1
...if the IRS characterizes the infrastructure assets as real estate.”
institutional investors from receiving
“unrelated business taxable income”
from the operation or leveraging of
real estate.
To use REITs to invest in infrastructure,
the infrastructure assets must be
characterized as real estate under the
IRC. As the REIT market has developed
over time, the IRS has concluded that
certain infrastructure assets—from
railroad tracks to broadcasting and cell
phone towers—may constitute real
property, thereby constituting good
REIT assets. Good REIT income will also
be created if the revenue streams from
such assets are allocated and structured
properly—often a challenging task
involving an analysis of both the assets
held and the income derived from
those assets.
The IRS recently concluded that both
an electricity transmission and distribution system and the rental payments
from the lease of such a system were
“REIT-able.” The IRS distinguished the
transmission and distribution aspects of
the system from the generation of the
electricity. Similar to railroad tracks, the
transmission and distribution assets are
passive conduits of a commodity
created elsewhere. The IRS concluded
that the underlying asset is real estate
that is producing rental income and not
operating income from a trade or
business. This rationale appears to apply
equally to the transmission and distribution of water, oil, gas, and new
sources of clean energy.
When applied to infrastructure, the
distinction between rental income and
operating income is reminiscent of the
early days of structuring operating leases
to facilitate REIT investments in hotels.
To avoid characterization as ordinary
income from an operating business, the
real estate was leased by the REIT to a
taxable REIT subsidiary so as to separate
the revenue stream and value of the
real estate from the revenues derived
from the operation of the hotel and its
other revenue generating enterprises.
Thus, in evaluating infrastructure assets,
if the IRS finds that they constitute
“good” real property but generate “bad”
REIT income, arrangements similar to
those employed in the hotel context
show great promise for allowing certain
private infrastructure investors to realize
returns in a tax-efficient manner.
that are related to the lease, ownership,
or use of toll roads, toll bridges, and other
physical infrastructure, sending shivers
through the cross-border real estate
industry by suggesting that such rights
may properly be characterized as USRPIs.
Accordingly, allocating value among
multiple components of a transaction can
be of great consequence. For example, is
more than half the value in an electric
company attributable to the generation
of electricity (an operating business)
or the transmission of electricity (a real
estate asset)?
While these results can sometimes be
mitigated through structuring, classifying
infrastructure assets as USRPIs is not a
positive development for attracting non-U.S. capital.
FIRP TA (Real Estate Taketh Away . . .)
Unfortunately, characterizing infrastructure assets as real property may be
detrimental to non-U. S. investors subject
to substantial federal withholding tax
under the FIRPTA rules. Under these rules,
withholding tax applies to distributions
The Bottom Line
to non-U.S. investors on proceeds from
REITs can be an effective tool to bridge
the sale of “U.S. real property interests”
the infrastructure gap, but only if the IRS
(USRPIs) and from the sale of interests
characterizes the infrastructure assets as
in or liquidation of a “U.S. real property
real estate. But even if so characterized,
holding corporation,” which is an entity
FIRP TA presents a formidable challenge to
with greater than 50% of its value
attracting non-U.S. capital. Determining
attributable to USRPIs.
whether real estate is the right label
The FIRPTA withholding tax analysis
for certain infrastructure assets and
hinges upon whether an asset, or a
revenue streams is the key to successfully
majority in value of the assets of a
marrying capital with infrastructure
company, constitutes a USRPI under
investment opportunity, and is likely to
the IRC. In the case of single companies
play a large role in privately capitalizing
with multiple assets, only some of
U.S. infrastructure.
which may be real estate, classification
is critical to analyzing and structuring
the transaction.
Current trends suggest an expansive
view by the IRS as to what constitutes
an interest in real property for these
purposes. In October 2008, the IRS issued
a request for comments regarding the
status of certain permits,
licenses, and other
rights granted by a
governmental entity
John M. Ferguson is a partner in the
New York office of Goodwin Procter,
and can be reached at (212)813-8827
or jferguson@goodwinprocter.com.
Mandee R. Silverman is an associate
in the New York office of Goodwin
Procter, and can be reached at
(212)813-8868 or msilverman@
goodwinprocter.com.
REsource Spring 2009
