financial
their firms do not desire
additional tax losses and furthermore do not want to incur the
impact of additional depreciation on earnings.
Other managers
were more inclined to favorably consider a joint venture where
a disproportionate share of the
the corporate
partner
flow.
In short,
subject
in
tax benefits are allocated to
in exchange
for a smaller share of cash
although special
view of
the recent
majority
of
officers
interviewed have
corporate
allocations are
passage of
real estate
not
yet
the Tax
managers
and
a timely
Act, the
financial
seriously examined
this
opportunity.
D. Master Limited Partnerships and Real Estate Investment
Trusts
None of the
corporations surveyed as part
has sponsored an MLP or a REIT.
estate
executives
suggested
seriously considered
be more
corporate
Several of the corporate real
that,
although
they
either investment vehicle, an
attractive than
real estate
of this study
a REIT
assets.
as a
An MLP
68
means of
is
had
not
MLP would
spinning off
perceived to
be
easier to establish and control than a REIT.
As
mentioned
cash-on-cash
operating
in
yields
and
facilities.
inappropriate
generate
Chapter
are
They
for
on
insufficient
a
or
determine
industry
suited
This
the level
of
interest in
a
or
Of
be
which
the
six
MLP were
more
was
ultimately
shareholders are
be subject to the unrelated
an
whole,
flow.
the corporation's
if
a
retail
buildings
concept
income tax
as
for
high
considered to
office
cash
institutional investors and would
business
require
evaluated the establishment of an
basis.
many of
MLPs
are generally
short-term
conceptual
rejected because
best
industrial
retailers surveyed, one has
MLP
Three,
formed.
In order
to
MLPs
in the
retailing
extensive
survey
would
be
required.
E.
Summary of Corporate Policy Implications
Based
briefly
on the
interview
summarizes
the
findings,
corporate
the following
asset
management
chart
policy
implications of the Tax Act by category of corporation.
Tax Act Policy
Implications
Corporation Type
I. Heavy Industrial/
Manufacturing/
- Relatively little impact on
lease versus own decisions.
Distribution
- Sale-leaseback activity is
minimal.
- Joint venture activity is
minimal.
- No interest
69
in MLPs or REITs.
Tax Act Policy
Implications
Corporation Type
II.
High Technology/R&D
-
Impact on lease versus own
decisions are mixed.
and
-
III.
Financial Services/
Sale-leasebacks are perceived
as more expensive form of
Office
financing.
-
Limited awareness
of special
allocation opportunities in
joint ventures.
-
IV.
Retail
No interest in MLPs or REITs.
- Relatively little impact on
lease versus own decisions.
-
Sale-leasebacks are perceived
as more expensive form of
financing.
-
Joint venture activity is
minimal.
-
Some preliminary interest
MLPs.
70
in
CHAPTER FIVE
SUMMARY OF FINDINGS AND CONCLUSIONS
This
chapter
final
the
summarizes
major impacts of the Tax Act
analysis of the
of the
briefly
interviews of
conclusions of this
preceding
and the results
corporate real estate
executives.
study are provided in the
The
context of the
four principal questions posed at the outset.
1.
to
How
overall
ownership
impacts
costs are
and
of
the Tax
too uncertain
should occur
in corporate
occupancy decisions.
--
affect corporations' decisions
lease or own new real estate facilities?
The
change
will the Tax Act
Act
on
to suggest
leasing
that a
policy regarding
While the direct
and
major
facility
impacts of the Tax Act
reduction in tax rates, extension of depreciation schedules
repeal
interest
of
in
increased
the
leasing,
rents,
reduced interest
facilities.
--
ITC
may tend
the
reduced
rates --
It is
to encourage
potential
indirect
impacts
short-term
property
values
would favor
important for
that the
direct impacts of the
relative
certainty
while
increased
ownership
the indirect
and
of corporate
corporations to
Tax Act can be
--
recognize
forecast with
impacts
are
highly
uncertain.
Consistent
analysis, the
indicated
with
the
indeterminate
interviews of corporate real
that the
Tax Act
will
71
have a
results
of
this
estate executives
minimal impact
on
corporate occupancy
decisions in
tend to be of equal or
ownership
most cases.
greater importance to the lease versus
decision
are
the
corporation's
considerations, cash position, debt
and
financial
financial
tax
statement
services and
general purpose
and
occupancy
decisions.
industrial-related
Corporations
high technology
financial
in
the
industries that
use
place the greatest
considerations
Firms
with
facilities
hand, tend to either lease
operational
capacity, cost of capital
impacts.
office space
other
Factors which
and
emphasis on
in
arriving
highly
at
specialized
retailers, on
the
other
or own based on corporate policies
which are not affected by the Tax Act.
2.
What
impact will the
Tax Act have
use of sale-leaseback financing?
Because
of the
reduction in
on corporations'
tax benefits
to
investors
resulting from the Tax Act, higher economic rents are required
in
sale-leaseback
transactions
to
rent,
after-tax
yields.
This
increased
capital
gains
corporation
cost
of
at the
higher
tax
time of
sale-leaseback
maintain
liability
coupled
incurred
sale, effectively
financing
from
investors'
the
with
the
by
the
increases the
corporation's
perspective.
The corporate
real estate executives
interviewed during
this study generally
concurred that, with passage
Act, sale-leasebacks
have become
conventional
forms of
equity financing.
debt and
where corporations continue to
more expensive
of the Tax
relative to
In cases
use sale-leasebacks as a means
72
of removing undervalued real
sheets, it
estate assets from their balance
is expected that tax-exempt
and foreign investors
will be attracted by the higher pre-tax yields.
3. Will the frequency and structure of joint ventures
between corporations and developers be affected by the
Tax Act?
For reasons
that are independent
venture partnerships
expected
to
between developers and
become
increasingly
structure of these partnerships
likely to change
of the Tax
Act, joint
corporations are
common.
The
financial
in the long-term, however, is
in many cases as a direct
result of the Tax
Act.
Under
prior
structured
to
benefits to
tax law,
allocate
joint
a
the developer
ventures
were most
disproportionate
partner in
share
exchange for
often
of
tax
a larger
share of cash flow and potential appreciation to the corporate
partner.
With the passage of the Tax Act, changes in marginal
tax rates and imposition of
passive loss rules for individual
investors have reversed the relationship between the corporate
and
developer
efficient
to
partners.
structure a
disproportionate
partner.
In
share
of
most
cases
joint
venture
tax
benefits
it
is
now
more
which allocates
to
the
a
corporate
The example of the equity lease presented in Chapter
Three illustrated how a
a corporate partner
special allocation of depreciation to
can enhance the effectiveness
of a joint
venture for both the developer and the corporation.
The majority of real estate executives interviewed during
73
this
study
were
allocations
unaware
of
the
opportunity
in developer/corporate
provisions
of the
reasonable
to
expect
structured
to
take
Tax Act
joint
become more
that
future
advantage
special
ventures.
As
widely known,
joint
of
for
the
ventures
it is
can
tax
new
the
be
shelter
opportunities for corporations.
4. How will the
Tax Act affect the potential
for the
securitization of corporate real estate assets through
the use
of master
limited partnerships
estate investment trusts (REITs)?
The provisions
of the
Tax Act were
with respect to MLPs and REITs.
be
used by
assets
corporations
from
their
Corporations that
have
shown a
there are
and real
generally favorable
Both vehicles can potentially
to remove
balance
(MLPs)
sheets
have securitized
strong preference
undervalued real
and
generate
their real
for the
estate
earnings.
estate assets
MLP structure because
fewer restrictions upon organization
than a REIT
and it enables the corporate
partner, to
maintain long-term
and operation
sponsor, as general
control over its
real estate
assets.
Because
MLPs require
high cash
returns, they
are best
suited for operating properties such as restaurants, fast food
outlets and
retail establishments.
It
is
unlikely that MLPs
will become widely used by Fortune 500 corporations since they
are
generally
considered
conventional forms
buildings and
to
be
of corporate
real estate, such
industrial facilities.
possibility that legislation will be
74
inappropriate
There is
for
more
as office
also a strong
enacted to treat MLPs as
corporations, resulting
in the double taxation
of income and
the reclassification of passive income as portfolio income.
Given the above considerations,
corporate
unlikely
real
estate
that there
executives
will be
and the responses of the
interviewed,
a widespread
it
appears
trend toward
the
securitization of corporate real estate assets through the use
of either MLPs or REITs.
75
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PERSONS
Dae Abram, Director of
June 22, 1987
INTERVIEWED
Real Estate,
McDonald's Corporation,
Charles Alesi, Partner, Touche Ross, June 3, 1987
Carol Ann Arvan, Vice President, Citicorp, June 25, 1987
W.C.
Bartow,
Company, June
Director
19,
Edward Bierman,
(Dayton Hudson),
of Real
Estate
Planning,
Raytheon
1987
- Real Estate,
Vice President
June 23, 1987
Target Stores
Alan Breitman, Tax Department, American Cyanamid Company, June
18,
1987
Robert
Kevin Brown,
Vice President
- Corporate
Real Estate
Advisory Services, Carter & Associates, June 9, 1987
Paul
Steven Burns,
Company, June
Cesar
- Corporate
Bureau, Manager
Corporation, June 19,
Vice President 23, 1987
Chekijian,
Vice
Private
President -
Manufacturers Hanover Trust Co.,
Daniel Costello,
Tax Department,
Southland
1987
Corporate
June 9,
Executive Vice
Equity, Bankers Trust
Real
Estate,
1987
President, Bank
of America,
June 23, 1987
Frank
Czerwinski,
Real
Corporation, June 17, 1987
Estate
Thomas Dudley, National Real
Service, Inc., June 22, 1987
Manager,
General
Foods
Estate Department, United Parcel
John Dues, Director - Corporate Real Estate, Mead Corporation,
June 18, 1987
Larry
Ebert,
Manager
of
Real
Estate
Acquisitions
and
Marketing, Boise Cascade Corporation, June 17, 1987
Harvey Fireman, Senior Manager, Ernst & Whinney, June 9, 1987
Michael Fox, Corporate Controller, Wang Labs, June 19,
Carmela
Hache, Director
Express Company, June 22,
Corporate
1987
81
Real Estate,
1987
American
Rod
Hohl, Vice President, Security
Services, June 9, 1987
Norman Holst, Director of
Bancshares, June 15, 1987
Larry
Kimbler, Vice
Pacific Realty
Advisory
Real Estate,
Commerce
Corporate
President -
Corporate Real
Estate, GTE
Corporation, June 17, 1987
James Kuerbitz, Manager of
June 17, 1987
James
Law, Corporate
Manager
Hewlett-Packard, June 17,
Kevin Luzak,
Real Estate, Dow Chemical Company,
of Land
Development/Planning,
1987
Salomon Brothers,
Inc.
June
23,
William Maloney, Tax Manager, Teradyne, Inc.
1987
June 9, 1987
Elliot Matz, Vice President, Chemical Bank, June 9, 1987
Carolyn
McBride, Director
June 17,
1987
of Real
Estate Development,
Robert
Mendenhall,
Operating
Vice
Department Stores, Inc.
July 2, 1987
President,
Federated
Robert Milburn, Partner, Laventhol & Horwath, June 18,
Alan Paul,
Partner, Grant Thornton, June 12,
Kendl
Philbrick, Director
Company, June 17, 1987
of Real
Christopher Rodgers, Real Estate
IBM,
1987
1987
Estate, Colgate-Palmolive
Manager, K Mart Corporation,
June 22, 1987
Jordan Roseman, Partner, Arthur Andersen & Co.,
Larry
Sidwell, Regional
President -
Vice
Department Stores, June 24,
Robert
Silverman, Director
June 3, 1987
June 17,
Real Estate,
1987
May
1987
of Planning,
Harvard University,
Joann Titley, Vice President, Citicorp, June 17, 1987
Squire Younger, Partner, Arthur Andersen & Co.,
82
June 10, 1987