Melody Bussey
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Melody Bussey in Special Situation Investing News,

No Swimming in these Waters Warns the IRS

Just when you thought it was safe to go back into the water m’pretties, the U.S. tax authority surfaces, once again, to put the kibosh on organizations who are trying to spin off real estate and unlock more value for their companies. Splitting their assets from mainstream operations isn’t anything new, but the prevalence of the practice, in particularly across many of the larger companies, has the IRS worried that they aren’t getting their fair share.

The IRS argues that corporations who are engaging in spin offs of this type are only attempting to disguise their dividends and other taxable operations so that they can avoid paying taxes. With this the IRS has declared that they will no longer give preapproval for these types of deals until they investigate further.

 This declaration doesn’t sit well with many companies who were, and are, in the middle of plans to spin off. One case in point is the Darden Restaurant chain (Olive Garden, Long Horn Steakhouse, Bahama Breeze, Seasons 52, The Capital Grille, Eddie V's, Yard House). Rumor has it that Macy’s and McDonald’s are putting their spin off notions on hold for the foreseeable future while they watch to see how much the waters are going to churn. With shareholders clamoring for the spin off, and the IRS putting on the brakes, no one is satisfied, least of all the companies involved.

Yahoo Inc., is another company that is upset with the new decision by the IRS. Yahoo doesn't own Alibaba, just shares in the company that it wants to monetize without having to pay tax on the gains. That's why they want to spin them off. The IRS turned down Yahoo’s request to proceed, which didn’t leave Yahoo with many options. Proponents at Yahoo have suggested that they might have a small business unit that would have up to 100 employees, with a projected $50 million in gross earnings. They could still move forward, but who wants to swim in those waters?

Many companies have decided to spin off REITs because the land and buildings will be valued at a higher rate than they otherwise would have been if included in the assets of the parent company. According to FactSet most activist investors support this practice, and more than 21 campaigns have been launched over the last couple of years, which is more than double the campaigns that have taken place in the last five years. Part of this is the lowered interest rates, but it’s also because activist investors know that REITs pay their income in dividends (almost like debt investments…but a higher yield) which beats bonds at almost every stage of the game.

The IRS released a statement saying that part of its concern is that the businesses who are engaging in the spinoffs are too small in comparison to the size of the actual real estate holding. The ruling, as it stands now, requires the spinoff to include an active trade or viable business in place. What’s been happening, however, is that many of the REITs have simply been charging and paying rent for the real estate, which doesn’t qualify, according to the IRS. 

Unfortunately, the resolution isn’t on the horizon, nor does the IRS seem to feel pressed to make a ruling on its ‘concerns’ anytime soon. Amid all of the controversy earlier in the year, and the ongoing issues with its restructuring and tax debacle, spin-off woes are the least of its priorities, spelling bad news for investors who had hoped to profit from this type of special situation.